Robert Bork and Transaction Cost Economics

Lawyer and Scientist

Economic science and antitrust doctrine go hand in hand.  Over a century ago, in Standard Oil v. United States, 221 U.S. 1 (1911), the Supreme Court famously announced that the Sherman Act bans only those agreements and other conduct that results in monopoly or the consequences of monopoly. The Court identified three (and only three) such consequences: (1) output below the competitive level; (2) prices above the competitive level; and (3) quality below the competitive level. Thus, as Justice Stevens explained for the Court in National Society of Professional Engineers v. United States, 435 U.S. 679 (1978), Standard Oil is based upon "economic conceptions," and courts applying  the decision's "Rule of Reason" must focus solely on a challenged restraint's impact upon "competitive conditions."  It is thus no surprise that advances in economic science have influenced the content of antitrust doctrine over the past century or more.  As Herbert Hovenkamp put it over two decades ago:

"One of the great myths about American antitrust policy is that courts began to adopt an 'economic approach' to antitrust problems only in the 1970s.  At most this 'revolution' in antitrust policy represented a change in economic models.  Antitrust policy has been forged by economic ideology from its inception."

See Herbert Hovenkamp, Enterprise and American Law, 268 (1991).

Of course, judges are not economists, and they lack the leisure time and expertise necessary to keep abreast of the latest developments in economic science.  At the same time, economists are generally not lawyers, with the result that many will have difficulty "translating" developments in economic science into appropriate proposed changes in antitrust doctrine.  For decades, then, economically sophisticated legal scholars have played the role of translators, bridging the divide between economists and economic science, on the one hand, and generalist judges, on the other.   Successful translators have included Robert Bork, Philip Areeda, Donald Turner, Frank Easterbrook, Herbert Hovenkamp, and Richard Posner.  

This account of the relationship between economic science and antitrust doctrine treats economic science as exogenous and legal scholars and judges as passive recipients of developments in economics.  Indeed, some legal scholars have described their contributions in exactly this way.  For instance, Robert Bork claimed that his work simply assessed and critiqued antitrust doctrine in light of what he called "conventional price theory" and "basic price theory."  See e.g. Robert H. Bork, The Antitrust Paradox, 117 (1978) (invoking "conventional price theory"); Robert H. Bork, Resale Price Maintenance and Consumer Welfare, 77 Yale L. J. 950, 952 (1968) (invoking "basic price theory").   Richard Posner also claimed that the Chicago School of Antitrust Analysis was simply a manifestation of rigorous application of "price theory" to antitrust problem, an approach that Posner characterized as "novel."  See Richard A. Posner, The Chicago School of Antitrust Analysis, 127 U. Penn. L. Rev. 925 (1979).  By characterizing their contributions as mere applications of scientific principles determined elsewhere, these and other scholars could enhance the authority and persuasiveness of their proposals.

The assumption that economic science is exogenous to the legal academy is roughly true. There is, however, one counter-example suggesting that this assumption is not entirely accurate, namely, Robert Bork's contributions to the body of economic theory known as Transaction Cost Economics.  Contrary to his modest claim that he merely applied basic price theory to antitrust problems, Bork also made original contributions to economic science.  Ironically, these contributions actually undermined certain facets of price theory, particularly price theory's account of non-standard contracts. As previously explained on this blog, basic price theory identified two and only two rationales for complete or partial vertical integration: (1) the realization of technological efficiencies or (2) the acquisition or extension of market power.  By their nature, technological efficiencies arise "within" individual firms, during production and before sale.  However, non-standard contracts (minimum rpm, exclusive territories and the like) necessarily reach beyond the boundaries of the manufacturer to control the behavior of other firms, particularly wholesalers and retailers.  As a result, price theorists naturally assumed that such agreements cannot produce efficiencies and thus inferred that they were instead efforts to acquire or preserve market power.  The result was the so-called "inhospitality tradition" of antitrust, which was particularly hostile to various forms of partial contractual integration.

Of course, even before World War II, Ronald Coase undermined price theory's account of vertical integration, demonstrating that such integration could reduce transaction costs, regardless of any technological efficiencies.  See R.H. Coase, The Nature of the Firm, 4 Economica (n.s.) 381 (1937). However, this contribution went unnoticed at the time, exhibiting no influence on economic theory itself, let alone antitrust doctrine.  Indeed, according to conventional wisdom (including the work of Coase himself), no one understood or applied Coase's insight until various economists, particularly Oliver Williamson, rediscovered and expanded upon Coase's insight, particularly by expanding the definition of transaction costs to include the risk of opportunism that can arise due to relationship specific investments.

There is no doubt that Williamson played the preeminent role in bringing attention to Coase's insight and developing the transaction cost paradigm of industrial organization.  For this work he properly earned the Nobel Prize in Economic Science.   At the same time, this essay, prepared for a conference at Yale Law School and recently published by this blogger, contends that Robert Bork, although not an economist, played a hitherto unappreciated role in rediscovering Coase's transaction cost explanation for vertical integration.

As the essay shows, in a 1966 article, Bork critiqued the conventional wisdom regarding certain forms of contractual integration, particularly: (1) vertical contractual integration between a manufacturer and its dealers and (2) horizontal contractual integration between partners in an otherwise valid joint venture.  See Robert H. Bork, The Rule of Reason and the Per Se Concept: Price Fixing and Market Division II, 75 Yale L. J. 373 (1966).  (For more on Bork's revolutionary contributions to antitrust thought, go here.)  This critique cited Coase's 1937 work for the proposition that "contractual" integration and "ownership" integration can be alternative means of achieving the same economic objectives, an assertion at odds with price theory's technological conception of the firm.  (By contrast, Lester Telser's transaction cost interpretation of minimum resale price maintenance, on which Bork also drew, did not mention Coase.) Moreover, Bork also employed transaction cost reasoning to explain how exclusive territories (both vertical and horizontal), customer restrictions and ancillary horizontal minimum price fixing could overcome various costs of relying upon unfettered atomistic markets to conduct economic activity.  In so doing, he expressly assumed the existence of post-transaction opportunism, a condition unknown to price theory, albeit not in so many words.  That is, Bork assumed that a manufacturer's or joint venture's reliance upon an unfettered market to distribute goods could result in "parasitical" behavior by some distributors, behavior that would "take advantage" of and "victimize" fellow trading partners by "appropriating" to the parasite the contributions of others.  Parties would anticipate such opportunism, he said, and respond by adopting non-standard agreements that could prevent such behavior and, for instance, ensure an optimal quantity and type of promotional expenditure. 

Bork also explained how relegating manufacturers and joint ventures to the alternative of specifying the promotional obligations of distributors would entail prohibitive information and monitoring costs, costs that price theory simply assumed away, such as a manufacturer’s cost of ascertaining the appropriate type and amount of promotion for each dealer’s locality.  Thus, Bork conducted the sort of comparative analysis of alternative contractual mechanisms that today is a hallmark of transaction cost analysis.  Indeed, Bork even went so far as to characterize vertically-imposed exclusive territories as contractual property rights that aligned the interests of manufacturers and dealers, thereby departing from price theory's assumption of fixed property rights. (For additional elaboration on the "property rights" interpretation of intrabrand restraints, go here.)


In short, despite his repeated invocation of "price theory" as the only appropriate source of economic knowledge relevant to antitrust, Bork himself rejected various price-theoretic assumptions and developed tools of transaction cost economics to offer a novel interpretation of various non-standard agreements that price theory's "inhospitality tradition" had condemned.  Instead of functioning as a passive recipient of scientific change, Bork helped initiate such change himself.  Hopefully Bork's contributions to economic science will receive the notoriety they deserve.   

Some Thoughts on the Legacy of Ronald Coase

 

Taught Us Why Firms Exist, And Much More

 

 

Earlier this week Ronald Coase passed away at 102.  Coase was the Clinton R. Musser Professor of Economics Emeritus at the University of Chicago Law School.   The University of Chicago has published an obituary here.

In 1991, Coase won the Nobel Prize in Economic Science.  The statement by the Royal Swedish Academy of Sciences that accompanied the award credited Coase with a "Breakthrough in Understanding the Institutional Structure of the Economy."   The Academy explained the "breakthrough" as follows:

"By means of a radical extension of economic micro theory, Ronald Coase succeeded in specifying principles for explaining the institutional structure of the economy, thereby also making new contributions to our understanding of the way the economy functions.  . . . .  Coase showed that traditional basic microeconomic theory was incomplete because it only included production and transport costs, whereas it neglected the costs of entering into and executing contracts and managing organizations. Such costs are commonly known as transaction costs and they account for a considerable share of the total use of resources in the economy. Thus, traditional theory had not embodied all of the restrictions which bind the allocations of economic agents. When transaction costs are taken into account, it turns out that the existence of firms, different corporate forms, variations in contract arrangements, the structure of the financial system and even fundamental features of the legal system can be given relatively simple explanations. By incorporating different types of transaction costs, Coase paved the way for a systematic analysis of institutions in the economic system and their significance." 

 

The core of Coase's contributions can be found in two articles:  The Problem of Social Cost, 3 J. Law and Economics 1 (1960) and The Nature of the Firm, 4 Economica (n.s.) 381 (1937).  Coase summarized and restated these contributions in his Nobel Lecture, The Institutional Structure of Production, 82 American Economic Review 713 (1992).

 In "The Nature of the Firm," Coase began by noting that a competitive, decentralized market economy "worked itself," without any central direction.  Despite this fact, much economic activity occurs within firms which, as Coase noted, involve a significant amount of planning.  For instance, owners do not make repeated daily or hourly bargains with employees about what tasks employees should perform, but instead simply direct them to perform this or that task.  Coase then posed the following question:

"Having regard to the fact that if production is regulated by price movements, production could be carried on without any organization [that is, without any firms] at all, well might we ask; Why is there any organization?"

When Coase posed this question in 1937, economists universally identified two, and only two, possible reasons for complete vertical integration in a decentralized market economy.  First, such integration could create technological efficiencies and thus reduce production costs.  The classic example of such technologically-induced integration was the combination of iron production and steel manufacture under single ownership.  See George J. Stigler, The Extent and Bases of Monopoly, 32 Amer. Econ. Rev. 1, 22 (1942) (referring to the "hot strip mill" as the "stock example" of "technological economies" that can result from vertical integration).  Such a combination, it was said, would avoid the cost of reheating iron ingot before transforming that ingot into steel.     Second, forward or backward integration could foreclose rivals from important  sources of inputs, thereby creating or fortifying the integrating party's market power.  See Stigler, Extent and Bases of Monopoly, 32 Amer. Econ. Rev. at 22. 

 

Coase offered a completely different explanation for vertical integration and thus the existence of firms.  According to Coase, reliance upon the decentralized market to conduct economic activity was not costless, contrary to what economists generally assumed in their static models.   See Coase, Nature of the Firm, 4 Economica at 390, n. 4 (noting that "static theory" assumes that all prices are known to everyone but that "this is clearly not true of the real world").  Instead, such reliance entailed various costs of arranging and consumating a transaction, what economists would later call "transaction costs."  See Coase, Nature of the Firm, 4 Economica at 390 ("The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism.")    According to Coase, such costs included the costs of discovering the prices of various inputs as well as the cost of negotiating with the input's owner over the terms of sale, including, for instance, wages and other terms governing contracts for labor.   By integrating vertically and thus performing an additional task itself, then, a firm could avoid such transaction costs it would otherwise incur.  When it came to individual labor, for instance, vertical integration replaced numerous discrete contracts for labor services with one overall contract, the employment contract, pursuant to which an individual employee agreed to follow the directions of the owner of the firm within certain limits, in return for a fixed wage.      


As Coase noted at the time, this explanation for vertical integration had nothing to do with market power or monopoly considerations. Nor did this explanation depend upon any reduction in technological production costs.  On the contrary, Coase's explanation completely undermined the "technological" account of vertical integration.  After all, absent transaction costs, independent economic actors can, by contract, create any technological combination of labor, capital and other inputs they collectively choose, without integrating vertically.   See Oliver E. Williamson, The Economic Institutions of Capitalism, 86-90 (1985) (explaining why technological considerations cannot explain vertical integration); Victor P. Goldberg, Production Functions and Transaction Costs, 397, in Issues in Contemporary Microeconomics & Welfare (George R. Feiwel, ed. 1985)  (explaining that technical economies cannot explain firm boundaries because, absent transaction costs, such economies can “be achieved equally well [by market contracting] if the factors of production are owned by independent individuals.”).  For instance, assume that making iron and steel in close proximity reduces production costs for the reasons explained above.  If so, then parties can, by contract, agree to locate their production facilities next door to each other, even "under the same roof," without vertical integration that combines such facilities under a single owner.   Thus, there must be some other motive, aside from a desire to operate in close proximity, that induces vertical integration in this setting.  Coase found that motive in transaction costs.  It is no understatement to say, as the Economist did yesterday, that Ronald Coase "explained why firms exist."  (See also e.g. here.)


Coase's argument about the rationale for complete integration also inspired others who were seeking explanations for partial contractual integration.  During the 1960s, for instance, Robert Bork relied upon The Nature of the Firm for the proposition that  "contract integration" and "ownership integration" were economically identical phenomena, both of which could reduce the costs of relying upon atomistic markets to distribute a manufacturer's product.   See Robert H. Bork, The Rule of Reason and the Per Se Concept: Price Fixing and Market Division, 75 Yale L. J. 383 (1966).   (Even before Bork, Lester Telser had argued that minimum resale price maintenance could encourage dealers to engage in optimal promotion of a manufacturer's product, by preventing dealers from free riding on the promotional expenditures of their fellow dealers.  See Lester G. Telser, Why Do Manufacturers Want Fair Trade?, 3 J. Law & Economics 86 (1960).  Unlike Bork, however, Telser did not cite Coase.)  For instance, Bork argued that vertically-imposed exclusive territories and exclusive territories ancillary to the formation of a joint venture could encourage promotional expenditures by dealers and joint venture partners by ensuring that each party could recapture the benefits of such expenditures.  

Subsequently other scholars, including Oliver Williamson and Benjamin Klein, would also identify transaction cost rationales for partial integration.   Such work also expanded the definition of "transaction costs" that could give rise to both partial and complete integration.  While Coase had focused on the cost of discerning prices and negotiating and memorializing agreements, costs analogous to technological production costs, these other scholars called attention to the problem of opportunism by trading partners, the risk of which constituted a cost of relying upon the market to conduct economic activity.  See generally Benjamin Klein, Transaction Cost Determinants of "Unfair" Contractual Arrangements, 70 American Economic Review 356 (1980); Benjamin Klein, Robert Crawford and Armen Alchian, Vertical Integration, Appropriable Rents and the Competitive Contracting Process, 21 J. L. & Econ. 297 (1978); Oliver E. Williamson, Markets and Hierarchies (1975).   See also Bork, Price Fixing and Market Division, 75 Yale L. J. at 382  (characterizing dealer free riding as "parasitical" conduct that "victimized" fellow venturers by "appropriating" to [the free rider] the contributions of other members of the group").   
 

Coase's 1960 work, the Problem of Social Cost, was equally revolutionary.   Before 1960, economists often asserted that market failure in the form of externalities could co-exist with perfect competition.  In 1957, for instance, future Nobel Laureate George Stigler opined that perfect competition would result in an optimal allocation of resources, unless there were positive or negative externalities which, according to Stigler, "the competitive individual ignores." See George J. Stigler, Perfect Competition, Historically Contemplated, 65 J. Pol. Econ. 1, 16-17 (1957).  More than two decades earlier, Arthur Cecil Pigou had similarly contended that externalities could persist in a world of "simple competition."  See  A.C. Pigou, The Economics of Welfare (1932).   Moreover, economists uniformly believed that some form of government intervention was necessary to correct such externalities.   Where "negative" externalities were concerned, such intervention could include so-called "Pigouvian taxes," or traditional "command and control" regulation. Where "positive externalities" were involved, such intervention could include state ownership, subsidies, and/or altering background rules so as to better specify and protect property rights.

The Problem of Social Cost debunked this universal consensus, altering how economists and others think about externalities and market failure.  In particular, Coase demonstrated that "market failure" is not an absolute or exogenous condition but instead depends upon the presence of transaction costs.  Indeed, Coase demonstrated that, in a world with no transaction costs, private parties --- what Stigler had called "the competitive individual" --- would internalize such externalities by bargaining, thereby eliminating any market failure.  (Coase also explained how some externalities do not result in market failure, given that the value of the activity producing the externality could exceed the resulting harm.  In such cases, internalizing the cost of harm via bargaining or otherwise will not alter the activity.)   This insight gave rise to what Stigler would later call the "Coase Theorem," i.e., that "under perfect competition, private and social costs will be equal."      See  George J. Stigler, The Theory of Price 133 (4th Edition 1966).

To be sure, as Coase himself recognized, transaction costs are never completely absent in the real world.  Still, such costs are often low enough that parties can negotiate to overcome a market failure that would otherwise result from an initial allocation and definition of legal entitlements.  Business format franchising provides a classic example of such bargaining.  Instead of creating and then owning franchise outlets itself, the franchisor grants licenses to independent operators, each of whom is thus entitled to operate under the franchisor's trademark.  Franchisors could stop there, allowing each franchisee to operate however he or she pleased.  In the real world, however, granting franchisees such absolute discretion in an unfettered market would result in market failure, as each individual franchisee made product design and quality decisions that would impact other members of the franchise system.  Not surprisingly, then, franchisors often include detailed provisions in contracts granting franchisees the right to operate under the franchise trademark, provisions designed to ensure optimal franchisee investments in quality.  See Paul Rubin, The Theory of the Firm and the Structure of the Franchise Contract, 21 J. Law & Economics 223 (1978).  As Coase would later explain, the legal system can facilitate such contracting by, for instance, making it easier to form contracts that overcome market failure.  See Ronald H. Coase, The Firm, the Market and the Law, 28 in Ronald H. Coase, The Firm, The Market and the Law (1988).

 

Taken together, Coase's work had obvious implications for numerous fields of legal study, including "common law" subjects such as Contract, Property and Tort, as well as statutory subjects such as Corporations and Antitrust.   For instance, Coase's assertion that the business firm is a particular type of contract inspired scholars to model corporations and other firms as a "nexus of contracts," the creation and maintenance of which the State could  facilitate by promulgating enabling corporate law consisting of mainly default rules that parties to the corporate contract could alter by satisfying formal requirements, such as shareholder vote.    See Frank H. Easterbrook and Daniel Fischel, The Economic Structure of Corporate Law (1991). 

 

Transaction cost economics also had a profound impact on antitrust law and policy.  During the 1950s and 1960s, courts articulating antitrust doctrine became increasingly hostile to various forms of complete and partial integration.  Such hostility followed naturally from the dominant economic account of the causes and consequences of such integration.  As noted earlier, economists believed that the only benefits of vertical integration were technological in nature. These supposed benefits naturally arose "within" the firm, as part of the process of production.  Thus, when economists, or, for that matter, antitrust courts or enforcement agencies, could not identify any efficiency purposes for such integration, they naturally inferred that the conduct was an anticompetitive effort  to obtain or protect market power.  Hostility toward partial contractual integration such as minimum and maximum resale price maintenance, tying, exclusive dealing, exclusive territories and exclusive supply contracts was particularly intense.  After all, such agreements reached beyond the firm, controlling the activities of trading partners before a firm took title to inputs or after a firm relinquished title by selling a finished product.  As a result, there were simply no apparent efficiency purposes of such agreements, which reduced rivalry of one form or another and thus reduced competition without any offsetting benefits.   The result was the so-called "inhospitality tradition" of antitrust law, pursuant to which the Supreme Court condemned vertical mergers in unconcentrated markets under Section 7 of the Clayton Act as well as  various forms of partial integration as unlawful per se or nearly so under Section 1 of the Sherman Act.


However, the work of Bork, Telser, Williamson, Klein and others completely undermined the economic premises of the inhospitality tradition, by explaining how complete and partial integration were often voluntary methods of overcoming market failures and thus producing non-technological efficiencies. See Oliver E. Williamson, The Economic Institutions of Capitalism, 28 (1985) (articulating rebuttable presumption that partial and complete integration has transaction cost origins).  See also here, explaining Bork's contributions in this regard.  Thus, beginning with Continental T.V. v. GTE Sylvania, 433 U.S. 36 (1977), the Supreme Court has repudiated or narrowed  several per se rules announced during the inhospitality era.  At the same time, the antitrust enforcement agencies have reversed their previous hostility to vertical mergers, and lower courts have uniformly adopted a more friendly stance to such transactions. Society's economic welfare has increased significantly as a result, thanks in large part to Ronald Coase.  Society is richer, literally, as a result.

 

Happy Birthday, Ronald Coase

102 Years Young

This Blogger wishes Ronald Coase, Professor Emeritus at the University of Chicago Law School, a happy birthday.  Born in 1910, Coase is 102 years old today.  As many readers know, Coase received the Nobel Prize in Economic Sciences in 1991.  Here is an excerpt from the Royal Swedish Academy's Press Release announcing the award:

"Coase showed that traditional basic microeconomic theory was incomplete because it only included production and transport costs, whereas it neglected the costs of entering into and executing contracts and managing organizations.  Such costs are commonly known as transaction costs and they account for a considerable share of the total use of resources in the economy.  Thus, traditional theory had not embodied all of the restrictions which bind the allocations of economic agents.  When transaction costs are taken into account, it turns out that the existence of firms, different corporate forms, variations in contract arrangements, the structure of the financial system and even fundamental features of the legal system can be given relatively simple explanations.  By incorporating different types of transaction costs, Coase paved the way for a systematic analysis of institutions in the economic system and their significance."

Coase’s work is the foundation of what modern scholars call “Transaction Cost Economics “ (“TCE” for short).  Coase began that work in 1937, with his now famous article “The Nature of the Firm.” As explained in a previous post, TCE eventually revolutionized antitrust law and policy, by altering how economists viewed both complete vertical integration and partial contractual integration via non-standard contracts such as exclusive dealing, minimum resale price maintenance, exclusive territories,  location clauses and tying agreements.  When Coase published "The Nature of the Firm," economists identified two, and only two, possible reasons for complete vertical integration.  First, such integration could create technological efficiencies and thus reduce production costs.  Second, integration could foreclose rivals from important  sources of inputs, thereby creating or fortifying the integrating party's market power.  Thus, when economists, or, for that matter, antitrust courts or enforcement agencies, could not identify any efficiency purposes for such integration, they naturally inferred that the conduct was anticompetitive.  The result was the so-called "inhospitality tradition" of antitrust law.

Coase's work and the resulting transaction cost revolution completely undermined these accounts of complete and partial integration.  According to Coase, reliance upon an unfettered market to conduct economic activity entailed various costs, what he dubbed "transaction costs."  By integrating vertically, then, a firm could avoid such transaction costs.  As Coase noted at the time, this explanation had nothing to do with market power or monopoly considerations.  Nor did this explanation depend upon any reduction in technological production costs.

Unfortunately Coase's work lay dormant for three decades, during which time antitrust courts and the enforcement agencies became increasingly hostile to complete and partial vertical integration.  During the mid-1960s, economists and others began to rediscover Coase's 1937 work, perhaps inspired to do so by Coase's "Problem of Social Cost," published in 1960.  Most famously, Oliver Williamson began to rearticulate and expand upon Coase's transaction cost thesis.  In particular, Williamson identified specific investments and the resulting threat of opportunism as an important source of transaction costs.  Moreover, during the same decade, Robert Bork cited Coase's Nature of the Firm in his 1966 work on the Sherman Act's treatment of non-standard contracts.  In particular, Bork explained why various forms of partial integration could align the interests and incentives of the contracting parties, thereby accomplishing the same economic objectives through partial integration that economic actors might otherwise achieve via complete vertical integration.  Most famously, building on the work of Lester Telser (who had not cited Coase), Bork argued that minimum resale price maintenance and non-price restraints such as exclusive territories and location clauses could ensure that independent dealers made optimal investments in promotional effort, thereby facilitating a manufacturer's strategy of relying upon a system of independent dealers to distribute the manufacturer's product.  As previously explained on this blog, this work, along with additional work by Bork and others, convinced the Supreme Court to repudiate numerous decisions from the inhospitality era.

Is The NCAA an Illegal Cartel?

Greedy Cartelist?

June 6, 2021 Update:

Earlier today I posted on this blog a forthcoming paper entitled: Requiem for a Lightweight: How NCAA Continues to Distort Antitrust Doctrine, 56 Wake Forest L. Rev. _____ (2021) (forthcoming).  (See here).  The paper critiques several aspects of the Supreme Court's decision in NCAA v. Board of Regents of the University of Oklahoma, 468 U.S 84 (1984), including the Court's decision to exempt all restraints imposed by sports leagues from per se condemnation as well as dicta suggesting that courts should subject some restraints that avoid per se condemnation to a "Quick Look" version of Rule of Reason.  The paper also endorses NCAA's dicta to the effect that horizontal restrictions on rivalry for the services of student-athletes can produce redeeming virtues, with the result that such restraints should survive per se condemnation.  The paper calls on the Supreme Court to correct these and other errors in NCAA v. Alston and thus ensure a more coherent jurisprudence under Section 1 of the Sherman Act that better reflects the teachings of modern economic theory.

An Op-Ed in Sunday's New York Times entitled "The College Sports Cartel," Joe Nocera decries the fact that NCAA student athletes cannot receive more than a full scholarship, room and board, and stipend to cover living expenses.   As the author notes, NCAA rules --- the product of an agreement between competing member schools --- forbid schools to pay student-athletes a salary analogous to what, say, a minor league baseball team would pay its players.  (Put another way, NCAA rules require student-athletes to remain amateurs.)  The author characterizes this agreement as "collusion" of the sort ordinarily forbidden by the antitrust laws, collusion that enriches member schools at the expense of purportedly "shackled" student athletes.   He ends by opining that "[I]t certainly would be worthwhile to see someone challenge [the NCAA's] cartel behavior in court."

And yet, as Nocera himself perceptively admits: "Sports leagues can’t exist without at least some [so-called] collusion."   A classic example, of course, the agreement between a league's members on the number of games in a season.  Thus, the NBA's decision that each team will play "only" 82 games in the regular season is a horizontal agreement on the output of games, a limitation that could be unlawful in other circumstances.  Ditto for members' agreement on the length of the playoffs, including how many games are in the finals.  (Imagine if Ford, GM and Chrysler announced they were agreeing on the number of pickup trucks they would produce in the coming year.)  Indeed, calling such agreements between members of the NBA "collusion" would deprive the word of any useful descriptive value in this context, as the term would become a synonym of "contract" or "cooperation."

Sports leagues are not unique in this sense.  All sorts of welfare-increasing economic activity is the result of agreements between rivals, agreements that economists and antitrust courts call "horizontal."  For instance, the formation of a partnership is a horizontal agreement that eliminates rivalry between the new partners.  Such partnerships often include explicit agreements between the partners not to "moonlight" and thus compete with the partnership.    Ditto for franchising, which many economists properly conceptualize as an agreement between actual or potential rivals (think of the numerous independent McDonalds franchisees in a medium-sized town).  Such agreements set product standards, decide what products members of the chain will offer, what ingredients each product will contain, etc.  Without such (horizontal) agreements, what consumers currently experience as a well-run franchise system would rapidly devolve into a loose confederation of business establishments that, while operating under the same trademark, would offer varying products and varying degrees of quality, sowing confusion in the mind of consumers and defeating the purpose of operating under a single trademark.  Thus, while such agreements reduce rivalry in some sense between members of a franchise system, they can ultimately enhance the quality of the products offered by a particular franchise system and thus further useful competition with other such systems, to the ultimate benefit of consumers and the rest of society. 

In short, like many productive ventures, the NCAA and other sports leagues entail cooperation between rivals, cooperation that could be problematic in other contexts when viewed in isolation.  The key question from the perspective of the antitrust laws is whether the cooperation in question, while nominally reducing competition between rivals, might in fact overcome a market failure and thus increase the welfare of society by inducing a more efficient allocation of resources.  That, in short, is the focus of antitrust's "Rule of Reason, " announced in Standard Oil v. United States.  (See this article for a more in depth explanation of the connection between market failure and Rule of Reason analysis.)

While litigation against the NCAA on this question might enrich antitrust lawyers, the Supreme Court has already explained how it would rule in such a case.  Twenty-five years ago, in NCAA v. Bd. of Regents of the University of Oklahoma, the Court evaluated NCAA rules limiting the number of games that networks could broadcast on television during any given season.  The rules also limited the number of times that any particular school could appear on television.  The Court condemned the rules under the Rule of Reason because they reduced output without any offsetting benefits.

In so doing, however, the Court expressly approved other horizontal restraints imposed by the NCAA, including those fostering amateurism by the players.  The Court's language (previously discussed on this blog) is worth quoting in full:

"What the NCAA and its member institutions market in this case is competition itself -- contests between competing institutions. . . . . [T]he NCAA seeks to market a particular brand of football -- college football. The identification of this 'product' with an academic tradition differentiates college football from and makes it more popular than professional sports to which it might otherwise be comparable, such as, for example, minor league baseball. In order to preserve the character and quality of the "product," athletes must not be paid, must be required to attend class, and the like. And the integrity of the 'product' cannot be preserved except by mutual agreement; if an institution adopted such restrictions unilaterally, its effectiveness as a competitor on the playing field might soon be destroyed. Thus, the NCAA plays a vital role in enabling college football to preserve its character, and as a result enables a product to be marketed which might otherwise be unavailable. In performing this role, its actions widen consumer choice -- not only the choices available to sports fans but also those available to athletes -- and hence can be viewed as procompetitive."

The Court then noted (as suggested above) that "a restraint in a limited aspect of a market may actually enhance market-wide competition."

Simply put, the Court concluded that unbridled competition between member schools for players, thereby allowing schools to pay players a salary, would result in a market failure.  That is to say, no individual school would, when setting players' compensation, take into account the impact of that decision on the overall "brand" or "image" of the product being offered.  While players might benefit in the short run, the "brand appeal" of college football would suffer over the longer run, as what was once amateur athletics associated with an academic tradition (and thus a natural fan base) would degenerate into a professional league inferior to the NFL and without a natural fan base.

The result may seem to countenance an unfair distribution of the benefits produced by NCAA football.  Certainly some schools earn millions each year due to the performance of their student athletes.  (At the same time, however, many others lose money on the sport, and no one is proposing that student athletes share in these loses.)  However, antitrust law does not exist to ensure a fair division of the gains from economic activity but instead only bans those agreements or unilateral practices that reduce economic welfare.