Is the Free Market Broken? Hardly.

Wants to Fix What's Not Broken

Senator Elizabeth Warren (pictured above) has convinced herself that the free market is "broken," thereby justifying intrusive and coercive regulation to fix market outcomes.  According to this article, the Senator has offered three examples of such disrepair: (1) student debt (apparently including both the amount of debt and the interest rates that students pay), (2) wages that are in some cases lower than necessary to support a family, large or small and (3) insufficient financial regulation.  She would have the national government repair the market by, for instance, coercively raising the minimum wage and lowering student loan interest rates to the rate that the Federal Reserve charges individual banks.   (See here and here)  This rate, the so-called "discount rate," is less than one percent. (See here).     Senator Warren's indictment of the free market does not withstand scrutiny and reflects confusion about the proper objectives of this critical social institution.  As will be seen, it will be useful to compare her views regarding the appropriate objectives of the market with those of Frank Knight, one of the most influential and thoughtful economists of the 20th Century. 

1. What Americans call "the market" is a social institution that depends upon various background legal rules, particularly private property, free contract and legal prohibitions on fraud and duress. Frank Knight ably described the free market system as follows:

"Ours is a system of 'private property,' 'free competition,' and 'contract.'  This means that every productive resource or agent, including labor power, typically 'belongs' to some person who is free within the legal conditions of marketing, to get what he can out of its use."

See Frank H. Knight, The Economic Organization, 11 (1951).

2. Any critique of a social institution must begin by identifying a plausible set of objectives society expects the institution to achieve. For instance, while society can (and should) expect its system of education to produce a literate populace, it cannot expect that system to produce a safe and abundant food supply.  Thus, while proof that many high school graduates cannot read or write would indict the educational system, proof that many people go hungry would not.

3. In the same way, any critique of the free market must begin by specifying the objectives that society legitimately expects the market to achieve.  Does society expect the market to defend the nation from foreign attack?  Eliminate cruelty to animals?  Prevent the spread of infectious disease? If the answer to any of these questions is "yes," the market is "broken," and coercive regulatory intervention is appropriate.  But of course, no rational society would expect the free market as such (as opposed to other social institutions), to achieve any of these objectives.  

4. What, then, can society properly ask of free markets? Frank Knight would have answered the question as follows: society should expect markets to allocate resources (including labor) and organize production efficiently so as to maximize the amount of "want satisfaction" that consumers derive from society's given endowment of resources and know how.  See generally Knight, The Economic Organization, at 9-10.   A secondary but related objective involves assuring what Knight calls "economic maintenance and progress."  See id. at 12-14.  In particular, a well-functioning market will ensure optimal allocation of resources toward capital investment (including investments in human capital) and technological progress.   In the medium and longer run, such investments can enhance the nation's overall productivity and thus its ability to produce goods and services that provide want satisfaction. 

5.  Of course, free markets sometimes fail to maximize such want satisfaction and/or ensure optimal capital investment and technological progress.  For instance, transaction costs can prevent voluntary private bargains from allocating resources to their highest valued use.  The classic example involves an activity that imposes costs --- what economists call "negative externalities" --- on individuals who are not parties to a given transaction.  The result can be be overproduction by the industry in question and thus overuse of resources that would produce more social value elsewhere.  Even the most dedicated adherents to laissez faire have long recognized that governments should intervene to correct such market failures and that such intervention should include, if necessary, coercive restrictions on output.  Moreover, high transaction costs can also result in positive externalities.  For instance, bargaining and information costs may prevent individuals contemplating investments in technological innovation from identifying and securing remuneration from other individuals who might reap the benefits of such investments.  Here again, some coercive intervention in the market, such as the creation of patent rights, might be necessary to ensure adequate investment in the creation of new technology and thus optimal increases in national productivity.

6.  None of Senator Warren's examples qualifies as a manifestation of market failure that somehow suggests that the free market is "broken" and thus ripe for coercive interference.  Take the minimum wage first.  Labor is an input in the production of goods and services, and firms purchase this input in the market, in the same way they purchase other inputs such as steel, electricity or bread.  The wage is simply the price for labor, a price determined by conditions of supply and demand.

It is certainly true that free market determination of the price of labor sometimes results in wages insufficient to support an average-size family.  In the same way, prices for other inputs may be insufficient to guarantee any profit whatsoever to the owners of firms that produce such inputs.  A company that makes and sells high quality steel to automobile companies will earn negative profits and fail if automobile companies forgo steel for aluminum, for instance.  In such cases, the wages of some steel workers will fall to zero as steel companies cease to employ them.  To be sure, one can imagine situations in which such low wages reflect a market failure resulting from an employer's status as the dominant purchaser of labor in a particular market. However, the Senator's proposal to raise the minimum wage would apply to all employment relationships, including those in markets that are competitive, as most labor markets are. Far from exemplifying a broken market, wages in competitive markets reflect a well-functioning economic system at work performing its social function of allocating resources to their most efficient use. Society may in some cases view the resulting wages as unjust, either because they are too high or too low,  Indeed, employers may pay wages as low as the market will bear so as to increase their own share of the fruits of productive activity. However, coercive regulation setting different wages than those set by the market will undermine the market's chief virtue, namely, encouraging the economic actors to organize and allocate productive resources, including labor, in the most useful way possible. Here again Frank Knight is persuasive:

"It is assumed . . . that there is in some effective sense a real positive connection between the productive contribution made by any productive agent and the remuneration which its 'owner' can secure for its use.  Hence, this remuneration (a distributive share) and the wish to make it as large as possible, constitute the chief reliance of society for an incentive to place the agency into use in the general productive system in such a way as to make it as productive as possible.  The strongest argument in favor of such a system as ours is the contention that this direct, selfish motive is the only dependable method, or at least the best method, for guaranteeing that productive forces will be organized and worked efficiently."

See Knight, Economic Organization, at 11-12.

Ironically, then, Senator Warren's proposed "fix," state-determined wages, would itself injure the market and reduce the amount of wealth this critical social institution generates.

None of this is to say that society must stand idly by while some hardworking citizens earn only poverty wages.  On the contrary, there is one obvious method for alleviating such poverty, viz., the earned income tax credit, previously discussed on this blog.  By subsidizing wages, the EITC both makes hard work pay off and avoids the job-destroying impact of the minimum wage. It is thus no surprise that thoughtful experts such as Christina Romer, who once chaired President Obama's Council of Economic Advisors, have advocated the measure as an alternative to the minimum wage. This blogger has previously called on Congress to expand the availability of the EITC.

Of course, governments must find resources to pay for this subsidy. During a recession, governments that embrace the Keynesian economic paradigm can borrow unused private savings and spend the proceeds on a more robust EITC.   If the economy is near full employment, however, such a "borrow and spend" approach can be inflationary, with the result that governments should find the revenues for wage subsidies by cutting spending elsewhere and/or raising taxes.  One obvious source of such funds would be a tax on carbon  emissions.  As previously explained on this blog, such a tax would discourage pollution creating activity while generate revenue.  In this way society can have the best of both worlds:  a free market that generates as much wealth as possible and spending policies that reward work and alleviate poverty.
   
7.  What about the current system of students loans and resulting student debt and interest payments? Here again, the current system on financing higher education, including the student loan system, is not evidence that the marker is "broken." To be sure, a purely private market will produce insufficient investments in human capital, including higher education.  As previously explained on this blog:

 “The background legal framework prevents individuals who invest in education from granting creditors a security interest in their most valuable asset, namely, the human capital that a college education creates.  A creditor cannot “foreclose” on an individual’s college degree if the borrower defaults on a student loan.”

Moreover, as the same post also explained, state and federal income taxes, which combined produce top marginal rates of nearly 50 percent in some states (and more than 50 percent in California), prevent individuals from internalizing the full benefits of such investments.  As a result, individuals will generally under invest in human capital, even if lenders can perfectly assess the ability of such borrowers to repay and assure repayment when borrowers are able.  The state can respond to this under-investment in various ways, including by founding public universities that charge tuition that is far lower than the cost of the education provided, as every state does. (States could also, of course, provide college-age students with vouchers that students could spend at any qualifying institution, public or private.)  At the University of Virginia, for instance, full tuition covers just 52 percent of the cost of educating an in-state undergraduate student,    Indeed, some private and public universities do not charge tuition, fees or room and board to students from low income families. Some of these same schools provide significant discounts to middle class students as well.  To be sure, a significant proportion (far less than half) of America's students emerge from college with some debt; the average amount equals the cost of a new minivan.  To be sure, a subset of this subset of students graduates with significantly more debt than the average.  However, given the availability of below-cost public education and need-based financial aid, it stands to reason that some (though not all) students who emerge from college with larger than average debt loads voluntarily chose to attend relatively expensive universities in lieu of more modestly-priced options.  It's not clear why such voluntary decisions are evidence of market failure that calls for intervention by the national government.

As previously explained on this blog, government subsidized student loans can also be part of the response to the sort of market failure that results in under-investment in human capital.  Such loans, already provided at below-market rates, further subsidize investments in human capital.  Indeed, under recent reforms, many student loan payments are capped at a percentage of the debtor's income, still further reducing the actual cost of borrowing.  Some borrowers are even eligible for complete loan forgiveness if such capped payments do not suffice to pay off the loan over 20 years.

So far as this blogger is aware, Senator Warren has not explained why the one-two-three punch of (1) below-cost tuition at the nation's public universities, (2) below market interest rates and (3) income-based repayment and possible forgiveness does not suffice to counteract the unfettered market's admitted tendency to produce insufficient investments in human capital.  The existence of a market failure does not justify the adoption of every conceivable policy response to that failure.  Her own proposal --- interest rates of less than one percent for long term student loans already subject to repayment caps and possible forgiveness --- could, when combined with numerous other subsidies for such investments, result in the allocation of too much scarce capital to investments in human capital, further increasing demand for higher education and exacerbating increases in tuition.  Here again, Senator Warren has not made the case that the market, supplemented by public universities and the current system of student loans, is in need of further repair.

8.  What, though, about financial markets?  Surely insufficient federal regulation resulted in the financial crisis and resulting recession in 2008, thereby establishing that the free market is "broken" and in need of additional intrusive regulation,  Here again the Senator has not made her case.  After all, the financial system extant in 2008 hardly exemplified the free market in action. Instead, the national government had intervened in financial markets in various ways that predictably caused market failure and distorted market outcomes.  For instance, the nation's policy of "too big to fail" resulted in dangerous moral hazard, as large banks did not internalize the potential downside of risky investments.  Banks quite predictably made non-optimal investments as a result.  Moreover, the national government encouraged lenders to develop financial products (e.g., no money down mortgages) that extended credit to individuals that did not meet traditional lending standards.  Banks were all too happy to extend such credit, knowing that they could immediately resell many mortgages to the Federal National Mortgage Association (FNMA), which was itself deemed "too big to fail" and thus lacked adequate incentives to examine the quality of mortgages it purchased.  The FNMA, in turn, would either hold these mortgages itself or guarantee their repayment and use them as backing for so-called "mortgage backed securities" that it issued.  (See here for a description of the mechanics of the FNMA's role in the mortgage market.)  Regulators encouraged banks to hold these securities to satisfy capital reserve requirements, even in lieu of other securities.  While federal regulations required banks to hold $4 in high quality reserves (e.g., U.S government bonds) for every $100 in lending, banks could avoid this requirement by holding $1.60 in mortgage-backed securities instead, thereby signaling the national government's confidence in the FNMA's guarantee of the mortgages that backed these securities. Little wonder, then, that, according to this same source, banks held half the outstanding debt backed by sub-prime loans when the financial crisis broke out.  Simply put, the 2008 financial markets were rife with various forms of federal intervention and involvement that produced market failure, moral hazard and also set the table for the 2008 financial crisis.  That crisis hardly qualifies as evidence that the market is broken.

9.   In sum, free markets have great potential but they also have limits.  Critics must take care lest they attribute to markets objectives they cannot plausibly achieve.  To be sure, transaction costs sometimes result in market failure, including negative or positive externalities.  In such cases, society properly steps in with coercive regulation to correct such failure.  However, failure to achieve distributive justice is not a shortcoming of markets.  On the contrary, markets produce the very wealth that its opponents wish to redistribute, and society can employ taxation to redistribute income for social justice purposes.  Moreover, the presence of some market failure does not thereby justify the simultaneous adoption of every imaginable policy response.  Finally, markets sometimes "fail" because ill-considered regulation or other forms of state intervention distort private incentives and thus induce market actors to engage in wealth-reducing economic activity.  Such state-induced market failure is hardly a justification for even more coercive regulatory intervention. 

Congratulations on Tony Shaver's 500th Career Win!

Last night William and Mary defeated the Washington College Shoremen, 86-46, extending the Tribe's record for the year to 6-3.  (For the story, including box score, go here.)  The victory was a milestone for head coach Tony Shaver, who chalked up his 500th career coaching victory.  Shaver, who previously coached at Hampden-Sydney College, is enjoying his 12th season at William and Mary.  He is the Tribe's winningest coach, with 142 wins thus far.   Congratulations to Coach Shaver and the Tribe.  Keep up the good work! 

O'Bannon, the Rule of Reason, and the Less Restrictive Alternative Test

Applied Reason to College Athletics

Earlier this year, in O'Bannon et al. v. NCAA, the U.S. District Court for the Northern District of California invalidated the NCAA's policy governing compensation that colleges and universities may provide football and basketball players. (Here is a link to the decision.)  That policy allowed schools to provide players a full grant-in-aid, namely, full tuition, fees, room and board, and the cost of textbooks.  Moreover, the policy also allows schools to provide additional compensation to the neediest student athletes --- those who qualify for federal Pell grants.   

Ordinarily, agreements between rivals regarding the compensation paid to input suppliers are unlawful per se.  Ditto for agreements that govern non-price aspects of the relationship between rivals and input suppliers.  If Ford, Toyota, Honda and General Motors agreed on the salaries or working conditions provided their engineers, for instance, courts would rightly declare the arrangement a buyers' cartel and condemn it as unlawful per se under the Sherman Act.  Ditto if, say, several silicon valley firms or an academic trade association agreed not to hire or "poach" individuals employed by rivals. 

In NCAA v. Board of Regents of the University of Oklahoma, 468 U.S. 85 (1984), the Supreme Court rejected the analogy between the NCAA's policy on player compensation and the sort of buyers' cartel just described.  As explained in much greater detail here, the Court, in an opinion by Justice John Paul Stevens (pictured above), recognized that, unlike buyer cartels, the NCAA is a legitimate joint venture, the existence of which is necessary to produce a product, college football, that many consumers find attractive.  The Court also recognized that unbridled rivalry between colleges and universities for student-athletes would transform college athletics into semi-pro athletics, thereby undermining consumer demand for the joint venture product.  Thus, the Court expressly noted that, in order to protect the integrity of this product, members of the NCAA must collectively set limits on player compensation.  In so doing, the Court rejected the "cartel" label for such restraints.  (For additional discussion of the NCAA decision by this blogger, go here.) According to the Court:

"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 field of play might soon be destroyed.  Thus, the NCAA plays a vital role in enabling college football to preserve its character, and as 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."

See NCAA, 468 U.S. at 101-102 (emphasis supplied).  

More technically, the Court essentially held that unbridled competition between NCAA member schools to attract and retain student athletes would result in a market failure and reduce economic welfare, including the welfare of consumers.  Such rivalry, one suspects, could result in six figure salaries for some players at some schools, over and above a full grant-in-aid.  The prospect of such a market failure, the Court believed, distinguished the NCAA's limits on player compensation from otherwise analogous forms of collective wage setting such as the hypothetical agreements between automobile manufacturers mentioned above.  (See this essay by this blogger explaining the role of the market failure paradigm in the antitrust jurisprudence of Justice Stevens, including his opinion in NCAA.) 

The NCAA court did not hold that agreements governing student-athlete compensation are lawful per se.  Instead, such agreements are to be analyzed under Standard Oil's Rule of Reason. After conducting this analysis, the district court in O'Bannon agreed with the NCAA (and the Supreme Court) that the NCAA's limits on student-athlete compensation produce significant procompetitive benefits by, for instance, enhancing consumer demand for college football and basketball.  These benefits, the court apparently assumed, would suffice to justify the restraints.   Nonetheless, the court invalidated the limits, holding that a "less restrictive alternative" would achieve the same benefits.  In particular, the court held that increasing the limit to "cost of attendance" (which includes grant-in-aid plus transportation and supplies), plus $5,000 per year, to be derived from "licensing revenue generated from the use of their names, images, and likenesses during college[,]" would be "less restrictive of competition, while at the same time achieving the same admitted benefits as the current policy.

This blogger has joined a brief amicus curiae by fifteen antitrust scholars taking issue with the district court's application of the less restrictive alternative test.  (Here is a link to the brief.  See here for a story about the brief on CBSSPORTS.com ) The brief does not question the role that a properly-applied less restrictive alternative analysis can play in rule of reason analysis.  At the same time, the brief contends that the district court misapplied this test.

Ordinarily the less restrictive alternative test involves identification of a different type of agreement, actually existing somewhere in the marketplace, that produces the same benefits as the agreement under scrutiny.  Thus, in the context of product distribution, courts evaluating vertically-imposed exclusive territories could conceivably conclude that so-called "location clauses" are less restrictive of competition and produce the same benefits in a particular setting as exclusive territories.  Cf. Continental T.V. v. GTE Sylvania, 433 U.S. 36 (1977) (describing location clause and holding that courts should evaluate such restraints under the rule of reason).  However, the O'Bannon court did not identify any such categorically different alternative actually existing in the marketplace.  Instead,  the court simply amended somewhat (upward) the level of compensation that players can potentially receive, without questioning the need for a collectively-set limit on such compensation.

Not surprisingly, then, the brief argues that the district court improperly treated the less restrictive alternative test as a license to substitute its own judgement about appropriate compensation for the judgment of market participants who adopted policies that, according to the court's own findings, produced significant economic benefits. Thus, the district court's approach empowers judges to function as regulatory commissions, recalibrating otherwise reasonable levels of compensation.  Such quasi-regulators would displace beneficial agreements that produce significant economic benefits, simply because the judge believes that a hypothetical variant of the agreement, in this case one involving somewhat higher compensation for some players, would produce marginally greater net benefits than the agreement the parties actually adopted.  However, as Judge Frank Easterbrook --- who argued NCAA for the defendants -- once explained when applying the rule of reason in a subsequent case: "the antitrust laws do not deputize district judges as one-man regulatory agencies."   See Chicago Professional Sports Ltd. Partnership and WGN v. National Basketball Association, 95 F.3d 593, 597 (7th Cir. 1996).  Instead, courts must simply ask whether a restraint is "reasonably necessary" to produce the benefits in question.   Hopefully the Ninth Circuit will agree with Judge Easterbrook and properly apply the rule of reason that has, thanks to NCAA and Justice Stevens, been applicable to such restraints for the past three decades.

Update:

Yesterday the U.S. Supreme Court granted certiorari in NCAA v. Alston, No. 20-512.  (See the SCOTUSblog entry for the case here.)  In Alston, the Ninth Circuit invalidated the NCAA's restrictions on the education-related benefits member institutions may offer student-athletes.  The petition seeking such review contends that O'Bannon "disrupted the judicial consensus" reached in other federal courts regarding how to assess restraints adopted by sports leagues, both amateur and professional.  (See petition at 11).  The petition also contends that, in Alston, the Ninth Circuit went "far beyond O'Bannon," by holding that "virtually all NCAA rules limiting so-called 'education-related benefits' are invalid." (See petition at 4).  The Supreme Court has not yet set the schedule for briefing and oral argument, but we can expect a decision by the end of this Supreme Court term, namely, early July, 2021.  Resolution of this controversy will require the Court to revisit its previous statements, convincing to this blogger, that unbridled rivalry between NCAA members for the recruitment and retention of student athletes would result in a market failure that undermines the integrity of the product that this joint venture offers to consumers.  The prospect of such a market failure, of course, would save such restraints from per se condemnation, because of the possibility that such restraints will produce redeeming virtues.  If the Court does reiterate this conclusion, it will presumably move on to provide additional guidance regarding how to conduct a fact-intensive assessment of such restraints under the Sherman Act's Rule of Reason.

 

FDR's 1942 Thanksgiving Proclamation

Fighting for Liberty

Including the Liberty to Give Thanks

By the President of the United States of America

A Proclamation

It is a good thing to give thanks unto the Lord.  Across the uncertain ways of space and time our hearts echo those words, for  the days are with us again when, at the gathering of the harvest, we solemnly express our dependence upon Almighty God.

The final months of this year, now almost spent,   find our Republic and the Nations joined with it waging a battle on many fronts for the preservation of liberty.   In giving thanks for the greatest harvest in the history of our Nation, we who plant and reap can well resolve that in the year to come we will do all in our power to pass that milestone; for by labors in the fields we can share some part of the sacrifice with our brothers and sons who wear the uniform of the United States. 

It is fitting that we recall the reverent words of George Washington, "Almighty God, we make our earnest prayer that Thou wilt keep the United States in Thy holy Protection," and that every American in his own way lift his voice to heaven.

I recommend that all of us bear in mind this great Psalm:

"The Lord is my shepherd; I shall not want.

"He maketh me to lie down in green pastures; he leadeth me beside the still waters.

"He restoreth my soul: he leadeth me in the paths of righteousness for his name's sake.

"Yea, though I walk through the valley of the shadow of death, I will fear no evil: for thou art with me; thy rod and thy staff they comfort me,

"Thou preparest a table before me in the presence of mine enemies: though anointest my head with oil; my cup runneth over.

"Surely goodness and mercy shall follow me all the days of my life: and I will dwell in the house of the Lord forever."

Inspired with faith and courage by these words, let us turn again to the work that confronts us in this time of national emergency: in the armed services and the merchant marine; in factories and offices; on farms and in the mines; on highways, railways, and airways; in other places of public service to the Nation; and in our homes.

Now, Therefore, I, Franklin D. Roosevelt, President of the United States of America, do hereby invite the attention of the people to the joint resolution of Congress approved December 26, 1941, which designates the fourth Thursday in November of each year as Thanksgiving Day; and I request that both Thanksgiving Day, November 26, 1942, and New Years Day, January 1, 1943, be observed in prayer, publicly and privately.

* * * * * 

Americans understandably take both Thanksgiving and the liberty to give thanks, in their own way, for granted.  But in November 1942, less than a year after the Axis Powers initiated war on the United States, liberty was in peril throughout the world.  Fortunately, America and her allies, including the United Kingdom, were fighting back.  Leaders like FDR and Winston Churchill, both pictured above on the HMS Prince of Wales concluding the Atlantic Charter, understood the threat and rallied their respective Nations to victory.  As we give thanks today, let us also remember leaders such as these and the innumerable sacrifices by those who followed them in a war that preserved both Democracy and Liberty.

William and Mary and Richmond to Meet for 124th Time

Tomorrow William and Mary and Richmond will continue their gridiron rivalry.  Unlike rivalries that some believe to be contrived, the Tribe/Spider rivalry is the oldest in the South.  The teams first played in 1898, and tomorrow's game will mark the 124th time the two have met.  The two schools will thus tie the Wisconsin-Minnesota rivalry for the fourth most prolific in college football history, behind Lehigh-Lafayette (150 games), Princeton-Yale (136 games), and Harvard-Yale (131 games). Once known as the I-64 bowl, the teams now play for the Capital Cup, in recognition of the fact that both Richmond and Williamsburg have served as capitals of the Commonwealth. 

William and Mary leads the series 61-57-5.  Richmond has shut out the Tribe 23 times, and the Tribe has returned the favor 19 times. The teams have played to three zero-zero ties, and the Tribe holds the record for the most points scored in a game, 59, in 2003.  (For the source of these data, adjusted to reflect last year's result, go to this source updated in 2014.)

The rivalry's 124th game has more than historical significance.  Both CAA teams are 7-4 and rank 21 (Richmond) and 22 (William and Mary), respectively in the Sports Network Poll of FCS teams.  One observer has speculated that the winner of tomorrow's game (and only the winner), will earn a playoff spot.  Kickoff will be at 7:30 PM, and tickets are still available!  (For detailed game notes, go here.)  Those unable to attend the game in person can watch on the NBC Sports Network.  Good luck to both teams, and Go Tribe! 

Will Georgia Reject Liberty for Tesla (and Consumers)?

Protecting Economic Liberty

???????

The nation's automobile dealers are at it again, attempting to thwart basic economic freedoms in a manner that protects themselves, and their manufacturers, from fair competition.  The battleground this time is Georgia, where the state's automobile dealers' association has filed a petition seeking to bar Tesla from selling automobiles in the Peach State to willing purchasers from outlets owned by Tesla.  The petition claims that Tesla, which holds an automobile dealership license in Georgia, has violated the state's Automotive Franchising Law by selling automobiles to willing consumers from a single Tesla-owned retail store.  That law makes it unlawful for any automobile manufacturer to:

"own, operate, or control, directly or indirectly, more than a 45 percent interest in a dealer or dealership in this state[.]"

Just last week, Tesla filed a motion to dismiss the dealers' anti-liberty complaint. (See here, for a report about Tesla's filing).  Hopefully the Georgia courts will look north for guidance on how to rule on Tesla's motion.  Earlier this fall, the Supreme Judicial Court of Massachusetts struck a blow for economic liberty and the welfare of consumers, by rejected a similar petition by automobile dealers demanding coercive economic protection.  See Massachusetts State Automobile Dealers' Association et al. v. Tesla Motors, MA, Inc. and Tesla Motors, Inc.   As in Georgia, the plaintiffs, an association of automobile dealers and an individual dealer, claimed that Tesla's direct sales to willing consumers violated Massachusetts' own statute governing automotive franchising, General Law Chapter 93B, entitled: "Regulation of Business Practices Between Motor Vehicle Manufacturers, Distributors and Dealers."

Section 3 of chapter 93B prohibits what it calls "Unfair Methods of Competition and Unfair or Deceptive Acts of Practices."  Section 4 in turn defines various practices that violate Section 3. Section 4(c)(10) provides that it shall be a violation of Section 3 for:

"a manufacturer, distributor or franchiser representative to . . . own or operate, either directly or indirectly through any subsidiary, parent company or firm, a motor vehicle dealership located in the commonwealth of the same line [or]  make as any of the vehicles manufactured, assembled or distributed by the manufacturer or distributor.”

Tesla obviously manufactures automobiles, and it distributes such vehicles in Massachusetts via Tesla Motors of Massachusetts, a wholly-owned subsidiary.  Nonetheless, the Supreme Judicial Court concluded that the legislature did not mean to protect the state's dealers from competition by unrelated manufacturers.  Instead, the court said: "93B is aimed primarily at protecting motor vehicle dealers from injury caused by the unfair business practices of manufacturers and distributors with which they are associated, generally in a franchise relationship."  In other words, if a manufacturer, say Ford, relies on independent dealers to distribute its vehicles, it may not then open its own dealerships that compete with such dealers.  On the other hand, a manufacturer such as Tesla that only engages in self-distribution is perfectly free to do so, even if the resulting sales reduce the profits of established manufacturers and their dealers.  As the court put things later in the opinion:

Chapter 93B "was intended and understood only to prohibit manufacturer-owned dealerships when, unlike Tesla, the manufacturer already had an affiliated dealer or dealers in Massachusetts."

While the court couched its ultimate holding as resting upon the plaintiff's lack of standing, the opinion's rationale also suggests that Tesla's self-distribution does not violate the statute in the first place.  If so, then a party that did have standing to challenge a purported violation would nonetheless lose any challenge to Tesla's practice on the merits.

Of course, the ruling by the Supreme Judicial Court is not binding on Georgia courts interpreting their own statutes.  Moreover, the operative language of the Georgia statute is somewhat different from that of the Massachusetts statute.  Still, both statutes govern the franchising relationship between manufacturers and existing independent dealers.  Moreover, both statutes ban numerous practices that manufacturers might employ to the detriment of such independent dealers.  Read as a whole, then, neither statute seems designed to govern manufacturers that, like Tesla, have no independent dealers whatsoever.  Perhaps the Georgia courts will recognize this apparent function of the statute and reiterate the Massachusetts approach.  Failure to do so would place red-state Georgia in the embarrassing position of rejecting a form of economic liberty recognized in blue-state Massachusetts, an a potentially ironic twist given credible rankings finding that Massachusetts otherwise lags far behind Georgia when it comes to protecting basic economic freedoms.

Even if courts in both states embrace a pro-liberty position, the respective state legislatures are still perfectly free to amend their statutes so as to abridge basic economic liberty by banning self-distribution by firms like Tesla.  Indeed, less than a year ago, and as reported here, a member of the Massachusetts legislature introduced a bill intended to "clarify" Chapter 93B. The bill included the following language that would have banned Tesla's strategy of self-distribution.

"The blanket prohibition on manufacturer ownership applies notwithstanding whether a manufacturer has used independently owned or operated dealerships to distribute its vehicles."

Hopefully both legislatures will resist any temptation to alter their statutes in this way.  As previously explained on this blog, free societies respect the rights of entrepreneurs to distribute products as they see fit, so long as the method chosen does not impose inefficient harms on third parties.    Like some other manufacturers, Tesla has chosen to rely upon complete vertical integration, a practice that can reduce the transaction costs that sometimes result from reliance upon independent dealers. While such dealers can provide valuable services, some consumers choose to forgo such services and purchase directly from the manufacturer.  Proponents of legislation imposing blanket bans on such vertical integration by automobile manufacturers have offered no plausible account of how integration by modestly-sized firms such as Tesla can produce economic harm. (See here, discussing and refuting arguments in favor of such a ban.)  Thus, some commentators have properly concluded that statutes banning Tesla's self-distribution "reduce competition in [the state's] automobile market for the benefit of its auto dealers and to the detriment of its consumers."  As a result, they conclude, such statutes amount to "protectionism for auto dealers, pure and simple." Such protectionism, of course, also raises barriers to entry for firms such as Telsa, who apparently believe that self-distribution is less costly than reliance upon independent dealers.  A state anxious to maximize the liberty and welfare of its citizens will reject such coercive protectionism.