This chart from The Economist shows that for some important market changing products the time from innovation to market penetration has become progressively shorter.

The article explains:

The upshot is that technology is spreading to emerging markets faster than it has ever done anywhere. The World Bank looked at how much time elapsed between the invention of something and its widespread adoption (defined as when 80% of countries that use a technology first report it; see chart 1). For 19th-century technologies the gap was long: 120 years for trains and open-hearth steel furnaces, 100 years for the telephone. For aviation and radio, invented in the early 20th century, the lag was 60 years. But for the PC and CAT scans the gap was around 20 years and for mobile phones just 16. In most countries, most technologies are available in some degree.

One might question whether any use of a technology in a particular country should be sufficient to put it on the map as a country in which the technology is practiced. For example, there are undoubtedly PCs and CAT scans available in Kumpala, even though the technology penetration rate of Uganda is among the lowest in the world. Uneven distribution notwithstanding, Uganda, I assume, would be a country reporting the use of PCs and CAT scans. That said, the chart is certainly plausible for those parts of the world where infrastructure permits the rapid dissemination of technology. The results should be even more striking for electronically distributed products among world-wide internet users (e.g., adoption of PDF as a document standard, mp3 as a music standard, Firefox, etc.)

One implication of more or less instant dissemination is that the arguments for longer copyright and patent periods are further weakened. The shorter the lead time from publication to full scale distribution, the more immediate the financial reward for the creator (or, more accurately, the rights holder), and the greater the total reward over the life of the exclusive right. In other words, even if the exclusivity period remained constant, more immediate and broader distribution result in increased revenues and incentives.

Technorati Tags: economics, innovation, patents

If you look at what a lawyer makes (in a particular city), that’s what an escort makes.

SFGate $4,300/hour?

While everyone else is waiting in line to check out Kristen’s MySpace page, we at the Antitrust Review keep offering wholesome nerd fare such as Paul Krugman’s 1978 Theory of Interstellar Trade. (HT: /.) The paper

extends interplanetary trade theory to an interstellar setting. It is chiefly concerned with the following question: how should interest charges on goods in transit be computed when the goods travel at close to the speed of light? This is a problem because the time taken in transit will appear less to an observer traveling with the goods than to a stationary observer. A solution is derived from economic theory, and two useless but true theorems are derived. … It should be noted that while the subject of this paper is silly, the analysis actually does make sense. This paper, then, is a serious analysis of a ridiculous subject, which is of course the opposite of what is usual in economics.

The First Fundamental Theorem of Interstellar Trade is:

When trade takes place between two planets in a common inertial frame, the interest costs on goods in transit should be calculated using time measured by clocks in the common frame, and not by clocks in the frames of trading spacecraft.

Indeed. For further elaboration I suggest that the reader turn to Alastair Reynolds Revelation Space universe and to Ken MacLeod’s Engines of Light trilogy. Frank Herbert, on the other hand, cheated his way out of the problem with FTL travel, which Krugman rightly dismisses.

That brings us to the Second Fundamental Theorem of Interstellar Trade:

If sentient beings may hold assets on two planets in the same inertial frame, competition will equalize the interest rates on the two planets.

The upshot is that interstellar trade can be viewed as long-term investments, similar to 17th Century merchant capitalism. Interestingly, Krugman remarks that:

Recent progress in the technology of space travel … raise[s] the distinct possibility that we may eventually discover or construct a world to which orthodox economic theory applies.

But what if the rate of innovation within the inertial frame makes any estimate of the value of goods in transit a wild guess? In that case, interstellar trade might not be trade in new goods but rather in antiques, a possibility that Cory Doctorow considers in his short story Craphound.

Technorati Tags: economics, SF, interstellar trade

Merger analysis works best in markets with unchanging, undifferentiated products, and costs that are affected more by scale than by changes in production methods. This is mainly because merger analysis is forward looking and the more tomorrow will look like today, the more reliable our prognosis. However (fortunately!) few markets that I have dealt with fall into this category. Katz’ and Shelanski’s excellent paper on mergers and innovation deals with the twofold effects that “innovation” has on merger analysis:

1. Innovation disrupts market definition and competitive effects prognosis; and
2. Innovation may be threatened directly by the merger.

The first effect they refer to as “innovation impact,” the second as “innovation incentives.”

Innovation impact

As long as the technology that forms the backdrop of today’s products and thus market boundaries doesn’t change much, there is a robust positive correlation between the number of rivals, the intensity of competition, and consumer welfare gains. More rivals, more intense competition, lower prices. That’s the tried and true structure-conduct-performance or concentration-competition-welfare paradigm. But what if technology changes or is about to change? Disruptive innovation:

• Severs the continuity between pre- and post-merger market definition;
• Makes pre-merger market shares both less reliable and less significant, which, in practice, suggests that new customer sales or license revenues are often more telling than share of installed base;
• Makes it much harder to identify competitors and entrants;
• Renders the SSNIP test pretty much useless, because where innovation rules, “price” (of what?) is often not a useful reflection of value.

Innovation incentives

Here, the concern is that the merger itself might change the nature, pace, and direction of innovation itself. Consider the acquisition of a small electric car maker by a traditional gasoline car manufacturer. The small company has every incentive to disrupt the market and steal share. The large company has to balance incremental profits from electric cars against potential losses from selling fewer gasoline-powered cars and, more importantly, undermining the market itself. Cannibalization can therefore be a significant disincentive to radical innovation. Redeploying the small company assets to make better car batteries and starters might thus be the more “civilized” approach to innovation. (Here are slides from my antitrust/ip course, discussing the replacement effect.)

Katz and Shelanski discuss the two traditional approaches to “innovation incentives,” that courts and agencies have taken in the past.

1. Extension of the static rivals-competition-welfare model to innovation cases, assuming that more rivals lead to more intense competition for innovation, resulting in increased consumer welfare.
2. Schumpeterian competition, with a three phase model of monopoly, creative destruction through disruptive innovation, and a subsequent race to monopoly, repeated over and over.

The authors find that there is only a weak correlation between increased concentration and less R&D, except in cases of mergers to monopoly, and a somewhat weakened connection between R&D and welfare, considering that some R&D races are wasteful. For example, spending an incremental $1 billion to beat a competitor in a paten race by one day. The incremental day is hardly worth $1 billion to society.

Efficiencies

In “innovation cases,” companies often make claims as to increased post-merger innovation. Katz and Shelanski identify the following:

1. Combination of complementary IP and R&D assets
2. Better R&D funding through risk-spreading; and
3. Higher margins, which will allow greater R&D funding.

Personally, I have never heard anyone make argument (3), for obvious reasons. As to the other claims, Katz and Shelanski find (2) unpersuasive because of cannibalization and because there is no evidence that a larger firm invests in qualitatively better R&D. In contrast (1) is plausible, provided that the parties can show that cooperative R&D is more promising than parallel, competitive R&D. In my view, (2) is not per se unpersuasive. It all depends on whether and to what extent the acquired potential for innovation competes with the buyer’s present capabilities and its valuation of its present market position going forward. A large buyer looking to displace the status quo may well be a more powerful disruptive force than a small firm, for example, because customers are more likely to adopt a radically new technology if it is backed by a blue chip corporation.

There’s more in this great paper. Download it while it’s hot!

Technorati Tags: innovation, antitrust, mergers

A while ago we discussed Radiohead’s decision to sell its new album on a “pay us what you think it’s worth” basis. Today’s NYT has a nice article on the band and the album release. With respect to the donationware pricing, Jon Pareles reports:

The band and its managers are not releasing the download’s sales figures or average price, and may never do so. “It’s our linen,” Mr. Hufford said. “We don’t want to wash it in public.” A statement from the band rejected estimates by the online survey company ComScore that during October about three-fifths of worldwide downloaders took the album free, while the rest paid an average of $6. Factoring in free downloads, ComScore said the average price per download was $2.26. But it did not specify a total number of downloads, saying only that a “significant percentage” of the 1.2 million people who visited the Radiohead Web site, inrainbows.com, in October downloaded the album. Under a typical recording contract, a band receives royalties of about 15 percent of an album’s wholesale price after expenses are recovered. Without middlemen, and with zero material costs for a download, $2.26 per album would work out to Radiohead’s advantage — not to mention the worldwide publicity.

As a general matter, the tradeoff here is one between royalty-free dissemination and obscurity. The graph shows a simultaneous release of a for-pay good (P) and a free electronic download (F), e.g., books, music, etc. Some customers substitute F for P (x%). Others buy P because they became aware of it through F (think Google, costless recommendations, etc.) (y%). As long as y% > x%, the publisher is better off. This is very likely a winning strategy for writers in the “long tail. As to music, I’m not sure, because the free download is a perfect substitute for the for pay version. Hopefully Radiohead will release its data at some point, or others will repeat the experiment.

Technorati Tags: music, radiohead, law & economics

Modern tying law is concerned with foreclosure in the tied product market, not customer exploitation in the tying product market. As a result, we require market power in the tying product market, because without market power, there’s nothing to be leveraged into the tied product market. But doesn’t the same logic suggest a requirement that the tying product market be at least 30% of the size of the tied product market? (Assuming, for convenience’s sake, that foreclosure of less than 30% is unlikely to significantly distort the competitive process.) Or put differently: If the tying market is less than 30% of the size of the tied market, then there’s no (per se) tying concern, irrespective of the defendant’s market power in the tying market. Because even if the defendant had 100% of the tying product market, and it imposed an airtight tie on its customers, it could foreclose no more than 30% of the customers in the (larger) tied product market. The chart below illustrates the concept.

In this example, A is a monopolist seller of a specialized lab tool that uses CD-ROMs. A requires its customers to buy standard CD-ROMs only from A, i.e., imposes a tie (e.g., for metering purposes). Some CD-ROM sales from B, D, and E to customer C will thus be foreclosed. But even if A has market power in the tying product market, the tie won’t make a dent in the huge, competitive market for CD-ROMs. Am I missing something?

Technorati Tags: tying, antitrust

Here is a process for determining the truth of any statement. This process greatly simplifies the law of evidence. Relevance, admissibility? How quaint!

Thanks Sean Bonner for this revelation.

Technorati Tags: The Truth

Moving cross country — in our case from the NY metro area to San Francisco — is above all time consuming. Most of the time is invested in information gathering. To be sure, the Internet is an incredible resource. We prepared for an exhausting three-day schedule of back-to-back showings using Craigslist, a mashup of Craigslist and Google Maps, our own Google Map of potential targets, a virtual pre-screening via Google Earth, crime stats from the SF Police Department (e.g., here), and the Steven Levitt filter, i.e., ignore all listings that describe the place as charming (i.e., toxic mold dump), great neighborhood (i.e., worst house on the block), happening (i.e., drunks fighting in the streets at 3 am), etc. Still, despite cross checks and a healthy amount of skepticism, the inaccuracy of the information is maddeningly frustrating. Only about 25% of the homes we saw were adequately described. If ever an industry needed to move from pictures to walkthrough movies, it’s real estate!

A couple of random observations:

• After we had left San Francisco, it occurred to us that we never even thought of checking the local newspaper listings. The Internet really owns this space. In contrast, seven years ago, when we were looking in New York, the NYT was pretty much the only game in town.
• I learned a new term from a realtor: Costco pantry. “These days, everybody does their weekly shopping at Costco, right? So the big pantries are back!”
• House hunting is a great example of how pervasive the information economy has become and that it is in no way limited to software, media, telecommunications, etc. I recall a comment from Cory Doctorow that his computer illiterate barber is part of the information economy just because someone wrote about him on eOpinions. Same thing with real estate: Any sector where information drives demand is part of the information economy.

Technorati Tags: San Francisco

Without generating by and large just results, any economic system loses its moral legitimacy in a hurry. Contracts, which are at the heart of the capitalist system, not only move goods from lesser to more highly valued uses, they are also the primary source of fairness in the marketplace. For all its real and alleged harshness, a market economy rests on consent. Consent, in addition to its economic and legal significance, has been at the heart of moral and political philosophy at least since the 17th Century. More recently, moral and political philosophers have identified contracts as justice generating procedures. As long as contracts are entered into voluntarily between competent parties, absent fraud, error, and vastly unequal bargaining power, we may plausibly presume the distributional outcome of an agreement to be fair. From a rights-based perspective, voluntary agreements among equals create obligations in an autonomy-preserving way, because no injustice is done to the willing (volenti non fit injuria). (Kant). From a consequentialist viewpoint, voluntary agreements are likely to be mutually beneficial, because otherwise at least one of the parties would have withheld its consent. (Hobbes). Both the rights-based approach (with the exception of a Nozick-style formalism) and the consequentialist approach require some measure of procedural and substantive equality for an agreement to be morally justified as fair. Against that backdrop, antitrust regulation serves two important purposes.

First, antitrust protects the the moral legitimacy of the economic system by promoting competition as a condition of contractual fairness. The ultimate subject of antitrust regulation is not individual transactions but markets, and the goal is to keep (or, more ambitiously, to make) markets competitive. Buyer competition ensures seller choice, and under conditions of meaningful seller choice, buyer—seller agreements can plausibly be presumed to be not only efficient but also fair.

Second, antitrust protects the integrity of the legal system. The operation of the legal system critically depends on its ability not to deal with certain problems. For example, the legal system refuses to decide political questions. It refuses to settle scientific or religious disputes. And it fights tooth and nail to stay out of the price setting business. In fact, when it comes to the latter, the display of humility by the judiciary is quite remarkable. Why such (self-) restraint? Because the legal system would quite literally overload and collapse if it had to deal with price setting in all but the rarest of circumstances. The legal system depends on prices being inputs, not outputs. Because the legal system is structurally coupled to the economic system through the institution of the contract, the law must insist on certain minimal conditions of justice in the economic system’s price setting mechanism. The maintenance of competitive markets through antitrust regulation is thus one the most important self-restraint-enabling interventions of the legal system in the operations of the economic system. Only as long as markets can plausibly be trusted to produce just results, can the law simply transform those results (prices) into enforceable obligations without fear of undermining its own legitimacy. The almost complete disengagement from substantive review at the transaction level requires certain procedural oversight of the market process. Antitrust performs that supervisory role.

Technorati Tags: antitrust, moral theory, proceduralism

The company behind EVE Online (which is far and away my favorite MMOG) recently hired Eyjólfur “Eyjo” Guðmundsson, a professional economist to analyze and advise on the in-game economy. In this /. interview, Guðmundsson talks about the macroeconomics of EVE and the evolution of cooperation in a low-trust environment.

Well, the whole macroeconomics of EVE are very interesting. Trying to figure out inflation, trying to figure out the monetary supply, trying to figure out the overall trade patterns … all of these macroeconomic trends are of interest and we’ll be working on those over the next few months. I also find it interesting to look at these resources, to think about how corporations and alliances are run. We can see how different corporate cultures have helped in obtaining different goods.

As to the supply and demand factors in the game:

PvP is essentially the way that resources are consumed in EVE. In order to operate a fleet, to outsmart your opponent, you need a lot of resources. In order to get these resources you get them in the most intelligent, efficient way possible. You need to get people to mine for you, you need people to make the right weapons for you, in as short a period of time in the right quantities. Specialization among the players is almost a requirement in order to get the best use out of time and resources in games. We have whole corporations in game that focus on mining and shipping, and there are individual traders who think they know what demand will be for in the near future; they do arbitrage trading all over Alliance space to the alliances and corporations.

Mining, of course, is for losers. PvP is where the action is

Technorati Tags: economics, EVE

For much of the 19th Century, legal formalism held sway both in the US and in Germany. The law was seen as a more or less autonomous, inward-looking, quasi-scientific endeavor. Normativity was ensured by a consistent internal point of view. The doctrinal ideal was coherence of each normative claim with all other parts of the system. To be sure, there were significant differences. US formalism never subscribed to quite the same rigor in its pursuit of internal non-contradiction, and it did not make (the received) Roman Law methodology the gold standard for proper syllogistic, analytical legal reasoning. Also, and maybe more importantly, the US legal elite comprised foremost of judges, whereas the German legal elite was firmly in the hand of professors. Lastly, the general philosophical climate was different. German legal philosophy was dominated by the teachings of Kant, Fichte, and Hegel, who despite their significant differences, can safely be described as non-consequentialists. (Kant, of course, made significant practical allowances for consequentialism. However, he rejected Glückseligkeitslehre as a foundation for moral theory. Similarly, consequentialist considerations play a role in Hegel’s philosophy of right. However, the source of normativity lies in a theory of recognition, not in a forward-looking balancing of benefits and burdens.) In contrast, the intellectual climate in the US was influenced much more significantly by Bentham’s and Mill’s utilitarianism.

Today, law & economics has become an indispensable part of legal scholarship in the US, whereas in Germany and other European countries (including the UK), law & economics is a rather specialized discipline situated outside the legal discourse proper. More broadly, legal scholarship in the US is dominated by an external or policy point of view, in which the law is the object of study, undertaken from an economic, sociological, psychological, etc. point of view. In contrast, most European scholarship — with the exception of legal history — proceeds from an internal point of view, that is, accepting of law’s normative constraints. E.g., in the US we would ask: “Is a strict liability rule efficient?” In Germany one would ask: “Given that we have strict liability rule for situation X, how can we explain a negligence standard for a related situation Y?” The assumption is that there must be an explanation within the legal system as it is. “Because folks exposed to Y had the better lobbyists,” is not an acceptable answer, it is irrelevant to the task of the lawyer and legal scholar. In the US, from an external point of view, that answer is perfectly fine (and more often than not correct).

Why have US and German legal scholarship (and, as a result, legal practice, as every antitrust lawyer who has dealt with both US and German courts and agencies will confirm) proceeded on such different tracks? In a recent, highly readable and thoroughly researched paper “The Transatlantic Divergence in Legal Thought: American Law and Economics vs. German Doctrinalism,” Kristoffel Grechenig and Martin Gelter argue that a pivotal moment in the history of legal thought came in the inter-war period, when legal realism destroyed the intellectual foundations of formalism in the US. Meanwhile in Germany and Austria, the Free Law School, whose program was similar to that of the early realists, never achieved the same level of success. Among the reasons for the demise of the Free Law School were:

• The thoroughly anti-consequentialist bent of German legal philosophy
• The concept of law as a pure, normative discipline (Kelsen)
• A legal elite comprised of professors (with much to lose), as opposed to judges
• Economic turmoil, hyper-inflation, and increasing political radicalism in Germany after WWI, culminating in the Machtergreifung of 1933. The Nazis immediately suspended many of the Free Law School luminaries (e.g., Hermann Kantorowicz).

To that list I would add:

• Judicial review of legislation by the Supreme Court, transforming what would otherwise have been a “great debate” in the legislature into a legal dispute between the executive and the legislative branch, e.g., during Roosevelt’s first term.
• A culture of signed, judicial opinions and dissents, which made the influence of personality on decision-making (and thus the indeterminacy of the law) immediately visible. Taft, Holmes, Brandeis, Cardozo, McReynolds, etc. were household names not only in the legal but also in the political and public discourse. Newspapers wrote op-eds about the “Four Horsemen” and the “Three Musketeers.” In contrast German opinions are issued as consensus decisions, that is, “decisions of the court,” not of individual judges. As a rhetorical device, this aggregation stresses the institutional aspect and permitted the illusion of legal determinacy to survive.

Grechenig’s and Gelter’s paper provides a detailed and convincing, comparative history of legal realism and law & economics as its foremost modern-day heir. Anyone interested in what really lies behind much of the transatlantic divide can hardly do better than download Grechning’s and Gelter’s paper, along with Brian Leiter’s account of American Legal Realism. My own views regarding a contemporary version of formalism are here.

Technorati Tags: antitrust, germany, comparative law

Jeremy Frandsen and Andrew Lock from the Renegade eBay Sellers Podcast explain how to dominate an industry through product differentiation and bundling. Beware, the sellers in this example wield crushing market power!

Technorati Tags: antitrust

Geoff Manne kicked off an interesting discussion about Radiohead’s experiment in variable (and voluntary) pricing for its new album OK Computer. The “give stuff away for free to sell the same and other stuff later” has certainly worked for other artists such as Bruce Sterling, Cory Doctorow, Peter Watts, and Ronald Jenkees to name a few, for whom, as Tim O’Reilly put it, “obscurity is a far greater threat … than piracy.” It seems that novelists have a bit of an edge in this game, because online texts, even nicely formatted ones, are incomplete substitutes for books. That can’t be said for Radioheads full-quality mp3s, which makes their experiment all the more interesting.

Technorati Tags: economics

I’ve been waiting for this for quite some time. Use restrictions (in the form of digital restraints management aka DRM, technological crippling of devices, restrictive architectures or contractual terms, etc.) diminish the value and thus raise the net price for a device. Here, Nokia is aggressively advertising the openness of its phones as a feature. “Open to anything.” I like it! (HT: BB).

Technorati Tags: antitrust, nokia

It is, I think, possible to be both a good economist and a conservative, a liberal, perhaps even, for some senses of the term, a socialist. But it is impossible, or at least very difficult, to be a good economist and an orthodox conservative, liberal, or socialist. There are simply too many political positions incorporated in each ideology that depend for their force on bad economics.

Well said.