Antitrust Policy, The Chicago School Consumer Welfare Standard and The Rise of the New Brandeisians

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>> Jon Hartley: Welcome to the New Books Network.

>> Jon Hartley: This is the Capitalism and Freedom in the 21st Century podcast where we talk about economics, markets, and public policy.

I'm John Hartley, your host. Today I'm joined by Luke Froeb, who is a professor of management at the Vanderbilt University Owen School of Management. And the former chief economist at the Department of Justice Antitrust Division and former chief economist at the FTC. Luke is one of the nation's foremost experts on antitrust issues and is a leading expert in competition policy.

Welcome, Luke.

>> Luke Froeb: Yeah, thank you for having me, I'm thrilled to be here.

>> Jon Hartley: Luke, I'm curious, where did you grow up and how did you first get interested in economics? I know you did your undergrad at Stanford. Was that where you got interested in economics and where you decided that you wanted to get a PhD in economics?

 

>> Luke Froeb: Yeah, I grew up in San Diego. I actually wanted to live at home and go to UCSD, and my mom kicked me out of the house and made me go to Stanford. So it was definitely my second choice, but-

>> Jon Hartley: You grew up in La Jolla, right?

 

>> Luke Froeb: Yeah, 50 yards from the beach. I mean, I had no idea, when I grew up there, it's a middle class suburb, and it's just, you go back there now and, my Gosh.

>> Jon Hartley: It's funny, I met your parents once on a family vacation. I didn't meet you, it's just a happenstance kind of thing.

But I remember I had heard a lot about you back in 2010. And since then we've met and got to know each other a little bit, so you grew up in La Jolla.

>> Luke Froeb: Yeah.

>> Jon Hartley: And then you went to Stanford, to northern California. Is that where you first got interested in economics?

 

>> Luke Froeb: Yeah, so I wanted to be a physicist, and so I got really excited about physics. When I was in high school, I took a physics class and I thought, this is so cool. I like the idea of modeling everything and that you could understand the entire world with physics.

And I got to physics and, I mean, I got to Stanford and I started taking physics. And you have to well over a half your required courses are our math and physics. And so it didn't leave much time for much else. And I found that I was one of the smartest kids, or the kids who did the best in my high school, in my classes.

But when I got to Stanford, I was just an average physics student. And my roommate was taking econ, and he kind of explained to me what it was, I had no idea what it was. Anyway, so he showed me some of his problems, and I could do them.

And I kind of got interested with this. It was the exact same tools as physics, and I love the idea of being able to model stuff and understand stuff through models. And so I started taking econ, and I really liked it, and I got interested. At the time, I was on the left side of the political way, left side of the political spectrum.

I lived in Colombia, the social change through nonviolence co-op, and I got interested in Marxist economics. I studied really hard, I remember this one guy who's a senior at the house. I was in 10th grade and he talked me through Das Kapital. And I was taking John Gurley, who is a really good teacher, and he was a Marxist and-

 

>> Jon Hartley: That's the Stanford econ department at the time.

>> Luke Froeb: Yeah, he was in the econ department at Stanford, and he introduced me to. I think he taught the core microeconomics class, and he was a really good teacher, it was really fun. And I thought, man, this is great.

And then I took his follow on Marx's class, and I looked back, I had a copy of Das Kapital. That was the reading in the class communist manifesto and Das Kapital, and there are a couple other readings. And I look back on that, I underlined everything. I just tried really hard to understand it.

I could never understand it. And it was only about a decade later when I look back on it, I go, yeah. They don't consider incentives, they just assume that everybody's gonna work for the common good. And, my gosh, I'll tell you a funny story. When I lived in Colombia, they model the house, and they still do, I think, they run the house by consensus.

And it's really easy to decide which third world political revolutionary we're gonna lend our support to. But when it came, it was an old frat house, and there were some really nice singles and some really terrible quads. And when it came to decide every quarter, we'd decide who lived in which room, and we'd have this consensus meeting.

And you'd have people arguing that for the good of the house and for the good of the social change through non violence, that was the theme of the house. I deserve the really nice single. And I go, this can't be right. And it was kind of the first inkling that I got, the idea of kind of collectivism just doesn't hold up with individual incentives.

And people were just naked self interest in these. Who decides who gets to live in which room? But when there wasn't a cost to lending our support to third world revolutionaries, that was easy to decide. But anyways, it was kind of funny looking back on it.

>> Jon Hartley: That's fascinating.

It's funny how central planning seems to work really well. I guess in a small family where you have sort of a dictatorial sort of parent or two, central planning works quite well, strangely. But when you expand it to more people, I guess, to size of a frat house or a school or a country, things seem to go really south in terms of efficient allocations.

 

>> Luke Froeb: I like to show my students at Vanderbilt. There's a great Tyler Cowen and Alex Tabarik at George Mason run this kind of online university called marginal revolution. And they have these great series of videos, and one of them is on private property rights. And they talk about the birth of modern China, which was in Xiaogang village when these villagers got fed up with collective ownership.

And nobody's working very hard because you got all these people in the village, and if you produce an extra bushel wheat, you only get a fraction of that. And so you had people free riding, and they divided up the collective land into private property and signed everybody a parcel of land.

And they call it the household responsibility system. And output went up by a factor of six when you have the incentive aligning effects of private property. I show that to all my students, but the same thing happened. Same thing happened in Vietnam, same thing happened with the pilgrims.

When John Bradley came over on the Mayflower, they had collective land ownership, nobody was working. And then he assign private property, and we all learned the mythology of thanksgiving. The reality of thanksgiving was that it was private property that we all would be thankful for, so I make my kids watch that every thanksgiving.

And then we go around the table, what are you thankful for? And everybody says, private property.

>> Jon Hartley: That's too funny, that's too funny. So I think you decided to get a PhD in economics while you were at Stanford, and you got into the University of Wisconsin, you did your PhD there.

I'm curious, how did you first get interested in anti-trust and competition policy?

>> Luke Froeb: Yeah, so I wanted to get out of state. I mean, I could have gone to Stanford in retrospect. Anybody who's listening to this, who's going to econ grad school, go to the best school you can get a into.

And so I probably should have gone to Stanford, but I wanted to get out of California. I'd spent my whole life in California, and so I went to Wisconsin just cuz the people were so nice there when I visited. And they're really good at econometrics, and that's what I was.

I took the first year econometrics when I was at Stanford. And so I studied econometrics at Wisconsin, and I got a job down at Tulane, and that was kind of fun. But I gave a paper at the Justice Department, and I wrote my thesis when I was at Wisconsin.

I was a time series macro econometrician, but I wrote my thesis on time series of profits and concentration, which was, I don't know. It was an esoteric topic, but it was using my methodology of time series econometrics. And I gave a paper at the Justice Department, they offered me a job, and I was the data guy at justice for eight or ten years.

And then I learned at the Justice Department, I learned everything I know about anti-trust and competition economics.

>> Jon Hartley: That's fantastic. So you grew up as a staffer, you spent many years as a staffer before coming back to academia.

>> Luke Froeb: So I was about eight or ten years as an econometrician at the anti-trust division of the Department of Justice.

And then I got a job offer, I decided to go on. My late wife and I were living in Washington, DC, and we were the first white heterosexuals in our neighborhood in Northeast DC. All the white people after the 68 riots, after MLK was assassinated. All the white people left everywhere in DC, and all moved to Northwest.

And the blockbreakers were the gay men in the early 80s. And when they died of AIDS, then the white heterosexuals moved in. And so we were the first white heterosexuals on our block in Northeast DC. And there were all these kids there on our block, and we're a mile away from the best museums in the world, best free museums in the world, and none of them had ever been.

So my wife and I, every Saturday morning, we'd take all our kids in our neighborhood and take them to go see all the free stuff around. And the most fun we had was taking them to the Tank Museum in Aberdeen, Maryland. There is 100 acre big plot of land out in the midst of Maryland, and it's just filled with every tank that's ever been produced, it's wild.

Yeah, you can take your kids there, they can play on them, plan of stuff. But it was really fun to see all the old tanks.

>> Jon Hartley: Wow, yeah, it's so fascinating just how much history you can go see around DC. And it's amazing how much DC has even changed just over the decades.

It's become an extremely wealthy place, in part because of, I think, some of these defense buildups during the Reagan and the Bush era. It kinda went from being what some people would call a seedy, very dangerous kinda city to a very nice and affluent one. I'm curious, tell me, so you went back to the FTC and to become their chief economist, and you became the chief economist at the Department of Justice Antitrust Division more recently.

Tell me, what do these positions do? I guess the US is somewhat unique in that it's got two anti-trust authorities. It's got the DOJ, and the FTC, and different industries. But I'm curious, what does the chief economist do? What do these economists working at the FTC and the DOJ anti-trust division, what do they do under?

 

>> Luke Froeb: So the chief economist has remarkably little power, and part of it is just the federal end of the civil service system. You can't fire, hire, promote, reward, punish. You can't do anything to align the incentives of the individuals with the goals of whatever your goals are. And the staff, they're very suspicious of the political appointees.

And the advantage I had, at least the first time I went around, I knew most of the staffers from my time, or I knew a lot of the staffers and I was a staffer like that. I'd go over there and eat lunch. One of my best friends worked at the FTC, so I had the advantage of that.

And so we'd have these Monday morning staff meetings, and the bulk of our work was just merger work. So every merger has to file a Hart-Scott if they're big enough. Now, I think it's about 55 million. You have to file a form with the federal government called the Hart-Scott Rodino form, and it goes to both agencies and they decide whether they wanna investigate it.

If they both wanna investigate it, then they have to decide who gets to do it. And there's a little bit of a kinda historical difference. But basically, if there's a big merger and they wanna investigate it, there'll be a fight over it. Yeah, and the chief economist, so that's what I did as chief economist.

The staff economists, they're organized as functional organizations and I've actually written a paper about this. I mean, some agencies sprinkle the economists along with the attorneys in the agencies. But justice and the FTC have this functional organization, where the economists do their own work and they analyze a merger and send it up the flagpole.

The economist criteria is, hey, is this merger good or bad? And the attorneys have a different focus. Their focus is, hey, can we win this one in court? And so they're always at odds, or if they're doing their jobs, they should be at odds with each other. They should not be cooperating with each other, and it was my job at the top of the food chain.

When the recommendations came up from the economists and the recommendation came up from the attorney, it would be up to the senior staff members to go ahead and decide to duke it out. And at the staff meeting and decide, I would represent the econ point of view and the attorneys would represent the staff point of view.

And sometimes I disagreed with the staff and sometimes the lead attorneys, or not the lead attorneys, but the attorney managers, they disagreed with their staff, too. And then it would ultimately go to the chairman or to the assistant attorney general if we're over at the Justice Department. So anyway, yeah, that was my job as the chief economist.

 

>> Jon Hartley: That's absolutely fascinating. So I wanna talk about the history of antitrust for a moment. Late 19th century, early 20th century, we start with all the big trust busting era, big monopolies. Teddy Roosevelt, Sherman Act, Clayton Act, Lewis Brandy's sort of the first era of antitrust policy or any sort of concept of antitrust policy.

And this is also after the first century of seeing some meaningful amount of economic growth in sort of the 1800. You get this sort of response to very, very big firms, the so called trust, the big banks, the big oil companies, the standard oils and so forth. And then a few decades after the war in the 1970s, 1980s, we see Bork, the Chicago school, the consumer welfare standard.

Which is very dominant from that period of time in antitrust policymaking and how the judiciary approaches mergers and how the FTC and DOJ approach mergers. And now we have in the sort of late 2010s, the emergence of these so called new Brandeisians. And I'm curious, what do you think about this trajectory?

And who do you think has it right here in these sort of opposing schools of thought when it comes to antitrust policy?

>> Luke Froeb: \Well, what I've seen in my lifetime, so I got there at the tail end of. There was actually a, Reagan appointed Stanford professor, and he had a very kind of economics approach to antitrust.

When I got to the Justice Department, it was the tail end of Reagan all through Bush and the beginning of Clinton. That was my tenure there and the Reagan revolution. And so I'm kind of passing over the earliest part, but this is what I've seen, and I don't study history.

I kind of have the Joey Ramon view of history, that's not where I wanna be. So I don't care about history cuz that's not where I wanna be. Rock, rock, rock and roll high school. But, I actually don't know that much about the early history of antitrust, but I do know the history of antitrust, beginning with the tail end of the Reagan revolution.

And economists were firmly in control of antitrust policy. And the attorneys, their memos would come up, and the economist memo would come up. And they often complained that it was harder to get a merger challenge out of the Justice Department than it was to win one in court.

And that was largely right, I mean, mainly because the courts were, this is the time of Von supermarket, the way they analyze mergers. They delineate a market, and if the shares are big, they block it. If it's a four firm going down to three firm, it's a four to three, three to two or two to one merger, they're gonna challenge it.

But this is the time when they were challenging mergers that were 20 to 19 mergers. It was just nutty, there was no rationale, there's no economic rationale for it. And the basically, starting in the 68 guidelines, they tried to write down some rationale and say, hey, we're concerned with market power.

And by the time that got to the 80s, and I don't know the history of it before I got there, the economists were in charge. And we'd say, look, is this merger gonna raise price? And that was our main concern, and we would build models and build empirical models.

And kinda look at cross sectionally, if there were markets across if there's supermarkets and we see a three to two. If we compare a three firm market with a two firm market, and is the price higher in the two firm market? And that would be an empirical model of merger or we see consolidation in the industry, and there was some data that we could look at, we asked whether price went up.

But by and large, most of our work was building models. We'd model how firms compete and then we use the model to forecast or simulate the loss of competition following merger. And basically, what the major models say is that four to three, three to two, and two to one mergers are bad, and that's basically the mergers we block.

But we'd have to support that, and it would obviously depend on how sensitive demand was to price. If demand is very sensitive to price and you try to raise price, you lose a lot of quantity. Then you're making more on the stuff you sell, but you're losing a lot of sales.

And that would make the merger unprofitable. So that's the kind of stuff that, and we estimated demand and we simulated, had some built models. Then what I'm known for is building these very tractable models that are actually used by the Justice Department. They're online if you wanna try them out @competitiontoolbox.com.

But that actually allow the government to figure out, hey, how much competition is gonna be lost by merger? Now, to relate that back to your question about the new Brandeisians, that intellectual tradition is still going strong. And the Biden appointees who are trying to turn back the clock to what I consider the battle days of antitrust, the 60s, before we had this economic rationale for them.

They're running into resistance from the staff, they're getting mugged by the, they say the conservative is just a liberal who's been mugged by reality. They're getting mugged by reality. Lena Khan came in wanting to block all mergers and she's losing everything in court. And you could say, well, it's the Reagan judge or the Trump judges.

They had a lot of appointees and, but by and large, it's the development of the common law. And the common law has evolved, again, this is not my area of expertise, I'm just relying on basically my co author, this guy Greg Worden. He'd spent his whole career at the Justice Department, 40 some odd years.

He's written probably 300 articles on antitrust and written a book about the history of antitrust. And he's told me that the courts have moved and it's very hard to move it back. You can't just come in and say, yeah, we're gonna turn back. We can bring cases, but we ultimately got to win them in court.

And they're not very successful at kind of turning the law around. And that's as it should be, I mean, these are enforcement agencies. They're not there to make law, even though kind of that's probably, if you ask Chairman Khan, that's probably what she'd say she wants to do, she wouldn't say that in public, but.

 

>> Jon Hartley: So it sounds like in terms of criterion, so in this, I think, pre-Lina Khan consumer welfare era of DOJ, FTC, and then how the courts sort of thought about these things, in terms of the mergers that aren't permissible. Those are sort of horizontal mergers that are sort of three to one, two to one, four to one type arrangements.

Now, I recall there was sort of maybe a change that vertical mergers are thought of very differently. If there's maybe some sort of synergies and that they're vertical mergers being they're not competing directly against each other. Instead they're sort of at different, the two merging firms are at different points in the-

 

>> Luke Froeb: The way I would phrase it, look, is when you combine substitutes. So I'm worried that if I raise price, I'm gonna lose money to you, that's what I care about, but if I buy you, that changes my profit calculus. So I'm no longer worried that I'm gonna lose consumers to you or dollars to you, and so if I buy you, that changes my profit calculus and I'm more willing to raise price.

That exact same logic, if you use that exact same logic on a vertical merger. If you have a vertical merger between two different stages in the same vertical supply chain, they're complementary products. And if you apply that exact same logic to complementary products, then a merger would reduce price.

It's like, why do super supermarkets own their own parking lots? Well, if they didn't, each of them would try to raise price to capture a share of the shopping dollar cuz you need to consume both the grocery store and the parking lot in order to buy food. And when they compete, they raise price, and if you let them merge, then they lower price.

And so it's the exact same logic that leads us to challenge horizontal mergers, would lead us to kinda let vertical mergers go through. Now having said that, there's a little bit of complicated, the one part of the story that I didn't get was, well, what happens to rivals, non-merging rivals?

And there is this effect called raising rivals costs that complicates the vertical analysis, but the first order merger effect, in vertical, is the exact opposite of horizontal.

>> Jon Hartley: So by rivals, do you mean things like collusion and price fixing? I remember-

>> Luke Froeb: No, no. When I was at the Justice Department, we brought a vertical merger case.

And I'm not allowed to divulge the internal deliberations of the Justice Department, but given what I just said, you can probably figure out whether I thought that was a good case or not. We blocked AT&T, Time Warner, and Time Warner had content, ATA&T had distribution. They owned Direct TV, they were everywhere.

And our theory of the case, and I supported it when I was at the Justice Department, it was really fun to watch. It's the first litigated vertical merger case in over 40 years. And our theory of the case was that the merged firm, AT&T, Time Warner, would raise the price of Time Warner content to non-merging firms like Comcast, and that would be an anti-competitive effect.

And the pro-competitive effect, of course, as I said before, that when you combine complementary products, there's an incentive to lower price. And sometimes that's called the elimination of double marginalization. It's more nuanced than that, but that's the offsetting effect. And figuring out how to balance the raising rivals costs against the vertical coordination or the vertical alignment of incentives, which is pro-competitive, is very nuanced, very difficult, and those cases are a mess.

And I pity the judge that has to decide that. They do their best, but this is really nuanced kind of economics, this PhD kind of style, nuanced stuff. I built these vertical merger models and just explaining them to somebody with non-merging, if you don't have non merging rivals, they're pretty easy.

But if you have the non-merging rivals, then you need game theory. And again, I build those models. My closest colleague is a mathematician who's interested. We build these game theoretic models of competition and simulate the loss of mergers. And I just can tell you from working with these models that the simple logic of vertical merger, they're almost always good.

It's really hard to find a vertical merger where the effect on non-merging rivals offsets the benefits to consumers of the vertical coordination between the merging products.

>> Jon Hartley: Fascinating, I'm curious, I'm gonna press you a little bit on models. I'm fascinated by this topic in general, and it is a very, unlike other areas of economics, I feel like applied microeconomics, think about tax policy.

You have these sort of natural experiments where you can look at a tax change and you have a, say, a treated state that lowered tax rates and a control state that didn't. And you sort of look at the differences on various outcomes like revenues or growth or something like that.

You measure that as your treatment effect and you can do that in a lot of place. But competition is just inherently a very difficult and sort of very model-driven type of economics industrial organization. Even though we call it the new empirical industrial organization or the new empirical IO sort of revolution of the 80s and 90s, it still relies on, even though it's empirical, it still relies on a lot of model assumptions.

So I'm curious, when you think about measuring consumer welfare, this is the whole idea that you can reduce deadweight loss and increase both consumer surplus and producer surplus by making sure that we have competition, and that we don't have monopolistic firms. That's sort of the theory. But I'm curious, do you use in terms of your actual metrics and data, do you use things like, say, Hirschman indices to measure the impact on concentration in an industry?

Sometimes it's vague what your denominator is or how big is your industry. For example, you could look at something like Google or Google search. Google dominates say 90 some odd percent of the online search category. But if you were to say that the real industry that Google's in is marketing and marketing revenues or something like that, it probably is a very small share of sort of marketing industry revenues.

But I'm curious, are there other things like.

>> Luke Froeb: I gotta say something about the Google Search case. So I'm not working on this case, so I can freely opine about it, but it's got a huge problem. So first of all, they have to delineate a market narrowly enough so that they can say to a judge, this merger is gonna eliminate competition in this market.

And they've denominated, they've delineated. What they call a vertical, I mean, a general search market. So Google, Bing and Yahoo, Duck Duck Go is really tiny, but those three, and Google has probably high 80s, 90% of the general search market. And one of the things that the repudiated merger guidelines by the Biden administration says, we're concerned about market power.

And you think, okay, first of all, how would you look at market power in, how would you exercise market power in search? Well, you'd raise the price of advertising, which gets you right back to, okay, is this a market for advertising? And if they raise the price, is it a market for targeted advertising?

And so they've defined this general search model, which is very narrow. But here's the huge problem. This is with monopolization cases. So the antitrust laws, there's three parts of the antitrust laws. One is horizontal collusion. You don't rig bids, allocate customers, or agree not to compete with your rivals.

But if you do, don't use the phone cuz it's so unbelievable. Whenever we prosecute these criminal cases, people calling each other up before auctions, first thing we do is subpoena the phone records. And they always kind of put them in a prisoner's dilemma, and they always kind of fess up.

But the other part is horizontal mergers, price fixing. Those are kind of loss of horizontal competition. That's fairly easy to understand. The monopolization cases are much, much harder to understand. First of all, you've got this paradox that were only going after really successful firms. So Google is a really successful firm.

How did they get that way? They innovated more than anybody else. I mean, I remember when I was back at the FTC, Google came in, gave a presentation to us, and they talked about how they developed their search tools. And so what they do is they find something wrong with their search tool.

And the example they gave us was, when you search for Essex, it came up with porn sites. And they say, okay, something's wrong with our algorithm. And it's a very complicated problem. But they've simplified it down to when you put a query in, they put it in their own language.

And when they turn that language into a search, they have this reduced set of instructions that give you an answer in less than a half second. I mean, if they can't do that, people won't use it. And so they've got this pretty complicated system. And so when they find problem like Essex, they play around with the code and they figure out what the problem is.

And then they AB test it. So then they take a bunch of queries and they send them, they're coming to Google search and they send it to the new and upgraded Google search. And they send some to the old search and then they show a bunch of people on Amazon Turk.

You know what Amazon Turk is?

>> Jon Hartley: Yes.

>> Luke Froeb: So they have paid people who look at the two searches and say, well, this one's better or this one's not better, and they won't adopt an innovation unless if it lowers the quality of the search. And they've been doing that for 20 years.

And it's no wonder they have the best search engine in the world. And because they've been working harder on it than anybody else. And the fact that they're big, I don't know, there's so many problems with that thing. And here's the killer. But here's the killer. So if you could look at all the big monopolization cases that occur once a generation, you look at the IBM case, you look at the Microsoft case, you look at the Google case, those are all monopolization cases.

There's no relief. What are you gonna do? I mean, and what are we gonna do to Google? We say, hey, you can't have such a good search engine. You gotta give some share to somebody else, I mean. Or in Europe, they gave people a choice. They say, hey, you can't be the default engine on Android.

And so they gave consumers a choice. And what did consumers choose? They all chose Google because everybody knows it's better. So now you're the antitrust authorities. What the F, is the Justice Department gonna do if they win this case and there's no relief? And if you look ahead, reason back chapter five of my textbook, what everybody should do is look at, okay, what are we gonna do if they win this case?

Well, they don't know what they're gonna do, there's no relief. And if there is no solution, there is no problem. And that's the real problem with these cases. There was no solution in the IBM case. There was no solution in the Microsoft case, and there certainly is no solution in the Google case.

That's not gonna make everything, it's not gonna harm consumers, and maybe that's the reason they want it. If I were a conspiracy theorist, they're very clever. They get rid of this consumer welfare standards so they can break up Google and not be accused of harming consumers because we don't care about that.

I don't know.

>> Jon Hartley: So, Luke, I wanna get a little bit more into the details of how exactly we measure the impacts on consumer welfare and the types of models. I wanna push a little bit on the types of models that you're using because empirical IO, it still relies on models and some model assumptions.

Unlike, say, applied micro, where you have sort of like a treatment and control group and the treated area receives the tax cut and the control group doesn't. You can look at various outcomes like output, or you can look at things like tax revenues and so forth. In IO and antitrust sort of economics, you're relying on some sort of assumptions.

What does the demand curve look like? How do you measure the amount of consumer welfare that's gained or lost? The whole theory kind of hinges on yet that a monopolist has a demand curve that looks a certain way. An oligopolist has demand curves that look a certain way in a perfectly competitive market.

Demand curves that look in some way. You have to measure demand curves somehow and you have to measure cost curves somehow. I'm curious, do antitrust authorities, how do they measure markups when you have difficulties measuring things like marginal cost? It's not easy to attribute marginal costs. Certainly if you're working with a multinational company, things can be a little bit difficult.

How do you measure opportunity cost? Do you assume things like Carnot competition that has a big element to it? Do you things like BLP, Barry Levenson?

>> Luke Froeb: That's a great question. When you're doing model based inference, you can use the model to basically fit the model to what you can observe, which is the current data.

And typically you don't have very good data. You don't have the time or luxury to run a complete generalized demand system. You're lucky if you get an aggregate elasticity and some shares, and that's about it. But been a lot of effort on the demand side saying, okay, let's try to develop these really cool conceptual, these flexible functional forms, develop these really interesting ways to estimate them.

There just isn't time in a merger investigation to do that. And it doesn't matter the times when we've been able to get a sophisticated demand model like BLP and estimate it and then simulate the effects of the merger. It just didn't matter that much. And one of the things you also asked about was relative, just a simple functional form like the logit model, which has just two parameters.

And so you give me some prices, shares, and aggregate elasticity of demand, and I can simulate a merger. And if you tell me that these two products are closer than others, put them in a nest, and you give me some accounting data, and I can calculate price cost margins, and I can fit the model to those data.

Or if I don't have those data, I can assume a competitive interaction, write down all the first order conditions that define the Nash equilibrium. And then use those to back out the marginal, the unobserved marginal costs. So, in the first, that's called calibration, cuz it's not really estimation, but you see, calibrate the model to the shares and the prices and the elasticities, and any margins you can observe, it's maybe four or five pieces.

The shares and the prices say it's a five firm industry. So that's ten pieces of information. And then you get an elasticity, and that's another piece of information. And you can use all that information and back out the parameters of the model. And then you say, okay, well, what about if these two firms are closer substitutes than each other?

Okay, we'll put them in a nest that adds another parameter. You give me a margin, and I can back out that nest parameter.

>> Jon Hartley: Fascinating, and yet, I'm sure there's quite a little bit of art, as well as.

>> Luke Froeb: Modeling is an art, yeah. Yeah, it's a real art.

And you got to be flexible enough that one of the kind of the really cool things about consulting, I'll put a plug in for consulting to all the grad students or any grad students that are out there. When you're an academic economist, you choose the questions you answer, and you choose questions that you can answer precisely.

And so the questions that we can answer precisely are really, really narrow ones, and nobody gives a damn about them. But the ones that people care about are the, kind of the less precise. Is this merger gonna raise price? And typically, there's not enough information to run. There's no good natural experiments, either cross-sectionally or with time series data, or the data are not available, or it's in lousy condition.

And so you really have to go to a model-based counterfactual. And so you say, okay, the observed world is what I can observe in the counterfactual is the post merger world that I can observe. And once I calibrate the model to the observed world, I can use it to forecast or simulate the unobserved counterfactual, which is the post merger world.

And sometimes the counterfactuals are different. We observe the monopolized world or we observe the collusion world. And we wanna know what would have happened if these guys were competing. Well, we can calibrate a model to a collusive observed equilibrium and then back out the, then use those parameters to figure out what the equilibrium would look like if they were all competing.

And they're basically Nash equilibrium models. And we've developed these models that work for bidding, for bargaining, for price setting, for quantity setting, for advertising, with capacity constraints, you name it. I mean, that's what we do. We build models, the tractable models that we can calibrate to just a few pieces of information for all different kinds of industries.

And that's been my professional life. It's really fun, it's really interesting and it's fascinating.

>> Jon Hartley: Well, it's fascinating, this whole approach, I think, to using models to think about how competition impacts consumer welfare output. The whole idea, it all goes back to that theory about if you have a monopolist compared to the perfectly competitive case, you have less queue or less output.

And this is sort of everything in between that trying to think about how mergers impact things like output and consumer welfare. I'm curious, I wanna just ask one question here on big tech and sort of national security, which I think is a little bit different. I think a bit of a newer front in these discussions.

And it's different, I think, from just the simple lean economy approach of everything that's big is bad, or, for example, the approach of they've gone after the Microsoft acquisition of Activision Blizzard. I think the big tech national security thing is a little bit different. And I think that's one area that certainly irks some Republicans and quite a few Democrats as well, which is even though tech firms provide lots of consumer surplus, you have all these apps like Gmail and Facebook they give away for free.

There's some caveat and that they're selling your data and there's been some property rights issues there. They do sort of have a tremendous amount of political power. Twitter censored, the Hunter Biden New York Post, laptop stories or false news weeks before the 2020 election. It turns out that story was actually true.

Apple is now canceling Jon Stewart's show, apparently because it is talking negatively about the Communist Party of China. There's some argument, which is really a political argument, not an economic one, that these companies may be influenced or captured by foreign enemies. In that sense, are Google and Facebook too large and too powerful in a political sense?

Should political, national security considerations matter when it comes to antitrust regulation? Or is this really more in the domain of something like rather than, say, the Department of Justice and the FTC?

>> Luke Froeb: Yeah, I think that there are valid privacy concerns, and the tech giants are doing their best to address those privacy concerns cuz obviously the GDPR has been been.

Yeah, one thing you did not ask me about is the difference between China, the US and the EU. And, my gosh. We'll talk about that in a sec. But the GDPR has almost killed innovation in Europe, what is just amazing to me is the lack of innovation in Europe.

I mean, if you look, there's a lot of metrics that you could use. You can use the number of unicorns. There's actually a guy at Stanford, this Ilya, I forget he's got a Russian name, ST last name, but he collects data on unicorns. He'd be a great guy to interview on your show.

The number of unicorns in Europe is pitiful. I mean, they really undercooked their coverage. Or relative to the US, you look at the age of companies on, say, the CAC 40. What's the age of the top ten firms in Europe versus the top ten firms in the United States?

They're all over 100 years old in Europe. In the United States, they're 25 years old. That's the average age of the top ten firms. And I think that just goes to the dynamism of our economy and the huge advantage we have over Europe. And the question that I kind of, against that backdrop, to get back to your question, is, whom do you want deciding what the future looks like?

Do you want these firms that are beholden to their customers and that are constrained by competition? Do you want them deciding, or do you want some government official deciding, like Lena Khan or me? Do you want us deciding what should go down? And I think the answer is absolutely clear.

And if we want innovation, which I think that in your grad school classes, you learn about the solo growth models and technological growth, and this is growth that can't be explained by growth and labor. Think about a production function, you've got output as a function of capital and labor, and then you try to fit that model to the data, and you see there's a huge component that's unexplained by either capital or labor.

They call that total factor productivity, and you'll learn about that. That is the technological innovation that drives our standard of living, I mean, we have grown and what makes us the richest country in the world is that we started growing a lot faster than anybody else a long time ago.

China has been unbelievable since 1978, when they kind of got private property and kind of got this version of capitalism. They've grown really fast, and their standard of living has gone up really fast. But it's this incentive alignment kind of letting the markets do their work, and President Xi, I think, has probably killed the goose that laid the golden egg, by attacking all the growth firms in China.

But, I mean, the counterfactual to that thing is, okay, yeah, you might be right that there is some threat to national security, I mean, what's the counterfactual? So do you want the government controlling these firms? I mean, the cost would just be enormous, and always think about, well, what's the alternative?

Well, so we got a bunch of government bureaucrats deciding what these firms can do, and there's always a balance. When we go from administration to administration, it's a little movement left, right, but basically in any trust, we agree on what the goal is. The Biden administration has been an outlier in that, they wanna turn back the clock, and the institutions of government are not letting them, the courts not letting them, and Congress isn't letting them.

And that's the beauty of our checks and balances, you can't just come in here with what I would call a zealous, actually, I've never heard that word without overzealous over in front of it. But a zealous enforcer who thinks that way too many mergers and that's harmed American consumers, and I think that's just a radical misreading of what's happened.

And we are so frigging lucky to live in the United States, where we have this relatively open, innovative economy, cuz that's what's making us rich, and let's not lose sight of that. And all you have to do is look at places like Europe, if you wanna innovate in Europe, first of all, they can't tolerate the kind of inequality that comes from innovation.

They couldn't tolerate a Jeff Bezos in Europe, so Jeff Bezos wouldn't be able to innovate in Europe, not to mention the regulatory miasma that makes it hard to move assets to higher valued users, it's too difficult. And I think when I talk to my colleagues in Europe, that's what they're concerned about, the regulatory overlay that's killing growth, I mean, they just don't see the same trade-offs that we do.

I mean, you talk about your question kind of implying, hey, we need more government. And I'm immediately thinking about the trade-offs, and I'm thinking, my gosh, what would be given up with more government control? And they just don't think about trade-offs that way, and President Xi, I don't think, does either.

And you haven't even mentioned the really big elephant in the room, which is the declining birth rates. I mean, China's dead, Europe's dead, and we would be dead but for the immigration, and we've got lots of immigration, so we still have a decent growth pyramid. And China's growth pyramid is starting to get inverted, as is Europe's.

And the ironic or unintended consequence of the illegal immigration, obviously, there's a right way to do that, we want security checks, make sure we're not letting in terrorists. But the benefit of letting a lot of young, healthy people in the United States in the prime of their life, that's gonna save our aging population, saving us from kind of the demographic death that is China and the EU anyway-

 

>> Jon Hartley: And not to mention illegal migrants, too, certainly migrants from India in particular tend to be much more innovative in terms of their patenting output than, say, the average American who's born here. So it's fascinating, I mean, there's been a lot of work that's been done on the connection between immigration and innovation by folks like Bill Kerr and others.

And I fully agree with you that I think these antitrust regulations closely align with economic growth challenges and innovation. And it seems I totally agree with your analysis that so far, it seems like the new brandishian Lina Khan has not been successful so far, and that they've just continued to lose cases that they've brought.

That certainly the judiciary, the FTCDOJ staff, and much of Congress is very much opposed to their attempt to overturn the consumer welfare standard.

>> Luke Froeb: So I've been thinking about this, so I have been actually modeling the antitrust process and kind of looking at what chair Khan is doing.

There's filing fees that you have to file before you even think, and they've made that thing really long, onerous and kind of open, and it's really hard to gather the information, they've quadrupled the filing fees. And if you think about that as a tax on mergers, kind of think about there's good mergers and there's bad mergers.

Well, we're deterring good and bad mergers, so if you think that most of the mergers are bad, you're thinking, hey, let's tax the hell out of the mergers. But if you think that, hey, 98% of the mergers that come through the Justice Department never even get a second request, so most of those are good.

We're deterring a lot of good mergers called those type one errors instead of filtering. And you think about, I don't want a tax that deters all merger, I wanna filter that distinguishes the good from the bad. And what this agency has done is they've dramatically raised the cost, they've dramatically increased the uncertainty of the process, and the cost and the uncertainty are deterring all mergers.

You think about what's the wealth creating engine of capitalism? It's the movement of assets to higher valued users, and our biggest and most valuable assets are corporations. And if we can't move those to higher value users, we're gonna kill the goose that laid the golden egg.

>> Jon Hartley: Absolutely, I fully agree with that.

This has been such an interesting conversation, Luke, it's been a real honor to have you on, thank you so much for joining us today.

>> Luke Froeb: I enjoyed it, and thank you very much.

>> Jon Hartley: Today, our guest was Luke Froeb, who is a professor of management at the Vanderbilt University Owen School of Management and the former chief economist at the Department of Justice Antitrust Division and the former chief economist at the FTC.

This is the Capitalism and Freedom, the 21st Century Podcast where we talk about economics, markets and public policy. I'm Jon Hartley, your host, thanks so much for joining us.