Tuesday, August 13, 2019

Limits for Corporate Bigness on Acquisitions, Patents, and Politics

The United States, like most places, an ambivalent view of big business. When big firms are making high profits, we are concerned that they are out-of-control and exploitative. If big firms are is performing poorly, with losses and layoffs, we argue over how or whether to rescue them. (Remember the auto company bailouts in 2009?) Might it be possible to strike a more lasting balance?

For example, here's one possible combination of policies. Corporate bigness is fine by itself, and will not be prosecuted. However, the biggest firms will be sharply limited in their ability to acquire other companies. In addition, they may face limitations on their ability to participate in politics, as well as compulsory licensing of their key patents. In one famous case in 1956, the Bell System was required by antitrust authorities to license all of its existing patents to all US firms for free.

Something like this policy mix was implemented in the US economy in the middle decades of the 20th century. Naomi Lamoreaux writes about "The Problem of Bigness: From Standard Oil to Google," in the Summer 2019 issue of the Journal of Economic Perspectives. She points out that many of the concerns about Standard Oil more than century ago, and about Google and other big tech companies in the present, are not about higher prices being changed to consumers. Instead, the concerns were about tactics used to choke potential competitors and about the political clout of bigness. Lamoreaux describes the pendulum swings of law and public opinion with regard to bigness, but here, I want to focus on the political balance that was struck with regard to bigness in the middle decades of the 20th century.

Lamoreaux points out that the large US firms that became well-established in the second and third decades of the 20th century remained successful for some time, but with no particular social trend toward greater concentration of industry. This is also a time when public attitudes toward corporate bigness were not very harsh. She writes:
Tracking the 100 largest firms in the US economy at various points between 1909 and 1958, Collins and Preston (1961) similarly found that the top firms gradually came to enjoy “an increasing amount of entrenchment of position by virtue of their size” (p. 1001). Over these same decades, moreover, there was remarkably little change in overall levels of economic concentration. Scholars have measured concentration in different ways and over different sets of years, and as a result, their estimates diverge somewhat. But ... there was no clear trend toward increasing (or decreasing) concentration, either in the manufacturing sector or in the economy as a whole.
Intriguingly, even as large firms consolidated their positions, the public’s view of them became increasingly accepting. Galambos (1975) analyzed references to big business in a sample of periodicals read by various segments of the middle class over the period 1890–1940 and found that the antipathy of the late nineteenth century had greatly diminished by the interwar period. Auer and Petit (2018) conducted a similar analysis, searching the Proquest database of historical newspapers to find articles that included the word “monopoly.” Even though Auer and Petit were selecting on a word with generally negative connotations in American culture, they found that unfavorable mentions dropped from about 75 percent of the total in the late nineteenth century to a little over 50 percent starting in the 1920s.
One why people were more at peace with large companies during this time period is, as Lamoreaux describes, that Congress and state legislatures passed rules placing limits on corporate political involvement. 
In addition to the new antitrust laws already discussed, Congress took a first step toward limiting business influence in politics by passing the Tillman Act in 1907, prohibiting corporations from contributing money to political campaigns for national office. The act was a reaction to a particular set of revelations—that large mutual insurance companies were using their members’ premiums to lobby for measures that weakened members’ protections (Winkler 2004)—but it built on pervasive fears that large-scale businesses were using their vast resources to shape the rules in their favor. By the end of 1908, 19 states had enacted corporate campaign-finance legislation of their own, and they had also begun to restrict lobbying expenditures by corporations (McCormick 1981, p. 266). Congress would write an expanded version of the Tillman law into the Federal Corrupt Practices Act in 1925 (Mager 1976).
Another reason why people of this time were more accepting of bigness is that the new antitrust laws gave them some reason to believe that bigness was less likely to be economically abusive. Lamoreaux writes:
The new antitrust regime seems to have been similarly reassuring, even though the 1920s are generally regarded as a period when antitrust enforcement was relatively lax (Cheffins 1989). The Federal Trade Commission got off to an inauspicious start in the early 1920s—most of the complaints it filed were dismissed by the courts—and in the late 1920s it was essentially captured by business interests (Davis 1962). By 1935, however, the agency was showing renewed vitality. The number of complaints it filed increased sharply, its dismissal rate fell to about one-quarter, and it was winning
the vast majority of cases that proceeded to judicial review (Posner 1970, p. 382). 
At the Department of Justice, there was no significant fall-off in the number of cases during the interwar period, with the exception of the early years of the Great Depression. Prosecutors seem to have targeted fewer large firms during the 1920s, but the department’s win rate increased from 64 percent in 1920–1924 to 93 percent in 1925–1929 (Posner 1970, pp. 368, 381; Cheffins 1989). Although most antitrust cases still involved horizontal combinations or conspiracies, by the 1930s about one-third of the cases filed by the Department of Justice were targeting abuses of market power, and the FTC’s proportion was closer to one-half (Posner 1970, pp. 396, 405, 408).
When the biggest firms recognized that anticompetitive practices, mergers, and political spending were going to come under enhances scrutiny, it encouraged them to move toward sustaining their competitive position through funding research and development and obtaining patents. Of course, all intellectual property is built on a tradeoff: on one side, it's an incentive for innovation, but on the other side, it locks in a competitive advantage for innovator for a decade or two. By the late 1930s, antitrust authorities were addressing this issue by requiring that large firms provide compulsory licenses to their key patents--in some cases without receiving any payments. Here's how Lamoreaux tells the story: 
After World War I, large firms had stepped up both their investments in research and development and their efforts to accumulate patent portfolios. According to surveys conducted by the National Research Council, the number of new industrial research labs grew from about 37 per year between 1909 and 1918 to 74 per year between 1929 and 1936, and research employment in these labs increased by a factor of almost ten between 1921 and 1940 (Mowery and Rosenberg 1989, pp. 62–69). Large firms generated increasing numbers of patents internally, but they also bought them from outside inventors. ...  The competitive advantages to large firms that broad portfolios of patents could bring, in terms of both what they could achieve technologically and how they could forestall competition, were becoming increasingly apparent—not least to the firms themselves (Reich 1985). As early as the 1920s, valuations on the securities markets began to mirror the size and quality of large firms’ patent portfolios (Nicholas 2007). 
Federal antitrust authorities began to pay attention as well, especially during the late 1930s ... In 1938, a specially created commission, the Temporary National Economic Committee, launched a three-year  investigation into the “Concentration of Economic Power.” The Temporary National Economic Committee began its hearings by examining large firms’ use of patents to achieve monopoly control, focusing in particular on the automobile and glass industries. In 1939, the committee held a second set of hearings to solicit ideas about how the patent system could be reformed (Hintz 2017). It also commissioned a book-length study by economist Walton Hamilton, Patents and Free Enterprise (Hamilton 1941). According to Hamilton, large firms had perverted the patent system. The system’s original purpose had been to encourage technological ingenuity, but now large firms were instead deploying patents as barriers to entry and using licensing agreements to divide up the market and limit competition among themselves (Hamilton 1941, pp. 158–63; John 2018).
The Temporary National Economic Committee’s patent investigation was headed by Thurman Arnold, assistant attorney general in charge of the Department of Justice’s antitrust division. Arnold’s views about the abuse of patents were similar to Hamilton’s, and at his insistence, the committee’s final report recommended compulsory licensing—requiring firms to license their technology at a fair royalty to anyone who wanted to use it. The recommendation went nowhere in Congress (Waller 2004), but Arnold nonetheless pursued it at Justice. As early as 1938, for example, he pushed Alcoa to license a set of its patents as part of an antitrust settlement, and the company agreed in a consent decree entered in 1942. By that time, Arnold had already secured three other compulsory licensing orders, and many more were to follow. Barnett (2018) compiled a complete list of such orders and their terms from 1938 to 1975. By the latter year, the total had risen to 136, one-third of which did not permit the firms to recoup any royalties at all for their intellectual property.
In the early and mid-twentieth century, concerns about excessive concentration of economic and political power in the hands of dominant firms helped constrain the ability of large firms to grow through mergers and acquisitions. During this period, if large firms wanted to grow, they often had little choice but to invest in internal R&D.
Antitrust policy not only encouraged large firms to invest in internal R&D, but also occasionally promoted technology diffusion. A leading example is the 1956 consent decree against the Bell System, one of the most significant antitrust rulings in U.S. history (Watzinger et al., 2017). The decree forced Bell to license all its existing patents royalty-free to all American firms. Thus, in 1956, 7,820 patents  (or 1.3% of all unexpired U.S. patents) became freely available. Most of these patents covered technologies that had been developed by Bell Labs, the research subsidiary of the Bell System.
Compulsory licensing substantially increased follow-on innovation building on Bell patents. Using patent citations, Watzinger et al. (2017) estimate an average increase in follow-on innovation of 14 percent. This effect was highly heterogeneous. In the telecommunications sector, where Bell kept using exclusionary practices, there was no significant increase. However, outside of the telecommunications sector, follow-on innovation blossomed (a 21% increase). The increase in follow-on innovation was driven by young and small companies, and more than compensated Bell's reduced incentives to innovate. In an in-depth case study, Watzinger et al. demonstrate that the decree accelerated the diffusion of the transistor technology, one of the most important technologies of the twentieth century.
This view that the consent decree was decisive for U.S. post-World War II innovation, particularly by spurring the creation of whole industries, is shared by many observers. As Gordon Moore, the cofounder of Intel, notes: "[o]ne of the most important developments for the commercial semiconductor industry (...) was the antitrust suit led against [the Bell System] in 1949 (...) which allowed the merchant semiconductor industry \to really get started" in the United States (...) [T]here is a direct connection between the liberal licensing policies of Bell Labs and people such as Gordon Teal leaving Bell Labs to start Texas Instruments and William Shockley doing the same thing to start, with the support of Beckman Instruments, Shockley Semiconductor in Palo Alto. This (...) started the growth of Silicon Valley" (Wessner (2001, p.86) as quoted in Watzinger et al. (2017)).
Scholars such as Peter Grindley and David Teece concur: "[AT&T's licensing policy shaped by antitrust policy] remains one of the most unheralded contributions to economic development possibly far exceeding the Marshall plan in terms of wealth generation it established abroad and in the United States" (Grindley and Teece (1997) as quoted in Watzinger et al. (2017)).
Large companies will always face a temptation to extend their power in other ways: acquiring competitors, using "patent thickets" to block competition, or exerting political pressures. In one way or another, the goal of antitrust policy is to steer big firms away from these options, and in this way to keep big firms focused on providing consumers with desired goods and services and on continued innovation.