TESTIMONY BEFORE THE FEDERAL TRADE COMMISSION
Hearings on Global and Innovation-Based Competition
Kenneth W. Dam
October 12, 1995
My name is Kenneth W. Dam. I am the Max Pam Professor of American and Foreign Law at the University of Chicago Law School. I also serve as Of Counsel to the law firm of Kirkland & Ellis.
In testifying today, I shall be drawing not only on my academic work and my antitrust experience with Kirkland & Ellis but also on government and business experience as Deputy Secretary of State from 1982 to 1985 and as IBM Vice President for Law and External Relations from 1985 to 1992. In short, I shall be relying on information and insights gained in these four arenas in responding to the questions posed for these hearings. Indeed, I shall attempt to integrate what I have learned in those four sectors into a point of view about international competition and (as your schedule contemplates) leave to later witnesses more technical questions about, for example, how the various sets of antitrust guidelines might be amended on this or that specific point of doctrine. I shall focus on global competition, but I shall also comment briefly on the second topic on today's schedule, innovation-based competition.
I.
It is obvious to all that competitive conditions have greatly changed over the past several decades. Clearly global competition has increased. It is sometimes said that globalization is partly myth because there was as much or more global integration before World War I as there is today. That may well be true, and if so it helps to explain why the United States in the half century before the First World War developed so rapidly, taking advantage of British capital markets and relatively free access to European markets for our exports. What is also true, however, is that there was a great collapse of global integration after 1914 and especially in the Great Depression. By the end of the Second World War, national markets were largely isolated, at least for manufactured goods and for services. Global integration is once more being achieved as a result of many developments, especially successful trade negotiations, technological advance and a better understanding around the world of the advantages of free markets. In the present international political environment the pace of globalization seems likely to continue and even accelerate.
Most of the talk about globalization in an antitrust context has concerned how foreign competition should be factored into the various antitrust rules. To take one extreme, the question naturally arises whether we should consider, for the purpose of rules that depend on market power and market share, a worldwide market, or look only at production in the U.S. market, or take some in-between standard. These are important questions whose answers may vary from practice to practice and from industry to industry. For example, the Merger Guidelines, with their well-known five percent rule, reflect a reasonable approach for mergers between U.S. firms but would be harder to apply for most Section 1 offenses.
Another aspect of globalization creates a rather new set of issues but is somewhat less obvious to the casual observer. While a more open international trade regime here and abroad has opened more national markets, including our own, to imports, the real driver of globalization has been a startling increase in private foreign investment, particularly since the 1980's. In the last decade U.S. private foreign investment has more than doubled, and private investment by foreign firms in the United States has also1 more than doubled. I am speaking here of real investment (i.e., plant and equipment) rather than trans-border portfolio investment in equity and debt securities, which has increased even more rapidly. Portfolio investment is another aspect of globalization but is less relevant for antitrust policy.
The rapid increase in real investment has many implications, but two stand out in particular. One implication is that much of the increase in international trade has taken the form of shipments within enterprises, rather than between unrelated enterprises. In 1993 exports from American plants of U.S. companies to their foreign subsidiaries and branches constituted 24 percent of all U.S. exports while imports by U.S. companies from foreign subsidiaries and branches constituted 18 percent of U.S. imports.2 Meanwhile, U.S. affiliates of foreign multinationals accounted for another 23 percent of U.S. exports and another 34 percent of U.S. imports.3 In short, 47 percent of U.S. exports and 52 percent of U.S. imports took place within single multinational enterprises. Since agreements within an enterprise do not under the Copperweld approach normally raise antitrust problems, it can be argued that the relevance of globalization for antitrust policy has been overemphasized. But there are several offsetting considerations arising from foreign investment that create specific problems for antitrust.
One such offsetting consideration is that as more American firms have established more subsidiaries and branches abroad, the possibility arises that they will enter into conspiracies with local firms concerning local markets. Since those conspiracies, even where they concern local production in that country, could be found to affect U.S. exports, there is a surface argument for sustaining U.S. jurisdiction over them. But the question arises whether those local conspiracies are worth the effort in these days of limited governmental resources.
A second offsetting consideration is that foreign investment today often does not take the simple form of establishing a subsidiary or branch in a particular country. Rather, in order to gain foreign expertise and to achieve local market access, investments increasingly take the form of joint ventures, strategic alliances, intellectual property licenses and the like. These increasingly popular forms of investment simply multiply the opportunities for antitrust intervention for the simple reason that the architecture of antitrust, under Section 1 of the Sherman Act, makes every agreement between firms of potential enforcement interest, especially where the U.S. and foreign firm are actual or potential competitors. These legal problems also arise, it should be noted, with respect to foreign companies' investment in the United States. (And indeed we are finding these same trends in purely intra-U.S. transactions.)
Another motivation for these complex inter-firm arrangements is that modern production of manufactured products, particularly in the advanced technology spher e, increasingly takes the form of components and subcomponents to be incorporated in machines. One could analyze these supply arrangements as vertical in character and therefore under contemporary antitrust doctrine as raising few antitrust problems. However, the firms buying and selling components tend to produce some products in competition with each other. Indeed, when what is involved is outsourcing, the end product firm formerly made the component (or subcomponent) in question and indeed may still do so, preferring the security of a second source of supply and even the discipline of working with component manufacturers for part of their supply so that the spur of competition keeps in-house suppliers efficient and resourceful. Furthermore, in the advanced technology arena, a great deal of inter-firm planning is required to make this kind of component specialization work well in practice; the components are often not off-the-shelf items but rather require extended joint planning and standardization.
For all of these reasons, the architecture of Section 1 casts a potential shadow over these agreements, depending of course on their details and the structure of the markets involved. Therefore, in the international sphere, it is important that we continue, as has been the general trend over the period since the Warren Court, to limit the category of per se offenses to price-fixing and equivalent practices such as customer and territory allocation. Further, we need to be sure that what appears to be price-fixing is properly categorized as such and is not in fact some variety of joint venture. Indeed, guidelines setting out "safe harbors" in the international sphere for complex inter-firm intra-industry arrangements might help promote the strength of American industry abroad. The National Cooperative Research Act of 1984, as amended to include production joint ventures, provides a precedent but does not go far enough in creating such safe harbors, especially for international transactions.
II.
One other preliminary point is that there seems to be a quite considerable fear of globalization in our society. It is increasingly blamed for everything from unemployment to declining real wages to a spread of tropical and other infectious diseases in the United States. No doubt there are major adjustments that globalization is causing for the U.S. economy and society. But it would be a mistake to conclude that these unpleasant and politically difficult side-effects of globalization should lead us in some way either to use antitrust to resist globalization or to handicap those firms, domestic and foreign, that are at the leading edge of globalization. The fact is that most of what we see that most people don't like--downsizing in large U.S. industries, the offloading to foreign countries of jobs in a wide range of industries from back office accounting to software engineering, and the difficulty of finding jobs for those with low skill levels--arises from developments other than globalization.
One such development lies in technology. Technology leads us to higher levels of income and creates many jobs, but it can do so only by displacing some people from the jobs they are currently in. Many of the displaced are hard pressed to find new jobs with their current skills. In my opinion, we have not yet begun to see the full effects of currently available technology on corporate downsizing. As Arno Penzias, a Nobel Laureate in Physics and the head of Bell Labs, has written in his new book Harmony: Life After Paperwork, millions of people in modern corporations, from clerks to middle management, earn their living moving information from one part of an organization to another, sometimes as part of traditional management techniques involving interfacing between employee levels and sometimes more routinely, such as by carrying paper from a computer-attached printer to a copying machine.
These jobs are disappearing fast because of what antitrust stands for: competition. No one firm can afford to retain jobs that can be replaced by modern information technology so long as other firms use the new technology. The same principle has long been a driving force in manufacturing. It is thus not globalization but old-fashioned competition at home that is leading to most corporate downsizing. It would therefore be a mistake to use antitrust doctrine to try to hold in check the supposed social effects of globalization.
III.
If we may take it as established that globalization is occurring, that global integration is already well advanced and that it would be fruitless and probably downright harmful to attempt to resist it, then the policy question is what implications this trend toward increasing global integration has for antitrust policy. In addressing that question it is important to distinguish at least three different parts of the economy: manufactures, services and nontraded goods. Globalization may have one set of implications for manufactures, which is indeed the economic sector where the pace of global integration has been the most pronounced. It is also a sector where we find some of our most productive firms -- in wide-bodied aircraft, computers and mass-market software. As for services, the pace of global integration has been picking up, especially in commercial and investment banking, but many kinds of services -- one thinks of insurance, utilities, telecommunications and so forth -- are heavily regulated by governments and indeed in many cases are still in government ownership, having thus far escaped privatization. Where government policy, whether through regulation or outright ownership, plays a strong role, markets are likely to be much less integrated globally. Moreover, the very existence of strong and intrusive government policies abroad, raise some of the most difficult issues of conflicting polices between governments, which in antitrust we normally discuss under the rubric of extraterritoriality.
Beyond manufactures and services, we have a sector economists often call nontraded goods. In fact, the most important of these are in fact not goods in the popular sense at all, but rather local services. Think, for example, of laundry services or motel rooms where international trade can hardly exist. Nontraded goods constitute a large fraction of the economy, and the possibility of collusion and monopoly certainly exists but has often not been the focus of national antitrust authorities because many nontraded goods are usually not provided on a nationwide basis but rather only locally. The rise in recent decades of state antitrust enforcement is therefore welcome in this sector of the economy. But whether the enforcement is by national or state authorities or by private citizens through private actions, globalization is of little significance for antitrust policy in the nontraded goods sector.
Even where markets are global, the United States has certain industries where U.S. firms face extensive import competition and are not strong exporters. These are industries in which the United States does not have a comparative advantage. These industries do not present any special challenge for antitrust policy. We have a long tradition of resisting cartelization and so-called rationalization agreements, including capacity reduction and production allocation agreements, in industries that face overcapacity. The fact that the overcapacity arises from foreign competition, or that an industry used to be national and has now become global, should make no difference for our national antitrust policy. Indeed, it is the hot breath of foreign competition that is most likely to bring innovation to industries that have fallen behind their foreign rivals in technology and consumer satisfaction.
To say that antitrust doctrine and enforcement policy should not change to address the problems of our internationally weaker industries does not mean that we should ignore the competition questions inherent in international trade policy issues. In the U.S. Executive Branch we have, of course, specialization in which those issues are dealt with in the U.S. Trade Representative's Office, in the Commerce Department and, too often, in the White House because they often present difficult political issues due to the pressures for protection. The antitrust agencies have traditionally stood aside from these issues, even though they go to the essence of global competition. The reasons are understandable. Still, as we go beyond the Uruguay Round toward an increased focus on making global competition effective, U.S. antitrust authorities will be under growing pressure to get involved. We already see this trend in trade negotiations to encourage Japan to enforce more vigorously its own antitrust rules. But the sauce-for-the-goose principle operates here, and there will be continuing pressures coming from abroad as well as from our stronger exporting industries to reexamine, to take one instance, our own anti-dumping rules from the standpoint of their competitive impact. This is more likely to be a question for the Antitrust Division than for the Federal Trade Commission, but it would be unfortunate parochialism to divorce antitrust from competition policy in general when one is discussing globalization.
If I may turn now turn to industries in which we are strong exporters and therefore compete in an international market, the questions become somewhat more complicated. It has been a strong emphasis in recent years in U.S. trade policy to strive to open foreign markets for U.S. exports. Most of the attention in that respect has been on the Japanese market. Certainly an international trade regime in which there is equal access to the major national markets is not only likely to be more economically efficient but also more equitable and therefore, from a foreign policy point of view, less likely to lead to international disputes that threaten other important aspects of U. S. foreign policy, especially national security policy.
The point for discussion here, however, is what the role for antitrust policy might be in opening foreign markets. It is important to recognize two points: First, most barriers to equal access abroad are regulatory and do not arise from purely private conspiracies; indeed, if it were not for foreign government policy, private conspiracies would be unlikely to last for long, even in Japan. Second, we should not forget that many U.S. markets are not fully open to foreign competition, again because of regulatory restraints--in this case legislation and regulations not just of the Federal government but in too many cases of state and local governments. Thus, it would be a mistake for antitrust policy to take on the job of opening foreign markets as if it were some holy mission; the United States, one judges from documents published by the European Union and the Japanese government, is nearly as often a sinner as sinned against. If the barrier to U.S. exports is the result of foreign governmental regulation, we should view the problem as one of extraterritoriality, a subject to which I shall return. Still, if the barrier to U.S. exports is purely the result of a private conspiracy, then we should have no more hesitation in attacking that foreign conspiracy than if it were a conspiracy directly aimed at U.S. consumers. To be sure, one can argue that a consumer-oriented antitrust policy would conserve its resources for conspiracies that impact U.S. consumers directly. But consumers are benefited indirectly by more vigorous international competition.
IV.
The questions to which witnesses at these hearings are asked to address themselves gloss over very important issues concerning extraterritoriality. I can understand why it is important to focus on the substantive rules of U.S. antitrust law. But I believe it is a mistake to ignore the extraterritoriality puzzle if our goal is to protect and indeed spur competition in an increasingly globalized economy. Let me put the problem directly and in a simplified way: We live in a global economy with separate nation states, each of which has legislative and enforcement power over its own territory and each of which pursues its own interests as it sees it. (Obviously I am passing over the special complication of supranational antitrust rules, notably those of the European Union.)
If it is the goal of the United States is to introduce the maximum degree of competition into the global economy, then the policy question is how best to deal with that simple problem. Again to put the issue in its most simplified terms, should we try to force our will on the rest of the world by applying our antitrust rules to the full extent of the Constitution? Or should we try to use our considerable leverage as a still powerful and still admired member of the international community to induce other countries to enforce their own antitrust rules and to limit their own anti-competitive regulatory regimes? In short, will we get further by providing leadership or should we just try to apply the U.S. antitrust laws unilaterally?
This problem of foreign laws and regulations that restrain competition rarely involve what has been called a true conflict: that is, a situation where complying with U.S. law will cause a firm to violate foreign law. Rather the problem almost always arises in a context where foreign law creates a regulatory regime at odds with the pro-competitive thrust of the U.S. antitrust laws. The effort to impose our laws on firms and their activities in the foreign country naturally gives rise to foreign policy problems and various kinds of foreign blocking legislation and court orders, especially where the firms are incorporated or headquartered in that country. These kinds of conflicts of sovereignty have gotten most of the attention in the voluminous literature on extraterritoriality.
My concern is a bit different. I am doubtful that simply applying our own antitrust laws, though permitted by our Constitution and approved by the Supreme Court in the Hartford case, is a solution that will maximize the competitiveness of the world economy.4 What we should be trying to do is to change the foreign law to make it more pro-competitive. That is the approach that has been used successfully in many rounds of trade negotiations, including the recently concluded Uruguay Round that created the World Trade Organization. Surely some kind of less unilateral, more cooperative approach has a good chance of working in some of the areas that are the most promising, especially large-scale service industries that have been prone to stultifying national regulation but that are becoming increasingly internationalized.
In addressing that antitrust extraterritoriality it is useful to look at the problem not as a specialized problem of antitrust doctrine or even antitrust policy but rather as one of a large class of problems where foreign substantive law differs from our own in ways that we regard as detrimental to the U.S. economy or the U.S. national interest. In such cases our government can in principle follow one of at least three strategies.5
The first, of course, is unilateral action -- simply applying our own law. The problem with that approach is simply that it leaves the foreign anti-competitive law in place while generating all kinds of problems for U.S. foreign policy, our other interests abroad and for the firms caught in the middle.
A second approach is to seek to change the foreign law by diplomacy. I have in mind persuasion, not leverage or quid pro quo concessions, which can work in many foreign and security policy areas but are unlikely to be effective in the competition sphere. While diplomatic persuasion alone rarely works in most international economic policy areas, the economic reforms now sweeping the world suggest that diplomatic persuasion can work in some situations, especially with those developing countries that are trying to reform their economic policies in any event. The failure of socialism and the rise of privatization reveal that many governments have turned their backs on the governmental control and regulation philosophies of earlier decades. In suggesting diplomatic persuasion I have to say that I do not believe much can be accomplished by trying to harmonize national antitrust laws, although6 little is lost in trying. The fact is that differences in the substance of national antitrust laws are rarely a serious problem, especially in the developed world. Aside from persuading some other governments to enforce the antitrust laws they have, which is best accomplished through diplomacy, the central problem is that so many sectors, especially services, have to be freed from anti-competitive regulation.
A third possible strategy involves negotiations. This is, of course, the approach used so successfully in reducing anti-competitive trade barriers. This approach has rarely been tried in antitrust, though perhaps some of the bilateral agreements involving cooperation in enforcement provide a precedent. This is a big topic that needs to be analyzed, but I believe the most promising approach would be for the United States to negotiate agreements involving allocation of jurisdiction; we would agree to restrain the extraterritorial enforcement of our antitrust laws in return for foreign agreements to phase out anti-competitive regulation. To make this approach work we would probably have to kick off the effort with legislation comparable to the path-breaking Reciprocal Trade Agreements Act of 1933, which paved the way for bilateral and later multilateral reductions in trade barriers. But to be effective, we would no doubt have to proceed bilaterally, country by country, and then industry by industry. The formula I have in mind is that the United States would agree to limit extraterritorial enforcement of the antitrust laws with respect to each country that agreed to enforce its own antitrust laws vigorously and with respect to each industry that was mutually agreed to be free of anti-competitive regulation in that country.
One important aspect of these negotiations is that they would have to bind not just the Antitrust Division and the Federal Trade Commission, as well as state governments, but they would have to exclude private actions as well. There is no problem with that approach under the treaty power of the Constitution. Aside from the fact that most of the judicial extraterritoriality decisions have involved private actions, the announced approach of the Guidelines involving the power to withhold government action as a matter of comity is frankly of little use in most situations because private treble-damage actions remain a threat. For that reason alone, we are unlikely to gain foreign government agreement to the pro-competitive action we are seeking from them unless we can deliver immunity from private antitrust actions under U.S. law.
I have raised the issue of extraterritoriality both because it is important itself and because I believe that U.S. antitrust authorities have traditionally been too compartmentalized in their thinking. Too often the attitude has been, "Our job is to enforce the law, period, and please don't bother us with concerns about foreign economic and security policy!" That response might have been understandable in earlier decades when the antitrust subcommittees on the Hill were populist in their thinking and we did not live in an age of globalization. I welcome these hearings because they recognize that antitrust policy has to be rethought as global integration, technological change and other rapidly changing conditions in the economic environment transform the world in which antitrust policy must function.
V.
I have chosen to focus my testimony today on globalization rather than innovation-based competition. The reason is that in my view there is nothing all that special about innovation-based competition that requires change in the antitrust laws. I am in fact more concerned with efforts in the literature, which have found some echo in the courts, to limit intellectual property protection on grounds that seem to involve competition notions. These ideas sail under a number of flags such as compatibility, standardization, and network externalities.
This development in intellectual property law is reminiscent of a prior era in which some courts, the Supreme Court included, tended to treat patents and copyrights as monopolies, thereby invoking rules concerning the exercise of market power. The fact is that although patents, for example, give a power to exclude competitors in a formal legal sense, they do not necessarily give market power, much less a monopoly, in any economic sense. Our most innovative firms today receive, as a result of massive R&D expenditures, a thousand or more patents a year, yet it is doubtful that these firms have a monopoly in any economically defined market. These "patents- and-copyright-as-monopolies" ideas seem to have been largely eradicated from antitrust doctrine, but they are knocking on the back door via intellectual property doctrine.7
The better approach here, I believe, is to resolve questions of intellectual property rights strictly on traditional intellectual property doctrine, which already does a good job of balancing incentive to innovate with the need for access to assure that innovation today is not unduly protected at the expense of innovation tomorrow. The resulting patents and copyrights then should be treated as other forms of property, such as industrial plants. One plant in a one-plant industry may give a monopoly, but not one plant in a thousand plant industry. If a firm has market power in a properly defined economic market, then the resulting antitrust rules based on market power (involving, for example, tie-ins) may be applied, otherwise not. If firms divide markets in the process of cross-licensing, then the rules against territory and customer allocation should be applied; the intellectual property rights should neither provide an excuse for validating such a practice nor be a reason for condemning it.
This analysis leaves open the question of whether the concept of innovation markets is a necessary or even desirable construct for antitrust policy. This concept certainly adds complexity to the analysis of antitrust issues in R&D-intensive industries. The question is what is the gain from adding this concept if whatever practices are being analyzed do not result in restraints in product markets. One can argue that an innovation-markets concept is needed to prevent future downstream effects in product markets. But that seems to me too much like the now rather discredited incipiency doctrine. Perhaps what is important is whether the recent explosion of competition in innovation-based industries does not itself show that current law is working just fine without this new concept. Indeed, the innovation markets approach, while analytically imaginative, appears to be an example of doctrine expanding to threaten invalidation of existing practices without any empirical or even anecdotal demonstration of need.
ENDNOTES:
1 For a general discussion see Jeffrey H. Lowe, Direct Investment Positions on a Historical-Cost Basis, 1994: Country and Industry Detail, 75 Survey of Current Business 61, esp. Table 2 and Chart 1 and accompanying text (March 1995).
2 Raymond J. Mataloni, Jr., U.S. Multinational Companies: Operations in 1993, 75 Survey of Current Business 31, 39 (June 1995). This does not include trade between foreign multinationals and their U.S. subsidiaries.
3 Mahnaz Fahim-Nader and William J. Zeile, Foreign Direct Investment in the United States, 75 Survey of Current Business 57 (May 1995).
4 Hartford Fire Insurance Co. v. California, 113 S. Ct. 2891 (1993).
5 Some of the ideas that follow are developed in my article Extraterritoriality in an Age of Globalization: The Hartford Fire Case, 1993 Sup. Ct. Rev. 289 (1994), especially at 322-326.
6 See Diane P. Wood, The Impossible Dream: Real International Antitrust, 1992 U.Chi.Legal F. 277 (1992).