How Antitrust Affects Innovation

There is an emerging consensus that antitrust law promotes innovation. According to this theory, a monopolist has little reason to create superior goods and methods unless those efforts would increase the monopolist’s market power. In fact, a monopolist can preserve or increase her market power by obstructing competitors from innovating rival products. Since monopoly power may restrain both competition and innovation, the case for making innovation a goal of antitrust law is that enforcement fosters competition, which forces firms to innovate to survive the competition.

The value of promoting innovation through antitrust law can hardly be overstated. In addition to the superior goods and methods that come from innovation, research and development (“R&D”) create “spillover effects” that include greater investment, higher employment, and a better trained and educated workforce. As a result, antitrust’s ability to generate innovation may benefit society more than its conventional purpose of fostering competitive prices.

This development, however, is actually counterintuitive. Scholars and policymakers have long thought that concentrated market power and monopolies produce more innovation than competition. Consider that patent law—which is the primary body of law aimed at creating incentives for innovation—was traditionally thought to conflict with antitrust law. Known as the “the patent-antitrust paradox,” it was often said that antitrust is designed to prevent monopolies and other exclusionary practices while the patent system does the opposite, granting exclusionary rights and market power in the form of patents. Given this framework, it makes sense that scholars, courts, and government agencies have only recently considered antitrust and patent laws to be complementary policies for encouraging innovation.

Very little evidence, however, indicates that antitrust law affects the rate of innovation. There are three possibilities. Antitrust enforcement could strengthen incentives to innovate. It could, however, also diminish them: If firms believe that aggressive innovation is likely to draw unwanted attention from regulators, their motivation to invent new goods and methods could wane. And as a practical matter, the courts are probably ill equipped to create incentives for technological advancement. The third possibility is that innovation and antitrust have no causal relationship.

In fact, scholarship has often noted how little is known about antitrust’s influence on innovation. Despite the literature’s efforts—employing case studies, formalized logic, and theoretical explorations—“the consensus is that there is no clear answer.” Professor Alan Devlin remarked, “[u]nfortunately, the specific antitrust policies that best promote technological advancement are far from clear.” Professor Marina Lao found that “there is neither empirical nor clear theoretical support for the hypothesis that monopolistic conditions, relative to competition, encourage more innovation.” One commentator summed up these efforts, stating that “we may not be confident that antitrust suits enhance innovation, but we cannot be confident that they retard it either.”

My research responds to this state of affairs by empirically testing antitrust enforcement’s relationship with innovation. The history of antitrust law is an ideal natural laboratory for empirical study since its rate of enforcement has fluctuated, creating variations that generate strong statistical results. For example, each category of antitrust action initiated by the government has changed in a unique pattern. The rate of Section 1 investigations has steadily declined, but merger enforcement—which has traditionally been less common than sections 1 and 2 investigations—peaked in the 1990s and has since become more prominent than Sherman Act investigations. As a result, it can be statistically determined with a high level of confidence whether the rate of innovation has changed in accordance with increases and decreases of antitrust activity, controlling for mitigating factors.

I constructed a new dataset of publicly available information as well as data received from Freedom of Information Act (“FOIA”) requests. The dataset spans from 1963 to 2015 with a unique entry each year. The results of the models are consistent, strong, and quite unexpected, demonstrating the effects of antitrust enforcement on society’s ability to produce patents and R&D.

First, a greater number of antitrust lawsuits filed by private parties—which are the most common type of antitrust action—impedes innovation. Second, the different types of antitrust actions initiated by the government tend to affect innovation in profoundly different ways. Merger challenges (under the Clayton Act) promote innovation while restraint of trade and monopolization claims (under sections 1 and 2 of the Sherman Act) suppress innovative markets. Even more interesting, these effects become stronger after the antitrust agencies explicitly made promoting innovation a part of their joint policies.

My results suggest that the arguments for and against antitrust have merit. On one hand, antitrust enforcement fosters the incentives to innovate when it preserves the number of firms competing within a market. Yet enforcement reduces innovation when it scrutinizes how firms compete. This makes sense. Commentators have noted that the Sherman Act is designed to raise suspicions about many activities in which innovative firms typically engage. An inventor may, for instance, exclude competitors from using her invention or enter into contracts and agreements with competitors to license or develop technology— either scenario can draw an antitrust challenge. Enforcing the Sherman Act can thus curb innovation by creating liability for inventors who would like to comply with the law. In short, antitrust appears to promote innovation when it maintains competition by preserving the number of firms competing within a market, but it retards innovation when it limits how exactly those firms compete against each other.

My analysis also supports concerns that the mere presence of the Federal Trade Commission and the Department of Justice in dynamic markets might chill the incentives to innovate. As the administrative state of antitrust increases—measured by the size of agency budgets and the number of investigations, actions, and personnel—the innovation in private industry decreases. To offer an analogy, when drivers can spot a police officer by the highway, they are more likely to drive below the speed limit, acting in an overly conservative manner. In the innovation context, a similar effect appears to be true: Although the presence of antitrust regulators in innovative markets may make some firms abide by the law, it can also make others overly cautious and reduce innovation.

This post comes to us from Professor Gregory Day at Oklahoma State University’s Spears School of Business. It is based on his recent article, “Innovative Antitrust and the Patent System,” available here.