The first antitrust laws and enforcement efforts in the United States were taken in response to the emergence of sprawling industrial conglomerations—the “trusts” in “antitrust”—that amassed inordinate power over the growing American economy. John D. Rockefeller’s Standard Oil, for instance, controlled as much as 90% of refined oil production in the country around the turn of the 20th century. The company was broken up under the Sherman Antitrust Act, spawning successor companies that would eventually become Exxon, Mobil, and Chevron.

In recent months, increasing interest has been focused on applying antitrust law to a new breed of “trusts”—the digital conglomerates that have amassed inordinate power over how citizens communicate, shop, and, possibly, cast their ballots. The Department of Justice and the FTC have initiated antitrust investigations of big tech, and in September, 48 state attorneys general announced that they are collaborating on an investigation as well.

Fiona Scott Morton, the Theodore Nierenberg Professor of Economics at Yale SOM, has been an intellectual standard bearer for the effort to effectively apply antitrust principles originally crafted for an age of steel and oil to the new digital landscape. Earlier this year, she chaired a committee of scholars that studied consumer harms caused by the market power of digital platforms like Google and Facebook, and proposed updated antitrust enforcement and regulation to address them. In August, she launched the Thurman Arnold Project, an initiative funded by the John S. and James L. Knight Foundation and the Omidyar Network that will leverage resources from across Yale to further understanding and action on these issues. “Antitrust enforcement and competition policy are lagging behind academic knowledge, and new energy is required to bring these issues to public attention and into the policy arena,” Scott Morton said in announcing the creation of TAP@Yale.

Two new papers co-authored by Scott Morton further this agenda by synthesizing findings from academic research in antitrust to explain how lack of competition can lead to decreased innovation and higher prices for consumers—and what can be done about it. Scott Morton describes the goal of her work as “trying to make the economic literature more understandable to policy makers, and trying to demonstrate where the results are applicable to, in particular, competition enforcement and regulatory issues.”

Scott Morton spoke with Yale Insights about how smart antitrust policy and enforcement can protect innovation and prevent exploitative markups.

Q: Why study antitrust and innovation? 

Antitrust enforcement is geared around consumers and the welfare of consumers. We’re trying to protect consumers by giving them competitive markets. Those competitive markets have firms continually trying to attract a consumer away from a rival. How do you attract a consumer? You attract them with a lower price, a better quality, or a more innovative product. And so the consumer welfare standard encompasses all three of those things.

Why do we particularly care about innovation? I would say today, even more perhaps than in past years, it’s because we’re seeing a lot of products where one side of the market has a zero money price. What are consumers getting out of their interactions with Google if they’re searching or using a map or a calendar? They’re not paying a money price; it’s a barter transaction. They’re giving their data, and they’re getting back some kind of service, and innovation in those services is the main way that the consumer is benefiting. So the maps get better, or the calendar gets more sophisticated, or the mail gets higher capacity.

Those innovation effects are a really, really important part of the benefit to consumers from competition. And when you look at the way firms compete, if you took an ordinary old market like automobiles, yes, they compete on price, but they most definitely compete on quality. Is the car going to be reliable? Is it going to break down? What kind of miles per gallon does it get? And they’re also competing on innovation. Does the car have Wi-Fi? Does the car have a nifty information system? Does the car have a new kind of braking mechanism, or an airbag that’s different and new? All of these are innovations, and consumers value them when they’re choosing a product. So it’s an important part of competition.

Q: The first line of your paper is, “We write in praise of market disruptors.” Why are disruptors important in keeping that innovation going?

The market disruptor is often a company that is not doing things the same way as everybody else. So Netflix—when they first started mailing out DVDs, you didn’t have to drive down to the video rental store. They came and they were sitting there in your TV room, to be used whenever you felt like watching a movie, and that was really different than the existing technology. The disruptor has a different business model, often, or a different product. They’re doing something innovative, and that really puts stress on the existing incumbent firms. Those existing incumbent firms would rather the disruptor wasn’t there, because they have a new value proposition for consumers. If they’re successful, they are attracting some consumers away.

That whole process of dynamism—new products, consumers moving to the new products, old products fading or having to get cheaper or better to retain the customers—that’s a real source of consumer benefit out in the marketplace.

Q: A disruptor could replace an entrenched company, but it also could put pressure on the company to improve, to try something new.

That’s right. For example, when my colleague Barry Nalebuff launched Honest Tea, one of the things that he did after Honest Tea was Honest Kids, which was a line of low-sugar kid’s drinks. One of the things that he is very proud of is that after they launched Honest Kids, the leading juice box brand reduced the amount of sugar in their juice boxes.

Q: In this paper you were looking at mergers and how those can affect whether disruptors can get in the market. Would you talk about that?

Let’s imagine that there’s a disruptor that arrives in a particular market and is stealing away customers from the incumbent firms. One of those incumbent firms might want to purchase the disrupting entrant, because by purchasing them, they then control that business model. They could either shut it down, or they could make it more similar to their business model, or they could keep it, because they think maybe it has a future, but they could raise its price, so it doesn’t cannibalize the old business model quite so much.

All of those things are reducing the options for consumers. They’re either raising prices, reducing choice, or lessening the competition between the incumbent and the disruptor. So it’s of concern. Any merger requires evaluation, but a merger between a disruptor that’s creating great benefit for consumers and an incumbent is one where we’re particularly cautious.

Q: What’s an example of this dynamic?

If you thought about the proposed AT&T-T-Mobile merger, there you had T-Mobile disrupting with a number of innovations. They were the first Android handset, for example. They did the first handset where you could connect straight to Facebook. They were being disruptive on the pricing front, too, because they needed customers.

After the merger was blocked, the pricing disruption became more clear, as you saw T-Mobile offering things like free international roaming or unlimited data plans. And these kinds of moves are the sort of effective price decline that intensifies price competition and makes consumers say, “My existing plan isn’t offering free international data. Maybe I should be switching.”

Q: How contentious is your perspective on protecting innovation?

I would say there’s a narrative out there that says that monopolists innovate, and that, I think, is part of the social-cultural baggage we inherited from Xerox PARC and AT&T’s Bell Labs, much of which was extremely important. I think those examples loom large, and what were they due to? They were due to the monopolists having so much profit that they could just run a little innovation center, kind of like a mini-university. And that’s great as far as it goes, but you’re not weighing that against the tremendous other problems that come with being a monopolist, and the price and quality and innovation in the product itself.

What we see in more controlled environments where, for example, trade barriers fall and a country’s producers are exposed to more competition, is actually that competition stimulates more innovation.

Q: The monopolists kind of innovate at their leisure.

They innovate at their leisure, that’s right.

Q: What do you see as the effective remedies when considering these kinds of mergers? 

The way to take innovation into account in merger review is known. We do it. We look for documents. We look for examples of the firms competing on this dimension already. I don’t think it’s necessary to change practice. We wrote the paper mostly to remind people what an important part of consumer welfare innovation is, because when you look at the macroeconomic literature, huge growth in standards of living can come from innovation—new ways to make engines in a car, for example. Let’s make an electric car. Let’s invent an airbag. So standards of living really are driven by technological innovation. And so we need to be sure, as we do merger review, that we are watching that element of competition very closely, and weighting it in accordance to its importance to consumers.

Q: You also wrote a paper about markups. Why was that?

The paper on markups arose because there’s an increasing macroeconomics literature that documents the rise over the last 40 years of markups in the economy overall. What do I mean by a markup? Price over marginal cost or variable cost. In the case of software, say, variable cost is almost zero, and it’s all the fixed cost of inventing it. If we’re talking about this table, there’s some fixed cost of setting up the factory and the design and so on, but then there’s variable cost in the metal and the plastic and the composites and so on in the table.

Why have markups been rising? The literature points to the highest-markup firms having yet higher markups, and those are coming from very low variable cost—digital products and pharmaceuticals and so on—and then potentially other explanations, such as insufficient competition to drive prices down. The paper tries to divide the interpretation of rising markups into, basically, those two groups—good markups and bad markups. Good markups come from the fact that people want medications, people want websites. To make a nice website you have to pay a website designer and a programmer to create it—that’s a fixed cost. But once you’ve created it, many, many people can visit it at low cost each, and that creates a very high markup.

That kind of high markup is not a competition problem; it’s the nature of the good that the consumer wants, and often the higher fixed cost is a sign of quality. That is to say, a better designed webpage, a more effective drug, a more innovative car—those might all have higher fixed costs to create.

But then there’s a set of markups that we might say are the problem markups, and these come from prices rising not to cover the fixed cost, but because there is not enough competition. So I make a car, but then there isn’t another car maker to compete with, and therefore the price gets even higher.

Markups that come from insufficient competition might in turn be generated by insufficient antitrust enforcement—competition authorities that are not keeping up with the economy and new products and learning how to enforce in those areas. These markups might also come from rent-seeking behavior in areas like intellectual property, licensing, deregulation. If those processes are captured by the firms themselves, they can end up writing very favorable rules, and then there’s very high markups in those places.

So the paper really walks through a number of these explanations, and the broad conclusions are that quite a bit of the rising markups is probably due to things we would consider good or at least neutral. But we’re also concerned that rising markups might also be driven by insufficient competition enforcement, and that, luckily, is something that we actually know how to fix. We could have stricter laws, we could put more effort into it, and that might really bring markups down that are the wrong kind of markup.

Q: So who’s on your naughty list? What makes for a bad markup?

The bad markups are, well, anti-competitive conduct, firms that exclude, mergers that are anti-competitive. There are also issues around, say, occupational licensing. Many, many states use occupational licensing as a way to create entry barriers into a profession. So do we really need an occupational license for dog shampooers and dog massages, and if we need it, what is the minimum amount of hours and training that’s required for health and safety, as opposed to creating a barrier to entry to a skilled person who is otherwise good at washing dogs?

Q: And are there differences across industries? 

Yes. For example, automobile retailing. Auto dealers are licensed by the state and the manufacturer. Manufacturers are not permitted to sell direct if they have licensed dealers. The dealers make a lot of profit from the fact that they can keep out other entrants. There are lots of ways in which the dealer license protects the dealer and makes the price of cars higher.

Q: What’s the connection between this and the innovation paper? 

One thing you see is innovation and copying—then you get a competition that drives down prices. But if I’m innovating to the right and you’re innovating to the left, then we’re differentiated, and that differentiation is going to appeal to different segments of people. And so while we’re competing, we’re competing much less intensely than if we were doing the same thing. If I sell a bushel of wheat and you sell a bushel of wheat, many consumers will be willing to trade off those things. If I sell a Tesla and you sell a Ford, those are quite different vehicles, and we might be appealing to different kinds of people with those vehicles.

The reason it matters that we’re appealing to different kind of people is that then that means that the return to the innovation is because I’m so different. I maintain my markup because I don’t have price competition from another vehicle. Now maybe there’s a vehicle that gets introduced that runs on a fuel cell, and that’s an exciting vehicle and that competes with the Tesla, but that excitement of pushing technology forward is, again, beneficial to consumers.