The Economics of Antitrust: Is Google Violating the Consumer Welfare Standard?

January 14, 2021 | Daniel Mathew

Edited by: Gabriela Baghdady

The United States Department of Justice and 20 state attorneys general filed a lawsuit against Microsoft Corporation in May 1998, on the grounds that it had unlawfully suppressed competition to safeguard its monopoly on software [1]. Four months later, Stanford graduate students Larry Page and Sergey Brin launched Google, LLC out of a garage in a San Francisco suburb [2]. The arguments advanced in the litigation against Microsoft, which in 2002 culminated in a settlement in which Microsoft agreed to alter some aspects of its commercial behavior, would parallel the complaints outlined by the Justice Department in its civil antitrust lawsuit against Alphabet Inc.’s Google two decades later. What are the defining statutes of American antitrust law, and in what ways does the Justice Department allege Google has breached them? Is Google still a monopoly if their search services are free and competing providers are just a click away? Is it ever acceptable for the government to allow a company to maintain monopoly power? This article aims to: address these and similar questions in light of the central and authoritative documents governing antitrust law in the U.S.; articulate the standard of consumer welfare as a litmus test for deciding whether it is in society’s best interest to sanction monopoly power in certain situations; and suggest how economics could help policymakers determine when the government should prevent— and when it should encourage— firms from amassing market power.

On Tuesday, October 20, the Department of Justice sued American multinational technology company Google, LLC for violating antitrust laws, claiming that the firm “maintains its status as gatekeeper to the internet through an unlawful web of exclusionary and interlocking business agreements that shut out competitors” [3]. According to a statement released by Attorney General William Barr, Google’s use of its monopoly power to “lock up key pathways to search on mobile phones, browsers, and next generation devices” has stymied competition and harmed “users, advertisers, and small businesses in the form of fewer choices, reduced quality (including on metrics like privacy), higher advertising prices, and less innovation” [4]. The complaint hinges on Section 2 of the Sherman Antitrust Act, which outlaws any attempts to “monopolize, or combine or conspire with any other person or persons” [5]. With little to no legal precedent to inform the courts on how to adjudicate the case against Google, its outcome will prove immensely influential and relevant to later antitrust lawsuits against Big Tech companies. Future courts will inherit answers to the question of what steps they should take, if any, to curb the influence of tech giants which have the power to restrict privacy, regulate information flows, and even shape political discourse. However, before delving into the details of the case, an overview of U.S. antitrust law and the economics underlying its rationale are in order.

Antitrust law, sometimes referred to as competition policies outside the United States, are laws designed to promote competitive markets by restricting firms from behaviors that limit competition. From a policy standpoint, these laws exist to protect consumers from economic harms caused by monopolistic firms, which have the ability to restrict production of goods and services and thus artificially increase their market price [6]. According to the Federal Trade Commission, antitrust laws are intended to “protect the process of competition for the benefit of consumers, making sure there are strong incentives for businesses to operate efficiently, keep prices down, and keep quality up” [7]. These laws regulate and prevent monopolies— markets that are served by only one firm— but also apply to a range of other market structures characterized by imperfect competition. This includes  oligopolies— markets defined by competition among a small number of firms— which may have steep and numerous barriers to entry, such as extreme scale economies, switching costs, product differentiation, and control of key inputs. The Federal Trade Commission, which shares the power to investigate antitrust claims with the Department of Justice, derives its authority from the Federal Trade Commission Act. Along with the Sherman Antitrust Act of 1890 and the Clayton Antitrust Act, these laws form the foundation of antitrust jurisprudence in the United States. The legislation leaves the courts with ample room for interpretation and aims to “protect trade and commerce against unlawful restraints and monopolies” [5].

(Intended) Effects of Antitrust Regulation in a Typical Monopolistic Industry

The monopolist’s profit-maximizing quantity occurs where the marginal revenue curve intersects marginal cost (as shown on the left). Antitrust law, in theory, is enforced to produce an increase in consumer surplus by introducing competition into a market, thereby lowering the equilibrium price and increasing equilibrium quantity

From an economic standpoint, antitrust law is justified by invoking the standard of consumer welfare and provides a metric for appraising the social desirability of pursuing antitrust action against monopolistic firms. Consumer welfare refers to the individual benefits derived from the consumption of goods and services [8]. In practice, applied welfare economics uses the notion of consumer surplus— defined as the difference between the price consumers would be willing to pay for a good and the price they actually have to pay— to measure consumer welfare, and thus the terms are used interchangeably in this piece. Industries such as monopolies or oligopolies inevitably end up with few competitors and substantial market power, raising the profit-maximizing markup price and decreasing the optimal output level. These firms’ ability to influence the market price of their products yields higher producer surplus levels and lower consumer surplus levels compared with competitive outcomes, and also leads to deadweight loss resulting from unrealized consumer surplus due to pricing above the marginal cost. The standard of consumer welfare, for its part, suggests that the government should only enforce antitrust laws when doing so is likely to increase net consumer surplus. Stated otherwise, intervention in the free market for antitrust purposes is only justified if such intervention would substantially bring down prices and increase consumption, decreasing deadweight loss and allowing consumers to recoup lost surplus. The question, then, is not whether Google has accrued outsize market power; according to the complaint filed by the Justice Department, Google accounts for “nearly 90 percent of all general-search-engine queries in the United States, and almost 95 percent of queries on mobile devices” [9]. (Compare this to the definition of perfectly competitive firm, which is a firm whose relatively small size in the market constrains it to take prices as given and which thus caters to just a small fraction of the total market). With its flagship search engine pre-installed via exclusivity agreements on roughly 40% of U.S. smartphones, that Google has acquired monopolistic proportions goes without saying [10]. However, whether or not dismembering Google or otherwise curbing its market power will lead to significant increases in consumer surplus is less clear.

The Justice Department’s allegations of Google’s anti-competitive tactics can be summarized by the following complaint: Google’s entering into exclusivity agreements that require companies to pre-install its search engine as the default option on their devices and browsers has created a “continuous and self-reinforcing cycle of monopolization,” which has directly harmed consumers by “reducing the quality of search (including on dimensions such as privacy, data protection, and use of consumer data), lessening choice in search, and impeding innovation” [11]. Google’s response, as expressed by chief legal officer Kent Walker, is that “[p]eople use Google because they choose to—not because they’re forced to or because they can’t find alternatives” [12]. In other words, Google does not violate Section 2 of the Sherman Act since it does not preclude consumers from choosing another search service. Moreover, Google counters the Justice Department’s claims by pointing to the fact that its search services are free, implying that antitrust litigation would be unlikely to lead to major increases in consumer surplus. “Google’s defense against critics of all stripes,” an article published by the Wall Street Journal observes, “has long been rooted in the fact that its services are largely offered to consumers at little or no cost, undercutting the traditional antitrust argument centered on potential price harms to those who use a product” [10]. Critics counter that producer benefits should also be considered in the cost-benefit calculus of the consumer welfare metric, and that a lack of robust competition per se is sufficient grounds to authorize antitrust action [13].

The Sherman Antitrust Act of 1890 Section 2, 15 U.S.C. § 2

Every person who shall monopolize, or attempt to monopolize, or combine or conspire with any other person or persons, to monopolize any part of the trade or commerce among the several States, or with foreign nations, shall be deemed guilty of a misdemeanor, and, on conviction thereof; shall be punished by fine not exceeding five thousand dollars, or by imprisonment not exceeding one year, or by both said punishments, in the discretion of the court.

Unless the parties reach a settlement, the outcome of the case will likely not be known for several years, during which time the U.S. judicial system will be tasked with evaluating the Department of Justice’s claims of anti-competitive practices and a monopolistic grip over the search market against Google’s defense that the traditional antitrust arguments do not hold since the company offers its search services at no charge. Adjudicators should be wary of purported metrics of harm that rely on counterfactual assumptions about what might have been if Google did not enjoy dominance in the search market. They should consider the fact that despite its market power, its pricing strategy permits users to derive maximized consumer surplus while obtaining producer surplus for itself through its advertising services and cloud-related businesses, such as the Google Cloud Platform. At the same time, the courts should aim to deliver a verdict that promotes a competitive outcome that acknowledges the fact that the great strides in technological innovation achieved in the last half-century would not have been possible without a business ecosystem generally free from barriers to entry and other constraints of concentrated market structures. For all we know, a more competitive search market may be all that stands between us and the next Google.

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Citations

1 “Microsoft Chronology.” The Wall Street Journal. December 22, 2004. Accessed December 27, 2020. https://www.wsj.com/articles/SB110373497059307218?mod=article_inline.

2 Bellis, Mary. “Google: The Story Behind One of the Richest Companies in the World.” ThoughtCo. Accessed December 27, 2020. https://www.thoughtco.com/who-invented-google-1991852.

3 Tracy, Ryan. “Big Tech’s Power Comes Under Fire at Congressional Antitrust Hearing.” The Wall Street Journal. July 29, 2020. Accessed December 27, 2020. https://www.wsj.com/articles/tech-ceos-defend-operations-ahead-of-congressional-hearing-11596027626?mod=article_inline.

4 “Statement of the Attorney General on the Announcement Of Civil Antitrust Lawsuit Filed Against Google.” The United States Department of Justice. October 20, 2020. Accessed December 27, 2020. https://www.justice.gov/opa/pr/statement-attorney-general-announcement-civil-antitrust-lawsuit-filed-against-google.

5 “Transcript of Sherman Anti-Trust Act (1890).” Our Documents – Transcript of Sherman Anti-Trust Act (1890). Accessed December 27, 2020. https://www.ourdocuments.gov/doc.php?flash=false&doc=51&page=transcript.

6 Chen, James. “Understanding Antitrust Laws.” Investopedia. September 16, 2020. Accessed December 27, 2020. https://www.investopedia.com/ask/answers/09/antitrust-law.asp.

7 “Federal Trade Commission Act.” Federal Trade Commission. December 14, 2018. Accessed December 27, 2020. https://www.ftc.gov/enforcement/statutes/federal-trade-commission-act.

8 Directorate, OECD Statistics. OECD Glossary of Statistical Terms – Consumer Welfare Definition. Accessed December 27, 2020. https://stats.oecd.org/glossary/detail.asp?ID=3177.

9 “Justice Department Sues Monopolist Google For Violating Antitrust Laws.” The United States Department of Justice. October 21, 2020. Accessed December 27, 2020. https://www.justice.gov/opa/pr/justice-department-sues-monopolist-google-violating-antitrust-laws.

10 Kendall, Brent, and Rob Copeland. “Justice Department Hits Google With Antitrust Lawsuit.” The Wall Street Journal. October 21, 2020. Accessed December 27, 2020. https://www.wsj.com/articles/justice-department-to-file-long-awaited-antitrust-suit-against-google-11603195203?mod=searchresults_pos14&page=1.

11 Tracy, Ryan. “After Big Tech Hearing, Congress Takes Aim but From Different Directions.” The Wall Street Journal. July 30, 2020. Accessed December 27, 2020. https://www.wsj.com/articles/after-big-tech-hearing-congress-takes-aim-but-from-different-directions-11596149053?mod=searchresults_pos14&page=2.

12 Board, The Editorial. “Opinion | Google in the Antitrust Dock.” The Wall Street Journal. October 20, 2020. Accessed December 27, 2020. https://www.wsj.com/articles/google-in-the-antitrust-dock-11603236357?cx_testId=3&cx_testVariant=cx_4&cx_artPos=4#cxrecs_s.

13 “Introductory Remarks of Deputy Attorney General at Announcement of Civil Antitrust Lawsuit Filed Against Google.” The United States Department of Justice. October 20, 2020. Accessed December 27, 2020. https://www.justice.gov/opa/speech/introductory-remarks-deputy-attorney-general-announcement-civil-antitrust-lawsuit-filed.

Photo Credit: Times Newspapers Limited 2021.