Blackboard economics at FTC

Antitrust regulators are at it again. The Federal Trade Commission remains under the sway of what Nobel Prize-winner Ronald Coase referred to as “blackboard economists,” theorists who have little understanding of the reality of dynamic competition. Antitrust regulators see our economy in the simplistic terms of static equilibrium. Their view of competition, in which homogenous firms offer standardized prices uniformly to all consumers at similar prices, has little to do with our rapidly changing economy. This thinking was on display in the FTC's recent failed attempt to block the merger between organic food retail giant Whole Foods with one of its major competitors, Wild Oats. Fearing Whole Foods CEO John Mackey sought to dominate the market (and, apparently, indiscreetly saying so in some online forums), the FTC argued that prices were lower in cities where both stores operated, and therefore competition needed to be “protected.” Fortunately, the judge hearing the case saw through this nonsense and denied the FTC request. To the FTC, the market is a static, fragile flower that must be protected by wise regulators. Yet the purpose of markets is not simply to provide established goods at reasonable prices but to encourage continuous innovation, for entrepreneurs to find new consumer wants and needs, and fulfill them as swiftly as possible. Whatever the merits of organic foods — which may be dubious — affluent urban consumers have made natural foods a highly profitable business. And the FTC should be seeking to maximize consumer welfare whether the product is a new car or an organic carrot. The FTC defines the “relevant market” as a set of firms that “most people” see as “competing” with one another. High-end organic food stores cater to a niche market of relatively affluent urban professionals. But as conventional supermarkets like Safeway or Kroger start offering organic foods — and sell the same type of food at lower prices — some consumers will switch. Some will remain loyal to Whole Foods, and possibly be willing to pay more for the ambience, but few of their guests will care to which store they went when they proudly proclaim, “It's organic.” Antitrust theory ignores the permeability of the boundaries of all markets. True, the first company to break into a market can charge higher prices and realize higher profits. After all, it takes time for established competitors to adapt to meet a newcomer's challenge. And the changes are obvious even to a casual observer — witness traditional supermarkets' adoption of organic foods. But potential new competitors are always waiting in the wings. Perhaps most troubling is the FTC's excessive focus on consumers in already served markets, at the expense of consumers in underserved areas. Innovations like the organic supermarket diffuse only slowly, reaching underserved areas only in time. Until the local Whole Foods store opens, there isn't much hope of enjoying benefits. Yet the welfare gains of underserved consumers is of little concern to the FTC. As another economist noted long ago, the hope for extraordinary profits lures the entrepreneur along the risky paths to the future. If fewer stores in an area mean higher profits, the rate of the stores' diffusion may well increase. The decisions of the court to reject the FTC's ill-advised request means American consumers will continue to benefit until <?xml:namespace prefix = st1 ns = “urn:schemas-microsoft-com:office:smarttags” />America is saturated with organic food stores. And while that may be a politically correct trend, it's not a bad thing. Antitrust regulators have ignored the market's diffusion potential before. During the 1990s, similar clucking greeted the rapid expansion of office supply superstores like Staples and Office Max. We will see such reactions again. Perhaps, the next innovator won't face this same problem — even federal bureaucrats can learn in time.