Articles by Jerry Ellig

Jerry Ellig is a senior research fellow at the Mercatus Center at George Mason University. He has also served as deputy director of the Office of Policy Planning at the Federal Trade Commission and as a senior economist at the Joint Economic Committee of the US Congress.


Regulatory Whack-a-Mole

by on November 11, 2009 · 0 comments

If you have any credit cards, you’ve probably received notices recently that your credit card company is going to do you some wonderful favors, like apply payments to the balances carrying the highest interest rate first. These same notices also contain changes in other contract terms that might make you worse off. One of mine, for example, tells me that henceforth my annual percentage rate on purchases will be the prime rate plue 11.99 percent, with a minimum of 17.99 percent. The company tells me this is higher than my old fixed rate. (I don’t know what it was, since I never use credit cards to borrow.)

These changes are the result of new federal regulations that were supposed to make credit card companies give us a break on certain terms and conditions. But since all of the terms and conditions of the credit card contract are not comprehensively regulated, the companies can adjust other terms to make up for the money they lose as a result of the mandated regulatory changes. Some scholars call this “term substitution.”  I call it “regulatory whack-a-mole,” after that carnival game in which you whack a mole that pops up out of a hole only to have another mole pop up out of another hole.

What does this have to do with technology policy? Term substitution is a pervasive feature of reality whenever regulators regulate some, but not all, aspects of a transaction. Since technology markets are not comprehensively regulated like public utilities, we can expect to see term substitution all over the place in technology markets in response to regulatory mandates.

If you want to find term substitution in technology markets, think of transactions that are only partially regulated: 

  • If wireless companies couldn’t charge early termination fees, we’d pay more for phones.
  • The last time the federal government tried to regulate “basic” cable rates (for your local broadcast and public affairs channels), rates for “expanded basic” and premium channels went up. 
  • Casket sales have also experienced term substitution. Responding to low-priced Internet competition and federal regulations that allow consumers to BYOB (bring your own box), funeral directors simply reduce casket prices and increase the price they charge for their services.
  • Net neutrality regulation might have this kind of effect, if it prevents network operators from charging high-bandwidth users different prices from low-bandwidth users. Forcing them to charge everyone the same, unregulated price could mean the low-bandwidth users pay more than they otherwise would.

I’m curious to hear more actual examples from readers of term substitution in technology markets.  What’s the most interesting thing you’ve seen?

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Did the White House review net neutrality regulations?

by on November 4, 2009 · 2 comments

As someone who follows the federal regulatory process, I was amazed to see this in a recent American Spectator post about White House technology advisor Susan Crawford’s return to the University of Michigan Law School:

But White House sources say that she ran afoul of senior White House economics adviser Larry Summers, who claimed he and other senior Obama officials were unaware of how radical the draft Net Neutrality regulations were when they were initially internally circulated to Obama administration officials several weeks ago … In the end, the proposed regulations were slightly moderated from the original language FCC chairman Julius Genachowski, a Crawford ally, circulated.

Unlike regulatory agencies that are considered part of the executive branch, the Federal Communications Commission is an “independent” regulatory agency — which means the president cannot fire its five commissioners. Before executive branch agencies can propose a regulation, it must be reviewed by the Office of Management and Budget’s Office of Information and Regulatory Affairs (OIRA). No administration has yet tried to bring independent agencies like the FCC under OIRA review.

Typically, congressional and private watchdogs scream bloody murder when they see the White House trying to influence independent agencies. But I haven’t heard any barking about this one.

Personally, I think independent agencies’ regulations should be subject to OIRA review. I don’t mind letting the president and his advisors have their say on regulations proposed by people he appointed. But I’d like to see it happen through the formal OIRA review process, where the public knows it’s happening and knows what the rules are.

For example: If you want to know which proposed regulations OIRA has reviewed, go here.  If you want to know the standards OIRA uses to review regulations, go here. If you want to know what outside parties have met with OIRA to discuss regulations, go here.

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A tisket, a tasket, no Internet casket

by on October 27, 2009 · 4 comments

Polvo Somos...
Creative Commons License photo credit: Gonzalo Fernández

Die-hard Halloween fans can find a hearse-load of ghoulish party supplies on the Internet, from Freddie Krueger window silhouettes to a severed arm that hangs from a car trunk. You could even order a casket; maybe use it as a beer cooler. 

One casket hawker on eBay named morbid611 boasted, “Will make a great Halloween prop and even keep it around the house and have fun with it when you have company over [!]  When your neighbors have their cardboard caskets or home made bulky looking box caskets they won’t be able to compare to your real casket.” (Emphasis added. In case you’re curious, the winning bid was $285.)

Unfortunately, in my home state of Virginia, it’s questionable whether I can order one via the Internet. That’s because Virginia is one of  a handful of states that prohibit anyone other than licensed funeral directors from selling caskets. I’m not sure how strictly this prohibition is enforced, though. Some online casket sellers claim they will ship anywhere, but Costco’s casket supplier won’t ship to Virginia.

The evidence is mixed on whether these restrictions increase overall funeral prices. In a 2008 study published in the Journal of Law & Economics, Judith Chevalier and Fiona Scott Morton found that funeral directors who face competition from independent casket retailers simply lower their casket prices and increase their prices for other services by about the same amount.  But the funeral directors’ casket prices still don’t match online prices.  The authors calculate that a simple funeral with a wooden casket would cost about $360 less if the customer purchased the casket online.

Dan Sutter, in an article published in the Journal of Law, Economics, and Policy in 2007, reached similarly mixed conclusions. He found that casket sales restrictions do not affect average receipts per death in the funeral industry (one measure of funeral prices). However, three states that had their casket sales restrictions invalidated by federal courts saw receipts per death fall more rapidly between 1997 and 2002 than states where these regulations remained in effect. In a 2005 study published in the Journal of Private Enterprise, Sutter found that Oklahoma funeral homes charged an average of 68 percent more than an Oklahoma-based Internet retailer charged for the same caskets.

It’s clear that consumers could save money by buying caskets online. Since not many consumers do, researchers have not found that the online competition has reduced funeral directors’ overall revenues in states where this competition is legal.

But this may change over time. Personally, I plan to haunt my family mercilessly if they end up drinking cheap booze at my wake because they overpaid for my casket!

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No wine from Amazon for now

by on October 27, 2009 · 0 comments

A recent article by Lisa Carley in the New York Wine Examiner reports that Amazon is suspending plans that would have allowed wine producers to sell direct to consumers.  The culprit? State regulations:

One of the main reasons why this program has been put on hold is the complexity of wine-shipping laws within the United States, and that fact that the major wholesalers spend millions of dollars on the state level to keep it difficult for the consumer to have access to wine they want at good prices.

About 35 states permit some form of direct shipment to consumers, but laws vary greatly. In Virginia, consumers can order wine from any winery or retailer licensed in any state, as long as the seller registers with the state of Virginia and collects taxes. In Maryland, direct shipment of wine to consumers is still a felony. Montana limits the total amount of wine any consumer can order to 12 cases per year, which means most wineries won’t ship there because an individual winery has no way of knowing how much wine the consumer has ordered from other sellers. I’m not making this stuff up; check the Wine Institute’s compendium of state laws.

In several studies, Alan Wiseman and I found that consumers can enjoy significant savings on higher-priced wines if they order online.  (The savings disappear for wines priced under $20 per bottle because of shipping costs.) The Internet also gives consumers access to wines that they might not find by simply walking into a store.   

It would be a shame to see Amazon’s idea die. Currently, a winery or retailer that wants to ship directly to consumers has to figure out and comply with each state’s laws. It makes a lot of sense that a single retail sales portal could consolidate and continuously update this information, then set up a system that lets any seller market its wine direct to consumers in states where that’s legal, in compliance with all state laws.

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Artificial sweeteners

by on October 21, 2009 · 2 comments

Anti-technology urban legends abound in regard to food.  The historical record includes butter producers who wanted to ban margarine and straight whiskey producers who wanted blended whiskey that contained fewer toxins to be labeled “imitation whiskey.”  Looks like the chatter about artificial sweeteners being more harmful than sugar can finally be laid to rest; check this out.

Serving suggestion: The article in the link in the sentence above says that saccharine has a metallic aftertaste.  Not in all applications, though. I’ve found that if I substitute saccharine for simple syrup in tiki drinks, the alcohol and tart fruit juices completely mask the aftertaste.

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A positive agenda to promote sustainable net neutrality

by on October 21, 2009 · 0 comments

I like the idea of having a neutral Internet that allows me to go where I want to go and read what I want to read, all for the price of my monthly subscription.  Sure, it took me awhile to figure out why anyone would want to access skype on an iphone (after all, an iphone is already a phone!), but now I can see why some people might enjoy making free international calls without having to plop down in front of the ol’ PC wedged into the guest bedroom.

At the same time, I don’t see a pressing need for regulation to ensure that we get whatever degree of neutrality is practical. Even in his speech announcing that he would propose net neutrality rules, FCC Chairman Genachowski could cite only the same three old anecdotes that have been tirelessly trotted out by others as proof that new regulation is required.  Sure, by Washington standards, that’s two more anecdotes than are usually required to justify issuing a regulation. But it’s hardly proof of a broad, systemic problem that requires new rules (as Jerry Brito and I argued here.)

Nevertheless, as the saying goes, “You can’t beat something with nothing.”  So I suggest a positive agenda to promote sustainable net neutrality. 

Many of the arguments for a non-neutral net are based on the assumption that last-mile bandwidth is, at least sometimes, congested — or may soon become that way as people use more bandwidth-intensive applications. One solution is for the network operator to prioritize some packets over others, so if I have a heart attack, my wife’s VOIP call for an ambulance doesn’t get crowded out by the neighbor’s kid playing video games with his buddies in Australia.  Another solution, though, is to make sure the network operators have adequate ability and incentive to build plenty of bandwidth. As an economist, I understand that some network management or usage-based pricing might be less expensive for consumers than building massive bandwidth. But that’s no reason to persist with policies that artificially constrain bandwidth. 

For wired broadband, a positive agenda to promote sustainable net neutrality means avoiding regulations that impair incentives for investment that increases the capacity of the last-mile network. For wireless broadband, that means freeing up more spectrum to be auctioned for commercial wireless services.  

And while you’re at it, FCC, maybe you can do something about the NIMBY problem that prevents me from receiving a decent 3G broadband signal in my house.  Now that would expand last-mile bandwidth and promote competition to boot!

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Dynamic Competition and Antitrust

by on October 14, 2009 · 0 comments

If you read nothing else this year about dynamic competition theory and antitrust, check out this recently-released paper by J. Gregory Sidak and David J. Teece, available from SSRN. Sidak and Teece explain why the current economic framework that formally underpins antitrust insufficiently accounts for “Schumpeterian,” “innovative,” or “dynamic” competition. They provide a good discussion of the insights from behavioral economics, evolutionary economics, Austrian economics, and corporate strategy that would be useful in remaking the economic foundations of antitrust. Then they explain implications for specific topics, such as market definition, defining potential competitors, mergers, and intellectual property.

Most intriguing is their claim that the antitrust agencies have been drifting toward dynamic competition analysis without always acknowledging that’s what they’re doing:

If a lesson can be generalized, it is that one should approach with considerable skepticism the august pronouncements of the suppleness of existing antitrust doctrine to accommodate consideration of dynamic efficiency. It is time for the antitrust enforcement agencies and the courts to address forthrightly the challenge of developing more dynamically efficient merger guidelines. Achievement of that goal would lay the foundation for an analogous refinement of substantive rules of liability, defenses, and remedies across antitrust law generally. (pp. 43-44)

Sidak and Teece note that the Federal Trade Commission and Antitrust Division’s recent solicitation of comments on their merger guidelines could provide an opportunity to articulate some new economic foundations for antitrust. After reading the list of things the FTC and DOJ do not intend to change, it looks to me like the agencies will cling pretty fiercely to many traditional static concepts used in antitrust analysis.  But two questions they raise provide glimmers of hope:

8. Should the Guidelines be revised to explain more fully … how market shares and market concentration are measured and interpreted in dynamic markets, including markets experiencing significant technological change?

15. Should the Guidelines be updated to address more explicitly the non-price effects of mergers, especially the effects of mergers on innovation?

Still, this seems narrow to me. “Normal” markets will remain subject to static analysis, while those special markets experiencing significant technological change might be analyzed differently.  That seems to define dynamic competition awfully narrowly.

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Will the FCC regulate wireless phone rates?

by on September 30, 2009 · 4 comments

Today is the filing deadline in a somewhat unusual Federal Communications Notice of Inquiry that asks how the commission should revise its framework for evaluating competition in mobile wireless communications. Among other things, the FCC asks how it should measure wireless companies’ profits. It’s clear from an earlier public notice issued by the FCC’s Wireless Bureau that regulators are looking for a way to identify “abnormal” profits that might justify new regulation.

For 13 years, Congress has required the FCC to issue annual reports on wireless competition.  These reports have usually found that wireless is pretty competitive by most conventional measures. There are now four national competitors, numerous regional ones that are growing larger, and a bunch of resellers.   The FCC’s most recent report provides numerous examples of innovation in technology, pricing, and services. 

About the only fly in the ointment is federal policies that severely limit the amount of spectrum allocated for “flexible use.”  Limits on the amount of flexible use spectrum are like taxi medallions: they hinder entry and  limit the amount of service the wireless firms can offer.

Nevertheless, the wireless industry’s performance has been impressive. Adjusted for inflation, average revenue per minute fell by 87 percent between 1997 and 2007, and average voice revenue per minute fell by 90 percent.  Just during the last five years, inflation-adjusted average revenue per minute fell by 53 percent, and average voice revenue per minute fell by 61 percent.

Could regulation improve on these outcomes? In our comments to the FCC, Jerry Brito and I offer a little thought experiment.  Suppose the wireless industry were subject to enlightened, highly efficient, and perfectly operating price regulation. Specifically, suppose the FCC had mandated a version of “incentive” regulation that allowed the wireless companies to increase their prices by no more than the rate of increase in the consumer price index minus an annual 7 percent offset to reflect increased productivity. (Seven percent is the highest productivity offset we’ve seen any telecommuncations regulator in the U.S. use in any context.) Would this be better or worse than what the market actually produced?

Wireless market vs incentive regs

This graph shows the answer.  If wireless had been subject to incentive regulation, even a 7 percent productivity offset would have reduced wireless revenue per minute by only 36 percent since 1997 and by 19 percent since 2002.  In other words, the lightly regulated wireless market produced price reductions nearly 2.5 times as large as those that could have been expected under severe, highly efficient, perfectly operating regulation. And these results measure only the price effects, not the explosion of innovation that accompanied the price reductions.

Would the results have been even better if more spectrum were available for wireless services?  Probably. But beyond that step, it’s doubtful that regulators could have done much else to improve on the 90 percent price reduction we’ve seen in the past decade.

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Grills! Grills! Grills! … Surprisingly Free!

by on September 29, 2009 · 0 comments

Technological change confers enormous benefits, even for those of us who do not rush out to buy the latest  neat new thing.  Here’s one example.

I like to grill. I own four barbecue grills and three smokers. We got one smoker as a wedding present, but the rest were bestowed free of charge by the progressive forces of technological change.

OK, no bestowing was involved; I fished them out of neighbors’ trash.  This model on the right was considered the iPhone of barbecue grills when it was introduced in the 1950s, and not just because it was a hot wireless device.   Before then, most grills were topless — which let wind, rain, snow, etc. wreak havoc with whatever was on the barbie.  George Stephen of Mt. Prospect, IL, cut a buoy in half, and the Weber grill was born.  According to one authoritative web site, “American grillers now had a way to protect their steaks and burgers from the wind and rain, and the lid also sealed in a moist and smoky new flavor.”  I know from personal experience it also works in a snowstorm.

By the way, that was once a $400 piece of equipment.  Weber grills cost $50 when they were introduced in the 1950s — which is equivalent to $400 today when adjusted for inflation.  I’m sure by the time the previous owner bought it, improvements in manufacuring methods brought the retail price down; this basic one now costs less than $100 new.  But it became mine — surprisingly free! — when its previous owner upgraded to the next big innovation, a gas grill.

So we all have a steak in innovation — even those of us who still drive cars with manual locking doors and only use our cell phones for conversation!

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Escaping cell phone early termination fees

by on September 11, 2009 · 3 comments

Did you know you can escape the early termination fee in your wireless contract simply by getting someone else to take over the contract? I discovered this little gem recently while reading the Federal Communications Commission’s 2008 report on competition in the wireless industry , released earlier this year (mentioned in paragraph 186, if you’re curious).

Cell phone companies charge early termination fees of up to $200. They charge these fees because they usually sell phones at subsidized prices and then get reimbursed over the life of the contract via the monthly fee. If someone else takes over my contract, the company still gets its money, so they’re OK with the practice of transferring the contract to someone else.

Consumer writers such as David Wood and Patrick at cashmoneylife.com explain how to transfer your contract to someone else.  Web sites  match up people who want to get out of their contracts with people who want to take over these contracts.  Some web sites offer to put parties in touch with each other for free.  Others charge $20 — far below the typical early termination fee. 

Score another victory for wily entrepreneurs who invented a win-win solution that benefits consumers and wireless phone companies as well. The Federal Communications Commission report cites 2006 and 2007 Wall Street Journal articles on this, so it’s not exactly a secret.  (I was unaware of it until now only because my wife and I use 5 year old cell phones, so we’ve been on a month-to-month wireless contract for years and have never had to look for a way around the early termination fee.) 

But for the past several years, federal legislators have been pushing wireless companies to prorate their early termination fees, supposedly because consumers have no choice but to pay the fee if they want to get out of a contract before it concludes.  In October 2007, I testified before the Senate Committee on Commerce, Science, and Transportion on a piece of legislation called the “Cell Phone Consumer Empowerment Act.”  The bill included a requirement that wireless companies prorate their early termination fees.  Apparently to head off the legislation or FCC regulation, the day before the hearing, AT&T announced it would follow Verizon’s lead and prorate its early termination fees; other major carriers followed suit. Sen. Amy Klobuchar (D-MN), sponsor of the legislation, took credit for the change, thanking AT&T for beginning the fee prorationing on her birthday.

When wireless companies prorate fees, they usually reduce them by $5 per month. Trading my contract, on the other hand, lets me escape the fee altogether.  So who got me a better deal — the federal government, or a pack of entrepreneurs I’ve never met?

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