Podcast: Why There Is a Disconnect Between the Economics of Innovation and U.S. Antitrust Policy, With David Teece

October 4, 2021

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Antitrust policy should favor dynamic, innovation-driven competition, yet antitrust regulators generally don’t see it that way. Why is that? Rob and Jackie sat down recently with David Teece, the Thomas W. Tusher Professor in Global Business at UC Berkeley’s Haas School of Business, to discuss the intersection of innovation and economics in antitrust policy.

 

Mentioned

  • David J. Teece, Dynamic Capabilities and Strategic Management: Organizing for Innovation and Growth (Oxford: Oxford University Press, 2009).
  • Rob D. Atkinson, Michael Lind, Big Is Beautiful: Debunking the Myth of Small Business, (MA: MIT Press, 2018).

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Rob Atkinson: Welcome to Innovation Files. I’m Rob Atkinson, founder, and president of the Information Technology and Innovation Foundation. We’re a D.C.-based think tank that works on technology policy.

Jackie Whisman: And I’m Jackie Whisman. I handle outreach at ITIF, which I’m proud to say is the world’s top-ranked think tank for science and technology policy.

Rob Atkinson: This podcast is about the kinds of issues we cover at ITIF, and the broad economics in innovation to specific policy and regulatory questions about new technology. And there’s one regulatory issue which, a lot of times, people don’t think about is a part of technology policy that really is central to that, and that’s antitrust policy.

Jackie Whisman: Our guest today is David Teece, who is an economist and an authority on matters of industrial organization, technological change and innovation, particularly as it relates to antitrust and competition policy and intellectual property. He is the Thomas Tusher Professor in Global Business and director of the Tusher Center on Intellectual Capital at Berkeley Haas, and a member of the board of overseers for the faculty of arts and sciences at the University of Pennsylvania. He has a PhD in economics from UPenn and has held teaching and research positions at Stanford and Oxford, and he’s received eight honorary doctorates. Congratulations on that, and welcome. Thanks for being here.

David Teece: Oh, I’m pleased to be here today.

Rob Atkinson: I just also mention, I’ve been following David’s work for a long, long time. I’ve read a number of his books and articles and I, really, David, really a lot of inspiration in your work, so I appreciate it.

Jackie Whisman: Throughout your career, you have researched and developed the notion of dynamic capabilities. What do you mean by these?

David Teece: Yes. What I mean by dynamic capabilities is the set of competencies that some firms have and others don’t to figure out the future and to invest in R&D to address the future, to capture value from that, to deliver value to customers, and keep doing this in a repetitive way so that they stay relevant and innovative over long periods of time. So it’s about one of the field of strategy we refer to as building competitive advantage at the level of the enterprise, and keeping that durable for as long as possible.

Rob Atkinson: It’s interesting, because when I got my PhD, one of my more interesting courses, I got it in city and regional planning at Chapel Hill, but I really didn’t study planning. I studied everything else, economics, history, business. But one of my more interesting classes was a doctoral class in business strategy, and right around the time Michael Porter was coming out with his work. But it’s still striking, though, in the business strategy literature, that what you’re talking about oftentimes gets underappreciated, I guess, I would argue.

David Teece: Yeah, it gets underappreciated in part because the field of economics really is not friendly to innovation. I know every economist thinks innovation’s important, but then they go ahead and use a set of methodologies and theories and ways of abstracting from reality, which almost always leaves the innovation story out, or if it’s there, it’s marginal. And so that’s one of the big tensions in the social sciences that has unfortunate policy consequences.

Rob Atkinson: Yeah, that’s been one of the core things that we focused on for a long time. I was always struck by reading Greg Mankiw’s book on, I have a number of macroeconomics texts on my shelf, just because I want to see what they say. And Greg Mankiw, who was Council of Economic Advisors’ chairman for George Bush, George W. It was a long, long macro book. David, I’m sure you’ve seen many of these. And he has one page on innovation, one example of innovation, and that’s the ice cream maker, the portable ice cream maker.

David Teece: Yeah. Well, and I’m sure if you sat down with a glass of wine with Professor Mankiw, he would immediately agree that innovation’s important. So it leaves the question as to why is there this gap between what economists know is important and what they prefer to put in the textbooks? And it really comes down to methodology. The board enters an equilibrium view of the world and they’ve rejected the Austrian approach, which sees disequilibrium and opportunities everywhere. And so in this equilibrium view of the world, it’s a real nuisance to talk about innovation, it’s a nuisance from a theoretical point of view, so it gets left by the wayside.

Jackie Whisman: And how does this view of economics and equilibrium inform US antitrust policy in your view?

David Teece: Well, you just look at US antitrust policy and the consumer welfare standard and the way it’s interpreted, it’s all in terms of the short-term effect on price. And if anything is going to raise the price a little bit a smidgen in the short term, it’s an enemy of the anti... or, should I put it this way, the antitrust enforcement people are concerned. Now, of course, it’s innovation which brings down prices, but not immediately. I mean, almost all major innovations take significant investment.

So the short term effect is the prices may be slightly higher, and then they come tumbling down. And that is the biggest driver of productivity and lower prices is innovation. But if you have a short-term view of things, and most of the conceptual approaches are quite short term, then innovation gets treated unfairly because there’s no way to recognize the investment that’s going into it. And also, the spillovers that flow from it.

I mean, the thing that’s now really powerful, and I just saw a paper by none other than Larry Summers and Ben Jones, which shows that the social returns to innovation, which is, if you look at all these spillovers, it’s many, many times the private returns. So the fact that now we have the mainstream economists recognizing these enormous social benefits, and by social benefits, I’m referring to these spillover benefits.

To me, the gig should be up in terms of the way that most policy analysis has done in the way, and the way antitrust is looked at, that the real objects of policy should be to favor innovation, always favor innovation and favor the future. That’s where productivity comes, growth comes from, that’s where real wage increases come from. Innovation needs to be put front and center in all policy analysis, including and looking at intellectual property.

Rob Atkinson: That’s interesting that you mentioned the Larry Summers and Ben Jones paper, because Nick Bloom, at Stanford, and his colleagues, recently came out with a piece about a year ago, and it, again, looked at all the literature and tried to update it on whether spillovers had gone down or up. They actually argued spillovers had gone up, to your point, David, why businesses don’t get anywhere near the benefits, all the benefits of that. And that has big implications for public policy.

But I want to transition a little bit into the implications for antitrust. You wrote a book, Dynamic Capabilities and Strategic Management, and I thought it was really interesting. Because in that book, you wrote quote, “Dynamic competition is heavyweight competition. Static competition is the light version of competition.” So dynamic competition, in other words, competing by coming up with something new, it’s like the Muhammad Ali of competition.

An antitrust policy that favors dynamic competition, as opposed to static, just competing at the margins here and there, seems like the right kind of competition that we should have. And yet, antitrust regulators generally don’t see it that way. And I guess, is it partly because they don’t, you can’t model it, as you said? In neoclassical economics, you don’t really model that kind of disruption? You can’t see it, you can’t guarantee it’s going to happen?

David Teece: That’s part of the answer. I think another part of the answer focused on recently is that most of the field of industrial organization is stuck in a 50-year debate. I’ll call it the Arrow-Schumpeter debate. They have misframed the whole question of the role of innovation in competition. They’ve misframed it in two ways. First of all, they see competition as driving innovation, but they’ve never looked at the fact that the big driver’s really the other way. It’s innovation drives competition. Both are important, but one’s being neglected.

The other thing is that Arrow did this little model, which showed that if you have a situation of no entry whatsoever, that if you have intellectual property protection, then you can end up with profits higher than would otherwise be the case and less output. But it’s all based on a model that assumes that entry’s impossible. And, of course, in just about every industry, entry’s possible. The profession loves analytical models, and they love simple, elegant models. And so this debate should’ve been over 50 years ago, in my view. It was over 15 years ago, but I’d say it occupies 50% of the air time and research thought of economists.

And the Schumpeterian tradition and looking at creative destruction in broad ways, is really very much under-researched in economics. But fortunately, in innovation studies, there’s a lot of work on disruption and recognition in the field of management. That, of course, disruption, which is really competition on steroids, really comes from innovation. And it’s often delivered by small firms against incumbents. So the antitrust community should really, really be delighted with this, because it makes a good case for keeping innovation alive, for creating small firms, for having strong IP.

Because the only way a small firm can compete with a big firm that might have some amount of monopoly power or market power is through the use of intellectual property. So there is plenty of ways in which antitrust economists could get excited about dynamic competition. And the good news is some of them are. I mean, I can say in the last three or four months, there is attention given to dynamic competition. But because there’s been insufficient work operationalizing it, most economists and people in agencies threw their hands in the air and say, “I don’t know how to do this.”

Well, of course they don’t know how to do it because nobody has put the effort into it for the last 50 years. And if only 1% of the industrial organization economists had put their shoulder to the wheel, I think we would be a lot farther ahead. But the good news is it’s now just starting. And I’m sure mistakes will be made and things will be gotten backwards and upside down and inside out. But, at the same time, there is now an emerging body of work, just looking at potential competition in a new light, for instance. I mean, if you believe in dynamic competition, you have a chance of reworking the very elusive concept of potential competition and making sense of it.

So once again, there’s been almost no innovation, if you will, or in the field of industrial economics. What we know about potential competition today isn’t substantially different from what we knew 50 years ago. But now serious scholars are starting to look at these questions. So I think things are starting to turn, but it’s ever so tragic that it’s taken this long, and it’ll take quite a while to fully operationalize the framework.

Rob Atkinson: Yeah. One of the things, David, I 100 percent agree with that, and it’s frustrating. Because you and a lot of other scholars, Richard Nelson, others, have long argued the importance of innovation and it’s always been the outside voice trying to reach the inside. And finally, I think it’s permeating as you say. But I think one of the other challenges, when you think about an incumbent, if innovation were easy, they would automatically, they would go and innovate. They’d just do the next thing. And oftentimes they don’t.

And so it’s hard for people’s minds to get around that. Like, “Well, what could come next?” You and I both remember when Walmart was seen as the unpenetrable monopolist. There was no way Walmart could ever be challenged until some guy who lived in New York drove across the country, decided to sell books online, Jeff Bezos. Dell, I don’t know if you remember, Dell was a monopolist. Was worried about Dell being a monopolist, because they were so good at what they did. They were so efficient, so creative. Okay, then tablets came along.

Same thing with Blockbuster. The DOJ was worried about Blockbuster being a monopoly. Well, okay, who cares whether they’re monopoly? Because now you have streaming, and you’ve got almost too many streaming services now. So part of it, I think, is a failure of imagination to realize that that’s just the nature of a capitalist economy is something new. There’s so many incentives to come along and disrupt somebody.

David Teece: Yes. And incumbents are actually vulnerable. The amazing thing is, the bias in industrial organization is that the big firms are the strong ones and the other ones that are impervious to competition. But, in fact, it’s just the opposite when dynamic competition’s involved. Any well-established firm, any successful firm, with its systems that are set up to optimize where it’s at, they’re all incredibly vulnerable. And the great news about the United States is we have a very active venture capital market. We got very active, private equity markets for that matter, too.

But the venture market is able to throw billions of dollars behind startups. And this changes the story completely in my mind. Our industrial organization models were built in the ‘40s and ‘50s when you didn’t have a VC industry at all. But now, it’s the quick that eat the slow, and it’s the small that eat the big, rather than the other way round. Now, sometimes, of course there is acquisitions that take place that may be, arguably, shouldn’t because they may end up nipping competition in the bud. So I’m not saying they’re on all the issues to look at with respect to the M&A world, but generally, M&A is one way in which big firms also stay relevant.

So long as you have a vibrant market for startups, then there’s going to be strong, dynamic competition, which will bring the benefits that society wants. So to me, it’s very important for antitrust policy to do things in favor an innovation ecosystem, a robust innovation ecosystem. And it’s not where antitrust policies focus, but it’s where they should give some attention quite frankly. Because that is the nursery, if you will, for new competitors, but somehow, rather, no one seems to be looking there.

Jackie Whisman: Do you think regulators should rethink the way they perceive market power? Using Rob’s example of Blockbuster and the temporary nature of this, in general. I mean, you’ve also said market power is often needed for innovation, and it doesn’t seem to me that antitrust enforcement really appreciates this or keeps this in mind.

David Teece: Well, this is where the one- to two-year period comes into play. Quite frankly, it’s ridiculous to have a focus on price effects in a one- to two-year period. That essentially means you’re going to blindfold yourself. You’re going to put blinders on and not see the true sources of competition. So the short-termism, I mean, American society is riddled with short-termism, and we shouldn’t be pushing it in our government agencies. The electorate doesn’t want short-term results. Yes, there may be somewhat of a here-and-now view in the eyes of many voters, but most of them are willing to look five to seven to 10 years, and look even to the next generation. So why is all of our policy focused on a six to 12 to 24-month impact? We should be looking beyond that.

Rob Atkinson: Yeah, no, I couldn’t agree more. If you think about, what would you rather have had, just use that example, Blockbuster with higher prices for five years and no Netflix? I’d rather take the latter.

David Teece: Right. So you always got to be favoring innovation. If there is one rule which should animate our competition policy, it should be favor innovation. Now, of course, we need to operationalize what that means, but that should be the big dog. Always. That should be the first question. And there is a risk, of course, that that can be operationalized in a way that actually leads to just the opposite. But I think with some experience and some wisdom, if we had the favor innovation always and favor the future always, I think you’d end up with a very different complexion to our antitrust policy.

And I don’t think the problem, by the way’s, antitrust law. Antitrust law is quite flexible and there is a recognition in the law that firms with superior foresight and acumen do better. And that’s okay under the law. It’s actually antitrust economics that is, in my view, causing enforcement agencies to focus too much on the here and now. And that, in turn, flows from the lack of willingness to embrace innovation economics and make it mainstream in the field of industrial organization.

Rob Atkinson: Yeah, well, that’s our tagline, our motto, our belief, our dogma, our passion. We should be focused on innovation in the future. I mean, everything else is secondary.

David Teece: Yes. And as part of this, by the way, one has to bring into alignment, and one will bring into alignment, technology policy, industrial policy, and competition policy. I mean, right now, these are all compartmentalized, and that’s unfortunate. If we could at least get some inter-agency cooperation on these issues, which actually requires, of course, a framework. That’s why I’ve worked hard to create a framework around dynamic capabilities on the one hand, which is the managerial focus, and dynamic competition on the other hand. Because I think dynamic competition can be the unifying idea. And dynamic capabilities and dynamic competition could be the two peas in a pod, which brings together technology policy, industrial policy, and competition policy.

Now you can be sure in China, these things are looked at holistically. No doubt about it. We are not looking at these things holistically. And we’re in global competition of existential importance in my view. And it’s no longer just an unfortunate loss of short-term economic welfare that we’re up against, it’s the loss of US leadership and, potentially, the loss of our democratic institutions. So this is a fight we’re fighting because it’s the essence of who we are and what we aspire to be.

Rob Atkinson: Yeah. I wrote about a case in a book, Mike Lind and I wrote for MIT Press called, Big is Beautiful, debunking the myth of small business. And I’m blanking on the name of the company, but it was a smaller semiconductor company. It wasn’t one of the major ones. It merged with a European one, and the DOJ forced it to divest one component of its business that made radio frequency chips. I said, “Well, we have to have competition in that market.” So they divested them, and guess who bought them? A state-backed company from China. Why is that possibly in our interest? And the answer is because commerce and DOD were not in, at the table when that decision was made. They’re not even there, so it’s just purely competition policy that’s at the table, not competitiveness policy.

David Teece: Well, I think the only reason why we segment these areas is for the convenience of the professionals in them. And it does simplify life, but that’s not a good enough reason. The convenience of the professionals and the ease of judicial action is certainly a consideration, but it shouldn’t be the primary one. And national economic welfare and the preservation of our institutions ought to be number one. And if that means that a little bit of heartache and a little bit of extra work that has to be done, so be it.

Rob Atkinson: Absolutely. So, David, we’ve gotten pretty much through the interview here, the discussion, and we haven’t talked about Neo-Brandeisians. We haven’t talked about this threat. A lot of what, the complaint you’ve been making articulately is you could apply to most current antitrust scholars. But as all our listeners know, there’s a new version of that. People call them Neo-Brandeisians, after Justice Brandeis who really hated large corporations.

And there are people like Lena Khan and Tim Wu, and the Tim’s in the White House and Lina Khan is now head of the FTC. And their argument is we should just go after big firms just because we don’t like big firms. Now they’ll couch it in all sorts of other things, but really at the core of that, it’s a Neo-Brandeisian argument. You don’t need big firms just run a successful innovation economy. If you had one message for Neo-Brandeisians, what would that be?

David Teece: This would be the following, there are issues associated with bigness, but they relate to control of information and content and speech and so forth. They should definitely be looked at. But if you’re looking to competition issues, the companies that Elizabeth Warren and others tar as being monopolous, and not the monopolous like the U.S. Steel, like tobacco, like oil of the past, or the railroads of the past. It’s not the industrial economy, it’s the digital economy.

And with the digital economy, there’s tremendous benefits for everybody taking large databases, for instance, of behavioral consumer data, and having that information used in multiple domains. And these big tech companies are doing that successfully, and they are competing like cat and dog amongst themselves. They cannot be thought of, and they cannot be analyzed in the same way that the railroads of old or the oil companies of old could be looked at.

So my answer to the Lina Khans of the world is, when you can demonstrate that you actually understand the underlying dynamics and the innovation that has been brought with great benefit to consumers, both short term and long term, when you demonstrate you understand that, then I’ll take more seriously your view that there’s strong monopoly power here that requires policy action. There is competitive advantage, but it’s flowing from good old-fashioned innovation. If those companies don’t innovate and keep innovating, they are going to be gradually chipped away at and marginalized.

So we need a new theoretical framework for thinking about the business organization. I’ve been working on that, and that’s work that I think a number of people are focused on. It’s not just about platforms, it’s a lot to do with how you manage and analyze big data and how it’s deployed in multiple domains in order to bring benefits to consumers, as well as benefits to society. So let’s gear up and understand the nature of this competition before we jump to conclusions that there’s market power and that divestiture is needed, or rather draconian regulation is needed. That will cripple the primary engines of growth in the US economy today.

Rob Atkinson: I couldn’t have said that better myself. It gets to the core of really what is innovation economics compared to normal, neoclassical economics and it applies to antitrust is each industry, each firm is different, needs its own analysis, can’t just apply broad, generalized rules. David, with that, unfortunately, we have to stop. This is such a great conversation. I could go on for a long, long time, but I don’t know that we can. So I just want to say thank you so much for being here.

David Teece: My great pleasure.

Jackie Whisman: And that’s it for this week. If you liked it, please be sure to rate us and subscribe. Feel free to email show ideas or questions to [email protected]. You can find the show notes and sign up for our weekly email newsletter on our website, itif.org. Follow us on Twitter, Facebook and LinkedIn @ITIFDC.

Rob Atkinson: And I should also add that we have our own, a new project, the Schumpeter Project on competition that David is kind enough to be an advisor on. And our lead analyst on that, Aurelien Portuese, is the leader of it, so I hope you’ll follow that as well. We have more episodes and great guests lined up, and new episodes drop every other Monday, so we hope you continue to tune in.

Jackie Whisman: Talk to you soon.

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Podcast: Why There Is a Disconnect Between the Economics of Innovation and U.S. Antitrust Policy, With David Teece