Is Protecting Sunk Investments an Economic Rationale for Antitrust Law?

Abstract

In recent years, the economic foundation of antitrust law is increasingly being called into question. The hypothesis that antitrust law seeks to promote consumer welfare has historically been extremely popular but in recent years has come under attack. In part this is due to the fact that neither the law, nor the decisions of competition law enforcers, can be fully explained as consistent with a strict consumer welfare standard. Neither do competition laws promote a textbook concept of total economic welfare, neither in their wording, nor in the way they are enforced. Some commentators argue that competition law should protect the competitive process, but this approach lacks a foundation in welfare economics and therefore lacks the ability to make basic trade-offs between desirable goals. This paper puts forward an alternative hypothesis, which focuses on the sunk, relationship-specific investments made by market participants. We propose that an important, and overlooked, role of competition law is to protect trading partners from the threat of hold-up, where it is unreasonable for the parties to use conventional mechanisms to protect those sunk investments themselves. This approach can help to explain features of competition law and law enforcement that cannot be explained by the traditional consumer welfare or total welfare frameworks. We suggest that this approach offers promise as providing a consistent, comprehensive, economic foundation for competition law.

Keywords: Consumer welfare hypothesis, textbook welfare hypothesis, transactions cost economics, protection of competitive process, hold-up, exploitation, deadweight loss

JEL Classification: K21 and K23