David R. Henderson  

McKenzie's Defense of Apple

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Interestingly, since 2010, when Apple and the publishers were supposedly conspiring against consumers, e-book sales have escalated by several hundred percent and as a percentage of all book sales, perhaps, in part, because of the so-called "anticompetitive conspiracy." That fact is prima facie evidence that the "conspiracy" is pro-competitive.

In the case of e-books, market collaboration, which leads to higher prices, can be doubly beneficial. E-book buyers can buy their books on an alternative platform, the iPad, with greatly enhanced features that the dominant platform, Amazon's Kindle, couldn't come close to matching in 2010. It's no wonder that Amazon has responded to Apple's entrance into the e-book reader market by bringing out the Kindle Fire and that most (not all) new e-readers on the market since 2010 have tried to emulate the iPad, not the Kindle.


This is from Richard B. McKenzie, "In Defense of Apple," the Econlib Feature Article for July. The whole thing is well worth reading. In it, McKenzie takes on the conventional monopoly model, showing its limitations when the antitrust authorities apply it to markets where firms need at least temporarily high profits as a spur to innovation.

I've known Richard since sometime in the 1980s. I remember being at a conference in Charlotte, North Carolina with him when he had a copy of Mikhail Gorbachev's newly released book, Perestroika. Richard thought Gorbachev really wanted to change things. "Yeah, right," I said to him at the time. I was deeply skeptical that a person who made it to the top of the Soviet political system would want to change things in a fundamental way. Well, I was wrong and Richard was right. He has often said things that seemed radical and then became the conventional wisdom within a few years. I think his article on Apple fits that pattern.



COMMENTS (8 to date)
R. Pointer writes:

Interesting new book on Gorby.

http://israelseen.com/2012/06/21/stolen-kremlin-records-show-how-soviets-created-many-of-todays-middle-east-conflicts/

Tidbit at the end: the Soviets heavily funded the CND in Europe... hmm.

Very good article. Great irony;

The current antitrust attack on Apple and its presumed co-conspirators confirms the validity of Judge Robert Bork's decades-old assessment of antitrust law....

Bork joined in on the attack against Microsoft. Much to the delight of Michael Kinsley--'Book Bork v. Browser Bork' in Slate.

Bill writes:
I was deeply skeptical that a person who made it to the top of the Soviet political system would want to change things in a fundamental way. Well, I was wrong and Richard was right.

David,

I don't think you were wrong. Check out the introduction by Yuri Maltsev to the concise anthology Requiem for Marx. His reading is that Gorbechev used perestroika and glasnost as a last resort to prevent the implosion of the socialist system in the USSR. He would have to be an ideologically hardened Party man to acheive the heights he did in the Soviet regime.

Sorry for going off topic, I enjoyed the whole McKenzie article.

Mike Rulle writes:

I do not understand the point being made. You are conflating cause and effect. The Ipad, which now seems like it would always be an obvious success, would have had a considerably smaller buyer group had they blocked the Ipad Kindle app---which was already on the iphone. All initial Kindle buyers, like myself, always wished there was a more aesthetic reader which could also access the web more cleanly. But the benefit of the e-reader was still there for those of us who find physical books clumsy. We already wished there was a "Fire".

Amazon blew it. The Ipad comes out and met all the wishes of kindle owners and more. But if Apple had chosen to block out the kindle app, it would have lost a huge percentage of their initial audience. Amazon had too large a share for kindle owners to just jump to ibooks.

The ibook reader had virtually nothing to do with the ipad success, because it was not first (like itunes was first, hence its success). The Kindle app was enough, and in fact was crucial to its success (which is why Amazon blew it). The ibook reader is an appendage. While its aesthetics are a bit higher than the ipad app, its book choices and pricing are so inferior that I rarely look there. Ibooks are where I store all PDFs and project guttenberg books.

The conspiracy, or whatever it was, had zero to do with e-book growth. The growth happened because prices were still low enough for its benefits not to be squashed by the conspiracy. The Apple attempt to copy itunes first mover success with ibooks did not work. Having said that, they lost a mini skirmish, and won the great war.

I cannot believe you are supporting a cartel attempt at price controls as causing an increase in sales. That is absurd, at least in this case.

Richard McKenzie writes:

Mr. Rulle is correct, a number of technological and market considerations other than the introduction of the iPad and the ebook pricing agreement fostered the dramatic growth in ebooks over the last several years. I wish I could have covered all of them in my article, and much more on the weaknesses of the government's antitrust complaint. But I faced a length retriction.

But I must take issue with Mr. Rulle on a couple of points: First, if the Apple/publishers' pricing agreement had no influence on the introduction and success of the iPad and subsequent sales of ebooks, you have to wonder why the "collaborators" organized their agreement, at some antitrust risk. Second, Mr. Rulle writes, "I cannot believe you are supporting a cartel attempt at price controls as causing an increase in sales. That is absurd, at least in this case." He simply missed the thrust of my article, that prices above Amazon's dictated price, or even above the competitive level, can be welfare enhancing because they can egender "creative production." I find it difficult to accept in this case that the introuction of the iPad combined with the pricing agreement curbed ebook sales from what they have otherwise have been, as would be expected with reference to conventional monopoly/cartel theory (which I consider to be fundamentally flawed). For more on the intricacies of this contrarian line of argument, see the book I did with Dwight Lee, In Defense of Monopoly.

Mike Rulle writes:

To Mr. McKenzie

Since growth has been so high in ebook sales (I maintain the primary cause is the ubiquitous appearance of the kindle app on virtually every computer and mobile device, all easily accessed in one account on the cloud) I cannot make a hard case (its a counterfactual in any event) that sales would have been yet even higher without "the conspiracy". In fact, I am inclined to agree that sales growth was not impeded.

I do not have the knowledge to engage in a general discussion on the theortical underpinnings of your critique of cartel theory, so I will not pretend to dispute it. In fact, I look forward to reading about it.

But my point is empirical, or more plainly, simply descriptive. What I do dispute, is that growth was promoted by Apple's policies (even assuming in other situations, your general idea is valid). Admittedly, I am one anecdote. But I am an avid peruser of books on Amazon and Ibooks. These range from crime novels to text books in a variety of subjects.

I cannot recall ever seeing a book on Ibooks that was not on Amazon. But the opposite is ubiquitous. Nor can I remember a book that was ever cheaper on Ibooks. I wanted to find these because I liked the ibook reader better, so I am biased toward wanting to move toward Ibooks. But it is pointless. However, I am certainly open to examples of how Ibooks specifically added value relative to the Kindle app.

My point is, I do not see the value added Ipad made to ebook sales (with the "minor" exception of creating the ipad itself!!). They priced themselves above the alternative pricer, easily filled by Amazon. Nor do I see how they helped Amazon in its lower pricing scheme, since the latter came first.

I humbly submit you picked a suboptimal example to make your larger point.

JVDeLong writes:

This is an excellent piece on a big problem. As Richard says, the standard model does not fit with industries that entail heavy fixed investment and low marginal cost – most industries, in fact. I am convinced that if antitrust lawyers and economists were physicists, they would conclude that the problem with the universe is the imbalance of heat, and that what is needed is perfect entropy.

When you corner economists, they will admit to this. But then, in their roles as antitrust enforcers, they return to the standard model. So the FTC/DOJ people act as if “competitive price” should equal “marginal cost price”, which is crazy.

The issue is not exactly rocket science, and one can easily come up to speed in a few hours. See, for example, the materials put together by CEI and the now defunct PFF in 2004 in a conference on Declining Marginal Cost Industries in the Global Information Age. These include a transcript, short bibliography, and video interviews with both Lester Telser and Ronald Coase.

William Baumol has written several pieces noting this problem in the profession – see, e.g, Regulation Misled by Misread Theory (2006). Atlantic blogger Megan McArdle discussed the public policy problems created by the illusion that everyone can be the marginal cost price consumer and that if this cannot happen then the industry must somehow be cheating -- The Qwikster and the Dead (2012). Solveig Singleton looked at marginal cost pricing in the context of intellectual property in Is Cheaper Always Better? Misusing the Concept of Marginal Cost in Policy Discussions (2008).

A recent column in BioWorld on The Star-Struck FTC bemoaned that agency’s obsession with generic pharmaceuticals, even though pharma is a paradigm of the high fixed/low marginal cost issue. The first pill costs a trillion dollars; the second costs 10 cents. I agree; I looked at the generic drugs issue in Saving the Goose: Intellectual Property & Follow-On Biologics (FOB) (2008), and argued that fostering low price at the expense of R&D is not at all in consumers’ interest.

In the end, market power, and the quest for it, is not the problem – it is the solution. Conventional doctrine has it backwards.

Industries caught up on the coils of antitrust have no incentives to address the problem. They are trying to get a deal done, and the road to this outcome is not to tell the enforcers “you people really need to rethink your premises about the nature of competition.” The rational short term course is to hire political fixers and ex-enforcers to convince the current enforcers. In the longer term, companies are not in the business of improving antitrust doctrine, which is a public good, so they forget about it until the next crisis.

Nor do the enforcers have much incentive to rethink. My view, noted in a recent book on the Special Interest State, is, “Antitrust law has little to do with protecting competition and much to do with protecting the income of the economists and lawyers who operate the system as well as the special interests that use these laws to suppress competition.”

David R. Henderson writes:

@JVDeLong,
Thanks for these valuable links.

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