Antitrust Basics: Rule of Reason Standard vs. Consumer Welfare Standard

Regulators have used two different standards to judge antitrust cases over the last century or so: the “rule of reason” standard and the “consumer welfare” standard. This post will briefly introduce them both.

The rule of reason standard was used for most of antitrust regulation’s history. It heavily relies on a judge’s discretion—whatever they think is reasonable is the rule. This usually, but not always, contains an implicit big-is-bad ideological bent. The rule of reason standard is less well defined than both the preponderance of evidence standard used in most civil cases and the reasonable doubt standard used in criminal cases. It also gives weaker protections to defendants.

The consumer welfare standard slowly replaced the rule of reason starting in the 1970s, and gained mainstream acceptance by the 1980s. Under the consumer welfare standard, big is OK, so long as no consumers are harmed. This stricter standard has resulted in fewer antitrust prosecutions, and nearly two decades since the last landmark case, which ended in a draw against Microsoft.

In the current populist moment, the pendulum is swinging away from the consumer welfare standard and back towards the old reason of rule standard.

Supreme Court Justice Louis Brandeis is one the intellectual fathers of the rule of reason standard. In 1911, during testimony before the Senate Committee on Interstate Commerce, Brandeis said, “I have considered and do consider, that the proposition that mere bigness can not be an offense against society is false, because I believe that our society, which rests upon democracy, cannot endure under such conditions.”

This feeling that size itself should a prosecutable offense ebbed and flowed over the decades, giving antitrust enforcement a distinct uncertainty and lack of clarity during the rule of reason era. In fact, during the New Deal, President Franklin Roosevelt reversed course almost completely, and wanted the government to actively encourage business cartels. After World War II, the old rule of reason standard resumed. Enforcement peaked in the early 1960s, then gradually receded.

During the rule of reason era, a company could never be quite sure if it was violating the law or not. An acceptable practice one year might not be if power changes hands in the next election, or if a new judge rules differently on a case than his predecessor would have.

Antitrust regulation had long been dominated by lawyers. Economists dating back to Adam Smith believed that monopolies were unsustainable without government help, with real-life examples limited to the Dutch East India Company and similar government-backed enterprises. If a company raises prices, another company can make a nice profit by undercutting it. If companies collude to restrict output to raise prices, the temptation to cheat is too strong to resist, and the cartel collapses on its own. As such, on-the-ground antitrust policy was of limited interest to economists. For them, this rarity was mostly a theoretical construct that existed in blackboard models.

Justice Department and Federal Trade Commission lawyers resented economists and their analysis both for ideological reasons and the fact that economic analysis, if consistently applied to antitrust law, would put most antitrust lawyers out of a job. After Arthur C. Pigou’s 1920 book “The Economics of Welfare” came out, welfare economics became all the rage. In this subfield, economists weigh a policy’s costs and benefits to the welfare of everyone involved and judge it accordingly. A welfare economist looking at antitrust isn’t going to care one way or the other about a company’s size. The question he is looking at is, does the current market structure benefit consumers or not? This approach led to the coining of the consumer welfare standard sometime in the 1960s.

By this time, a growing law and economics movement began to apply economic reasoning and methodology to antitrust regulation. A few economists were even able to get jobs at the Justice Department and Federal Ttrade Commission, though they likely won few popularity contests at first.

The new law and economics movement was at first largely centered at the University of Chicago, though law and economics departments now exist at most major universities. Early Chicago figures such as Ronald Coase, Aaron Director, and Frank Knight influenced a new generation of competition scholars who made the consumer welfare standard the mainstream practice in antitrust law. These scholars include Richard Posner, George Stigler, Yale Brozen, Robert Bork, Harold Demsetz, and Sam Peltzman, among others.

The most famous defense of the consumer welfare standard remains Robert Bork’s 1978 book “The Antitrust Paradox,” which was one of the first major law books to heavily incorporate economic analysis.

As the consumer welfare standard slowly and informally supplanted the rule of reason standard, antitrust activity greatly slowed. In 1981, the federal government dropped a 13-year long antitrust case against IBM after more than a decade of technological advancement and market competition rendered the case moot. In 1984, the government broke up the AT&T monopoly it had previously enforced, and the last hurrah for old school antitrust came with the Microsoft case, which ended with a settlement mostly in Microsoft’s favor. Since then, some mergers have been blocked, but always on consumer welfare grounds rather than the fear of bigness that had motivated Justice Brandeis.

Contrary to stereotype, most advocates of the consumer welfare standard do not oppose antitrust law. Even Robert Bork defends antitrust enforcement, arguing on p. 311 of “The Antitrust Paradox” that “Antitrust is valuable because in some cases it can achieve results more rapidly than can market forces. We need not suffer losses while waiting for the market to erode cartels and monopolistic mergers.”

This ignores both knowledge problems and public choice-style incentive problems facing regulators, as numerous scholars have noted. The best antitrust policy is no antitrust policy. But so long as antitrust regulations remain on the books, it is best to rein in their harm as much as possible with a strict consumer welfare standard for enforcement.

For more, see Wayne Crews’ and my paper, “The Case against Antitrust Law: Ten Areas Where Antitrust Policy Can Move on from the Smokestack Era.” Further resources are at antitrust.cei.org.

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