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Acrylic Latex and the Pretense of Knowledge

March 20, 2011

One thing I’ve heard from defendants in Federal Trade Commission cases is that the Commission likes to display overwhelming force. One attorney told me that his firm sent two — and only two — lawyers to represent his client at an FTC trial. The Commission had “as many as 30 lawyers and staff in the court.” The attorney compared it to a “wedding at which the groom’s family doesn’t approve.” In another case, a CEO told me that his party of three was met by “about two dozen” FTC staff, this time at an informal conference to discuss the Commission’s “concerns” related to a merger.

You would think with all this staff presence, the FTC would at least be well-informed about whatever it is they want to regulate. Yet time and again we see that’s not even close to true. I’ve reported many examples in this space. And new ones seem to crop up almost daily. One that caught my eye recently involves Dow Chemical Company. Last year the FTC forced Dow to sell an acrylic latex plant in Torrance, California. The FTC staff determined there was insufficient competition in this particular market. Hilarity ensued.

The FTC staff decided Dow should sell the plant to a company called Arkema. The FTC order required “divestiture” of the entire California plant and the surrounding land. The only problem was Arkema didn’t want the entire plot of land, which included “several industrial sites leased to and occupied by third parties,” according to Dow. And Dow cannot just sell Arkema that part of the land where the plant is located, because, Dow says, “Under the California Subdivision Map Act, it is illegal to sell (or transfer fee title to) the portion of the overall site that houses the Torrance latex plant without first creating as a separate legal parcel the real estate underlying the Torrance latex plant.”

So Dow is now trying to serve two masters — the FTC and California — with conflicting demands. The FTC wants the land sold to Arkema. California won’t allow a subdivision of the land without a lengthy regulatory process. In the interim, Dow is leasing the land to Arkema, which is technically in violation of the FTC order, while trying to create the necessary subdivision to eventually allow Arkema to acquire just the plant itself. And Dow has also petitioned the FTC to modify its earlier order to make this “legal.”

What amuses me is that it appears nobody at the FTC anticipated this problem. The staff spent months bludgeoning this “consent order” out of Dow, and they were no doubt proud of themselves for doing so. But none of them anticipated that either their handpicked buyer didn’t want the entire piece of land or that California law would make it difficult to subdivide the land later. Or perhaps the Commission staff simply didn’t care.

As I said, this isn’t the first time this sort of thing has happened. Last September I reported that another FTC-mandated factory sale hit a snag when the Australian government suggested the Commission’s order violated their labor laws (the factory was in Australia). The FTC quickly tried to cover up its mistake, but again, the point is that nobody on the staff thought to check this issue out beforehand.

Call it the “pretense of knowledge.” The FTC staff has it in spades. Like any regulatory agency, the staff is conditioned to think that their form of regulation is not only superior to the free-market process, but that it also superior to every other regulatory process that may exist. Before I referred to a CEO who presented a defense of his merger to two dozen FTC staffers. The staff challenged all of the CEO’s post-merger plans, including the construction of several new buildings. When one staffer expressed his disagreement with a particular architectural decision — something that’s supposed to be well outside the purview of an FTC merger review — the CEO’s architect replied that he was merely complying with the local government’s building codes. Such local knowledge is irrelevant to the FTC, however, which is only concerned with fitting all situations into its predetermined worldview.

This is a key point that many supporters of state regulation either ignore or fail to grasp. Since it’s impossible for any regulator — even the smartest, most well intentioned one — to possess all of the relevant knowledge necessary to determine the “correct” outcome of the marketplace, the regulator’s only option is to simply act as if he’s infallible and rely on some sort of “credential” to justify his position. In many cases this means hiring an outside “expert” who may or may not possess any greater relevant knowledge than the regulator himself. (I’m reminded here of the FTC’s case against Rambus, which partially relied on an engineering expert who had no actual experience in the type of circuit design at issue in the case.)

This pretense of knowledge is especially dangerous when dealing with economics, because there’s a tendency to place blind faith in pretty, mathematical-looking models that masquerade as economic science. Again, this is commonplace in FTC cases, where the Commission hires an outside economist to “prove” the FTC’s predictions about a given marketplace are correct. Of course, the only way this works is for the FTC to give the economist a set of input assumptions that exclude any potentially complicating variables. (Again, this happened in Rambus; the FTC asked its economic expert to project what the market would have looked like if one variable had been changed in the distant past, without any regard for how decision-making might have been altered throughout time.)

In merger review cases, the most obvious flaw with the pretense of knowledge is the inability of a regulator — or anyone, for that matter — to project what competition might emerge in the future. A standard merger case starts with the assumption that the previous number of firms offering a given product or service is ideal, and that any temporary reduction in that number “harms” competition. The FTC staff will merely assume that no new competitor will enter the given market, based on the further assumption that all other market conditions will remain static. For example, the FTC won’t take into account any new technology that might displace existing firms (e.g., Netflix supplanting traditional video stores like Blockbuster) nor will it allow for the possibility of a sudden shift in consumer preferences.

Ultimately, the more the FTC “regulates,” the more errors it will make, since each additional case only further exposes the pretense of knowledge. The FTC staff won’t improve their performance with practice, primarily because unlike the market, there is no natural feedback mechanism to correct the basic errors in the Commission’s methodology. The FTC is not subject to market competition — or even consumer demand — so any errors made are simply labeled “the cost of doing business.”

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