The dangers of the FTC becoming a competition national nanny

A century ago Congress gave the Federal Trade Commission broad powers to prevent anticompetitive conduct. The powers were broad but not unrestrained, yet two cases the FTC is currently litigating— against an Idaho health system (St. Luke’s) and an Alabama pipe fitting company (McWane)—suggest the FTC is becoming a competition national nanny second guessing the workings of the market and suggesting a one size fits all approach to competition.

Fortunately Commissioner Maureen Ohlhaussen, like a Delphic oracle, has cautioned the Commission and called for “regulatory humility.” In one of her speeches she turned to the Greek myth in which the rogue blacksmith Procrustes takes to lopping off limbs or stretching guests when they don’t fit his special iron bed. A Procrustean FTC falls into the same trap when it brings enforcement actions based on its assumption of the best way that firms should compete.

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The St. Luke’s case involves an Idaho-based health system’s acquisition of a physician practice in Nampa, Idaho. The FTC sued and the court enjoined the merger, however expressing in extraordinary detail the benefits of the deal. He complimented St. Luke’s for having the foresight to move from a “fee-for-service health insurance reimbursement system that rewards providers, not for keeping their patients healthy, but for billing high volumes of expensive medical procedures” to a system that focuses on “maintaining a patient’s health and quality of life, rewarding successful patient outcomes and innovation, and encouraging less expensive means of providing critical medical care.”

The judge recognized that this better health care system requires “a more integrated system where primary care physicians supervise the work of a team of specialists, all committed to a common goal of improving a patient’s health.” The efficiencies were compelling. Courts regularly recognize efficiencies from vertical integration and healthcare is no exception.

The FTC used its procrustean ruler to reject those efficiencies, suggesting the benefits of integration could be achieved through contractual arrangements. However, contractual arrangements and affiliations between hospitals and physicians are often inadequate to bring efficient integration and are greatly hindered by an outdated regulatory regime that discourages cooperation. Under a contractual agreement, hospitals have much less control over quality initiatives which align incentives for providing better coordinated care more efficiently. And the Medicare anti-kickback law stops them from rewarding physicians for adhering to evidence based medicine, e.g. using steroids for reducing respiratory distress in premature babies.

Fully integrated systems, such as Intermountain Healthcare and Kaiser Permanente, excel at controlling costs because hospital and physician incentives are aligned. Contractual models are a second-rate alternative and with the critical need to lower costs, the country should not be forced to accept a second rate system. The FTC approach restricts the ability for hospitals to use a sensible approach to lower costs and align incentives.

McWane involved an FTC challenge to an effort by an Alabama company that entered into distribution arrangements. The FTC found McWane’s contracts prevented its less efficient rival (Star) “from meaningfully competing.” The key finding was that McWane “deprived its rivals, mainly Star, of distribution sufficient to achieve efficient scale” in the domestic iron pipe fitting industry. The Commission defined efficient scale as owning and operating a pipe fitting foundry.

Without efficient scale, the Commission reasoned, Star was slowed or prevented from effective entry and costs were raised.

The specificity of narrowly defining “efficient scale” as the scale necessary to own and operate a foundry is alarming. If there was evidence that this was the only path to viability, then the FTC might be right in reaching such a conclusion. However, the second-leading supplier of fittings, Sigma, was a significant rival even though it did not own a foundry. Star itself was able to enter, compete, and grow without operating its own foundry. Clearly there is more than one way to reach viability.

By imposing liability the FTC is effectively forcing McWane (or similar firms) to pull its competitive punches so a rival can thrive. But the purpose of the antitrust laws, as the Supreme Court has instructed is to “protect competition not competitors.” This prescription for foundries is very much like Procrustes’ iron bed, and competitors in the future will have to fear whether they will have to cut off their own feet and stretch their competitors to fit some FTC model of proper competition in an industry. The FTC’s desire for domestic iron pipe fitting companies to have their own foundries is especially unsettling in light of evidence that suggests there was barely enough sales volume to support even one domestic foundry.

Both the St. Luke’s and McWane cases are headed to appeal. In the meantime, the FTC should heed the teaching of the Ninth Circuit in United States v. Syufy Enterprises that it should exercise humility in situations in which judicial intervention can have the perverse consequence of stifling innovation and competition. It should also heed the moral of Commissioner Ohlhausen’s favorite myth and get out of the business of enforcing with procrustean beds.

David Balto is a public interest and policy attorney in Washington D.C. and former policy director of the FTC.