Are Regulatory Agreements to Address Climate Change Anticompetitive?

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A federal antitrust investigation of automakers cooperating with California probably has no basis in law.

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Last week, the Wall Street Journal reported that the U.S. Department of Justice has launched an investigation of four automakers—Ford, Honda, BMW, and Volkswagen—to determine if they had violated the antitrust laws by agreeing with the state of California to adhere to higher standards for tailpipe emissions than those favored by the Trump Administration. That automakers’ agreement, if subsequently adopted as part of a regulation, may or may not eventually be challengeable on administrative law grounds. Here, though, I consider whether the  agreement might violate the antitrust laws.

Proving an antitrust violation in this case would confront significant hurdles. At the outset, there must be the right kind of agreement. If each car maker agreed individually to follow a proposal from the State of California, then there could not be an antitrust violation. For a single non-monopolist firm unilaterally to follow a state’s suggestion or even its order would not meet the antitrust law’s requirement for a conspiracy. But suppose that the four automakers had agreed with the state of California and with each other to reduce their automobile emissions? For example, suppose that they had discussed the standards with one another and then voted to implement them. That would satisfy the Sherman Act’s agreement requirement.

In that case, the courts would next have to consider the “state action” exemption from the antitrust laws. This judge-made exemption, which dates back to the 1940s, permits anticompetitive conduct that has been authorized by the state. Importantly, the conduct need not be mandated; it need only be approved. If an agreement contemplates private discretionary conduct, then the conduct would also have to be “supervised” by a neutral public official or agency. However, supervision is not necessary if there is nothing to supervise—for example, if the state simply sets a standard and the automobile companies comply with it. With California and the automakers, a court would have to determine whether government supervision is necessary. If it is needed, the California program very likely meets the requirement. For example, if a government agency sets the standard and then delegates responsibility to people with no financial interest in the outcome to test automobiles for compliance, that would be adequate supervision.

Antitrust law’s state action exemption sometimes approves anticompetitive conduct that would otherwise violate the antitrust laws. The exemption gives effect to an important principle of federalism, which is that the under the Constitution states have the authority to regulate their own economies even if they would do so differently than the federal government would. The U.S. Supreme Court first recognized the exemption in 1943 in Parker v. Brown, which upheld a California agricultural program that reduced the output of the state’s raisin producers, in conflict with federal antitrust policy. In effect, the program operated as a state-sanctioned cartel. Furthermore, under the state action doctrine, it is no answer that the state’s rule has a significant effect outside the state, as the California emissions rule may have. In Parker v. Brown, 90 percent of the affected California raisins were shipped outside the state, to customers who paid more as a result.

People with strong commitments to federalism often believe that the state action doctrine should be even broader than it currently is and that the federal courts should simply refrain from applying antitrust law to states’ regulation of their own economic actors. For example, in a 2015 case, Justices Alito, Scalia, and Thomas dissented from a Supreme Court decision striking down a state-sanctioned cartel of dentists, arguing that the majority’s decision amounted to nothing more than federal interference to ensure that a professional board be structured so as to “merit a good government seal of approval.”

Suppose that the emission agreement between California and the automakers is found not to be immunized by antitrust’s state action doctrine. Then a court would have to confront the antitrust merits and treat the agreement for what it is—not a naked cartel but a standard-setting agreement. Such agreements setting both product and professional standards are ubiquitous throughout the economy. Although some standards are created by state or federal governments, others are developed and administered by private parties. Often, standard-setting is “cooperative,” in the sense that a government agency participates by proposing or enacting privately-created standards.

For example, the National Fire Protection Association is an organization of more than 50,000 insurance companies, manufacturers, and others involved in developing safety standards for electric installations, fireworks, fire alarms, and flammable liquids. Its private members draft model codes, which state and local governments can then enact. Although this organization is composed of many private competitors, it has generally avoided antitrust liability except for one well-known case in which a group of its members that produced steel electrical conduit attempted to use standard-setting to cartelize the market by drafting a code provision that excluded plastic conduit.

Standard-setting by private firms is lawful under the antitrust laws unless it facilitates collusion. To be sure, a standard that reduces automobile emissions may require technology that increases an automobile’s costs. That is also true of standards that require physicians to be licensed, boat trailers to have waterproof tail lights, or stretch limousines to meet the same safety standards as ordinary automobiles. But such standards perform in just the opposite way from price fixing agreements: they increase complying firms’ costs, not their prices. To the extent a California auto emissions standard will have an impact on participating automakers, who must compete with others, the automakers’ agreement is costly rather than profitable. In that case, antitrust legality is virtually certain.

When standards are designed to permit the standard-setters to earn monopoly profits, the courts are much more critical. A recent example is the North Carolina State Board of Dental Examiners case, which struck down a state dental association standard that required someone to be a licensed dentist to whiten teeth, a task traditionally performed by dental hygienists and cosmetologists and even by self-help. The record in that antitrust case made clear that the dentists’ principal concern was not with health or safety, but rather with protecting their own high prices from lower price competitors. In one well-known case analogous to the current situation with California, a group of automobile makers conspired with each other to refrain from developing fuel-efficient technologies for automobiles. That was a purely private conspiracy, with no cooperation from any state or the federal government. Further, it was a pure cartel agreement: that is, the firms would profit by agreeing with each other not to compete in the research and development of more fuel-efficient cars.

A final problem is market power. Although Ford, Honda, BMW, and Volkswagen are large firms, they collectively control approximately 26% of the American automobile market for new car sales and roughly the same percentage of the California market. Although standard-setting is generally treated leniently by the antitrust laws, it is treated even more leniently when the firms practicing the standard do not dominate the market in which they sell.

In sum, a private agreement among the four automobile manufacturers to cooperate with California to set tougher emission standards would almost certainly survive antitrust examination under the rule of reason. It does not enable the participating automakers to charge monopoly prices. To the extent it imposes higher costs on the participants than on non-participating manufacturers, it would harm them—unless, of course, consumers preferred the cars that complied with the higher standard.

Why would the Department of Justice conduct an investigation of automakers that are cooperating with California? Many antitrust investigations are terminated without any enforcement action, but in most of these cases the agencies had at least a reasonable suspicion of an antitrust violation. Perhaps the Justice Department is aware of some facts that have not been made public, but for a high-profile issue such as this one that seems unlikely. A more likely explanation is that this is an attempt to placate an Administration angered by California’s insistence on more stringent emission standards than the federal government requires. If so, it is only another waste of public resources for a harmful purpose.

Herbert Hovenkamp

Herbert Hovenkamp is the James G. Dinan University Professor at the University of Pennsylvania Law School and the Wharton School of the University of Pennsylvania.