The Law and Economics of Privacy, Personal Data, Artificial Intelligence, and Incomplete Monitoring: Volume 30

This issue of Research in Law and Economics covers several areas of important research by a variety of international scholars. It contains theoretical papers on privacy, the protection of personal data, the use of regulatory monitoring under legal standards vs. rules, a study of the properties of market efficiency in securities fraud litigation, as well as an analysis of nonexclusionary price floors. It also contains an empirical paper on the relationship between uncertainty of patent approval of artificial intelligence applications and the Supreme Court's decision in Alice Corp. v. CLS Bank International. Finally, Volume 30 contains a law-and-economics assessment of the Chinese financial system within the context of the trade-off between centralized control and rapid growth.

We propose a simple model consisting of two separated markets: the market for good y and the market for good x. Purchasing information about consumer behavior in the former market helps the monopolist firm, in the latter market, to price-discriminate. Consumers differ in their income and in their level of myopia. Personal data market regulation could both increase consumers' awareness about the treatment of their data and allow them to have their data erased from the data holder. We find that the former aspect of the policy reduces the number of transactions, and hence tends to reduce total surplus, while the second typically boosts willingness to pay of consumers and has positive effects on surplus, provided that the share of high-income consumers is not too high. The overall effect of regulation on total welfare depends on the share of high-income and myopic consumers.

The context of this chapter is the use of data and advanced data analytics in a commercial setting. Privacy is considered as protection from vulnerability, whereby vulnerability is understood as the state of being exposed to the possibility of being harmed, either physically or emotionally, or in fundamental rights other than privacy. Therefore, privacy's policy instruments, in particular data protection law, could be seen as a means to reduce the risk of harm resulting from data use. Such harm is probabilistic and often uncertain, which, however, does not exclude analyzing costs and benefits of regulatory data protection policies. When balancing privacy protections and opportunities for knowledge gain, regulatory policy could be viewed as superior, when it expands the range of possible trade-offs between vulnerability protection and gaining socially beneficial knowledge.

Artificial intelligence-related inventions raise complex questions of how to define the boundaries around patentable subject matter. In the United States, many claim that the recent doctrinal developments by the Supreme Court have led to incoherence and excessive uncertainty within the innovation community. In response, policymakers and stakeholders have suggested legislative amendments to address these concerns. We first review these developments, and subsequently use the patent examination record to empirically test the claims of increased uncertainty. We find that, although uncertainty did spike following the Supreme Court's holding in Alice, it quickly returned to levels comparable to its historic norm. This has implications both for those advocating for legislative changes to the law of eligible subject matter, as well as other jurisdictions considering adopting a test similar to that applied in Alice.

The economic doctrine of market efficiency plays an essential role in securities fraud litigation. In lawsuits alleging violations of SEC Rule 10b-5, the plaintiffs typically must argue that the market for the relevant security is efficient, and therefore that the “fraud on the market” doctrine applies. However, the term “market efficiency” is often applied imprecisely. In this chapter, we discuss properties of efficient markets that have been proposed in academic research, legal scholarship, and case law. We explore what must be assumed about capital markets for each of these properties to hold. We then ask how, in practice, each property could be rebutted.

Regulators can adjust penalties to compensate for incomplete monitoring of regulated parties that are subject to legal rules, but compensating penalty adjustments often are unavailable when regulated parties are subject to legal standards. Incomplete monitoring consequently invites greater noncompliance under standards than under rules. This chapter develops a model that quantifies some of the specific tradeoffs that regulators face in designing standards regimes under incomplete monitoring. The model also considers the extent to which suboptimal compliance due to incomplete monitoring is likely to result in deadweight loss in different settings.

This chapter integrates two separate branches of the law and economics literature to demonstrate the two-sided risk of market exclusion by a vertically integrated firm (VIF) with upstream and downstream market power. The ratio of downstream (retail) to upstream (wholesale) price-cost margins is key. A margin ratio that is “too low” can result in a vertical price squeeze, whereas one that is “too high” can create incentives for the VIF to engage in non-price discrimination or sabotage. A price squeeze occurs when a rival is inefficiently foreclosed because the upstream (input) price is too high relative to the downstream (output) price. Sabotage arises when the VIF raises its rivals' costs which, in turn, raises their prices and diverts demand from the rivals to the VIF. Displacement ratios delineate the range of safe harbor margin ratios within which neither form of market exclusion arises. The admissible range of these margin ratios is decreasing in the degree of product substitutability and reduces to a single ratio in the limit as the competing products approach perfect substitutes. The policy challenge is to apply these pricing constraints judiciously to prevent market exclusion in accordance with a consumer-welfare standard, while recognizing the risk that these protections can be appropriated and used strategically in the errant pursuit of a competitor-welfare standard. These issues may take on greater prominence in light of the recent release of the DOJ/FTC draft vertical merger guidelines.

While many believe that nonperforming loans (NPLs), privatization of banks, informal lending, and other forms of shadow-banking, as well as technological advances in machine learning for assessing creditworthiness will place China's financial regulatory system on a trajectory toward openness and privatization, other trajectories are possible and likely. Consider that each disturbance can be met with controlled alternatives. For NPLs, there are asset management companies; for informal lending, there is new technology to lower transaction costs and increase formalization and consolidation; for systemic risk presented by other forms of shadow-banking, there is systemic isolation of the traditional banking sector which substantially lowers that risk; and while machine learning promises more accurate assessments of creditworthiness for millions of individuals and small- to medium-sized enterprises, it promises far less improvement to assessments of China's 3,500 large enterprises that present substantially different variables. Privatization and openness is not necessary for China's continued development for a time just as liberalized payment regimes and foreign direct investment rules do not imply the implementation of broad, liberal capital controls. Financial regulators in China, therefore, will continue to implement policies of limited and piecemeal openness so long as the benefits of control continue to exceed those of faster-paced development.