Interstate Protectionism and the Dormant Commerce Clause

All 50 states ban the direct sales of motor vehicles from manufacturers to consumers. The politics of this regrettable policy are clear: auto dealers are powerful political players in every state, while only a few states actually have manufacturing facilities. Banning direct manufacturer sales benefits dealers while hurting manufacturers and consumers.

State governments continue to insert themselves into the contractual relationships between car manufacturers and dealers, typically to the ostensible benefit of the latter. The New Hampshire Senate recently passed a bill regulating the terms and conditions of dealer contracts with manufacturers, prohibiting manufacturers from requiring dealers to alter the appearance of their showrooms, for instance. (Disturbingly, the state director of Americans for Prosperity in New Hampshire supports the bill.) The bill is actually unlikely to change any “balance of power” between automakers and auto dealers. Automakers will simply respond by vetting potential dealerships far more closely and perhaps charging higher franchise fees. The onus of this response is likely to fall more on new dealerships than on incumbents. So the real losers from the bill are going to be potential entrants into the car dealer industry and, of course, consumers.

These are not the only examples of “state protectionism,” in which state governments adopt laws meant to reduce competition from out-of-state businesses for the benefit of local incumbents. Some states still prohibit certain out-of-state direct-to-consumer wine shipments. Regulatory barriers can accomplish the same ends. States have widely varying regulations on insurance products, making regulatory compliance a huge barrier for a company trying to market a standard policy in multiple states. For a long time, major life insurance companies lobbied Congress to adopt a national life insurance regulatory regime, pre-empting state laws. They were opposed by local life insurance agents, for whom knowledge of and compliance with distinctive state regulations were a significant source of competitive advantage. In the end, no national legislation materialized, but Congress authorized the formation of an interstate compact, essentially a contract among consenting states that sets up a single insurance regulator. More than 40 states have joined the Interstate Insurance Product Regulation Commission, which regulates life insurance and annuities.

Such state protectionism potentially runs afoul of the so-called “dormant commerce clause” of the U.S. Constitution. The commerce clause allows Congress to regulate trade among the several states. By implication, then, states are presumptively prohibited from burdening interstate trade, unless authorized by Congress. Unfortunately, courts have been reluctant to scrutinize state economic regulations that have an essentially protectionist character, although especially blatant discrimination against out-of-state imports has been overturned.

Beyond judicial intervention, however, another solution may be the interstate compact. The U.S. Constitution requires Congress to authorize interstate compacts, though, and given Congress’ dysfunctionality, that is often a tall order. Moreover, topic-by-topic compacts will fail to achieve the comprehensive results that something more along the lines of a World Trade Organization analogue would. For instance, few states would want to join a compact dedicated solely to liberalizing the rules on auto sales. The dealer lobby is too strong in most places. But they might have an interest in joining a compact setting up an Interstate Trade Organization to liberalize rules on many different kinds of commerce. In that context, “exporters” might gain enough political influence to outweigh the demands of “import-competing” industries. The key is the ability for state governments to make policy “trades” across different dimensions, increasing the scope of the interstate organization’s remit. A state might “lose” (politically) on one dimension, like direct auto sales, but gain on another dimension of greater importance to its own export industries, like direct wine sales. As Koremenos, Lipson, and Snidal (2001: 770) note in their article, “The Rational Design of International Institutions”:

Sometimes two seemingly unrelated issues are linked. A trade issue, for example, may be linked to a security issue to facilitate agreement and compliance. Or a side payment may be offered, as when the Nuclear Nonproliferation Treaty offered the transfer of peaceful nuclear technology to states that agreed to forgo nuclear weapons. Such side payments are clear evidence that scope is being manipulated to facilitate cooperation.

Koremenos et al. conjecture that the “scope” of an organization increases with the heterogeneity and number of the members and the severity of the “distribution problem” (for instance, prisoner’s dilemmas as against coordination games) and of the “enforcement problem” (how to punish defectors). For state governments engaging in protectionist policies, just as for national governments doing the same, all of these problems loom large. Therefore, wide scope is likely to be important for any organization dedicated to trade liberalization.

4 thoughts on “Interstate Protectionism and the Dormant Commerce Clause

  1. I don’t get it.

    Wouldn’t a free market either be direct manufacturer control of dealerships, or dealerships selling a variety of cars from different manufacturers? When I’m car shopping, I am looking at several similar cars from different manufacturers. A one stop shop that specializes in efficient sedans makes more sense than four different dealerships that have sedans, but also SUVs and trucks.

    1. The dealer exclusive franchise model may well be wholly a result of regulation. OTOH, franchising does work well in other industries, such as restaurants. Brand identity and reputation can be important assets that franchising protects. But we’ll never know what the efficient models are in the current policy environment.

  2. I like the idea of an Interstate Trade compact. I find that the vast majority of economic laws passed by state and local government are purely for protecting incumbent business interests, so expanding the interest pool might well result in better policy.

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