Competition and Markets — Part 2

Competition in the market and competition for the market are substitutes, as I mentioned in the previous post on the matter. When firms can freely enter (and exit) a market, it is called a free market. In a free market, firms compete with each other and the outcome of that competition is that prices are driven down to the cost of production. When we have a large number of identical firms producing a homogeneous good competing with each other we have a perfectly competitive market.

In perfectly competitive markets, firms don’t make (economic) profits — which is the same as saying that prices reflect the underlying (total) costs. Theoretically, the outcome of perfect competition is social welfare maximizing. In reality, however, firms are never identical and the goods they produce are never homogeneous. Therefore in reality some firms do make (economic) profits. But we abstract away all the details of the real world to gain a basic understanding of how the real world works.

Firms Hate Competition

It is easy to appreciate that firms don’t like competition because it hurts their profits. The fewer competitors they have in the market, the greater their profits. In the extreme case, if they are the only firm in the market — a monopoly — they are the happiest. If being a monopoly is not an option, incumbent firms would settle for being in a market in which firms face entry barriers and therefore competition is limited. Profits are inversely related to the degree of competition in the market.

Each firm in the market would like to eliminate its competitors. Burning down the factories of its competitors could be a useful strategy but it is generally frowned upon by society at large. Murdering the owners of competing firms is also not an acceptable form of limiting competition unless you are talking of illegal drugs’ cartels. So what is a firm to do? There is a way out: get the government to limit competition in the market and share some of the resulting profits with those in the government. That is, change the nature of the competition from being in the market to being a competition for the market.

Governments Hate Competition

So far the story is not all that interesting. Yes, firms like to limit the competition they face because they want to maximize profits or dominate the market. That is an innocuous observation and nothing extraordinary. The really interesting bit comes in when you introduce government into the picture. Governments have the general power to coerce and more particularly they have the power to meddle with the market. Governments stop markets from being free and that’s the start of a long list of maladies that end up impoverishing countries and wholesale destruction of life, liberty and happiness.

That’s a tall claim but it enjoys superb analytical and empirical support.

Competition in the market moves to being competition for the market under government patronage. What’s in it for the government? Follow the money. When the government totally forbids entry into the market, as in the case of a government monopoly, the public sector firm makes monopoly profits. These profits come out of the pockets of the consumers. Wherever there are economic profits, there are social welfare losses called “deadweight losses.”

(Let’s say that the consumers pay an extra $1000, and the firm makes $500 economic profits. The deadweight loss in this case is $500 — the bit that consumers lose but no one gains.)

We have to remind ourselves that when we say the “government” we mean actual living breathing people, people who are motivated by self-interest, greed and fear — just like the rest of us. They are not saints working selflessly for the benefit of mankind and “the greater glory of god” (as the monotheists put it.) The reason government people love monopolies is that they have access to the pecuniary and non-pecuniary benefits that arise from their monopoly control. Public sector monopoly is bad for the economy but good for the government. The public sector airlines is an easily observed example: the government uses it as its own private airline.

(Note that civil aviation has been liberalized to the extent that the private sector firms are allowed but the public sector airlines continue to exist for no discernible reason — other than the politicians can continue to have their private airline.)

Governments Profit by Limiting Competition

Instead of a public sector monopoly, the government can grant a private firm exclusive access to some market thus creating a private sector monopoly. How much can the government (or more accurately “the politicians and bureaucrats”) make from this? Theoretically whatever profits the monopoly firm can make in the market.

The government can invite bids from firms and sell off the right to be the monopoly supplier to the highest bidder. The firms competing for the market compute how much profit they are likely to make. The one which expects the highest profit is likely to bid the highest, and win the right to ply its trade as the monopoly supplier. A part of that bid ends up in the pockets of the people in government.

It’s the same when the government decides that it will restrict the market to not just one firm but to a few. Limited competition in the market –> profits for firms –> part of the profits given to government.

Free markets maximize social welfare under a reasonable set of conditions. When these conditions are not met, some degree of intervention is required. But we need not go into that here. The focus is on why governments in dysfunctional economies like India needlessly interfere in the market in ways that leads to social welfare losses. They do so because it is profitable for them.

This is much worse than what it appears. Being in government is profitable if the government interferes in the market and restricts competition. If it had been a free market, it would have led to maximum social gain. By shifting competition from being in the market to being a competition for the market, it leads to social welfare losses. That’s the first order loss. There are much greater higher order losses.

Market Interference Leads to Corruption

Suppose the government did not needlessly interfere in the markets. That is, it did not limit competition in the market. Then there will be no (economic) profits in the market, and consequently there will be no profits that firms could, or would want to, share with the people in the government. Which means that being in the government would not be economically profitable.

Conversely, if being in the government is economically profitable, then it would attract the criminally inclined to compete to be in government. The ability to limit the free market shifts socially beneficial competition in the market of goods and services to socially harmful competition in the political market.

The criminalization of politics is a direct and unavoidable consequence of the government’s ability to interfere in the free market.

Criminals are good at crime. They are not good at governing, which involves the ability to reason, to have a vision of what a good society is, to be able to propose and enforce socially beneficial policies and programs. So therefore if the government has the power to interfere in the free market, it leads to criminals filling the government and that means bad economic and social policies.

The UPA Government is Corrupt

The Antonia Maino-led UPA government at the center is a striking example of extreme corruption, an example of the nexus between bad economics and rampant political corruption. The UPA government is filled to the brim with crooks — from Dr Manmohan Singh to P. Chidambaram to this or that Raja — the list is seemingly endless. Scams are reported with sickening regularity. Examine any instance of corruption and you will find that underneath it all, there’s the government meddling in the market. Whether it is coal or spectrum or food grains or civil aviation or whathaveyou — the government has the power to distort markets and make a quick few hundred billion.

Crony capitalism or relationship capitalism — whatever it is called, the result is the same. India is an impoverished country not because Indians are particularly stupid as a collective but because of structural reasons. The rules of the game are lousy. And the most important rule book of them all is the constitution of the nation.

You hardly ever hear criticism of the Indian constitution. But it is a flawed constitution. It has to be because the evidence is overwhelming that under its dispensation, you have a political system that selects criminals in the highest places — including the head of the state and the head of the government.

Hardened criminals occupy every position of power and influence in politics and through their patronage, the most venal liars dominate the media. It’s a cozy arrangement with the media shielding the criminal politicians by hastily burying the scams by focusing on the trivial and the inconsequential such as sex, cricket and bollywood.

Idiots Running the Opposition

Certifiable idiots are promoted as saviors of the people. Dog and pony shows — exhibit A is India Against Corruption — make the headlines. People are led to believe that expanding the size and power of the government is the way to end corruption. I suppose that some people feel left out of the gravy train and they therefore want to add a few dozen coaches to the train so that they and their cronies can get on.

What I have argued in here (and in the previous piece) is that if the government has the power to distort markets, it inexorably leads to criminals entering politics, which then means that corruption becomes endemic, and that leads to economic disaster. To put it in plain terms, a competent criminal does not a good economist make (regardless of how loudly one is proclaimed to be one by a paid media.) Criminals make lousy economic policies — see the “economists” in the UPA government — which leads to economic disasters. Economic disaster then leads to popular discontent. And that leads to attempts at revolt — and the next act in this sordid play is when the government cracks down on any visible sign of protest.

The substitute for the invisible hand of the market is the very visible heel of government coercion.

Sometimes I feel sorry for Indians. Then I remember that India is a democracy and people have the freedom to vote. Enjoy your so-called “freedom”, Shri & Shrimati Indian Voter. You deserve the police heel on your throats and the lathi on your backs, and you deserve it good and hard.