Competition in Free Markets

I ended the previous bit with the claim that competition in a second-best world can be bad.

Competition in a free market is nearly always good because it is that process which provides the incentive to market participants to do the best they can, which leads to all the advances we all enjoy.

Remember that every one of us is a market participant. Therefore we all have to compete. It doesn’t have to be cutthroat but it we cannot avoid competing.

But what about cooperation? Doesn’t that matter? Yes. It matters enormously. We even have to compete in our cooperation. Individuals who are good at cooperating out compete those who are bad at cooperating. This holds true for higher levels of aggregation too. More cooperative, high trust cultures do better than cultures that mistrust and don’t honor their word.

In a perfect world, which in our case we don’t have, competition would always be good for everyone. Even those who lose out in their particular competition would nevertheless be better off in this world of competition because competition raises the general level of welfare, than they would be in a world without competition.

In our imperfect world, however, competition can be bad. We live not in a “first best” but a “second best” world. In a second-best world, the rules of the first-best world don’t necessarily apply. 

Consider an arms race between two large economic powers. That competition does not benefit either party. It is the quintessential negative-sum game. The harder the competition, the worse off both parties are. The higher the stockpiles of weapons of mass destruction grow competitively, the higher the chances that something will accidentally go off.

In such a case, it may be better if they cooperated instead of competing. For example, if one side has the technology for making missile silos bomb-proof, it would be good for it to share that technology with the other side. That is, help your enemy to defend itself better, so that you would be more secure. This is the logic of mutually assured destruction — that it is in your interest to cooperate with the enemy.

Well, you’d say, that the world of the military. What about competition in civil society? 

There is intense competition to become a Hollywood actor. Thousands of young men and women try — frequently ruining their lives in the attempt —  and only a few of them succeed to get to the top. Collectively these people may have spent more in trying to become successful actors than the collective earnings of all the top actors. 

This sorry situation is fairly common. Failed writers outnumber successful authors by at least three orders of magnitude. They also toil but never quite make it. The fact is that life is not fair. Very few are endowed with the extreme beauty or intelligence that helps one win the various competitions that modern society entails.

This is a striking feature of the world we live in. The world has nearly 8 billion people. Much of the basic survival needs are met by the work of a relatively small fraction of the world’s population. The rest of the people then have to compete on non-essential stuff like entertainment, arts, etc. Unfortunately for these people, large parts of that world is becoming a “winner take all” game.

In this winner-take-all world, there is not much space for the average-talented person. The good news for all us average folks is that as long as we don’t suffer from envy, we are better off in today’s world because we have without too much effort the benefits of the extremely talented. This is wealth we enjoy and did very little to deserve. That was made possible by competition — and that means competition in free markets. 

In the next bit, I’d like to explore what happens when competition meets distorted markets.