On Monopoly

“I am confused about the correctness of government interference to break monopolies. Sometimes I think this is good. I do believe that a free market without competition is terrible. But if the government starts deciding what a “monopoly” is and what is not, we have just let in a thin wedge that can corrupt free markets beyond any limit. But then, if the government does not break monopolies, who will? Can the free-markets self-correct? Has it ever happened in practice?”[1]

Those are not easy questions to answer in a blog post since the issues involved are many and far from trivial. Volumes have been written on the definition and analysis of the economic concept of monopoly, and experts frequently disagree on what, if any, harm monopolies do, and what should the policy response be.

My thinking has evolved since I first began learning economics. Trained in the neoclassical tradition, I used to think that monopolies were harmful for the economy, and therefore government intervention was required to break them up for economic efficiency and consumer protection. However, the more I studied Austrian economics, the more I realized that monopolies weren’t the great threat to economic health as they were made out to be.

I begin with a “relatively absolute absolute” principle I hold: the government (state) must not interfere in the economy. The only role the state has vis-à-vis the economy is to prevent force, fraud and theft; to punish offenders when that happens; to protect property rights and to enforce contracts. The free market takes care of the rest. That’s the background “axiom” we hold as a “maintained assumption.” That assumption may be contested, and I can defend it at length but not here and now.

Let’s begin with a simple definition of what a monopoly is. A monopoly exists when there is only one producer (seller) of a good or service in the market. Simple Econ 101 analysis says that in that case, the producer has the ability to increase its monetary returns (profits) by restricting the quantity it sells. It chooses to sell a lower quantity at a higher price, instead of selling a higher quantity at a lower price. We call this “market power” — the power to choose a profit-maximizing quantity and price. The producer sets the price; he is a price-setter.[2] This profits the monopolist at the expense of the consumers.

In contrast to that, Econ 101 theory goes, in a competitive market — which has a lot of producers producing that stuff — a producer does not have the power to set the price. He is a “price taker” because the market price is the price at which he can sell as much as he wishes; but at a higher price, he will not be able to sell any at all since buyers will buy from other producers, who are also price-takers, at the lower market price.

Free markets are conducive to competition because a free market is one in which there are no barriers to entry or exit for producers and consumers. In a free market, anyone is free to sell (or not to sell) whatever, and anyone is free to buy (or not to buy) whatever. Whatever means whatever: widgets, NFTs, labor, pet rocks, wheat, mobile phone services, medical services, garbage (one man’s garbage is another man’s treasure), jetliners, legal advice, ad infinitum.

If there’s competition in a free market, monopolies don’t generally obtain. And even when monopolies do arise, it’s only temporary. In the long run, monopolies die — like the rest of us. That’s the law of nature, and also the law of the jungle we call the economy. Why? Because the universe is dynamic. Things don’t stay the same. Change is universal and unstoppable. The Buddha stressed that impermanent nature of the universe.

How do monopolies (temporary though they may be) arise? First, it could be due to a firm’s property. Suppose MegaCrop owns the only source of Meganisium on the planet, and Meganisium is a necessary input in the manufacture of mWidgets which most people are as desperately addicted to as their smartphones. Their demand for mWidgets in inelastic. Therefore MegaCrop has 100 percent market share for mWidgets.

Or say only FizerCorp has the formula for a drug Xtendlife. It’s a trade secret and therefore no one knows how to manufacture Xtendlife. Again, FizerCorp is a monopolist with respect to that drug.

Good for them but it is not going to last. People find substitutes. Because profits. Yesterday’s mega-profitable monopolists are today’s has been. Gone. Departed. Finished. No governmental action needed at all.

How? Technological changes. Inventions and innovations put all companies out of business, even monopolists.

What about “natural monopoly”? Consider a city and its sewage system. They are extremely expensive to build (high fixed costs, and high sunk costs) and have scale economies (the larger the scale of operation, the lower the average costs.) Then it would be inefficient to have more than one sewage company serving the city.

Natural monopolies are few and far between. They have the ability to exploit their customers but it does not happen to the extent one would imagine. Why? They don’t have local competitors but they do have competitors in other cities. People will figure out that their sewage company charges are out of whack with other cities’.

Then there are artificial monopolies. That’s when the government (using the threat of violence) legally prohibits entry into the market and therefore establishes a monopoly. In the US, the US Postal Service has a monopoly on First Class Mail, for example.

In India, there are lots of legal monopolies — the railways, for example. Commercial aviation was a monopoly (Indian Airlines) not too long ago. Telephony was a monopoly in India too. Technological change forced an end to that. These monopolies are bad and cause immense losses to the economy. They are created because it enriches the bureaucrats and the politicians.

But let’s be very careful in distinguishing between true monopolies as opposed to merely some firms having a very large share of the market. Google has like 60 percent of the search market; Microsoft has a similarly large share of the operating system market. Market concentration is a feature of our modern world.

In the US, 80% of the market is held by three mobile companies, 70% of the domestic airline industry is controlled by four airlines, etc. But these are all contestable markets — entry is possible and happens all the time.

Consumers have choices even if there’s industry concentration. I haven’t used Google search for years, having opted for DuckDuckGo. I do use Gmail but I can (and will) choose to migrate to ProtonMail (once I stop being lazy.)

Right now, in my neck of the woods, I can only choose between Comcast’s Xfinity and Verizon’s Fios. But guess what — Starlink will give them a run for their money. Consumer choice is what keeps corporations honest.

Even in markets where there are only two major firms — a duopoly — such as Boeing and Airbus. Each keeps trying to do its best to make better planes because of the threat from the other. There’s no need for government intervention at all to make the planes safer or more efficient. It is in the interests of both firms to do the best they can — or else they’ll be history.

Indeed, you could have only one firm in the industry — therefore a monopoly — and yet that firm will not behave like the Econ 101 course would lead you to believe. The threat of entry is sufficient to discipline the incumbent firm.

All firms eventually exit the market. Remember at one time, Pan Am was big. Now it’s gone. AOL. CompuServe, Blockbuster, Sears. All gone. Market domination does not last because the world is not static. Here’s a bit from an article titled Fortune 500 firms 1955 v. 2017: Only 60 remain, thanks to the creative destruction that fuels economic prosperity:

Group A: American Motors, Brown Shoe, Studebaker, Collins Radio, Detroit Steel, Zenith Electronics and National Sugar Refining.

Group B: Boeing, Campbell Soup, Colgate-Palmolive, Deere, General Motors, IBM, Kellogg, Procter and Gamble, and Whirlpool.

Group C: Amazon, Facebook, eBay, Home Depot, Microsoft, Google, Netflix, Office Depot and Target.

All of the companies in Group A were in the Fortune 500 in 1955, but not in 2017.

All of the companies in Group B were in the Fortune 500 in both 1955 and 2017.

All of the companies in Group C were in the Fortune 500 in 2017, but not 1955.

The lesson here is that there’s churn in market composition. In free markets, there are entrances and exits. Fortunes rise and fall. We just don’t know what the future will bring (if we did we’d make millions in the stock market) but we can be certain of  one thing: tomorrows corporations will bring us better products at lower prices.

It is fashionable among politicians and bureaucrats to push the false notion that monopolies are bad for people. The irony, oh the irony! Government is the biggest monopolist and it causes nearly all the harm that humans are forced to endure. Not just that it is the biggest monopolist, it is the most pernicious of monopolies because it is a monopoly in the use of violence.

The government’s attempt to break up monopolies or even very large corporations ostensibly to protect the public is a cynical, naked attempt at extracting rents from the corporation. Large firms are definitely not bad for the consumer, and indeed may be good for consumers.

Why? Because of scale economies. Since this post is already very long, I will go into that later. For now, let me reiterate that the greatest threat to human welfare is the state, and that the market can, and does, take care of so-called “market imperfections” provided the government keeps out of it. The government poisons everything.

NOTES:

[1] From a comment on a previous post.

[2] The market power to set a higher price and obtain higher profits depends on a market demand characteristic known as “demand elasticity.” For inelastic demand (the quantity demanded does not change significantly when the price changes), the profits go up by limiting quantity, but if the demand is elastic (the quantity demanded changes a lot in response to price changes), then increasing prices by limiting quantity does not work as well. We’ll avoid wading into the technical weeds to keep this post reasonably brief.