PART III:
The study of a social science like economics is different from that of a physical science like chemistry or physics. When the chemist combines his elements incorrectly he may get a bang or a fizzle; either way, he can be definitively sure that his attempt has been a failure. If he tries to sell a product that contains a fundamental error he will find few takers, and no repeat customers. Even such a willing buyer as the government, spending other people’s money (OPM), will not long tolerate the embarrassment that comes with the unambiguous failure of a product. Voters and taxpayers will revolt if their government issued toothpaste causes their teeth to fall from their heads, and it will be hard to disguise fault if a space shuttle falls out of the sky – with economic science, however, there is always ambiguity in the results of the “tests” of its propositions. There cannot be controlled experiments; there is only the logic of human action.
But Ben thought otherwise. Economists had discovered what “competition” was to a mathematical certainty with their equilibrium and perfect (price) competition models, much the same way as metallurgists had discovered the recipe for steel. If a batch of metal was produced and the result was without the characteristics we know of steel, then it was not steel, and it followed that there must have been something wrong with the process by which it was produced. The same went, for Ben, with “competition,” one of the shibboleths of the free-market economists. He knew the recipe, and he knew what the results were supposed to look like, so he could therefore tell when what he saw violated those conditions. Because of this, he saw nascent or full-blown monopolies everywhere he looked.
“Take, for instance, the advertising we see everyday!” he complained. “These are transparent attempts to trick people into paying more for products than a truly competitive market would allow. The ‘law of one price’ is pretty clear on the subject, so it’s obvious that their higher prices could only be the result of monopoly power. And the range of products and brands! These are clearly an attempt to circumvent the competitive market process whereby homogeneous goods are sold at the price and quantities determined again by competition. How can these firms afford to spend money on these things, unless they are already making monopoly profits? You worry about rising prices, but a firm raising its prices is prima facie evidence of monopoly power!”
He was nearly out of breath, so I took the opportunity to explain that competition is a process, not a state of being. “Sure, prices don’t move in most industries exactly as the models would predict, but that’s only because they don’t take into account changes in consumer preferences, producer innovations, and especially time. We agree that water will seek and settle to its own level?”
“Yeeessss…” he replied cautiously, aware that agreeing to something so obvious must be a trick of some sort.
“Well, if you were to tilt a bucket of water to one side and take a picture of the water the instant you tilted the bucket, you would be astonished to find that the water was higher on one side than the other, then wouldn’t you?”
“Ah-ha!” he shot back. “The water just hasn’t had time to level out yet.”
“True, but that is just the process that the market is undergoing all the time. The models assume perfect information, but firms must discover the preferences of the consumers, the most efficient production methods, and the prices that the market for their products will bear. The models assume an identical rate of return for all industries when there is access to capital markets, but profits caused by ‘high prices’ are different from those gained through ‘low costs[i].’ “ Again I was channeling his older brother Alan, though as usual I was referring to the positions he had held as a younger man. “You are thinking of coercive monopolies, those who derive their position by use of force.”
“Oh, you mean like the mafia; like when they will only allow one deli in town, and so the deli can charge higher prices. But I’m not talking about them. Besides, they just end up paying away all of their extra profits to the mob, either as payment to keep their monopoly, or in ‘protection money’ to keep their shop from spontaneously combusting, if you know what I mean.”
“Well, you’ve hit the nail on the head. A monopoly, in the sense you seem to be worried about, can only exist if there is force to keep out the competition. A market without artificial barriers to entry will always tend to lower prices and increase quality over time. The ‘excess profits’ you worry so much about are like nectar to those with capital to invest. The only way to really earn above average profits is to reduce your costs while at least maintaining quality, not by just simply raising prices – otherwise competitors will swoop in and undercut you. In this way the free market always and everywhere puts pressure on producers to become more efficient and to develop new technologies.”
“But these so-called ‘competitors’ are really just wanna-be monopolists themselves,” retorted Ben. “They lower prices below their costs to drive the competition out of the market. The big corporations use their ‘war chests’ of stored up funds to subsidize the sale of their own goods long enough to soak up all the customers; when they’ve succeeded in clearing away the competition they just raise prices through the roof to make up their losses, and then some.”
“Are you suggesting that low prices are an indication of monopoly as well? And why can’t the firms in your example simply buy the ‘below cost’ goods sold by the would-be monopolist, and then resell them at a profit while their competitor continues selling at a loss? Or borrow from the capital markets until the aspiring monopolist runs out of steam and depletes his ‘war chest’? Or, even if they are driven from the market, what is to stop new entrants from joining as soon as the monopolist attempts to raise his prices above the ‘equilibrium’ rate? With free-entry into a market, potential competition is just as good as actual competition, as the example of ALCOA amply demonstrates[ii].”
“I’m glad you brought them up,” Ben fairly hissed, “because they are one of the worst monopolists of all time. Some overarching mafia organization controlling competition to enrich itself is not the only way to prop up a monopoly or cartel. Unfair competition can take the form of overly efficient firms, or even just working too much harder than your competitors. But don’t take my word for it. Listen to the words of one of the greatest Progressive judges ever, Judge Learned Hand:
It was not inevitable that [ALCOA] should always anticipate increases in the demand for ingot and be prepared to supply them. Nothing compelled it to keep doubling and redoubling its capacity before others entered the field. It insists that it never excluded competitors; but we can think of no more effective exclusion than progressively to embrace each new opportunity as it opened, and to face every newcomer with new capacity already geared into a great organization having the advantage of experience, trade connections and the elite of personnel.[iii]
At this Ben leaned back into his chair with a satisfied look that could only have been enhanced had he puffed on a cigar while stroking a fluffy white cat. There was really only one escape from his idea of monopoly.
“So let me get this straight. Firms that charge too much are monopolies…”
“If they weren’t, how could they continue to charge so much?”
“And firms that charge too little – monopolists who should be restrained as well?”
“Quite so. Their low prices are a weapon to destroy their competition in order to gain control of a market.”
“So then I think I’ve got it. High prices mean gouging, so lock them up; and low prices are predatory, so lock them up, too. So the only thing left is to make sure that your prices are the same as your competitors, right?”
But then he shook his head resignedly. “Tsk, tsk, tsk… that’s collusion.”
Next week: the Conclusion
[i] Rand, p. 69
[ii] Rand, p. 70
[iii] Rand, p. 72
Rand, A. (1967). Capitalism: The Unknown Ideal. New York City, Signet
Photo credit: Hoffman/Bloomberg
