The Competitive Economy

The Competitive Economy, by Yale Brozen (ed.), Morristown, NJ: General Learning Press, 1975, 481 pp., $12.95.

Many of the general public are now painfully aware of the Keynesian revolution of the 1930's and its subsequent effect on macroeconomic policy (government policy concerned with adjusting economic "aggregates" such as "employment" and "income"). Few of that same public, however, realize that a corresponding "revolution" occurred in microeconomics (the theory of how individual price and output decisions are made) during that period, and that the changes in public policy induced by that intellectual upheaval have also had serious, though perhaps more subtle, economic consequences.

Prior to the 1930's the majority of economists acquiesced in the notion that effective competition between business firms is realizable as long as markets are legally open to competition. Corporate size was certainly not to be condemned per se; in fact, a firm's market share implied a concentration of resources and production justified by free consumer choice and scale economies. If massive capital accumulations proved "inefficient" they would eventually dissolve and be replaced by more efficient arrangements. While there was support for governmentally enforced rules against collusion and other various division of market agreements, the structure of a market was of no unique significance, as far as economic performance was concerned, and no general deconcentration policy commanded support among professional economists.

MARKET STRUCTURE AND COMPETITION

With the publishing of the Berle and Means classic The Modern Corporation and Private Property (1932), however, and the subsequent microeconomic model-building of Joan Robinson (The Economics of Imperfect Competition, 1933) and Edward Chamberlin (The Theory of Monopolistic Competition, 1934), the classical position on market structure and competition began to rapidly melt away. Robinson and Chamberlin argued (within certain assumptions that are virtually always neglected) that firms which sell in imperfectly competitive markets charge prices that exceed marginal costs and, thus, inherently, misallocate economic resources. Berle and Means asserted that corporate assets were becoming more concentrated, that increasing concentration implies increasing economic power for corporate managers beyond stockholder (owner) control, and that meaningful relationships exist between corporate size, prices and profits. An intellectual marriage of the two sets of theories produced a bastard discipline—industrial organization—and the "liberal" promise (in the late 1930's) of a renewed and more vigorous antitrust policy that would radically restructure monopolistic business and create "more competition."

The "new" microeconomics gained amazing strength in the 1950's and early 1960's. With almost all the top academic talent preoccupied with so-called macroeconomic considerations (unemployment and inflation), the industrial organization theorists began to knit together—without important opposition—a theoretical and empirical doctrine on monopoly and competition which became, eventually, the accepted conventional wisdom on such issues. Indeed, these notions so fill elementary and intermediate textbooks that the student is led to believe that no competing theories even exist.

Pure competition—an equilibrium construct that older theorists had found pedagogically useful—was somehow metamorphosed into a welfare ideal, and departures from such a condition became the measure of "resource misallocation." Barriers to entry that "limit" competition were expanded from clear-cut legal examples to any difficulty or impediment that a new firm might have to overcome in order to compete successfully. Thus scale economies and commercially successful product differentiation enjoyed and employed by existing firms became, in the new jargon, "barriers to entry" that limit competition and reduce consumer welfare! And an almost fetish-like concern with empirical "evidence" produced dozens of regression and correlation studies demonstrating—according to the practitioners—that industrial organization theorists were, indeed, on the right track, since "bad" structure did seem to be statistically associated with "poor" economic conduct and performance.

Stated briefly, the thrust of the structuralist argument was that large firms in concentrated industries are likely to perform poorly vis-a-vis smaller firms in less concentrated industries. Poor performance, in turn, implied that oligopolies earn higher than average long-run rates of return, raise prices at faster rates than competitive firms (or, alternatively, do not allow their "administered" prices to respond quickly to changing demand conditions), subtly collude to keep out newcomers by adopting "costly" competitive strategies, and engage in or threaten predatory pricing practices designed to discipline or eliminate competition. And, of course, it was only a small step from such notions and studies to academic advocacy that government "do something" meaningful about such "inefficiencies." Senator Philip Hart's proposed Industrial Reorganization Act (S1167) is an absurd but fitting climax to over 30 years of sloppy theorizing and phony empiricism in industrial organization.

ECONOMIC REVISIONISM

Although "revisionist" arguments and positions in industrial organization and antitrust have been developing for years (see, for instance, John McGee's excellent In Defense of Industrial Concentration, Praeger, 1971), it is a safe bet that Yale Brozen's The Competitive Economy: Selected Readings will become the definitive theoretical and empirical counterattack to the structuralist orthodoxy. For here in one volume (a second companion volume is forthcoming) are forty-two devastating articles (reprints) by some of the most prominent and respected economists in the profession (Brozen, Stigler, Demsetz, Schumpeter, McGee, Posner, MacAvoy, etc.). They systematically explode the structuralist hobgoblin position on industrial concentration, profits, prices, collusion, and unfair competitive practices. Indeed, once the bulk of these scholarly contributions has been digested, one wonders how the structuralists have been able to bamboozle the rest of the profession—and more recently certain legislators and the Department of Justice—for so very long with so little.

The Competitive Economy is divided into four sections. Part One, "The Requisites of Competition," includes articles dealing with entry conditions, numbers of firms, and competition as a market process. Included in this section are some famous reprints, such as Professor Demsetz's provocative "Why Regulate Utilities?" and Schumpeter's deservedly classic treatment of "creative destruction."

My particular favorite here, however, is Professor Paul J. McNulty's "Economic Theory and the Meaning of Competition." In the Austrian economic tradition, and with distinctly Hayekian overtones that are made explicit at certain points, McNulty argues persuasively that neo-classical economists have paid insufficient attention to the distinction between the idea of perfect competition (the equilibrium static condition) and the process of competition itself. Indeed, more often than not, economists (and others) have hopelessly confused the two distinctly different meanings of the term.

While McNulty grants that perfect competition might be the final result of an open-entry, perfect-knowledge market situation and, therefore, a useful pedagogical device, the perfectly competitive equilibrium has nothing whatever to do with an understanding (or appreciation) of the competitive process. McNulty notes that while the classical economists had a disequilibrium, market process view of competition, the modern neo-classical approach has been to emphasize—indeed substitute—the static equilibrium condition. But, of course, to emphasize or substitute the static equilibrium condition is to "drain the concept of all behavioral content." Worse, as far as public policy is concerned, modern microtheorists have come to label as "monopolistic" (and, therefore, undesirable) the very elements of competitive process that tend to move the market towards equilibrium (price adjustments, for instance), since these characteristics of the behavior of firms are impossible under conditions of perfect competition. Thus, in the final absurdity and a la 1984, competitive processes have become monopolistic! In short, Professor McNulty's article is an excellent nutshell statement of much that is wrong with conventional competition and monopoly theory these days, and is an important contribution to the strength of this reader.

INDUSTRIAL CONCENTRATION

Part Two, "Are Concentrated Industries Oligopolies?", critically examines the concept and causes of concentration, and the alleged relationship between market concentration, profits, and price movements. There are many important articles here (Professor Weston's summary article on recent research in industrial organization is excellent) but none, perhaps, more significant than Brozen's own "Concentration and Profit: Does Concentration Matter?". For here Brozen carefully demolishes almost twenty years of structuralist dogma on the alleged relationship between high concentration and high profits, first explored in the literature by Professor Joe Bain in the early 1950's. Reworking the original Bain study—but, importantly, employing a larger sample size of industries—Brozen "discovers" that higher rates of return simply were not associated with highly concentrated industries between 1936 and 1940. (A similar analysis for the postwar years also casts doubt on other influential studies that had "confirmed" the Bain hypothesis.) Hence, much of the earlier concentration-profit studies, so influential in current debate over deconcentration policy, are clearly suspect, and have been dealt a methodological blow from which they are unlikely to recover.

Part Three, "Are Price Conspiracies Effective?" contains my own "Price Fixing in Theory and Practice" and a number of other articles that argue, one, that price conspiracies in legally open markets are unstable and, two, that such instability leads either to the breakup of the cartel via a merger, or to governmental intervention to "remedy" the cartel's ineffective control over price and market share.

"PREDATORY" PRICING

And finally Part Four, "Unfair Competition" contains six important reprints that examine both the theory and the reality of so-called predatory practices. Included here is John McGee's lasting contribution, "Predatory Price Cutting: The Standard Oil (N.J.) Case," and Professor Bowman's incisive analysis of the Utah Pie decision which (he) ranks as the "most anticompetitive antitrust decision of the decade." The thrust of all the articles in this section is that true predation is extremely rare in open markets, and that most of what is labeled predatory or discriminatory pricing is simply price competition by firms with specific cost advantages.

Professor Koller's "The Myth of Predatory Pricing: An Empirical Study" ought to be singled out for special attention. In a careful analysis of twenty-six alleged predatory pricing cases, Koller concludes that predation has been an "infrequent occurrence" with "fairly insignificant competitive effect." Interestingly, in a majority of cases investigated where predation was allegedly attempted, governmental activity (taxes, tariffs) appeared to precipitate the activity. Finally, Koller provides an excellent analysis of one of the phoniest antitrust cases ever—the American Tobacco Case of 1944—where, as usual, competition between large and small companies was mistaken for predatory practices on the part of the larger companies.

The Competitive Economy is a superlative anthology of pro-competition articles, and Brozen is to be congratulated for his editorial work in this regard. The volume is an absolute must for the serious student of economics and, perhaps, for the businessman who seeks ammunition for a rational defense of free enterprise. Highly recommended.

D.T. Armentano holds a Ph.D. in economics from the University of Connecticut, and is a professor of economics at the University of Hartford. He is the author of The Myths of Antitrust and has published in a variety of journals, including REASON.