Free Enterprise and the Monopoly Myth

It is a widely accepted myth that free enterprise leads to monopoly or the control of industry by a few and that the government must intervene to protect consumers. Even strong supporters of capitalism have been taken in. But, to the contrary, (1) there is no movement toward concentration; (2) such a movement could never happen; (3) no harm comes from the private ownership of an industry even by one or a few; (4) even if there were harm, the government is incapable of alleviating it; (5) government actions themselves create harmful monopolies and cartels.

A monopoly is a firm protected from competition by force. A cartel is two or more firms so protected. Since the private use of force to drive out competitors is usually prohibited (except for labor unions), governments are responsible for most monopolies and cartels. These are the traditional and most useful definitions.

Many people today, however, give these labels to one or a few firms that dominate an industry. If they maintain their position without using coercion, they are simply single sellers or (if a few act together) group sellers, respectively. [1]

Several studies have been made to determine if industry is becoming more and more concentrated and their results strongly indicate that the relative concentration of ownership has remained virtually the same since the turn of the century (when the earliest study begins). [2]

People often mistake the increasing size of business with concentration because they forget that the size of the market is growing too. Several forces work to increase competition. Cheaper transportation gives consumers greater choice. The rapidly growing franchise businesses (like pick-up food vendors and service stations) give opportunities to those with little capital who want to start their own businesses.

CONCENTRATION

While some industries attract attention when they become more concentrated (autos), industries that are becoming more diversified are overlooked. When U.S. Steel was organized in 1901, it produced two-thirds of America's steel ingots. By 1925 it held only 42% of the market and holds about one-third today. [3] Likewise, Rockefeller's Standard Oil company refined 80-90% of American oil in the 1890s but only 44% in 1912 when it was convicted of "monopolizing." None of these market losses can be attributed to the Sherman Antitrust Act because prosecutions were rare in those days. These and many other such experiences should dispel the illusion that a large firm doesn't face competition or cannot lose its market position.

A very large obstacle to concentration is the immense difficulty of managing large organizations. The problems of bureaucracy, information, control, decision making, red tape, etc. quickly raise the costs of firms that expand too far. General Motors found many years ago that it had to decentralize in order to remain efficient. Most decisions are now made on the plant level with the central office making only broad decisions and raising capital. Thus, the different plants and divisions of General Motors virtually compete in the market as if they were separately owned.

TRUSTS

The Democratic Party Platform of 1888 called tariffs and quotas the "mother of monopoly." The famous trusts of the time (e.g., sugar and tobacco) were protected from foreign competition. It was wisely argued that free trade would protect the American consumer by allowing the whole world to compete for his business. Monopolizing the world production of a product is infinitely more difficult than monopolizing a national market. When Brazil tried to restrict her coffee sales to raise prices, she only succeeded in causing coffee to be grown in other countries, which meant greater production and lower prices than before.

It is also commonly believed that a firm can lower its prices below costs, drive out its competitors, and then raise its prices above the old competitive price and make up its losses and more. But such actions cannot and do not take place. [4] No firm could profit from such action. If it wanted to be the sole or major seller, there is a better way of doing it.

COMPETITORS

If a firm cut its price below its cost, it would be giving away wealth and taking a loss. The larger its share of the market the greater would be its loss. Meanwhile, its competitors could cut their losses to a minimum. In effect, the demand for their product will be reduced but not indefinitely. To argue that they would be permanently driven from the market is to ignore the fact that every business faces a fall in demand at some time. For example, the demand for Christmas trees is zero for most of the year. Yet every year we find sellers as Christmas approaches. Wars occur sporadically and usually without warning, yet producers seeking contracts swarm government procurement offices whenever the demand is restored for war materials.

Most firms will either shut down (to reopen later) or produce for inventory (to be sold when our aspiring single seller quits his foolishness). They might even buy the cheap product for their own inventory to be sold later.

If you were to invest in either company, you would naturally bet on the competitors who are sustaining the smallest loss, certainly not on the one that is suffering the greatest loss and is thus bound to lose the struggle. Even if it began as a wealthy company, wise investors and creditors will withdraw their money and put it with the sure winners—the competitors. [5] In short, you cannot threaten anyone by promising to inflict more damage upon yourself than upon them.

Even if you force them (competitors) to close temporarily, they would always be back when you tried to raise the price above the competitive level. If starting up again required a lot of capital and they feared you might lower your prices again, all they need do is go to your customers, whom you are now overcharging, and get a contract to supply their needs at the competitive price, build a plant, or reopen an old one. They need have no fear of you and, what is more, you may lose all of your business.

If you want to be a sole producer, there is a much easier and cheaper way to do it. Simply buy out or merge with your competitors. Of course, if you raise your price above the competitive level, you will simply find new competitors appearing, as they always appear when demand is present. Again, they can protect themselves for long run production by getting contracts even before they open.

PRICING

Suppose, however, a firm were more efficient than its competitors (could produce at a lower cost) because of some special management, patent, labor, land resources, organization, innovation, etc. It could then either sell at the competitive price and make a pure profit, or slightly below the competitive price (the lowest cost of its competitors) and expand to produce for the whole market while forcing out its competitors. It could not charge above the old price without competitors coming in (by using contracts, if necessary, as before). It could charge near the competitive price and get the pure profit (which in the long run would go to the owner of the resource that gives the special advantage). This serves as an incentive in the economy to innovate, discover, become efficient, etc.

You might also practice price discrimination, i.e., sell to some of your customers at the competitive price and others at lower prices down to the lowest cost of producing an additional unit. This practice will not only bring you the most profits but is economically efficient, as resources will go to their highest valued use. [6]

Those who value the product most will pay the highest price and those who value it less will pay less. Some may not "like" it, but they will all pay as much or less than the value they receive, thus they will all be better off. Also, the right amount of product will be produced.

There may be two obstacles to price discrimination. First, those who pay the lower price may resell to those who must otherwise pay the higher price. To avoid this possibility, you need only require buyers to sign a contract not to resell. Courts should enforce such contracts.

Second, discovering or administering the right prices to the right people may cost more than the increase in revenue. Under such circumstances the single efficient seller may simply charge the higher, competitive price to everyone and restrict the output. Such would be inefficient only if there were a cheaper alternative.

In this case, it is usually argued that government should step in with either price or rate controls or antitrust legislation. [7] It is quite unlikely, however, that these policies, even in theory, would do more than increase the waste.

REGULATION?

To try to make the company produce at the lowest cost and output as if it had equally efficient competitors encounters the classic problems of price regulation. [8] First, what price and what quantity? No two economists or accountants or regulators will agree (even in principle, not to mention after sorting through the books and figures of the company!). If the firm is directed to produce at the lowest cost (as determined by the regulators), the firm's owners will simply take their profits increasingly from the expenses of the firm (fine offices, company cars, pretty secretaries, etc.). With costs now up, they will apply for and invariably obtain permission to raise their rates. It would have been better to have given them their profits in cash and let them buy what they want.

Also, if this is the way innovation is rewarded, it will be stifled. Thus, price regulation offers us no hope of improvement but almost a guarantee of greater loss.

The same is true for antitrust laws. At best they can keep the efficient firm from expanding, thus perpetuating the old price and output which was the worst of the free market solutions. What is more likely, it will prevent an efficient firm from expanding, lowering prices, and increasing output in the long run, thus thwarting progress and improved standards of living. This is, in fact, what U.S. antitrust laws have come to do. [9]

GOVERNMENT "HELP"

Whereas the emergence of harmful or wasteful single sellers in a free enterprise economy is not possible, government imposes a host of harmful monopolies and cartels on the American people. [10] The Postal Service, much of our educational system, public and private utilities, taxis in major cities, etc. are largely monopolies. The FCC, ICC, CAB, and FPC enforce cartels upon the communications, transportation, airline, and utility industries. [11] Government helps farmers, unions, doctors, lawyers, and some businesses to organize to exclude competition, raise prices, and restrict output. [12] All of these create waste because (1) efficient firms and resources are kept away from their highest valued use and (2) price discrimination is usually disallowed, preventing efficient solutions.

If one agrees with any one of the six points (listed in the beginning), he will have to conclude that (free) enterprise should be left alone and that our desire to end monopolies and their evils should be directed at ending the government regulations that create them.

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NOTES AND REFERENCES

[1] Alchian, Armen A. and Allen, William R. UNIVERSITY ECONOMICS (Belmont, California: Wadsworth Publishing Co., Inc., rev. 1967), pp. 320-22, point out some of the difficulties of getting a group of sellers together to agree on prices and quantity. (1) It is difficult to determine one's competitors because of the many substitutes facing all products. (2) It is difficult to get agreement among sellers. (3) There are "gains from secret cheating." (4) "…Not all competitors (actual or potential) can be induced to join: excluded firms are delighted…" to get more business. (5) "If expensive facilities are involved, the colluders will suffer a loss of their own large investment if new entrants do appear—an effect that will continue after the effectiveness of the collusion has ended."

[2] Telser, L.G., "Cutthroat Competition and the Long Purse," JOURNAL OF LAW & ECONOMICS IX (October 1966), pp. 276-77. "No one who examines concentration data can fail to be impressed by the stability of the concentration ratios from industries, the average industry concentration ratio was 44.1 per cent in 1947 and 43.6 per cent in 1958."

[3] Stigler, George J. "The Dominant Firm and the Inverted Umbrella," JOURNAL OF LAW & ECONOMICS VIII (October 1965), pp. 167-71.

[4] McGee, John S., "Predatory Price Cutting: The Standard Oil (N.J.) Case," JOURNAL OF LAW AND ECONOMICS I (1958), pp. 137-68. McGee found "little or no evidence" to support the widely accepted account of the systematic use of predatory price discrimination by the Standard Oil Co. of New Jersey. Any serious student of the subject should read McGee's entire article.

Brozen, Yale, "Competition, Efficiency, and Antitrust Compatibilities and Inconsistencies: An Economist's View,"delivered at the National Industrial Conference Board's Eighth Antitrust Conference, New York, 6 March 1969. "Open entry may be a sufficient condition for competition and enforcement of efficiency. The meaning of entry has been confused by considering only the appearance of a new contender in the market as entry and failing to consider that any expansion of capacity from whatever source is entry."

[5] Gerber, Albert B. THE BASHFUL BILLIONAIRE (New York: Dell, 1967), pp. 228-54. The very wealthy Howard Hughes (about $2 billion), despite determination and every possible legal and financial maneuver, lost control of TWA to his creditors though he still owned over 75 per cent of its stock. This shows the weakness of private wealth against competitive financial institutions such as banks, investment houses, and insurance companies. Hughes wasn't running TWA profitably so they squeezed him out.

[6] UNIVERSITY ECONOMICS, p. 331, f. 13.

[7] IBID., pp. 324-26. "The case against effective collusion comes down to the same point raised in connection with price-searchers' markets—'inefficiency' in the allocation of resource uses. Granted for the sake of argument that there is a misdirection of resources, a proposal to prevent voluntary pooling of private wealth is denial of private-property rights. The criterion of 'misdirected' or inefficient use of resources is itself dependent on the normative premise that individuals should have the right to make choices about use of goods. If we accept a criterion of efficiency relying on open market revelation of values we cannot logically deny fully contracting rights to achieve efficiency meaningful only for private-property rights. Yet that is what a refusal to allow mergers amounts to."

[8] Stiger, George J. and Friedland, Clair, "What Can Regulators Regulate? The Case of Electricity," JOURNAL OF LAW & ECONOMICS V (October 1962), pp. 11-12. "The ineffectiveness of regulation lies in two circumstances. The first circumstance is that the individual utility system is not possessed of any large amount of long run monopoly power. It faces the competition of other energy sources in a large proportion of its product's uses, and it faces the competition of other utility systems, to which in the long run its industrial (and hence many of its domestic) users may move.

"The second circumstance is that the regulatory body is incapable of forcing the utility to operate at a specified combination of output, price, and cost.…Let us assume that the commission would set a price equal to the average cost…then the utility can reduce costs…by reducing one or more dimensions of the services which are really part of its output: peak load capacity, constancy of current, promptness of repairs, speed of installation of service. It can also manipulate its average price by suitable changes in the complex rate structure (also with effects on costs). See Demsetz, Harold, "Why Regulate Utilities?" JOURNAL OF LAW & ECONOMICS XI (April 1968), pp. 55-65. "In the case of utility industries, resort to the rivalry of the market place would relieve companies of the discomforts of commission regulation. But it would also relieve them of the comfort of legally protected market areas. It is my belief that the rivalry of the open market place disciplines more effectively than do the regulatory processes of the commission. If the managements of utility companies doubt this belief, I suggest that they re-examine the history of their industry to discover just who it was that provided most of the force behind the regulatory movement."

[9] [a] Bork, Robert H., "The Supreme Court Versus Corporate Efficiency," FORTUNE (August 1967), pp. 92ff. Professor Bork analyzes the Proctor & Gamble Supreme Court decision and its ramifications, which he calls a "manifestation of long-term trends in antitrust. For roughly the last thirty years, in one antitrust context after another—mergers, exclusive dealerships, patent-license restrictions, price discrimination and so on and on—the Supreme Court has steadily and drastically reshaped the law to protect the inefficient producer at the expense of consumers."

[b] See opinion of Judge Learned Hand in United States v. Alcoa, 148 F. 2d 416, 431 (2d Cir. 1945). Judge Hand in effect ruled that efficiency is virtually a crime. His opinion in this landmark case stated: "[Alcoa] 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."

[10] UNIVERSITY ECONOMICS, p. 325. "Where successful collusions have been carefully investigated, it has been found that special laws, favors, tax exemptions, or government controls have enabled colluding groups to 'police' recalcitrant members and keep out new producers."

[11] See Brozen, Yale, "Is Government the Source of Monopoly?" INTERCOLLEGIATE REVIEW V (Winter 1968/9), pp. 67-78. Stone, Christopher D., "ICC"; Peltzman, Sam, "CAB", Hurt, Robert M., "FCC", NEW INDIVIDUALIST REVIEW II (Spring 1963), pp. 3-37. Hilton, George W., "The Consistency of the Interstate Commerce Act," JOURNAL OF LAW & ECONOMICS IX (October 1966), p. 87. Coase, R.H., "The Federal Communications Commission," JOURNAL OF LAW & ECONOMICS (1959). Brozen, "Competition…" op. cit. "The main barriers to entry are those imposed by regulatory commissions, tariffs, quotas, licensing requirements, and some of the activities of the antitrust authorities."

[12] UNIVERSITY ECONOMICS, p. 336. "Without laws restricting entry to the profession, there would be many more doctors of lower quality. It can be contended that there would be fewer deaths if lower-quality and hence more mediocre medical aid were available, because at the present time even worse substitutes are used—nurses, druggists, books, self-medication, faith-healers, friends, hearsay, phone calls instead of personal inspection, not to mention no medical attention at all."