The Misplaced Fear of “Monopoly”
by
<http://fff.org/author/thomas-e-woods-jr/>Thomas
E. Woods Jr. February 14, 2013
Those of us who get drawn, often against our
better judgment, into Internet debates soon
discover that the case against the market economy
in the popular mind boils down to a few major
claims. Here I intend to dissect one of them:
under the unhampered market we’d be at the mercy of vicious monopolists.
This fear can be attributed in part, no doubt, to
the cartoon history of the 19th century virtually
all of us were exposed to in school. There we
learned that rapacious “robber barons” gained
overwhelming market share in their industries by
means of all sorts of underhanded tricks, and
then, once secure in their position, turned
around and fleeced the helpless consumer, who had
no choice but to pay the high prices that the
firms’ “monopoly” position made possible.
This version of events is so deeply embedded in
Americans’ brains that it is next to impossible
to dislodge it, no matter the avalanche of
evidence and argument applied against it.
Historian Burton Folsom made an important
distinction, in his book The Myth of the Robber
Barons, between political entrepreneurs and
market entrepreneurs. The political entrepreneur
succeeds by using the implicit violence of
government to cripple his competitors and harm
consumers. The market entrepreneur, on the other
hand, makes his fortune by providing consumers
with products they need at prices they can
afford, and maintains and expands his market
share by remaining innovative and responsive to consumer demand.
It is only the political entrepreneur who
deserves our censure, but both types are
indiscriminately attacked in the popular
caricature that has deformed American public opinion on the subject.
Andrew Carnegie, for instance, almost
single-handedly reduced the price of steel rails
from $160 per ton in 1875 to $17 per ton nearly a
quarter century later. John D. Rockefeller pushed
the price of refined petroleum down from more
than 30¢ per gallon to 5.9¢ in 1897. Cornelius
Vanderbilt, operating earlier in the century,
reduced fares on steamboat transit by 90, 95, and
even 100 percent. (On trips for which a fare was
not charged, Vanderbilt earned his money by selling concessions on board.)
These are benefactors of mankind to be praised, not villains to be condemned.
To be sure, there are caveats, as there always
are in history. For a time, Carnegie did support
steel tariffs. Since he substantially reduced the
price of steel rails, though, this political
position of his did not harm the consumer. Other
critics will point to the Carnegie and
Rockefeller foundations and the dubious causes
those institutions have supported. Their
objection is irrelevant to the specific question
of whether the men themselves, in their capacity
as entrepreneurs, improved the American standard of living.
That question is not even debatable.
Mainstream economics identifies monopolists by
their behavior: they earn premium profits by
restricting output and raising prices. Was that
behavior evident in the industries where monopoly
was most frequently alleged to have existed?
Economist Thomas DiLorenzo, in an important
article in the International Review of Law and
Economics, actually bothered to look. During the
1880s, when real GDP rose 24 percent, output in
the industries alleged to have been monopolized
for which data were available rose 175 percent in
real terms. Prices in those industries,
meanwhile, were generally falling, and much
faster than the 7 percent decline for the economy
as a whole. We’ve already discussed steel rails,
which fell from $68 to $32 per ton during the
1880s; we might also note the price of zinc,
which fell from $5.51 to $4.40 per pound (a 20
percent decline) and refined sugar, which fell
from 9¢ to 7¢ per pound (22 percent). In fact,
this pattern held true for all 17 supposedly
monopolized industries, with the trivial exceptions of castor oil and matches.
In other words, the story we thought we knew from our history class was a fake.
Predatory pricing
Beyond the appeal to specific examples from
history, critics of the market propose
plausible-sounding scenarios in which firms might
be able to harm consumer welfare. Larger firms
can afford to lower their prices, even below
cost, as long as it takes to drive their smaller
competitors out of business, the major argument
runs. Once that task is accomplished, the larger
firms can raise their prices and take advantage
of consumers who no longer have any choice but to
buy from them. That strategy on the part of
larger firms is known as “predatory pricing.”
Dominick Armentano, professor emeritus of
economics at the University of Hartford, surveyed
scores of important antitrust cases and failed to
uncover a single successful example of predatory
pricing. Chicago economist George Stigler noted
that the theory has fallen into disfavor in
professional circles: “Today it would be
embarrassing to encounter this argument in professional discourse.”
There is a reason for that disfavor. The strategy is suicidal.
For one thing, a large firm attempting predatory
pricing must endure losses commensurate with its
size. In other words, a firm holding, say, 90
percent of the market competing with a firm
holding the remaining 10 percent of the market
suffers losses on its 90 percent market share.
Economist George Reisman correctly wonders what
is supposed to be so brilliant and irresistible
about a strategy that involves having a firm --
albeit one with nine times the wealth and nine
times the business -- lose money at a rate nine
times as great as the losses suffered by its competitors.
The dominant firm, should it somehow succeed in
driving all competitors from the market, must now
drive prices back up, to enjoy its windfall,
without at the same time encouraging new entrants
(who will be attracted by the prospect of
charging those high prices themselves) into the
field. Then the predatory-pricing strategy must
begin all over again, further postponing the
moment when the hoped-for premium profits kick
in. New entrants into the field will be in a
particularly strong position, since they can
often acquire the assets of previous firms at
fire-sale prices during bankruptcy proceedings.
During the period of the below-cost pricing,
meanwhile, consumers tend to stock up on the
unusually inexpensive goods. This factor means it
will take still longer for the dominant firm to
recoup the losses it incurred from the predatory pricing.
A chain-store variant of the predatory-pricing
model runs like this: chain stores can draw on
the profits they earn in other markets to sustain
them while they suffer losses in a new market
where they are trying to eliminate competitors by means of predatory pricing.
But imagine a nationwide chain of grocery stores,
which we’ll call MegaMart. Let’s stipulate that
MegaMart has a thousand locations across the
country and $1 billion of capital invested. That
comes out to $1 million per store. Those who warn
of “monopoly” contend that MegaMart can bring to
bear its entire fortune in order to drive all
competitors from one particular market into which it wants to expand.
Now for the sake of argument, we’ll leave aside
the empirical and theoretical problems with
predatory pricing we’ve already established.
Let’s assume MegaMart really could use its
nationwide resources to drive all competitors
from the field in a new market, and could even
keep all potential competitors permanently out of
the market out of sheer terror at being crushed by MegaMart.
Even if we grant all this, it still makes no
sense from the point of view of business strategy
and economic judgment for MegaMart to adopt the
predatory-pricing strategy. Yes, for a time it
would enjoy abnormally high profits, and indeed
the prospect of those profits explains why
MegaMart would even consider this approach. But
would the premium profits be high enough for the
whole venture to be a net benefit for the company?
George Reisman insists, correctly, that they
would not. “Such a premium profit is surely quite
limited -- perhaps an additional $100,000 per
year, perhaps even an additional $500,000 per
year, but certainly nothing remotely approaching
the profit that would be required to justify the
commitment of [the firm’s] total financial resources.”
Let’s suppose that the premium profit that could
be reaped by MegaMart after removing all its
competitors amounted to $300,000, the average of
those two figures. Assume also that the average
rate of return in the economy is 10 percent.
That means MegaMart can afford to lose $3 million
-- the capitalized value of $300,000 per year --
in order to seize the market for itself. Spending
an amount greater than that would be a poor
investment, since the firm would earn a
lower-than-average rate of return (lower, that
is, than 10 percent). For that reason, MegaMart’s
$1 billion in capital is simply irrelevant.
What follows from this, according to Reisman, is that
everyone contemplating an investment in the
grocery business who has an additional $5 million
or even just $1 million to put up is on as good a
footing as [MegaMart] in attempting to achieve
such [premium] profits. For it simply does not
pay to invest additional capital beyond these
sums. In other words, the predatory-pricing game,
if it actually could be played in these
circumstances, would be open to a fairly
substantial number of players -- not just the
extremely large, very rich firms, but everyone
who had an additional capital available equal to
the limited capitalized value of the “monopoly
gains” that might be derived from an individual location.
Market defenses
Coming back to the more general “predatory
pricing” claim, one final argument buries it
forever. Economist Don Boudreaux invites us to
imagine what would happen if Walmart adopted the
predatory- pricing strategy and embarked on a
price war over pharmaceutical products, with the
aim of driving other drug retailers from the
market. Who would be harmed by this? Consumers,
to be sure, as well as rival drug suppliers.
But there’s a less obvious set of victims, and
it’s they who hold the key to solving the alleged
problem. Companies that distribute the drugs to
Walmart also stand to lose. Why? Because if
Walmart drives competitors from the field and
then raises drug prices, which is the whole point
of predatory pricing, then fewer drugs will be
sold. It’s as simple as the law of demand: at a
higher price of a good there is a lower quantity
demanded. That means a company like Merck, which
distributes a lot of drugs to Walmart, will sell less of its product.
Is Merck going to take that lying down? Of course
not. Since a successful predatory-pricing
strategy for Walmart would mean lower sales and
profits for Merck, it has a strong incentive to
block Walmart’s move. And it can do so by means
of minimum- or maximum-resale- price-maintenance
contracts. A minimum-resale-price-maintenance
agreement establishes a minimum selling price at
which a retailer must sell a company’s product.
Such a minimum would make it impossible for
Walmart to engage in predatory pricing in the
first place; they would have to sell the product
at the stipulated minimum price, at the very
least, and could not go any lower.
Maximum-resale-price-maintenance agreements would
allow a company, once predatory pricing has
succeeded -- and again, for the sake of argument
we set aside all the reasons we’ve given for why
predatory pricing can’t work -- to limit the
extent of the damage. It would forbid a retailer
to sell its product above a stipulated price.
Walmart’s putative “monopoly profits” could not
be realized to any great extent under such an arrangement.
In other words, profits all across the structure
of production are threatened when one stage,
whether retailing or anything else, attempts to
reap so-called monopoly profits. You can bet that
firms threatened with a reduction in their own
profits will be particularly alert to the various
ways in which they can prevent the creation of “monopolies.”
What about the DeBeers diamond cartel? Surely
that is an example of free-market “monopoly,”
defying the economists’ assurances that cartels
on a free market tend to be unstable and
short-lived. In fact, there has been no free
market in diamonds. The South African government
nationalized all diamond mines, even ones it
hadn’t yet discovered. Thus, a property owner who
discovers diamonds on his property finds
ownership title instantly transferred to the
government. Mine operators, in turn, who lease
the mines, must get a license from the
government. By an interesting happenstance, the
licensees have all wound up being either DeBeers
itself or operators willing to distribute their
diamonds through the DeBeers Central Selling
Organization. Miners trying to distribute
diamonds in defiance of government restrictions have faced stiff penalties.
In short, opponents of laissez faire have spooked
public opinion with a combination of bad history
and worse theory. The average person, although in
possession of few if any hard facts in support of
his unease at the prospect of laissez faire, is
nevertheless sure that such a dreadful state of
affairs must be avoided, and that our selfless
public servants must protect us against the
anti-social behavior of the incorrigible predators in the private sector.
This article was originally published in the
November 2012 edition of Future of Freedom.
http://fff.org/explore-freedom/article/the-misplaced-fear-of-monopoly/
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