Interesting article.....I find it hard to believe that Professor Armentano could find no examples of predatory pricing, but if this is correct, then the whole theory of the Anti-Sherman Act and the Act itself should be revisited.
On Fri, Feb 15, 2013 at 3:44 PM, MJ <[email protected]> wrote: > > *The Misplaced Fear of “Monopoly” > *by Thomas E. Woods Jr. <http://fff.org/author/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/ > > -- > -- > Thanks for being part of "PoliticalForum" at Google Groups. > For options & help see http://groups.google.com/group/PoliticalForum > > * Visit our other community at http://www.PoliticalForum.com/ > * It's active and moderated. 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