Monopoly and Competition: Government Intervention and its Effects on the Free Market

Damien Manier — Tue, 30 Mar 2010 16:01:00 GMT

One of the roles of government, debated even among those of a libertarian or small government perspective, is that of regulating monopolies and ensuring competition. On a larger political scale, the debate may focus on how free or how socialized should a market be, but among those that believe the markets should be as free as possible there is still concern over monopoly practices and how the government could be used as a tool to respond to them. The first step in understanding and forming conclusions in this debate is to determine a definition of monopoly. The three offered here are: One seller or producer of a good or service; the establishment of a monopoly price; and a firm or corporation that has been granted market power and special status by the government, either directly or indirectly. Also, the requirements for competition must be established, which economic textbooks may point to as: many small buyers and sellers; standardized product; and no barriers to entry or exit.¹ After close inspection of the definitions of monopoly and the textbook requirements for competition, I hope to demonstrate that “barriers to entry or exit” are the only true requirement to competition and that all barriers are due to coercion, either from government or criminal activity among businesses and individuals.

The first definition of monopoly is that of one seller or producer of a good or service. This is the most literal definition (“monos” means “only and “polein” means “to sell”) and the most common understanding of the word monopoly. While this is a very clear cut and precise definition of monopoly its application is much less so and its use to justify government intervention is even more hazy. The application of this definition becomes difficult when one has to determine what constitutes a single product or service. Since there will be some sort of differentiation between every product offered by different people one could rationally claim that everyone is a monopolist. For example, while Hershey's Chocolate company may not be a monopolist of chocolate they are monopolists of “Hershey's Kisses” and John's doctor is a monopolist of medical services to John. This is further complicated if we accept that fact that the point that the differentiation is substantial to lead to a product being categorized by a different product is solely in the mind of the consumer and can not be defined by any specific attributes or by committee. The second flaw with the use of this definition is when it is used to justify government intervention in the markets based on misconceptions of individual rights and freedom. While individuals do have the freedom to act on available choices they are not entitled to any certain number of choices. If there truly was only the choice of purchasing a product or service from one producer or not purchasing it at all then the individual is free to act on that choice, not require more choices be made available to him. Murray Rothbard uses the example of “Crusoe and Friday bargaining on a desert island” where they “have very little range or power of choice; their power of substitution is limited. Yet if neither man interferes with the other's person or property, each one is absolutely free. To argue otherwise is to adopt the fallacy of confusing freedom with abundance or range of choice. No individual producer is or can be responsible for other people's power to substitute.”²

The second definition, achieving monopoly price is explained best by Ludwig von Mises: “If conditions are such that the monopolist can secure higher net proceeds by selling a smaller quantity of his product at a higher price than by selling a greater quantity of his supply at a lower price, there emerges a monopoly price higher than the potential market price would have been in the absence of monopoly.”³ The concerns raised by the proponents of this defintion are that a single producer or a cartel made up of a few producers will restrict supply in order to gain increased profit margins at a higher price point on the supply-demand curve. However, this will only be profitable for products or services whose prices are inelastic above the “theoretical” competitive price. The flaw in this defintion is determining “competitive price” versus “monopoly price.” Since in the free, or unhampered, market every seller will “absolute control...over the price he will attempt to charge for any particular good...the question is whether he can find any buyer at that price. Similarly,...any buyer can set any price at which he will purchase a certain good; the question is whther he can find a seller at that price.”⁴ Naturally, sellers will seek the highest price and consumers will seek the lowest price and whatever price they agree on, absent coercion, is the competitive price. Along the same line, how would one determine if the producer was moving from a “sub competitive price” to the competitive price for their goods as opposed to moving from the competitive price to a monopoly price. The “demand curve is not simply 'given' to a producer, but must be estimated and discovered” and any restriction may simply be a correction of past supply to demand errors by the producer.⁵ These flaws lead to the conclusion that there can be no definable monopoly price on the free market since all prices are based on free-exchange between buyer and seller and whatever terms they come to are by definition the competitive price.

The third definition of monopoly is the original definition of government granted, direct or indirect, market power or protected status. Lord Coke, a definitive source of Common Law in 17^th Century England, defined monopoly as “an institution or allowance by the king, by his grant, commission, or otherwise . . . to any person or persons, bodies politic or corporate, for the sole buying, selling, making, working, or using of anything, whereby any person or persons, bodies politic or corporate, are sought to be restrained of any freedom or liberty that they had before, or hindered in their lawful trade.”⁶ The formation of monopolies and the negative consequences of monopoly power is made possible only due to government intervention and it is therefore ironic that one of the few areas where limited government advocates tolerate government intervention is in the regulation of monopolies. Monopolies are created through barriers to entry into their market and government is the creator of these barriers, which include explicit grants of monopoly status, in industries deemed “public utilities” or “natural monopolies”, patents, license requirements, and economies of scale.⁷ Another barrier is the entire system of corporatism, the alliance between big business and government to create regulations and other burdens on new entrants into the market in order to hamper competition.

The most obvious, and accepted as necessary by some, way the government creates monopolies is by granting exclusive franchises to industries deemed “public utilities.” Some common examples have been energy providers (gas and electric), telephone service providers, and cable tv. The rationalization used is that certain industries, due to high fixed costs, economies of scale, and land usage limitations, are better served by having a single provider. The conclusion is that government should choose a single provider and protect them from competition while at the same time heavily regulating the selected monopoly to prevent monopoly pricing and pass the savings of the increased efficiency on to the customer. However, history does not seem to support this theory. Many industries that claim they are “public utilities” were competitive in the past or became competitive after time spent with protected monopoly status and the customer did not see great advantage in the monopoly years, especially when taxes used to subsidize the utilities are taken into account and other government intervention is not present in the competitive years. “In one of the first statistical studies of the effects of rate regulation in the electric utilities industry, published in 1962, George Stigler and Claire Friedland found no significant differences in prices and profits of utilities with and without regulatory commissions from 1917 to 1932.”⁸ Also, substitutes or alternative technology prevents the formation of “natural monopolies” on the free market. For example, when three competing gas companies tried to merge in 1888, an inventor named Thomas Edison “introduced the electric light which threatened the existence of all gas companies” and while all had “heavy fixed costs which led to economies of scale...no free-market or 'natural' monopoly ever materialized.”⁹ In 1940, economist Horace M. Gray noted that “public utility status was to be the haven of refuge for all aspiring monopolists,” to include, “radio, real estate, milk, air transport, coal, oil, and agricultural industries...who found it too difficult, too costly, or too precarious” otherwise. The label of “public utility” is arbitrary and history has shown that government designated monopolies to do serve the public well and stifle innovation and technological progress as well as violate the rights of entrepreneurs who wish to enter protected industries.

One of the first industries to be deemed a “natural monopoly” or “public utility” was the telecommunications industry, led by AT&T. Initially the monopoly was due to patents that Alexander Graham Bell held from 1876 to 1894. During this time period AT&T held between 85-100 percent of the market power for telephone systems and adoption was slow with average daily calls per 1,000 people increasing from 4.8 in 1880 to only 37 in 1895; the number of telephones per 1,000 people also increased slowly from 1.1 in 1880 to 4.8 in 1895. However, after the patents expired and competition was able to set in daily calls per 1,000 jumped from 37 in 1895 to 391.4 in 1910 and telephones per 1,000 people also increased much more rapidly, going from 4.8 in 1895 to 82 in 1910.¹⁰ The government, however, did not see this competition and rapid expansion of services and options as a good thing, instead they saw it as “duplicative,” “destructive,” and “wasteful” and during a Senate Commerce Committee hearing in 1921 it was stated that “telephoning is a natural monopoly.”¹¹ This was in spite of the apparent boom in competitors and service. AT&T lobbied for this “natural” monopolization and put itself “squarely behind government regulation, as the quid pro quo for avoiding competition.”¹²

From the AT&T case we can see that it was able to form its original monopoly, before the government explicitly granted it monopoly status, through another government barrier to competition, patents. Patents are probably the most common and most accepted, among capitalists, form of government barriers to competition since they supposedly protect the innovations of individuals and allow them to reap the benefits of research, investment and ingenuity without someone else profiting from an idea they did not share the costs in discovering. However, there is strong evidence that patents are unnecessary and in fact stifle innovation instead of promoting it as intended. The telephone industry demonstrated this earlier but another example would be in the field of steam engines and steam power. In 1768, James Watts patented the steam engine and used his political clout to extend the patents until 1800. He aggressively pursued his competitors with patent violations and prevented many innovations from taking place in the area of steam power or improvements in the steam engine. As a result, “during the period of Watt's patents, the United Kingdom added about 750 horsepower of steam engines per year. In the thirty years following Watt's patents, additional horsepower was added at a rate of more than 4,000 per year. Moreover, the fuel efficiency of steam engines changed little during the period of Watt's patent; however between 1810 and 1835 it is estimated to have increased by a factor of five.”¹³ The book, Against Intellectual Monopoly, documents many examples like this in almost all fields. Without patents, the original innovators will still find advantage since people are only likely to imitate successful innovations that would mean the original innovators would have time to establish themselves and gain market power and brand name recognition before competitors really started entering the market.

The requirement of Licenses to conduct a particular type of business or to work in a particular field are another widely accepted form of government intervention that creates a barrier to entry for potential competition. One of the reasons for this is that licenses are not sold to the public as protection for existing businesses from potential competitors or as a restriction on the supply of labor to artificially raise wages above market level for favored professions, but instead is billed as a means to protect the consumer by ensuring quality service. However, just like the other barriers to competition, licenses, when required by law, do more harm to the consumer by reducing available options when there is a strict quota on the number of licenses available or when smaller competitors can not afford licensing fees; monopoly pricing due to cartelization since “the governmental administration of licensing is almost invariably in the hands of members of the trade”¹⁴ who have an obvious interest in limiting entry into their field to individuals who are of similar mind to keep prices higher.

All of the barriers mentioned so far and others have become part of the system of corporatism that is actually the dominant force in US and western markets, not capitalism. The high fixed price that leads to economies of scale and prevents smaller businesses from competing is government. “It is no surprise, then, that throughout U.S. history corporations have been overwhelmingly hostile to the free market. Indeed, most of the existing regulatory apparatus--including those regulations widely misperceived as restraints on corporate power--were vigorously supported, lobbied for, and in some cases even drafted by the corporate elite.”¹⁵ In this essay we have mostly focused on the direct barriers to competition placed by the government but there are also many less obvious ways that government intervention helps favored corporations such as inflationary credit expansion, where the first to receive the new dollars will get to use them before the inflationary effects kick in and corporate law itself that allows the individuals who act, or make decisions, in a business to separate themselves from the liabilities involved with those decisions causing a serious accountability issue in our markets today. A “corporation is an artificial being, invisible, intangible, and existing only in contemplation of the law.”¹⁶ This arbitrary grant of artificial personhood status to businesses is yet another barrier to free competition and a fraud is committed when corporate law is presented as part of capitalism and the free market or as advantageous to consumers.

In conclusion, monopolies, oligopolies, unnaturally high market concentrations all stem from government intervention into the free market placing various barriers to the entry and exit of competing businesses. This is done in the guise of regulating or promoting capitalism but is actually within a system of corporatism, the alliance of big business and big government. Big business works with big government to “socialize costs in exchange for a share of profits.”¹⁷ Big business also likes big government because “it has a competitive advantage over small business in doing business with it and negotiating favors. Big government, in turn, likes big business because it is manageable; it does what it is told.”¹⁸ This alliance has distorted our markets and increased the power of both partners at the expense of competition, consumers, and citizens.

1Jacqueline Brux, Economics Issues and Policy Fourth Edition, (Ohio: Cengage Learning, 2008), 246.

2Murray Rothbard, Man, Economy, and State: A Treatise on Economic Principles (Alabama: Ludwing von Mises Institute, 2004), 653.

3Ludwig von Mises, Human Action: A Treatise on Economics (Alabama: Ludwig von Mises Institute, 2008), 278

4Murray Rothbard, Man, Economy, and State: A Treatise on Economic Principles (Alabama: Ludwing von Mises Institute, 2004), 662.

5Ibid., 690

6 Quoted in Richard T. Ely and others, Outlines of Economics (3rd ed.; New York: Macmillan & Co., 1917), pp. 190–91.

7Jacqueline Brux, Economics Issues and Policy Fourth Edition, (Ohio: Cengage Learning, 2008), 251-253.

8Thomas DiLorenzo, "The Myth of Natural Monopoly", The Review of Austrian Economics Vol.9, No.2 (1996), 49-50.

9Ibid., 48

10Adam Thierer, “Unnatural Monopoly: Critical Moments in the Development of the Bell System Monopoly”, The Cato Journal Vol. 14 No. 2 (Fall, 1994)

11Ibid.

12Ibid.

13Michele Boldrin, David Levine, Against Intellectual Monopoly (New York: Cambridge University Press, 2008), 1.

14Murray Rothbard, Man, Economy, and State: A Treatise on Economic Principles (Alabama: Ludwing von Mises Institute, 2004), 1095.

15Roderick Long, “Corporations Versus the Market; Or, Whip Conflation Now”, Cato Unbound, 10 November 2008.

16Frank van Dun, “Is the Corporation a Free-Market Institution?,” Ideas on Liberty, March 2003.

17Robert Locke, “What is American Corporatism?,”, Front Page Magazine, 13 September 2002.

18Ibid.

Damien Manier : capitalism, patent, license

Monopoly and Competition: Government Intervention and its Effects on the Free Market