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Static Analysis

October 17, 1998

For decades the Congressional Budget Office and the Office of Management and Budget have consistently understated the benefits of tax cuts with "static analysis" that ignores how such policy changes provide added incentives to work, save, and invest. The result has been bigger and more powerful government at the expense of a smaller private sector.

Another kind of static analysis that is just as harmful to entrepreneurship and economic growth is the government's antitrust analysis, exemplified by the ongoing antitrust assaults on Microsoft, Intel, and other high-profile cases. For most of this century antitrust regulators have adopted an unrealistically static view of competition that takes a snapshot view of markets, at one point in time. If one or a few firms are seen to "dominate," then those firms are likely to be the victims of an antitrust investigation.

But real-world markets are (and always have been) dynamic; market "dominance" is never permanent, especially in the computer industry, as IBM can attest. Competition, the Austrian School economists correctly teach, is a dynamic, rivalrous process of entrepreneurial discovery. Businesses are constantly trying to outdo their rivals by price cutting, advertising, differentiating their products, and myriad other techniques -- including tie-in sales and exclusive-dealing contracts -- business practices that are apparently kosher when adopted by thousands of American businesses but not when they are used by Microsoft, according to the Antirust Division of the U.S. Justice Department.

When the Sherman Antitrust Act was passed in 1890 virtually all economists embraced the Austrian School vision of competiton as a dynamic, rivalrous process. As a result, they were opposed in principle to the existence of antitrust laws, which they believed could only interfere with the natural evolutionary process of competition. As historian Sanford D. Gordon concluded after reviewing all professional journals in the social sciences and all books written by late nineteenth-century economists regarding the trusts, "a big majority of the economists conceded that the combination movement was to be expected, that high fixed costs made large scale enterprises economical, that competitoin under these new circumstances frequently resulted in cutthroat competition, that agreements among producers was a natural consequence.... They seemed to reject the idea that competition was declining, or showed no fear of decline."

Richard T. Ely, a co-founder of the American Economic Association, wrote that "large scale production is a thing which by no means necessarily signifies monopolized production" and opposed the Sherman Act. As did his co-founder John Bates Clark, who wrote, "that combinations are to play an increasingly important part in economic affairs, is altogether probable. But that competition is to be a corresponding extent destroyed should not be too hastily accepted."

Virtually all other prominent, turn-of-the-century economists, such as the University of Chicago's Herbert Davenport, Irving Fisher, and James L. Laughlin; Columbia's Edwin R.A. Seligman and Henry Seager; Wharton School founder Simon Patten; Yale's Arthur T. Hadley; Harvard's Frank Taussig; and Cambridge's Alfred Marshall, expressed opposition to antitrust regulation because it was inherently in conflict with competitive rivalry.

But by the 1920s economists began to change their minds about antitrust. The late Nobel Laureate economist George Stigler once wrote that the reason for this was that economists came to realize that they could earn "substantially more than the minimum wage" as antitrust consultants. Maybe so, but a more important reason is the adoption by the economics profession, and later by policy makers, of the static theory of "perfect" competition.

Inspired by mathematicians, economists adopted this fanciful theory that redefined competition as an equilibrium situation whereby there had to be "many" firms, each producing a homogenous product and charging the same price; information was "costless" in this perfect world, as was entry into and exit from an industry. Competition came to mean "a hypothetically realized situation in which business rivalry...was ruled out by definition," writes economist Paul McNulty. Competition "is by its nature a dynamic process whose essential characteristics are assumed away by the assumptions underlying static analysis," Nobel Laureate economist Friedrich Hayek once wrote. In this sense, "perfect" competition "means indeed the absence of all competitive activities."

This transformation in the meaning of competition from dynamic, rivalrous, entrepreneurship to a set of "equilibrium conditions" based on totally unrealistic and undesirable economic assumptions (who wants homogenous products!) has been the source of endless mischief by antitrust regulators. For over a century businesses have been fearful of cutting their prices too vigorously for fear of being prosecuted for "predatory pricing" or price discrimination. Competing too vigorously and becoming too dominant in an industry is another way to find yourself harassed for years -- if not decades -- by antirust "investigators." And efficiency-enhancing mergers are routinely blocked by antitrust regulators armed with static antitrust analysis.

Unless a more realistic view of the business world is adopted, Microsoft -- and many other successful firms in the future -- will be irreperably harmed by misguided antitrust regulators. The absurdity of it all is that it is consumers who are harmed the most by these supposedly "consumer protection" policies.

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Thomas DiLorenzo, a senior fellow of the Mises Institute, is Professor of Economics at
Sellinger School of Business and Management in Loyola College in Maryland.


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