In economics textbooks, monopolies are socially dysfunctional because they raise price above marginal cost. This implies deadweight loss – consumers’ pain is not producers’ gain. Picture a matinee at a movie theater. The marginal cost of admitting one more viewer is practically zero, but the price is still, say, $10 a seat. If someone values attendance at $9, charging him $10 destroys $9 of consumer’s surplus without yielding a penny of profit.
Economics textbooks also routinely claim that antitrust laws exist to mitigate this harm. What’s strange, then, is that antitrust laws almost never simply punish firms for charging prices above marginal cost! Yes, antitrust authorities try to change market conditions to make high prices less likely; forbidding mergers in highly concentrated industries is a typical approach. But if Amazon, with all its monopoly power, doubled every one of its prices today, antitrust authorities probably wouldn’t lift a finger.
What justifies this inaction? If you pressed informed economists on this point, they’d probably say two things.
First, many firms – especially firms in concentrated industries – have high fixed costs. Given this cost structure, pushing prices down to marginal cost wouldn’t hand consumers a pile of cheap products. Instead, it would disastrously drive every business into bankruptcy.
Second, the textbook model totally ignores what economists call dynamic efficiency. Sure, raising price above marginal cost implies deadweight costs today… but it also yields a monopoly profit. The opportunity to earn these monopoly profits gives entrepreneurs a powerful incentive to create and improve businesses. And that, of course, is how progress happens. Everyone – including everyone who pays monopoly prices – should smile to read the words “If you come up with a great new business idea, you’ll get rich” emblazoned above the gates of the world of business.
Both of these arguments are solid. The first implies that antitrust authorities should definitely leave firms alone unless they’re earning supernormal profits. The second implies that antitrust authorities should at least consider leaving firms alone even if they are earning supernormal profits.
Yet on reflection, neither argument justifies the status quo. The challenge: If it’s bad to use antitrust to directly force prices down to marginal cost, why isn’t it bad to use antitrust to indirectly force prices down to marginal cost?
Suppose, for example, that HBO and Netflix want to merge. Antitrust authorities plausibly argue that this horizontal merger will substantially raise the prices consumers pay for premium entertainment. They’re probably right, but the story doesn’t end there. The knowledge that successful firms can legally merge increases the incentive to create successful firms. Not just successful firms in the entertainment industries. All firms. If you take dynamic efficiency seriously, you should at least be open to the possibility that the net economic effect is positive – the naive textbook monopoly model notwithstanding.
The same goes for monopsony as well. If your business is awesome, you’ll be able to pay your workers less than their marginal product. However, this in turn amplifies the incentive to make awesome businesses. Every worker should want to live in a world where this incentive is supercharged.
Once you buy this argument, you’ll see most other “suspect” business practices in a favorable new light. What’s so bad, for example, if employers add a non-compete clause to their employees’ contracts? There may be some static inefficiency, but it’s nice to live in a world where entrepreneurs know they can profit as they please if they make their firm great.
Further point: Dynamic efficiency may take – and last – a long time. The current success of Jeff Bezos isn’t merely incentivizing his fellow 54-year-olds to make great businesses. Word of his fabulous fortune is already inspiring our business-savvy kindergarteners. Verily, as Maximus says in Gladiator, “Brothers, what we do in life, echoes in eternity.” The way your culture feels about business matters. It’s not crazy to think that the monopoly profits Rockefeller earned in the 19th century continue to fuel the ambition of the aspiring Rockefellers of the 21st century. Nor is it crazy to think that the antitrust case against Rockefeller continues to numb American entrepreneurship. “If you build something great, the government just might decide to smash it” is a demotivating whisper.
So should we learn to love monopoly? Not exactly. Business excellence is one route to monopoly power. The other, however, is government favoritism, which stifles static and dynamic efficiency alike. Is this really a big deal? Absolutely. Government routinely and deliberately crushes free competition, most egregiously with immigration restrictions, housing regulation, and occupational licensing. If you really want to fight socially dysfunctional monopoly, don’t urge government to tame monopoly. Instead, urge government to create less monopoly. We have a massive monopoly problem. But government is not a solution to our problem; government is the problem.
READER COMMENTS
Peter Mannino
Jul 24 2018 at 2:59pm
Isn’t the entire case against non-compete clauses exactly that they stifle dynamic efficiency? Imagine if the traitorous 8 couldn’t leave Shockley to found Fairchild semiconductors, or Noyce and Moore couldn’t leave Fairchild to found Intel. California’s hostility to non-compete’s is one reason why we have a tech sector…
I guess the problem is that some business practices prevent the world from being a place where “entrepreneurs know they can profit as they please if they make their firm great.”
Nathan Smith
Jul 25 2018 at 9:25am
A much needed post. Antitrust is a government policy libertarians are sometimes reluctant to go after because it seems to promote “competition” or even “free markets.” Libertarians need to be educated about how little the competitive general equilibrium model describes the world, and about the inevitable arbitrariness of government policies that try to micromanage the degree of market competition, protecting IP here and blocking mergers there. I would add that private tycoons not only do much good in the course of making their money, but they tend to do good in the course of spending it, whether as creative and energetic private philanthropists, patrons of art and architecture, early adopters of cutting-edge technology, patrons of scholarship via exorbitant paying exorbitant university tuitions, etc. But they can set horribly bad examples of personal conduct (Donald Trump) or patronize evil ideas (Friedrich Engels), so the record is mixed. Even moderately virtuous rich people are a great asset to society, but wicked rich people can make a lot of trouble.
An interesting case study in the odd results of big government ideology is that the Department of Justice would never allow a merger of Coke and Pepsi, and I presume that your typical progressive would say that of course it shouldn’t: a united CokePepsi would have too much monopoly power. At the same time, progressives often favor soda taxes to address the negative externalities (via obesity and partially socialized health care costs) of excessive soda drinking, or simply from paternalism (nudge people to healthier lifestyles for their own benefit).Well, guess what? If a Coke-Pepsi merger harmed consumer interests, it would do so because CokePepsi would raise soda prices to increase profits. But that would lead to less soda drinking, and less obesity, and lower health care costs. In effect, then, Big Government makes Coke and Pepsi to keep soda prices low with one hand, by enforcing competition, while trying to undo the damage by taxing them with the other hand. Why not promote public health in a more libertarian fashion, by letting Coke and Pepsi collude to raise soda prices? After which, as likely as not, some future Coke-Pepsi Foundation, burgeoning with monopoly profits, would wipe out a couple of diseases, open a few thousand schools in refugee camps, fix a famine or two, and so forth.
Robert EV
Jul 27 2018 at 10:26am
No, it would do so through a probable reduction in products, as well as possible knock on effects in the distribution chain (as Coke and Pepsi distributors historically distribute for smaller soda companies which produce flavors that they don’t directly compete with).
A Coke and Pepsi merger would likely just lead to the third string companies gaining market share, so other than the likely reduction in flavors I’m not opposed to it.
Floccina
Jul 25 2018 at 11:26am
Isn’t that what they do with the electric companies though?
njhoepner
Jul 25 2018 at 8:02pm
Basic argument seems to be “everything will be cool if entrepreneurs know they can do whatever they want.” I’m not convinced. Entrepreneurs could do whatever they wanted during the Industrial Revolution, especially prior to 1833 (in Britain) and around 1870 (in the U.S.). Many things were decidedly NOT cool, in particular working conditions, living conditions, wages, waste disposal, and environmental damage.
If we assume that human nature is basically good, then perhaps the article’s argument might hold. However, if wealth is power, and monopoly is power, and human nature is basically selfish, then unrestrained power might yield some good, but also a whole lot of evil. I think it is wise to put some reasonable restraints on the accumulation of power, including monopoly power.
Gaurav B
Jul 28 2018 at 11:01am
“Many things were decidedly NOT cool, in particular working conditions, living conditions, wages, waste disposal, and environmental damage.”
It’s true that by modern standards all of these were bad. But you have to compare them to what was there before and the alternatives at that time. As bad as wages may have been in 19th century factories, they were better than life on the farm, which is why so many people flocked to them. Both America and Britain made tremendous economic gains through the 19th century.
“However, if wealth is power, and monopoly is power, and human nature is basically selfish, then unrestrained power might yield some good, but also a whole lot of evil. I think it is wise to put some reasonable restraints on the accumulation of power, including monopoly power.”
I think any libertarian would say some constraints, such as prohibition of force, coercion, fraud, etc. are entirely reasonable and desired. But if power is bad, then we must also consider that the government itself is a powerful monopoly subject to the same selfish human nature.
Robert EV
Jul 27 2018 at 10:20am
Wouldn’t the knowledge that successful firms cannot legally merge increase the incentive to create even more successful firms (as merging is a quick way of gaining markets instead of growing them, and if the only way to gain markets is to grow your business, then this is what CEOs and boards will be incentivized to do)?
You seem to be conflating ‘large’ with “successful”, and I wonder if this is justifiable.
I don’t give a damn about strong companies, or large companies, I give a damn about the robustness of our republic (USA), which is immediately predicated on the power of the average citizen.
zeke5123
Jul 27 2018 at 12:27pm
If you presume diminishing marginal returns to utility is a general rule, then relaxing merger rules will have less of an impact on dynamic efficiency compared to allowing some monopoly pricing to excite entrepreneurs. This doesn’t suggest one is better than the other; instead, the idea that once one is permitted, the other won’t have as large of an effect.
Thus, it is perfectly justifiable to support the status quo ante, because even though the same theory supports both allowing monopoly pricing and permitting all mergers, it doesn’t follow the benefits are the same if we change from the status quo ante.
Now, maybe the cost-benefit is worth it — I am fairly agnostic on this position — but there is a cost-benefit calculation to consider.
N. Joseph Potts
Jul 29 2018 at 10:25am
Perhaps we might fall back on first principles here. Which alternative entails/allows the greater freedom? Not every decision must be made on such doctrinal bases, of course, but decisions like this one, where there might be a cost-benefit trade-off that is hard if not impossible to evaluate …
Freedom/less government is a value in and of itself. A very great value, in my calculus.
A Country Farmer
Jul 30 2018 at 9:52pm
I read the third sentence as, “Picture a manatee at a movie theater.” 😀
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