Regulation and Monopolies

How does one respond to the idea that government needs to regulate monopolies? More specifically, in laissez faire economics, is there any time when government would intervene "for the consumer's good"?

Unfortunately the free market has gotten a bad reputation as a facilitator of centralized power in the form of business monopolies. In a free market, as the saying goes, "[d]iamonds may be forever, but monopolies seldom are." (Thomas 1990)

Much of the attack on free markets on this question comes from a failure to comprehend just what a monopoly is, what constitutes "market share," and the powerful forces free markets bring to bear in disciplining even the largest of firms when it attempts to abuse its position.

In Adam Smith's day, monopoly referred to a firm that enjoyed some government grant of exclusive privilege (e.g. the Navigation Acts of 1651 or the Tea Act of 1773)--the use of the power of government on behalf of one or more special, private interests, to hobble or preclude competition. One step further in this direction, of course, is an actual government monopoly itself whereby government says, "We will do this work and will forcibly shut down anyone else who tries to compete with us." First class mail delivery is a good example.

Governments can do this in overt fashion as explained above, or it can indirectly accomplish some degree of the same thing (intentionally or otherwise) by burdensome taxation and regulation. Taxes and regulations usually hit newcomer or smaller businesses harder than the older, bigger, or politically well-connected firms; the effect is, to some extent, to limit competition and thereby confer a degree of monopoly privilege on the existing or larger firms. Many people today are candidates to start a business, perhaps in competition with large existing companies, but they do not do so because the tax and regulatory barriers discourage them from the start.

When governments, by one method and to one degree or another, limit competition by the various means described above, the result is a coercive monopoly for those producers who benefit from the limitation of competition. This is the kind of monopoly to be concerned about because it breeds a situation where a company (or the government itself) can get away with abuse that would doom a company in a truly competitive, consumer-responsive market.

The other kind of "monopoly" some of us refer to is known as an "efficiency" monopoly. It is simply a situation where a company gets a high market share not because of any government grant of exclusive privilege, subsidy, special tax treatment, or the like, but because it simply does the best job. I think Eastman Kodak may be a good example. To my knowledge, Kodak doesn't get any special goodies from the government, but it nonetheless sells the great majority of film in this country. If Kodak ever became sloppy and complacent, it would be like hanging out a sign reading "COMPETITORS WANTED," and that's precisely what it would get.

A free market system provides powerful restraints against any company abusing its customers or its competitors. (It even whittles away at coercive government monopolies: by my communicating with you via e-mail, I am undermining the Postal Service's legal monopoly on first-class mail.) In a free market, the following constitute some but not all of the ways an abusive firm is disciplined:

A. Free entry--the fact that another entity (a newcomer or an existing firm that may not even currently be in the same business) will find it attractive to enter a market in which consumers are unhappy with the current major supplier.

B. Competition of substitutes--the fact that for most goods, there is some reasonable substitute. Breakfast cereal is a good example.

C. Foreign competition--the fact that simply opening the borders to free trade is enough to imperil the monopoly position of almost any domestic producer. Once, many considered that Detroit would dominate the automobile industry with its powerful market share forever, but Japan found a way into the market, and slowly chipped away at the big three's hold on consumers worldwide.

D. Competition of ALL goods for the consumer's dollar--the fact that if I don't like the air fares charged by the airlines, for example, I may take that disposable income and buy the washer and dryer I've been thinking about. In that case, United Airlines competes directly against Maytag.

I would be remiss if I did not also mention the simple matter of the "price" mechanism. Should any firm or firms establish a dominant market share of any industry, let's say, airlines--for instance--any rise in price and profits acts as an instantaneous signal that alerts other aviation entrepreneurs to an opportunity for profit.

Of course, a tricky problem is always the question of what constitutes "market share." I have a 100% monopoly on lectures by Lawrence Reed, but I hardly have a monopoly over "lectures on economics." If ATT is thought of as being in the telephone call market, it looks very large. If it is thought of as being in the communications market, which comprises all the ways in which we talk to each other, ATT doesn't seem quite so large or menacing.

A few years ago, the Federal Trade Commission tried to convict 5 ready-to-eat cereal manufacturers of what it called a "shared monopoly," because those 5 firms sold 80% of the "ready-to-eat" cereal in the U.S. Trouble was, those 5 firms not only competed against themselves, but they also competed against anything anybody eats for breakfast! (So don't lose any sleep over a vicious, price-gouging, Captain Crunch monopoly). The point is, depending on how you define market share, you can make almost anybody look like a monopolist if you think monopoly has something to do with market share alone.

One accusation often made is that "monopolistic" firms use "predatory pricing" as a weapon in suffocating competition--as a "barrier to entry"--so as to maintain its preferred status. As you will see, it is a highly unlikely proposition.

1. If you send or e-mail me your physical address, I will immediately send you an article I wrote a few years ago entitled, "Witch-Hunting for Robber Barons: The Standard Oil Story." Although it focuses specifically on Standard Oil, it contains a point-by-point refutation of predatory pricing, which is a technique allegedly used to obtain or maintain a monopoly.

2. Perhaps the very best, pioneering work ever done on predatory price cutting theory can be found in Professor John McGee's article in the Journal of Law and Economics, October 1958.

3. Gabriel Kolko is a socialist, but a very good historian. His book, The Triumph of Conservatism, examined the competition/monopoly question in terms of the late 19th century American economy. He propounded the "Kolko Thesis," which holds that the American economy (contrary to the popular myth) was becoming LESS centralized and MORE competitive and that numerous attempts by certain industrialists to "corner" markets or freeze out competition failed due to the powerful winds of competition in a relatively free market. Some of those same businessmen, Kolko contends, then went to government to get it--through regulation--to do the monopolizing for them. I highly recommend Kolko's book, because it refutes the monopoly charge as it often has been made against various American industries around the turn of the century--oil, meat packing, steel, etc.

4. Another great book on the subject, which also takes you through an interesting history of antitrust law, is D. T. Armentano's The Myth of Antitrust.

Michael LaFaive, staff economist at the Mackinac Center for Public Policy would like to add a few additional remarks regarding your query.

You asked, "Is there any time when government would intervene for the consumer's good?" Yes. Of course. Government should do what people can not do for themselves, collectively and individually. Anti-trust is not necessarily one of those things.

Government's role should be limited to "defensive enforcement" such as ending contractual disputes. Even then, it is possible to do this through arbitration (private enforcement). Another role that government may have is with respect to "market failure." Pollution is a good example. Government may have some role in preventing a corporation's toxic emissions from exceeding a certain level because the cost of it is borne by society at large. Still, there are more efficient ways to handle this problem than one-size-fits-all mandates imposed by government. Emission Reduction Credits are a good example.