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Economics

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Free markets and monopoly

by amagi-nation

Competition is an important aspect of capitalism. Companies compete for the consumer’s patronage, which results in lower prices and better services. Adversely, a monopoly has little or no incentive to provide a great product at a low cost. It is for this reason that many people, even some that are free market advocates, support antitrust laws to ensure that companies remain competitive. Many argue that an unregulated market would lead or has lead to monopoly. I will argue that this is not only erroneous, but that the very laws intended to preserve competition have in fact stifled it.

Free Market vs Government-Granted Monopoly

First, it’s important to define a monopoly. Monopolies were originally known as a government privilege, where government would grant a company exclusive privilege to be the sole provider of a good or service. This can only exist with government intervention, for only government can create entry barriers into an industry. Many have the misconception that a monopoly is when a company is the sole supplier of a particular service, but traditionally a company was not considered a monopoly unless they were the sole supplier as a result of government granting them this position. In other words, a company is a monopoly when all potential competitors are prohibited from entering the field. Since many perceive a company being a sole provider of a service as bad, even if entry to the field isn’t prohibited, I will address it as well and I will be describing this scenario as a free market monopoly. In a free market monopoly, there is always opportunity for other competitors to enter a field. Even in if a company gains a large share of the market, or in the rare case that a company gains a market position with no other competitors, the company still has incentive to keep prices at a market level and produce quality goods and services. If they don’t, a potential competitor will see an opportunity to enter the market and take much of their business. In an unregulated free market, the only way to gain a high market share is to provide products or services that benefits people at a cost that they can afford. This is certainly not a bad thing and gaining a monopoly of an industry through serving the consumers is not as easy as it may seem.

In his book Antitrust and Monopoly, Dominick Armentano states:

“To establish monopoly in a free market would require perfect entrepreneurial foresight, both in the short run and the long run, with respect to consumer demand, technology, location, material supplies and prices and thousands of other uncertain variables; it would also require an unambiguous definition of the relevant market. Few, if any, firms in business history, before or since antitrust, have ever approached such unerring perfection, let alone realized it for extended periods of time.”

The second type of monopoly, which is the original meaning, is a government-granted monopoly. In a government-granted monopoly, competitors are prohibited from entering a field. Government has many ways of prohibiting or limiting competitors from entering a market (licensing, tariffs, regulations, etc.). When this occurs, a company not only has a significant share of the market, but they also do not have to worry about new competitors entering their field and thus have little incentive to maintain competitive prices and quality services. Of the two types of monopoly I discusses, only government-granted monopoly conflicts with the idea of competition that I discussed at the beginning of this post.

Antitrust Laws

I’ve discussed how a free market monopoly does not remove the incentive to maintain low prices and quality services. The problem is when there is barrier to the entry of a market. Antitrust laws do nothing to prevent this. Most often, corporations employ anti-trust laws against their competitors. Companies will use the laws in the perverse way, to limit their competitors and gain more protection for themselves. In other words, the laws are used to achieve monopoly power, not to maintain it. And it’s very easy for a company to file an antitrust lawsuit against a competitor because laws are so broad. If a company charges higher prices than competitors, they are accused of price gouging and profiteering. If a company charges lower prices than competitors, they are accused of predatory price-cutting. If they were to charge the same amount as competitors, they could be charged with collusion or cartelization.

Predatory Pricing

Now that I’ve distinguished between a monopoly in a free market, and a government-initiated monopoly, I will now discuss the notion of predatory pricing in a free market. Predatory pricing is the notion that a big firm that can afford to temporarily sell products at a loss and drop their prices so low that smaller firms will be driven out of business. Then after the competition has been eradicated, the predatory firm can increase its price and enjoy monopoly profits. This sounds plausible, but it’s actually a very poor business strategy and if one looks at history, it will be difficult to find an example of this being exercised successfully for a long period of time. John D. Rockefeller was accused of predatory pricing by Ida Tarbell (one of Rockefeller’s biggest critics) in her book The History of Standard Oil Company and the concern over predatory pricing was mainstream amongst economists until an economist named John McGee debunked this claim in an article he wrote for The Journal of Law and Economics, where he had perused 11,000 pages of the Standard Oil trial record and concluded that Rockefeller did not engage in these practice and that it would have been foolish to do so.

A company would suffer significant losses, which would be difficult to recover because rival firms are capable of exiting the market when prices are lowered and then re-entering when prices are increased. In his book Capitalism, George Reisman points out that a larger firm suffers larger losses than the smaller firms. If one firm owned 90% of the business in a specific market, and lowers prices to inflict losses upon a smaller business that owns 10% of the market, then the predatory business is suffering losses of 90% compared to the latter’s 10%. He goes on to state “It’s difficult to see the advantage constituted by nine times the wealth and nine times the business if money is lost at a rate that is 9 times as great.”

The only way a company could recoup from a predatory pricing scheme is if government were to create barriers to enter the industry.

Earlier this week, I provided an example of a failed attempt of predatory pricing where a German cartel called Bromkonvention was selling bromine in the United States for less than half the market price in order to put Herbert Dow out of business so that he could not compete with them in Europe. The cartel had a fixed price of 49 cents per pound, compared to Dow’s price of 36 cents per pound. The Bromkonvention began selling bromine in the United States for 15 cents per pound in order to put Dow out of business so they could gain a larger market share in Europe. The scheme backfired when Dow bought the bromine in the US at the lowered price of 15 cents and then sold it in Germany and Europe at a competitive price of 27 cents per pound. The Bromkonvention continued to drop the price in the US and Dow continued to be competitive in Europe.

John D. Rockefeller and Standard Oil

It’s difficult to have a discussion on monopolies without the topic of John D. Rockefeller and Standard Oil being brought up. Most people will point to this case as proof that companies do raise prices arbitrarily and that antitrust laws are needed. It is true that the company’s share of the refinery market rose from 4 percent in 1870 to nearly 85 percent in 1880. However, Standard’s share of the petroleum market fell to 68% by 1907.

In 1892, Standard had refined 39 million barrels of crude oil. This amount increased to 99 million barrels in 1911. Despite the fact that Standard Oil refined larger volumes of crude oil, its own oil production as a percentage of total market supply decreased from 34% in1898 to 11% in 1906. This was all prior to the antitrust suit that was filed against Standard oil in 1906.

Dominick Armentano states:

“The little-known truth is that when the government took Standard Oil to court in 1907, Standard Oil’s market share had been declining for a decade. Far from being a monopoly, Standard’s share of petroleum refining was approximately 64% at the time of trial. Moreover, there were at least 147 other domestic oil-refining competitors in the market; and some of these were large, vertically integrated firms such as Texaco, Gulf Oil, and Sun. Kerosene outputs had expanded enormously (contrary to usual monopolistic conduct); and prices for kerosene had fallen from more than $2 per gallon in the early 1860s to approximately six cents per gallon at the time of the trial. So much for the myth of the Standard Oil “monopoly.”

So Standard Oil’s share of the market was declining prior to the antitrust laws and prices of kerosene were dropping. And it’s no doubt that Rockefeller provided a service that benefited people and improved people’s standard of living.

Conclusion

There are many historical example that could be discussed, and I’d be happy to provide statistics on any specific antitrust case that one may have questions about. I would like to eventually do more posts about history of big businesses and alleged monopolies in the future, but the main intent of this post was to explain how a free market would not result in exploitation and that in fact it is government intervention that removes the incentives to be competitive. The problems do not occur when a company gains a large percentage of an industry, but when entry to the industry is limited or prohibited by government. Rather than implementing antitrust laws, which are often protectionist in nature, the most important thing a government can do to prevent monopoly is to remove barriers and allow all people to compete in a market.

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