“Austrian” Business Cycle Theory – An Easy Explanation

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Against the simple and straightforward siren song of “underconsumptionist” and “underspending” theories of boom and bust, “Austrian” business cycle theory (ABCT) can seem contrastingly complex and lacking in communicability. The former types of theory, associated with “mainstream” schools of economics, in spite of their falsehood, are at least advantaged by the veneer of plausibility. A huge glut of business confidence and spending will, it seems, naturally lead to an economic boom, a boom that can only come crashing down if these aspects were to disappear. For what could be worse for economic progress if people just don’t have the nerve do anything? Add in all the usual traits of “greed” and “selfishness” with which people take pride in adorning the characters of bankers and businessmen (again, with demonstrable plausibility) and you have a pretty convincing cover story for why we routinely suffer from the business cycle. ABCT, on the other hand, with its long chains of deductive logic, can seem more impenetrable and confusing. Is there a way in which Austro-Libertarians can overcome this problem?

“Austrian” economics is unique in that all its laws are deduced from a handful of self-evident truths, the most important being the action axiom, often peppered with a few additional assumptions or empirical truths (such as the desire for leisure time). The entire corpus of economic law – right from the isolated individual choosing between simple ends all the way up to complex structures of production, trade and finance – therefore forms a unified and logically consistent whole. This is not true, however, of “mainstream” schools of thought which tend, nowadays, to be splintered and scattered into separate, specialised areas of study that are based upon their own, individual foundations. The fissure between so-called “microeconomics” and “macroeconomics” is a prime case in point; while “Austrians” will read much that is agreeable in “microeconomics” (although it still contains many faults and general misunderstandings resulting from the lack of coherence and soundness that is furnished by deduction from the action axiom), “macroeconomics”, on the other hand, seems to be a completely different ball game, considering only “the economy as a whole” without reference to its individual components1. It is this fact that “Austrians” can use to give them the upper hand when explaining the business cycle. For in ABCT, the explanations of “macro” phenomena are little more than an extension of what is found in “micro” price theory.

The market price for a good is the price at which the quantity demanded equals the quantity supplied. Prices therefore serve to ration goods as a response to their scarcity, the goods available being traded from the hands of the most eager sellers to the most eager buyers. Those buyers who are not willing to pay the market price will go away empty handed and those sellers who are unwilling to sell at the market price will not be able to get rid of their goods. What happens, then, if this relationship is disturbed by a forced fixing of prices by the government? First, if the price is raised above the market price to create a price floor, the new price will attract more sellers into the market for that good because the price that they will receive for a sale is now the price at which they are willing to sell. However, at this heightened price there are fewer people wishing to buy the good. Some, who were not previously prepared to pay the lower, market price, are certainly not going to pay the higher price now. And those who would have paid the market price before may now decide that the new price is too high so they also do not buy. What results, therefore, is an increase in sellers and a decrease in buyers which can lead to only one thing – a surplus of unsold goods. The sellers may be very eager to sell at the new price but they will have a hard time finding anyone to sell to. Secondly, the opposite case, where the price is lowered below the market price (a price ceiling) creates, as one would expect, the opposite effect. This new price will attract more buyers into the market for that good because the price that they will pay for a purchase is now the lower price at which they are willing to buy. However, at this lowered price there are fewer people wishing to sell the good. Again, some, who were not, before, prepared to sell at the market price, are certainly not going to sell at the lower price now and those who would have sold at the market price may now decide that the new price is too low so they also do not sell2. What results, therefore, is a decrease in sellers and an increase in buyers which, clearly, leads only to a shortage of goods. Buyers will swarm into the marketplace eager to purchase the articles at the new, attractive price but, to their dismay, the shelves will be empty, cleared out by all of the more hasty buyers who got there before them3.

It is this latter scenario – that of artificially lowered prices – that is relevant for ABCT. For the business cycle is, according to “Austrians”, little more than price fixing on the widest scale, the fixing and the manipulation of what is possibly the most important price in the economy – the interest rate on the loan market. Rather than being the price at which a single good is traded, the interest rate is the price at which saved funds are borrowed and lent (i.e. demanded and supplied) in the economy.

When the stock of money is fixed, if one person wants to borrow (demand) money then another must have saved it in order to lend (supply) it. The resulting rate of interest is the point at which the quantity of money saved/lent equals the quantity of money borrowed. Any borrowers who want to borrow at a cheaper rate and any sellers who want to lend at a higher rate will find themselves priced out of the market for loanable funds, the sub-marginal buyers unable to borrow any money and the sub-marginal lenders unable to lend any. This situation produces a stable amount of saving, lending, borrowing and investment because the interest rate – the price of saved funds – is in harmony with the preferences of consumers, in particular, their preferences for allocating their funds towards either capital or consumer goods. The portion of his funds that the saver retains for consumption will be spent on consumer goods (i.e., present consumption) whereas the portion that he allocates towards saving and lending for investment will be spent on capital goods that will not provide any immediate consumption but will provide a greater amount of it in the future. At the market rate of interest goods and resources in the economy will be allocated in harmony with these desires. If, for example, a borrower wishes to borrow money to build a factory (a capital good) and his calculations reveal that the prevailing rate of interest is low enough for him to make a return on this enterprise, it means that savers are willing to lend a sufficient quantity of funds in order to make it viable. If, however, the prevailing interest is too high it means that savers are not willing to lend enough funds to build the factory – the money that could be spent on building the factory they would prefer to spend on their own, immediate consumption4.

What happens, then, if the rate of interest is set below the prevailing market rate? Exactly the same as what happens when prices are forcibly lowered for any single good. At this rate borrowers who before found the rate of interest too high for their ventures suddenly find that they can afford to borrow. The quantity of funds demanded, therefore, will rise at this new, low price. Savers, however, will be less willing to lend at this price. Certainly if they weren’t prepared to lend at the previous rate of interest they will not be induced to do so by an even lower rate and some savers who were prepared to lend at the market rate will not be prepared to do so at the new, artificially fixed rate. The increase in borrowers and decrease in sellers, therefore, causes a shortage of saved funds, or at least it should do so. Why, then, does this shortage not materialise immediately at the point that the interest rate is fixed? Why aren’t the banks empty of cash and why can they keep on lending and lending and lending? Why can this situation perpetuate for years and end in a calamitous crash that causes almost unrelenting havoc?

This is where a degree of complexity enters the explanation. What is really being borrowed and lent is not money but, rather, the real goods and resources that they can buy. We said above that if someone wishes to borrow money another person has to have saved it. But what this really means is that the saver has to have worked to produce real goods and resources in order to earn that money. He then lends that money to the borrower and the borrower uses that money to buy those goods that the lender produced and diverts them towards his enterprise. If, of course, saving, lending and borrowing took place with real goods, or if the supply of money was fixed, then obviously a forced lowering of the rate at which these goods could be borrowed would result in their shortage very quickly. But the fact that the saving and lending takes place through the mechanism of an easily expanded paper money supply creates a clever smokescreen. For our entire financial system rests not on the principal of every pound borrowed requiring a pound to be saved, but rather that pounds can be “created” out of thin air by the central bank and lent out even though someone has not saved. By printing fresh money (or its digital equivalent) the volume of borrowing can expand without a corresponding expansion of the volume of saving. This easy ability to produce more money to meet the higher demand for borrowing means that the artificially low interest rate never causes a shortage of money as we would normally expect when the price of any other good is fixed below its market price. A second problem, though, is that the real goods that this new money can buy have not increased in line with the increase of the supply of money, but, rather, have remained constant and there is, therefore, still only the same quantity of goods that have to be allocated towards either consumption or investment. Surely the artificially low interest rate will mean that there will be a shortage of real goods to devote towards investment?

Unfortunately, at the beginning, this is not so. For the newly printed money transfers purchasing power over goods out of the hands of those holding existing money and into the hands of those who have the new money. The result of this is that the borrowers of the new money – those who want to devote the goods purchased to capital investment – now have an advantage over those who wish to devote them to consumption. Let’s say, for example, that I earn £1000 in a given month. This means that I have worked for and created real goods in the economy on which I can spend this £1000. Let’s say that I allocate £750 towards consumption and £250 towards saving and investment. Therefore, what I want to achieve is to consume 75% of the goods on which I can spend the money and save and invest 25%. This £250, the 25% of the goods I wish to devote to saving and lending constitutes supply in the loan market that will help to set the market rate of interest. We can illustrate this allocation accordingly:

Consumption  £750   75%

——————————

Saving          £250   25%

——————————

TOTAL           £1000  100%

If, however, a commercial bank depresses the interest rate and simply prints an extra £500 to meet the new demand at this lower rate, what has happened now? There has been no change, remember, in the quantity of goods – the new money must be still be spent on these goods. The purchasing power of the existing money that I wished to spend on consumption therefore reduces and that of the new money that is to be spent on lending and investment correspondingly increases. All that happens therefore is that the proportion of goods that can be devoted to lending and, hence, to investment has now been forcibly increased from £250 to £750 – and increase from 25% to 50% of the new total stock of money, thus:

Consumption  £750   50%

——————————

Saving          £250   17%

New Money    £500   33%

——————————

TOTAL           £1500  100%

Newly printed money that enters the loan market therefore forces the economy onto a different consumption/investment ratio from that which is desired by consumers. The poor consumer will find that the newly created money has caused the prices of goods to rise; he is forced, therefore, to curtail his consumption in real terms. The goods that he can no longer afford to buy and consume will be purchased by the new borrowers who will devote them towards their capital enterprises. It is for this reason that none of the expected effects of price fixing occur and the economy proceeds along what appears to be a sustainable boom in capital investment. The problem, though, is that capital projects usually take several years to complete and rely on a continuous supply of goods throughout this time. But consumers don’t want to save voluntarily the amount necessary to complete these projects. The interest rate must therefore be constantly kept low and the new money reeling off the printers to meet it if the projects are to continue. It is only down the line when price inflation inevitably begins to accelerate and the central bank forces an increase in the interest rate and a corresponding reduction in growth of the money supply that the problems are revealed. For now the consumption/investment ratio once again begins to reflect the preferences of consumers – they want, if we remember, more consumption and less saving which means that lending and investment has to reduce. Hence half-finished capital projects have to be left incomplete. They have been starved of the resources necessary as they can no longer afford to purchase them at the new rate of interest. This precipitates a collapse in the prices  of capital assets, a collapse that causes widespread bankruptcy and liquidation of firms and enterprises that, hitherto, had seemed sustainable and profitable. Ludwig von Mises describes the perfect analogy:

The whole entrepreneurial class is, as it were, in the position of a master-builder whose task it is to erect a building out of a limited supply of building materials. If this man overestimates the quantity of the available supply, he drafts a plan for the execution of which the means at his disposal are not sufficient. He oversizes the groundwork and the foundations and only discovers later in the progress of the construction that he lacks the material needed for the completion of the structure. It is obvious that our master-builder’s fault was not overinvestment, but an inappropriate employment of the means at his disposal5.

Mises’ last sentence is important. As the prices of capital goods were accelerating upwards during the boom and then suddenly come crashing down, there is a temptation to analyse this as “overinvestment”. While this is true and that “too much” has been devoted to long term investment projects it should be clear from our analysis that the real problem is malinvestment – a diversion of resources from desired consumer goods to capital goods.

Observant readers might say that it is actually the return to the market rate of interest and not the fixed rate that has caused the sudden shortage of capital goods. This would not be a correct interpretation. Artificially lower prices always give the illusion of plenty, of abundance and availability for everyone. It is just that with the fixed price of a particular good the illusion becomes obvious more quickly. But with fixing the rate of interest, because it takes effect through the mechanism of money, the illusion of plenty is obscured and, for a time, looks very sound. For this new money has the very real ability to divert resources away from consumption towards capital investment. Nothing more has been created but it looks like there has. Couple that with price inflation with higher nominal wages and people, at least, think that they are better off than they were before the “miracle” of artificially low interest rates. Real abundance and plenty, however, would not merely divert resources from consumption. Rather, resources for capital investment would exist independently of and in addition to those desired for consumption, as dictated by the desires of consumers.

Conclusion

What we have seen, therefore, is that ABCT sits coherently with the examination of individual price action and is little more than an extension of it. The business cycle is simply a case of price fixing writ large, causing widespread waste, chaos and misery when its effects are finally revealed. There are no separate bases or foundations of this “macro” sphere of economic theory. There are, however, certain special features that make this form of price fixing especially insidious and long-lasting – that of the easy ability to print fresh money to meet the new, low rate of interest, permitting purchasing power to be transferred to new borrowers and, hence, the real diversion of resources. As soon as this situation ceases the smokescreens vanish to reveal the waste and futility of these diversions.

Whenever, therefore, one has difficulty in either understanding or explaining ABCT, think back to what you know about simple price fixing. In fixing the rate of interest, the most important price in the economy, “Austrian” economics, with its strict deductive logic from the action axiom, will tell you that the results will be the same.

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1Murray N Rothbard, Man, Economy, and State with Power and Market, p. 269 (n. 19).

2This isn’t just stinginess on the part of sellers; rather, the cause of their unwillingness to sell will be, in the long run, that they simply cannot – the lower price will usually not be sufficient for them to recoup the costs of production so they have to abandon the particular line altogether.

3These results were seen during the high inflation of the 1970s in the US when price controls led to long queues at gasoline station because the demanded quantity of gasoline could not be supplied at the artificially low price.

4An interesting question is whether the interest rate may strictly be considered a “price”. In the exchange of goods, the price of a good is the quantity of another good that is fetched in exchange. For example, if one apple sells for two oranges, then the “orange” price of an apple is two oranges (and the “apple” price of an orange is 0.5 apples). In the complex economy, of course, every good is exchanged for money so we always reckon prices in terms of the quantity of money received in exchange. However, whatever the other good that is received, it makes no sense to compare the two physically heterogeneous goods in terms of magnitude. For how does one calculate the “difference” between two apples and one orange, or between £2.00 and a bag of oranges? In the exchange of a present good for a future good, which is what happens in the loan market, this is not the case, however. If a borrower agrees with a lender to borrow £100 today and to pay back £110 in one year’s time, strictly the price of one unit of present money is 1.1 units of future money (or the price of 1 unit of future money is approximately 91p of present money). But because the two goods are physically homogenous we can compare the two magnitudes – 1.0 and 1.1 – in order to derive a rate or ratio between them of 10%. We would therefore state that the interest rate per annum in this scenario is 10%. This rate is therefore not strictly a price but an expression of two prices – the price of present money in terms of future money and the price of future money in terms of present money. However, it should be clear that a manipulation of the rate of interest would have the effect of fixing the actual prices of present and future money. If, for example, the interest rate is forcibly lowered to 5% then the price of one unit of present money is now 1.05 units of future money rather than 1.1 units of future money. The resulting effects of price fixing will therefore be felt in this scenario. Hence, it makes sense to speak of the rate of interest as a price just like any other and, indeed, this is how it is treated by acting humans in the loan market.

5Ludwig von Mises, Human Action, p. 557.

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Competition and Antitrust Law – Economic Misunderstandings

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What do Alcoa, AT&T, Standard Oil and Microsoft have in common? That they are (or at least were) all bastions of free market progress and innovation? May be so, but one other interesting aspect is that they have all been subject to prosecution under a body of law known as competition law (or anti-trust law in the US). One of the government’s self-appointed duties is the prevention of so-called “anti-competitive behaviour” – that if a firm comes to “abuse” its dominance on a market or “colludes” with other firms then it is somehow guilty of harming consumers, normally by increased prices. Theoretically this rests on the imaginary construction of “perfect competition”, a situation in which any one supplier of a good is met with a horizontal demand curve – i.e. no given supplier is able to affect the price of a good by reducing or increasing its supply. As soon as any one firm attempts to restrict supply other suppliers will simply reap the sales. Variations from this apparent economic nirvana are viewed as a cause for suspicion. This essay will challenge some of the economic misunderstandings that underpin this body of law.

Defining a Market

Every supplier in the marketplace contributes only a bare handful of the vast array of goods and services that are available for purchase. Competition law views its first task as defining “markets” for particular goods and then identifying the suppliers that participate in that market. For example, there might be a “market” for “apples”, or for “cars”, or for “fizzy drinks”. Suppliers are deemed to be competing if they are in the “market” for the same good. Similarly, a supplier may be said to be a monopolist if he is the sole supplier of a good. Various tests are used to determine whether two goods are in the same market.  Substitutability is one of these tests. If the price of good A rises by a certain increment and people, consequently, flock to good B then good A and good B would be said to be in the same market. However, if the price of good A rises and people do not replace it with good B then goods A and B would reside in distinct markets.

To the praxeological economist, this approach must be viewed instantly as complete nonsense. First, the entire analysis is based on hypotheses of future action rather than action itself; past action provides no firm base on which to judge future action. The entire raison d’être of action is constant and unceasing change. What is desired today may be discarded tomorrow, and vice versa. Secondly, even if this was not the case there is no such thing as separate “mini-markets” of individual goods. Rather, all goods are competing with each other for the contents of a customer’s wallet. Every consumer has only a certain amount of disposable income to which he must allocate the ends that are most valuable to him and these ends are ranked in one, single order. If I earn £1000 in a month I will spend this money on what is most valuable to me first, then on what is next valuable, and so on, until my funds are exhausted1. And it follows, therefore, that every good is “substitutable” for another if the price is right. For example, a person may have only enough disposable income to pay for either an annual holiday or a car. If he chooses the holiday then the car is discarded. The car was, therefore, competing with the holiday even though competition law would not view suppliers of cars and travel agents as being in the same market. However, if the price of holidays skyrockets to a level where the car becomes the preferred option (or even if the person just decides that he doesn’t want to go on holiday in a given year and can, consequently, afford the car) then the holiday will be discarded and the car will be purchased. The car has not really “substituted” the holiday; rather the holiday, owing to its cost, slipped down in the ranking of that person’s ends owing to its heightened price and other, completely different ends, became more pressing as a result. Competition law, in defining markets in the way that it does, effectively attempts to survey the Grand Canyon with a microscope, looking too narrowly at the economic situation in order the appreciate it. Indeed we might say that the problem lies in the confusion of markets with industries, the view being taken that everything that goes on within a certain industry is, somehow, hermetically sealed from anything else. Yet there is also no logical reason to suspend or restrict the categorisation at a certain level. Let’s say, for example, that Whitmore Grocers sells only fruit. Which market am I in? Am I in the general grocery market? Or am I in the fruit market? Or are the separate fruits in their own markets, so I am in the apple market, the banana market, the orange market, etc. simultaneously? Or am I in the Whitmore fruit market, that is, fruits that are provided uniquely by me in my shop? These definitions are important precisely because a definition of a particular market itself will determine who is dominant on that market – for if a market is defined as being for goods and services that are supplied by me only then it is obvious that I am and only ever can be a monopolist2.

The most absurd applicability of these market definitions can be seen in cases of declining industries. Often, when demand for a certain good or service is universally falling, the only way for formerly competing suppliers of that good and service to continue operating and to make the best of a bad situation is to merge. Yet these mergers are often blocked as being an “affront to competition” because they reduce the number of “competitors” for that good or service. Such was the case when Blockbuster attempted to merge with its rival Hollywood Video, the narrow market definition of “video rental stores” obscuring the fact that that entire “market” was suffering an onslaught from supermarkets and online video rental. These types of case will appear even more ridiculous as we now consider the dominance of certain suppliers on the “market” for a particular good or service.

Dominance

Once a market is defined, the situation is, as we have just alluded, viewed favourably from the point of view of competitiveness if there are many suppliers on that market and unfavourably if there is a single or only a handful of suppliers. Consumers are said to be benefited if they are confronted with an array of choice for an article that they may wish to purchase. However, the precise number of competitors and their relative size is itself an outcome of the preferences of consumers. An industry becomes large, thriving and with varied suppliers because consumers are willing to pay for that variety. In other words, industries where the final selling price of a product is far in excess of the costs of production give the most breathing room for actual competition to emerge. Where this is not the case, however, in industries where the difference between revenue and costs is narrow, attention turns to other considerations such as the urgency of cutting costs. Mergers and acquisitions then become viable because the net revenue gained from consolidating operations and achieving economies of scale outweighs that to be gained from deconsolidation. Consequently the costs saved releases productive resources so that they can be devoted to other ends in the economy. Indeed it will sometimes be the case that consumers are only willing to support a single, lone supplier in an industry. This individual supplier may be able to achieve cost savings that permit it to achieve a small profit and keep going, whereas two or more suppliers may struggle, individually, to rake in revenue that outweighs their costs. In short, an endless number of suppliers in each and every industry would be a recipe for losses and waste. In these cases, therefore, the prevention of mergers and acquisitions on grounds of competition concerns simply mean suicide for the entire industry, as we highlighted above in the Blockbuster case.

Monopoly Prices

Dominant players on a “market” for a certain good are often said to “abuse” this dominance by, say, charging “monopoly” prices or, through colluding with a number of other suppliers in the same industry, to “fix” prices. In other words they somehow raise prices higher than what they “should” be, raking in higher profits for their own enrichment at the expense of consumers who have to fork out the highest possible price. The only way that this can be achieved is if the demand curve for a particular good is inelastic, so that supply can, for example, be halved in order to more than double the price. Reducing or “restricting” the supply in such a way is said to be an abuse of a monopolistic position, harming consumers with artificial scarcity and high “monopoly” prices.

There are numerous theoretical problems with this point of view. First, in the absence of artificial government restriction by force that restricts supply to the benefit of a particular supplier, the concept of a “monopoly price” cannot be defined distinctly from that of the free market price. All suppliers in the market place, whether they are competing for the same good or not, estimate production at a level where they think revenue will be maximised, in other words all suppliers will set their quantity supplied at a point above which demand is inelastic (where further production would result in lower revenue) and below which demand is elastic (where reduced production would result in the same)3. Secondly, in the instant when any supplier on whatever market takes advantage of an inelastic demand curve, there can be only one of two responses from everybody else – either the increased price will attract others into the industry to produce more of the good, or it will not. If the first outcome occurs it means that the raised price has increased profits so much that it becomes viable for competitors to divert resources from other uses and direct them to producing more of the good in question. Indeed, one of the very reasons why some “monopolists” do not take advantage of an inelastic demand curve and are content to rake in merely average profits is precisely because they do not wish to rock their boat by attracting competition. In other words, potential competition as well as actual competition is always a factor in a supplier’s mind that disciplines him to keep prices at a moderate level by not “restricting” supply. In the second outcome, however, if no one else bothers to enter the industry following a rise in prices this can only be because it is too costly to divert resources from other uses – in other words, even with the price set so “high”, the profits achieved are not high enough to attract others into the industry. If the competition authorities step in to attempt to cure the “restriction” then it is clear that this can only be at the loss of other some other, more highly valued industry. For in order to increase supply to avert the restriction, resources have to be brought in from other industries. If other suppliers are not willing to do this voluntarily then it means that those resources are better off in the alternative industry and to divert them to solve an alleged “restriction” of another good would be nothing more than a waste4. Indeed, applying a reductio to the logic of “restriction”, why should we not castigate any supplier for not producing more of anything? Aren’t they all restricting supply by only producing and selling a certain amount? And further, why should we not also criticise them for only producing a certain good? Shouldn’t we, for example, criticise Apple for only producing IT products and not bothering to produce, say, beverages? Aren’t they “restricting” their supply of beverages by not abstaining from entry to the beverage market? Any failure to understand the absurdity of these positions is a failure to understand the fact that we do not live in the Garden of Eden and that we have to divert the scarce resources available to producing a “restricted” number of goods as far as possible in line with highest ends valued by consumers.

Finally, as we mentioned above, one of the very reasons why you see merger and acquisition activity in a certain industry is precisely because competitive activity between two suppliers is, in fact, wasteful to the consumer. If profit margins are slim then two competitors can achieve cost savings by realising economies of scale by consolidating their operations, thus releasing resources to be used elsewhere in the economy. Without this the result is that the industry as a whole cannot gain the profits necessary in order to develop and fulfil the demands of consumers but also resources are unnecessarily wasted on maintaining separate, costly operations. And as we again noted above, in declining industries this ability to cut costs could mean the difference between life and death and simply preventing a merger or acquisition because it leaves fewer “competitors” in the same, arbitrarily defined market is economic nonsense.

Predatory Prices

Another “abuse” is so-called “predatory pricing”, whereby a large and dominant supplier attempts to force a newcomer out of the market for its good by temporarily undercutting the latter’s prices, absorbing the temporary losses until the upstart is forced out of business. Surely here we have a clear abuse, an actual targeting of competition in order to completely eliminate them. Shouldn’t the competition authorities step in to try and out a stop to this blatant abuse to the consumer?

Unfortunately, it is not quite as simple as that. In the first place, in the case where suppliers are raising prices one can at least see some kind of prima facie affront to the consumer. But is there not something distinctly odd about criticising the lowering of prices? Isn’t that good for the consumer? Secondly, all suppliers attempt to better their competition in whatever way they can. It is precisely because there is potential or actual competition that suppliers are kept on their toes and there are numerous responses that a supplier can take to its presence – better products, cost savings, and lower prices. If a supplier chooses to lower prices to ward off the competition it is, for some reason, deemed to be “predatory”. But if the response is to develop a sleek, new product shouldn’t we also call that “predatory innovation”? Or couldn’t we also have a “predatory cost saving”? Why is it only prices that attract this wrath of the competition authorities? And finally, if a supplier sets its prices at a level whereby its profitability attracts competitors, then once that competitor has been vanquished through “predatory pricing”, wouldn’t the restoration of prices to the previously high level just create the same situation again and result in yet another upstart (or more) entering the field? And wouldn’t the whole operation of undercutting and loss taking have to be repeated again and again to permanently ward off all competition? Obviously the only sensible response to this would be, as we noted above, to keep prices permanently low, thereby forever warding off any competitors that would enter the field. And low prices can only ever be a boon to consumers.

Collusion

So-called anti-competitive behaviour can, as we have been discussing, be “perpetrated” by a single entity or entities can “collude” to agree in restrictions or setting prices (commonly known as “cartel” arrangements). We will not go into the detail of the fragility of cartel agreements that restrict production to raise prices; suffice it to say that there is always the temptation by one of the players to break the cartel, increase production and undercut its prices. Rather, we shall concentrate on the illogical proscription of collusion in the first place. Partnerships and corporations all involve the co-operation of individual human beings – shareholders, managers, employees, etc. – in running an enterprise to provide goods and services to consumers. Indeed a company is nothing more than a large collection of people coming together to agree and perform a common purpose. Part of this purpose will involve decisions on the level of production and the prices of the goods that are to be sold. It is clear from this arrangement that we do not castigate members of a board for “colluding” with managers, or with each other, when they agree the level of production that the firm is to undertake, nor do we see it as an affront to competition when a chief executive agrees with his divisional manager to raise the price of a certain product. The benefits from this should be obvious for virtually none of the wide scale production that we so take for granted today could exist without the co-operative behaviour between often large numbers of human beings in the same organisation. However, “collusion” between organisation is little more than the same thing – agreements and co-operative behaviour between human beings. The only difference is that the human beings belong to different legal entities. So why is it when one set of agreements and co-operation – with all of its obvious benefits – is permitted while the other is not? Why are agreements within a firm allowed yet between firms they are not? If advantages can be reaped by co-operating within the firm then why can’t they also be reaped by co-operation between firms? Taken to its logical end, anti-collusion would require literally everyone to be a sole-trader, never engaging in any joint enterprise whatsoever. We might also say that collusive activity lies somewhere on a scale between total independence and total merger. The former, we have just noted, is permitted and the latter, as we have analysed above, is better for the consumer if it is sustainable in the marketplace. Why is a point on the scale between these two positions bad?

Government Privilege and Monopoly

All of the economic analysis above refers to the situation on the free market, absent any government interference. As we have shown the several aspects of competition or antitrust law that we have examined have no legitimate basis at all in theory. However, competition law is surely viewed at its most ridiculous (nay, hypocritical) when we consider the wider fact that government itself is the most anti-competitive behemoth on the planet! One of the reasons why competition is said to be so good is that keeps suppliers sleek and nimble, forever reducing costs and innovating the best products to meet the ends of consumers in the most economical way. Monopoly, or a lack of competition, however, encourages only complacency, sloth, shoddy, inferior products and poor, expensive service. However, not only do even the smallest governments “enjoy” a territorial monopoly of law, order and the use of violence, but modern, large governments have either nationalised or have heavily regulated entire industries. This raises an obvious question – if private monopoly is so bad then why is government monopoly so good? If all of the evil results of monopoly are bad enough in the video-rental market to attract legal proscription then why are they not so pressing in the production of, for example, security and healthcare? Indeed it is often stated that certain “key” industries should be in “public” (i.e. government) ownership in order to insulate them from the “greed” of the profit motive, that seem greed and motive that ensures brings about competition. But why, if the industry is so important, is a monopoly provider now so brilliant and wonderful? Is competition only beneficial in trivial industries? Government itself is peopled by human beings who respond to exactly the same incentives as those who populate private industry – won’t the results of a government monopoly be the same as a private monopoly? And these government monopolies aren’t voluntary either – they are absolutely compulsory! At least with private monopolies you have the choice to abstain from purchasing the product but with government you have to fork out the taxes regardless. Even if competing services emerge the advantage that government has from the ability to levy compulsory tax revenue puts everyone else on the back foot. In its fields of interference, therefore, government is the ultimate anti-competitive bully, forever able to price its competitors out of the market or legislate them (i.e. chase them away with a gun) out of existence. But it gets worse than this for government has the ability and, often, the hubris to regulate or interfere with any industry it chooses, privileging favoured lobbyists and political donors with the glittering prize of exclusivity in certain lines of production. Indeed monopoly itself was once considered to be a government-granted privilege, a forced exclusion of everyone else from a certain craft or trade. But even “mere” regulation reduces market competition because the cost of compliance is easily absorbed by larger, more established entities than by smaller and more nimble upstarts. The latter are simply priced out of the market by the artificially created cost burden. Ironically, therefore, the monopolistic corporate ogre is a creature begat of government and not of the free market, with many industries that are nominally privatised – utilities, food, public transport etc. – reduced to a handful of well embedded, government-favoured players.

Conclusion

What has been demonstrated, therefore, is that key concepts utilised by competition or antitrust law are not only embedded on a tissue of economic falsehoods and misunderstandings but also its very promoters and guardians – the government – are themselves the biggest anti-competitive monolith. However, the wider belief in which these economic falsehoods is couched is the belief that competition is an end in itself rather than a process – a process of determining the structure of production that directs the scarce resources available in a manner in which they can best serve the ends of consumers. This may, within a particular industry, result in one, a few, or many players depending upon how consumer demand wishes that industry to be structured. The widely held assumption that the existence of many suppliers and “choice” is good for the consumer is not the case unless that array has arisen through voluntary activity. If it has not then forcing it to appear is a waste of resources. Indeed, the very illogic of competition as the goal is manifest in the fact that it results in a supplier being able to compete but not to win. Yet what is the point of a supplier competing if it is not able to better its competition?

Perhaps the best illustration of the absurdity of competition law, on which we shall end, is two jokes that economist Walter Block stated that he gave in a lecture on this subject to anti-trust lawyers and economists. The first joke is that there are three prisoners in the gulag in the former Soviet Union and they discuss why each of them is there. The first said that he came late to work and was accused of cheating the State out of labour. The second stated that he came early and was accused of brown-nosing. The third guy said that he came to work everyday and exactly on time, and the KGB accused him of owning a Western wristwatch. The second joke is that there are three prisoners in the U.S. They too begin to discuss what they are inside for. The first said that he charged higher prices than anyone else and the government then accused him of price gouging and profiteering. The second prisoner said that he charged lower prices than anyone else and they accused him of predatory and cutthroat pricing. And the third said that he charged the same prices as everyone else and they accused him of collusion and price fixing. Block’s audience apparently laughed heartily at the first joke. The second, needless to say, they found not quite so amusing.

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1This includes putting funds into savings or cash balances – present goods must compete with future goods and all goods and services must also compete with the desire to hold cash, at least if they wish to attract higher nominal revenues.

2And, by logical extension, every labourer becomes a monopolist of labour services provided by him.

3Murray N Rothbard, Man, Economy, and State with Power and Market, Scholar’s Edition, pp. 687-98.

4One of the so-called affronts to competition, “barriers to entry”, is itself a cost and it would still be a waste of resources to overcome it.

Liberty in our Lifetime

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Perusing many libertarian and “Austrian” oriented websites, podcasts and newsreels, it is very easy for one to lapse into despair when considering the possibility of ever achieving a world of liberty. The stories and the commentary are always the same – of collapsing economies, increasing government interference in our private lives, and the increased propensity for war and conflict. Indeed, at times, the state can seem so overwhelming in its march towards total domination that the typical libertarian, normally isolated as he is, can only sink into despondency over how any of this may be stopped let alone reversed.

There are, however, five reasons to be optimistic for the prospect of gaining liberty, even in our lifetime. Furthermore these are not mere fleeting trivialities but, rather, relate directly to aspects that are pertinent and essential to the existence and strength of government. Let us consider each of them in turn.

1. Government is Small

As government is parasitic upon the productive element of the economy it can never, in its totality, consist of more than a mere fraction of the total population. If the majority become the parasite and the minority the host then the latter will simply collapse under the weight of the burden. Government cannot continue to siphon labour and capital from the productive sector and divert it to the unproductive. Even if we live in an era when all of our emails and telephone calls are stored, the government will always be in the position of having only a handful of people who will be able to scrutinise and read these emails. It takes even more than that – talent and intelligence – to analyse these communications and to put two and two together. In short there will never be enough man-hours in order for the government to manage and spy on the lives of everyone from dawn until dusk. Even before we had mass electronic communication and had to rely on snail mail the government still failed to crack down on black markets, drug shipments, smuggling, and all of the other free market responses to the non-crimes that it created, the circumvention of which was successful because it served the needs of the majority. Government will forever be burdened by the fact that it is in the minority and this is a major obstacle towards both its growth and the effectiveness of its meddling.

2. Government is Stupid

Why was Great Britain the biggest imperial superpower of the nineteenth century and why was that role taken on by the United States in the twentieth? By contrast, why did the Soviet Union fail to make any headway at all in international dominance after World War II up until the point it collapsed? Both Great Britain and the US were internally liberal countries in their respective eras, both accumulating a massive amount of capital that enabled a vast number of goods to be produced and the resulting standard of living to rise. There was, therefore, a plentiful store of wealth into which the government could tap in order to fund its foreign ventures. The Soviet Union, on the other hand, with its centralised, socialised economy, could not produce the wherewithal necessary to enable it to enforce itself imperialistically on foreign nations. In other words, government relies on keeping the society on which is leeches relatively free in order to guarantee the productivity that will enable government to expand its operations. In contrast, government itself, as has often been said, cannot even run the post office. Indeed government has failed to invent anything valuable or worthwhile during its entire existence and is only able to take over and operate industries that were kindled and developed in the private sector. This is true of every government operation that is, today, taken for granted – roads, healthcare, communications, utilities, and so on. The only thing that government has ever been able to do with modest efficiency is construct gallows and develop nuclear weapons, i.e. to invent the machinery that kills millions of people. Because of the absence of prices, profits and losses, totally socialised societies failed to harmonise the stages of production that is necessary in order to produce a vast amount of wealth, and very quickly these societies had to revert to at least a kernel of market activity. Indeed, it was a running joke among Soviet economists that they needed at least one country to remain free of international socialism so that the planners and bureaucrats would know what the prices of goods should be. Government without the free market is blind and stupid, unable to generate the resources it needs to carry on its overreaching activities. Therefore, if government was to extend itself to an all-encompassing dominion the only thing it could be certain of achieving is suicide.

3. Government is Greedy

Libertarians often point out that what is often forgotten in mainstream discussion of government is the fact that it too is populated with human beings who have desires, choices and ends and that they will happily use the legitimated violence through the mechanism of the state in order to achieve these ends. It follows, therefore, that as soon as that system fails to enable them to grab the wealth and riches that they desire, then they too, the government officials and the bureaucrats, will lose faith in their own organisation. One of the reasons why the Soviet Union collapsed is not because the people revolted but because the inner circle themselves began to see that the very system they were operating was not even giving them a particularly high standard of living. They were simply (to use a clichéd phrase) rearranging the deck chairs on the Titanic, playing around vainly with an ever diminishing pool of wealth on the path to destruction. It is, therefore, a mistake to suggest that any post-Cold War politician is a “socialist” or a “communist” in the true sense of those words. Rather, they have to keep the capitalist means of production going in order to blood suck from the wealth that is furnished by private industry. The most we are likely to get today is government partnership with big business, a form of fascism (minus, perhaps, the excessive nationalistic overtones of Hitler and Mussolini) rather than strict forms of socialism or communism. Ironically, therefore, government’s own greed for luxury and largesse will itself stop government from becoming too powerful and overreaching.

4. Government Cannot Risk Revolution

All governments, being a minority of the population, require, at least, the tacit acceptance of the majority of the population in order to remain in power. As soon as this acceptance is lost and there is active resistance then government ceases to function and will simply collapse. One of the reasons why the majority of the population today has become so tacit is because the standard of living, compared to previous ages, is so high. Although this standard would be much higher in the absence of any government at all, it is still the case that capitalist production and free exchange is able to both fund all of government’s boondoggles and also ensure that even an average wage earner in the Western world can live in relative comfort. It must be admitted that, on balance, in spite of the proportion of their productivity that is siphoned off by the government being at its highest point in history, people are relatively content. Although we are not yet quite as soma-induced as the inhabitants of Huxley’s Brave New World, the attractions of entertainment and leisure time that are made possible by capital accumulation through the free market provide a permanent and satisfying distraction from all of the nasty things that government is doing. Indeed some people’s thoughts never move much beyond analysis of the last football game or of the latest participants in The X Factor. The resulting apathy towards political and social matters, we might say, is the very bedrock of the tacit acceptance of government. Government, therefore, cannot risk destroying the origin of the production of the standard of living that makes this possible if it is to continue to gain its tacit acceptance. Whereas in previous ages there was nothing much to lose from the tightening of a king or emperor’s grip, today there will be a very marked change in the efficacy of production if the government’s tentacles strangle the capitalist system. Deprived of supermarket shelves stocked full of food, water that runs as soon as the tap is turned on, lights that illuminate with the flick of a switch, and televisions that flood their living rooms with Strictly Come Dancing, people would flock to overthrow the government that had so obviously failed. Indeed, it has been said that any nation is only three meals away from revolution but with our standard of living so much higher now it might not even take an empty stomach to arouse the masses. Hence any government worldwide could be less than a single day away from being toppled if its citizens are deprived of some comfort that was, hitherto, taken for granted. Food for thought, one might say, for any politician in power.

5. Government will be Out-Innovated

It is something of a truism amongst military historians that generals are always fighting the last war. They fail to adapt their methods of assault and defence to the new technologies and methods of fighting that have emerged since the previous conflict. Hence the mechanised horror and destruction of World War I made possible by twentieth century technology was met with strategies and tactics that dated from the nineteenth. This points to what is, perhaps, the biggest hope that we have for liberty in our lifetime – that government will not be able to keep up with the pace of free market innovation. The free market is necessarily heterogenous, decentralised and unbureaucratic whereas government is the precise opposite – big, unwieldy and burdened by procedure in a lengthy chain of command which always puts it on the back foot compared to the scattered mass of private citizens. We have already stated that government cannot create anything useful and must largely rely on the innovation of capitalists from which to draw its expertise and technological know-how. And further, we have also already pointed out that government has always failed to control black markets and underground trading that emerge in response to government induced shortages and prohibitions. These aspects can only accelerate in the technological age, when it is possible to transfer wealth and information to the other side of the world at the click of a button. Already innovations such as virtual currencies have emerged in response to the debt-laden and corrupt government-approved financial system and no doubt, in the wake of the scandal of the US’s spying program as revealed by a former NSA contractor and CIA operative, Edward Snowden, there will be increased market innovations to provide for privacy and security. Indeed we might even say that the internet itself caught government on the back foot – with a worldwide network of information and resources emerging and developing successfully before they were even aware of it, it’s difficult to believe that government wouldn’t want to turn back the clock and put strangleholds on such a boon to freedom. In short, government always has to react to the obstacles that are put in its way by innovative forces that are far superior. If the free market invents letter writing government has to find a way to intercept letters. If the free market invents the telephone it has to find a way to tap phone lines. And if the free market invents email then the government must determine how it can download and read these. The ultimate achievement will be when each individual person will be able, at very low cost, to protect his/her person and property from the aggression of others – perhaps through some kind of invisible force field or other such futuristic invention. The precise means are not as important as the concept; for if this could be achieved it would, in one fell swoop, eliminate both the means through which government leeches off its productive citizenry (force) and its very raison d’être – the production of security and the protection against private criminals and foreign, invading states. Indeed the latter might prove to be more important than the former given that the very justification of government for most people lies in the fact that society would be consumed by plundering and pillage in the absence of government. Take that alleged necessity of government away and what reason is left for it to exist? The fact that it would not even be able to exist in such a world where it would obviously be deprived of tax revenue might just be the icing on the cake.

Conclusion

Far from sinking into depression or despair at the state of the world today, we have demonstrated that there is, in fact, much to be hopeful for in the prospect for liberty. Furthermore, if the last point we noted above is true, then we should also be optimistic of the chances that there will also be very little violent revolution and we can look forward to a libertarian world emerging peacefully and with little bloodshed.

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The Limits of Libertarianism

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A distinct disadvantage of advocating a libertarian society as opposed to some sort of collective is that libertarians seldom win the emotional battle when pitted against competing ideologies. Democratic socialists and redistributionists can effectively wear their bleeding hearts on their sleeves, forever waxing lyrical about their concern for the poor, the sick, the elderly, and which ever other group appears to be in need of pitiful platitudes at this particular time. Libertarians, on the other hand, in calling for the right of every person to own his/her income, appear to advocate nothing more than greed and selfishness, the slippery slope to the disintegration of society as we each ferret ourselves away in an increasingly atomised existence.

This is a misunderstanding that is common not only among the opponents of libertarianism but also among libertarians themselves and it is high time that the latter stood up for themselves and realised how to counter these straw man attacks. Libertarianism is not and never has pretended to be a complete philosophy of how a given person should live his or her life. It is only states that each person should be given the freedom to choose what he does with his person or property. It does not mean that because an individual should have such a choice that he should keep his person and property for himself. One of the options is that he could, for example, give some of his money to the poor. It is, therefore, quite open to and consistent for the libertarian to state that a person should do X, Y or Z but that such a person should not be forced to do so. Simply because a person cannot be forced to do something does not mean that libertarians do not, individually, believe that people are subject to other moral obligations; it’s just that libertarianism itself stops short of discussing them. So as long as these obligations are not violently enforced then they are compatible with libertarianism, but do not form part of it.

Collectivism, however, is markedly different. For when collectives posit a certain forced redistribution of wealth and income amongst society this is usually based on an all-encompassing moral and political theory. So, for example, a collectivist might state not only that a person should donate a portion of his income to the poor but that also he should be forced to do so. It is this aspect that makes collectivists look more “caring” and “sensitive” to the needy – the fact that they are prepared to “enforce” their moral outlook seems to show they mean business. Libertarians, in contrast, come across as cold and uncaring, relying only on a vaguely defined notion of voluntary charity to take care of society’s ills.

There are three possible ways in which this may be countered. The first is to admit that libertarians are somewhat guilty of contributing to this view as few have developed an additional moral philosophy on top of their libertarian beliefs (although we can perhaps excuse ourselves given that the weight of government violence and intervention in today’s world is more than enough to be getting on with). But we must either turn our attention to developing our own, private, moral philosophies on which our passion for liberty forms the core, or, at the very least, we must be prepared to acknowledge the problem and explain the compatibility of any moral philosophy with libertarianism as long as it permits the individual to choose.

Secondly, contrary to popular opinion, the history of ideas has seldom been one of “liberty” vs. “collectivism”; rather it has been that of one version of collectivism versus another. As Mises pointed out, everyone has their own idea as to how they think goods and resources should be distributed throughout society: “In the eyes of Stalin, the Mensheviks and the Trotskyites are not socialists but traitors, and vice versa. The Marxians call the Nazis supporters of capitalism; the Nazis call the Marxians suporters of Jewish capital. If a man says socialism, or planning, he always has in view his own brand of socialism, his own plan. This planning does not in fact mean preparedness to coöperate peacefully. It means conflict”. (Omnipotent Government, p. 253). By pointing out this fact libertarians can demonstrate how, in a free world, everyone can pursue, in harmony, the ends that he believes are morally right with his own person and property, whereas to do so violently would just mean endless conflict with everyone else who happens not to share your view.

Thirdly, if a collectivist claims to care about the needy in society then we are entitled to ask why he favours a system that is almost guaranteed to make them worse off and why they oppose the very system – capitalism and freedom – that has been responsible for the most enormous increase in the standard of living in the whole of human history. Poverty is the state of nature of humans in the world; it is their ingenuity that has flourished through freedom that has allowed them to harness the powers of nature and increase the amount of wealth and satisfaction that we gain from them. If we compare the condition of human existence in 1800 (where 85% of the world’s population was living on $1 a day) to that of today (down to 20%) then we can see that freedom has been exceedingly good to the poor. Perhaps smart libertarians, accused of ignoring the plight of the needy, should raise this point and query whether, in fact, it is their ideological opponents who are really the ones who don’t care?

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