Prices and Cost of Production

Leave a comment

A major field of study in the science of economics is the pricing of consumer goods and their antecedent factors of production. The history of this area of thought provides an almost textbook example of the falsehood of the “Whig theory” of historiography – the idea that the knowledge of humanity progresses in an ever upward direction and that what we know now is better and more enlightened than what we knew before. For this area of study in particular is marked by progression, retrogression and progression once more, often with disastrous consequences.

The most serious case of retrogression in this regard was of, course the Marxian labour theory of value that stipulated that the exchange ratio of goods depended upon the quantity of labour time inherent in their production. This theory, together with its corollaries and associates such as the iron law of wages and the exploitation theory, was derived, so it was believed, directly from the largely pre-capitalist classical economics of Smith and Ricardo.

A basic “Austrian” response to this is to reject Marxism and its supposed classical parent by pointing out, of course, that costs are also prices. To explain prices in reference to prices, therefore, would appear to be a case of circular reasoning. Rather, the prices of the factors of production were derived from the value of the final good. Capitalists would bid up the factors of production according to the valuation of the final product. Thus the value of every factor was explained not according to the effort expended but, rather, according to its value in producing consumer goods.

Unfortunately, however, this basic understanding of the “Austrian” approach towards prices ignores the much richer theoretical tapestry inherent in the “Austrian” approach (especially that of Böhm-Bawerk) which, in fact, does not contradict many of the tenets of price theory in classical economics but, rather, armed with the law of marginal utility, provides a more powerful explanatory basis for them. Thus, one need not throw out the classical economics baby with the Marxist bath water and risk losing many of the important and true conclusions that were abused and distorted by Marx.

An immediate problem with the basic “Austrian” view is that the sequence of valuations from consumer good through the stages of production to the ultimate land and labour factors is the reverse of the temporal sequence of events. A product has to have been produced through all of its stages of production before a consumer can bid a price for it. Thus, the prices of the factors of production pre-date those of the consumer goods upon which the former are supposedly based. It is difficult to understand, therefore, how something can be derived from something else that does not yet exist. The more accurate view is, of course, that the prices of the factors of production are based upon the estimated selling prices of the future consumer goods. In a static equilibrium such as the evenly rotating economy the prices of the final goods are known in advance and hence the pricing of the factors of production will accurately reflect the value of the final consumer goods. But as helpful as this model may be in conceptualising the structure of production, it is woefully easy to draw from it the conclusion, so beloved of mainstream economists, that a boost in the value of consumption must necessarily result in a subsequent boost of the value of the factors of production. In other words that consumption feeds production. This, of course, is patently untrue. As John Stuart Mill said, “demand for commodities is not demand for labour”. Rather, to produce a commodity for purchase, labour (and all of the factors of production) must already have been demanded by capitalist-entrepreneurs. In other words, it is production that feeds consumption not vice-versa.

Second, if the prices of the factors of production of a good are based upon the valuations of consumers this does not explain the individual pricing of the factors. If, for example, a consumer will buy a loaf of bread for £1.00, why does the flour that went into it cost, say, 40p, the labour 50p and the hire of the oven to bake it 10p? Why doesn’t flour cost 50p, labour 30p and the oven 20p? Or any other possible combination of prices? One possible answer to this problem is that each factor earns its marginal revenue product – that is, the portion of the value of the increased product that it is attributable to an incremental increase of that particular factor. So for example, if I have a patch of land and a given number of seeds and apply increasing units of fertiliser then each additional unit of fertiliser will be priced according to the additional revenue earned by the additional physical product that results. The problem with this view is that it ignores the fact that no additional product is the result of a single factor alone and that the value of the additional product need not be imputed solely to the additional fertiliser. What if, for example, the purchase price of the land and the seeds already accounted for the fact that additional fertiliser could be applied to it to produce a larger physical product? Moreover, even if, say, the land and seeds were purchased at a price that reflected the fact that only a limited quantity of fertiliser was available and thus only a reduced physical product could be yielded from them, any unexpected increase in the available quantity of fertiliser and thus increased physical product and increased revenue would also cause an increase in the capitalised value of the land and the price of seeds. In other words, there is no reason to assume that the marginal revenue product should be imputed to only a single factor. We are therefore no closer to solving our problem – what is it that causes the particular array of prices between the factors? As we shall see, each factor does, in fact, earn its marginal revenue product, but not in a partial equilibrium where we examine only a particular end or use for a factor. Rather we have to consider the entire assortment of uses to which a good can be directed.

A further problem with the basic “Austrian” approach is revealed when we consider large consumer goods such as cars and computers. It is patently obvious that the value of a car is zero unless it has a steering wheel. Indeed, the demand for steering wheels is likely to be extremely inelastic, stretching all the way up to the height of the value of the entire car. However, in reality, the full value of the car does not result in the imputation of that full value to the steering wheel but rather to all of the other factors as well. Similarly, a computer is useless without the monitor; a television without a plug; glasses without lenses. In fact, it is clear that the utility of thousands of goods is dependent upon the unity of all of their individual components and if any one of them is missing the utility of a particular good drops to zero. Yet in many cases we never have to pay more than a few pounds for the “essential ingredient” to be produced.

How then do we arrive at the prices of all of the individual factors? The answer to this question lies in a deeper understanding of the law of marginal utility. As we know, this law states that the value of a unit of a good is equal to the value attached to the least valuable use to which that unit can be directed. So if, for example, I have five bottles of water, I might use the first for my most important end which is drinking, the second for the next most important end which is washing, the third for cleaning laundry, the fourth for watering plants, and the fifth to make into ice cubes. As each bottle is interchangeable, if one bottle was to be lost it would be the least valuable use – making ice cubes – that would be foregone. Thus, the value of any one unit will equate to the value of the least valuable end of making ice cubes, in spite of the fact that some of those units will be directed to ends with far greater value.

What we can see, however, is that if the value of any one unit of a good equates to the value of the least valuable use to which that unit can be directed then this value must also be imputed to the factors of production. If a portion of those factors was to be lost, the resulting reduced supply of goods would result in the loss of the least valuable ends. Thus, each unit of the factors of production that created the five bottles of water must themselves be valued at the lowest valuable use of a good that those factors will produce.

However, this law will also apply when the factors of production are not specific and can be used to produce any range of goods that satisfy a number of different ends. Let’s say, for example, that a given quantity of factors of production can be used to produce the following consumer goods in descending order of value:

  1. A bottle of water;
  2. A loaf of bread;
  3. A bar of soap;
  4. A pair of socks;
  5. A box of tissues.

If the same factors of production can be used to produce my most valuable good, a bottle of water, as my least valuable good, a box of tissues, then it follows that the factors of production will be valued according to the value attached to the box of tissues. The loss of any portion of those factors of production will result in the cessation of the production of tissues while all of my other goods are still produced. Here, then, is the key to understanding the different prices of the factors of production. The value of a factor is based not upon the utility attached to the specific good to which that factor is directed but, rather, upon the least valuable good to which a portion of its supply is directed. Only highly specific factors of production which can be devoted only to a single end will derive their value fully from that specific end.

In real life, of course, it is never the case that whole combinations of factors of production can be exchanged between different ends. Rather factors have to take their place in different combinations of specific and non-specific factors. It is these various arrays that produce, at any one time, the individual prices of the factors of production. Thus the breakdown of prices of factors used to produce a particular good is derived from the lowest valued uses to which portions of the supply of those individual factors are directed.

We are now, therefore, in a position to see what we mean when we say that a factor of production earns its marginal revenue product. If we gain an additional unit of a particular factor, that unit will be directed towards the next most valuable end that is currently unfulfilled in the economy as a whole. All of the most valuable uses for the factor will already be fulfilled. Yet all units of this particular factor will now be priced according to the value of the marginal unit which will be derived from the least valuable end.

However, the pricing of the factors of production according to their marginal uses is not the only effect of the application of the law of marginal utility. It also affects the value of the supra-marginal products whose direct marginal utility is above that of the marginal product. These products too will be priced according to the combination of prices involved in their factors of production as the loss of any given portion of a factor will not result in the loss of this product but in the loss of the marginal product. Thus, the prices of most goods in the economy are priced according to the least valuable goods that are produced out by the marginal units of their shared factors of production. As George Reisman explains:

Allow me to illustrate Böhm-Bawerk’s point here by means of a modification of his famous example of the pioneer farmer with five sacks of grain. As will be recalled, the five sacks serve wants in descending order of importance. One sack is necessary for the farmer to get through the winter without dying of starvation. The second enables him to survive in good health. The third enables him to eat to the point of feeling contented. The fourth enables him to make a supply of brandy. The fifth enables him to feed pet parrots.

[…]

Now let us slightly modify the example. Let us imagine that the first sack of grain has been used to make a supply of flour, which in turn has been used to make a supply of biscuits, and that it is this resulting supply of biscuits by means of which the first sack of grain performs its service of preserving the farmer’s life […] We can imagine a little tag attached, this time saying, “Biscuits Required for Survival.” As before, our farmer still has four remaining sacks of grain, any of which can be used to make a fresh supply of flour and then a fresh supply of biscuits. And now, just as before, we may imagine rats or other vermin destroying the supply of biscuits. Will the answer to the question concerning the magnitude of the farmer’s loss be materially different? Certainly, his life does not depend on the supply of biscuits any more than it did on the sack of grain. For he can replace that supply of biscuits at the expense of the marginal employment of the remaining sacks of grain, which, of course, is the feeding of the pet parrots. To be sure, additional labor will have to be applied as well, but the magnitude of value lost here is that of the marginal product of that labor, which might be  something such as the construction of a sun shade or an additional sun shade or even the feeding of the parrots. The point is that the value of the biscuits will not be determined by the importance of the wants directly served by the biscuits but by the importance of the marginal wants served by the means of production used to produce biscuits and from which a replacement supply of biscuits can be produced at will.1

Thus, we can conclude, that for the majority of products that are available for sale today, their selling prices are based not upon their direct marginal utilities but, rather, upon their costs of production which is derived from the marginal utilities of the least valuable products to which factors of production are directed. There are several noteworthy effects of this analysis.

The first is that this does not nullify the operation of supply and demand in determining the price of any supra-marginal good. Rather, it results in a shifting of the supply curve to the right so that it intersects the demand curve at a level where price equals the cost of production, plus the going rate of profit. Changes in the availability of the factors of production which either increase or decrease their marginal utility will cause similar shifts of the supply curve to the left or right which will have the corresponding effect of raising or lowering the price of the specific consumer good. This is possible without any change in the quantity that is bought and sold if, for example, the shift of the supply curve takes place on a highly inelastic stretch of the demand curve. The same quantity will be bought and sold simply at a higher or lower price.

The second observation, derived from the first, is that this obliterates the standard economic analysis behind monopoly pricing. The basis of this analysis is that suppliers can exploit inelastic demand curves to reduce supply, raise their prices and thus rein in an artificially expanded profit at the expense of the consumer. However, our theory here reveals that the opportunities for doing this are minimal. For the raising of prices and consequent swollen profit margins will cause competitors to shift factors of production away from the production of marginal goods towards an increase in production of the goods whose prices have been raised, thus restoring an increase in supply and the reduction of prices back to near their costs of production. Thus, for any businessman, the primary tool for estimating his selling price is not elasticity of demand of the particular good that he is selling; rather, it is the cost of production of any potential competitor. It is for this reason why very basic goods such as bread, milk, eggs, salt etc. which have an inelastic demand curve are priced very low; and it is for this reason why sole suppliers in particular industries will earn only the going rate of profit; any attempt to raise prices will simply attract competition.

The third important observation is the impact of this analysis on wages. For labour too is, of course, a factor of production and thus will only draw income in line with the marginal use to which it can be devoted. What results, therefore, is that labour is paid a rate of wages that is far below the direct marginal utilities of the goods that the very vast majority of labourers will be producing. Yet it is also clear that, because the value of marginal products is imputed, via their factors of production, to the supra-marginal products, it is clear that the resulting lower prices means that labour can buy all of this produce. Thus increases in the supply of labour, resulting in the direction of the latter to further marginal uses and thus a lowering of the nominal wage rate, will have no bearing upon the ability of labourers, in their capacity as consumers, to buy its produce and, indeed, will serve to increase the real wage rate. Thus the argument that increases in the supply of labour through, say, immigration are largely unfounded.

What we can see therefore is that the “Austrian” understanding of the prices of goods and their costs of production, although complex, provides a strong bulwark against false theories in many important areas such as stimulus spending, wages, and competition law. Every individual who wishes to offer powerful affronts to the falsehoods that abound in these areas should study it avidly.

View the video version of this post.

1George Reisman, Eugen von Böhm-Bawerk’s “Value, Cost and Marginal Utility”: Notes on the Translation, QJAE, Vol. 5, No.3: 25-35.

Advertisements

Competition and Antitrust Law – Economic Misunderstandings

1 Comment

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.

View the video version of this post.

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.