Saturday, February 25, 2006

Monopoly and the General Welfare

UPDATED, 02/26/06

I began an earlier post by illustrating (with a "Jack and Jill" example") how a regime of liberty fosters prosperity. I concluded:
In sum, liberty -- which includes the right to engage in voluntary exchange -- makes both Jack and Jill better off. Moreover, because they are better off they can convert some of their gains from trade into investments that yield even more output in the future. For example, to continue with this homely metaphor, imagine that Jill -- fueled by additional food -- is able to produce the usual amount of butter in less time, giving her time in which to design and build a churn that can produce butter at a faster rate.

Liberty advances the general welfare, which means the general well-being -- not handouts.
You may have noticed that I did not argue that Jack and Jill's well-being can somehow be aggregated into a "social welfare function." As I wrote here, there is no such thing:

Suppose . . . that a faction of US citizens (call it LW) is unhappy because of certain actions being taken to prevent an attack by AQ. The actions that make LW unhappy don't make me unhappy. In fact, they add to my happiness because I despise LW; anything that makes LW unhappy makes me happier. Thus, I'll continue to be happy, despite LW's unhappiness, unless and until (a) LW's unhappiness leads to a political decision to stop defending US against AQ or (b) AQ attacks US successfully.

I could go on, but I think you get the idea. My happiness (or unhappiness) is mine, and yours is yours. The best we can say is that voluntary exchange in free markets, protected by strict enforcement of laws against force and fraud, would make almost everyone happier -- and wealthier. So much wealthier that there'd be plenty of money with which to buy off the free-loaders. But that's another story.

(See also this post.)

In yet another post I defended monopoly:
Where, for instance, is there room in the socialist or regulatory calculus for a rule that allows for unregulated monopoly? Yet such an "undesirable" phenomenon can yield desirable results by creating "exorbitant" profits that invite competition (sometimes from substitutes) and entice innovation. (By "unregulated" I don't mean that a monopoly should be immune from laws against force and fraud, which must apply to all economic actors.
(There's more here.) And in this post, on the subject of monopoly (scroll to item 19), I opened by saying, "Monopoly (absent force, fraud, or government franchise) beats regulation, every time." This follows:
Regulators live in a dream world. They believe that they can emulate -- and even improve on -- the outcomes that would be produced by competitive markets. And that's precisely where regulation fails: Bureaucratic rules cannot be devised to respond to consumers' preferences and technological opportunities in the same ways that markets respond to those things. The main purpose of regulation (as even most regulators would admit) is to impose preferred outcomes, regardless of the immense (but mostly hidden) cost of regulation.

There should be a place of honor in regulatory hell for those who pursue "monopolists," even though the only true monopolies are run by governments or exist with the connivance of governments (think of courts and cable franchises, for example). The opponents of "monopoly" really believe that success is bad. Those who agitate for antitrust actions against successful companies -- branding them "monopolistic" -- are stuck in a zero-sum view of the economic universe (see No. 13), in which "winners" must be balanced by "losers." Antitrusters forget (if they ever knew) that (1) successful companies become successful by satisfying consumers; (2) consumers wouldn't buy the damned stuff if they didn't think it was worth the price; (3) "immense" profits invite competition (direct and indirect), which benefits consumers; and (4) the kind of innovation and risk-taking that (sometimes) leads to wealth for a few also benefits the many by fueling economic growth.

. . . What about those "immense" profits? They don't just disappear into thin air. Monopoly profits ("rent" in economists' jargon) have to go somewhere, and so they do: into consumption, investment (which fuels economic growth), and taxes (which should make liberals happy). It's just a question of who gets the money.

But isn't output restricted, thus making people generally worse off? That may be what you learned in Econ 101, but that's based on a static model which assumes that there's a choice between monopoly and competition. I must expand on some of the points I made in the original portion of this commandment:
  • Monopoly (except when it's gained by force, fraud, or government license) usually is a transitory state of affairs resulting from invention, innovation, and/or entrepreneurial skill.
  • Transitory? Why? Because monopoly profits invite competition -- if not directly, then from substitutes.
  • Transitory monopolies arise as part of economic growth. Therefore, such monopolies exist as a "bonus" alongside competitive markets, not as alternatives to them.
  • The prospect of monopoly profits entices more invention, innovation, and entrepreneurship, which fuels more economic growth.
I will now try to braid these strands into a rope fit for hanging trust-busters. Returning to Jack and Jill, suppose this:
  • Jack can make 1 loaf of bread a day; he does not know how to make butter.
  • Jill and June each can make 1 pound of butter a day; neither knows how to make bread.
  • Jack is a "natural monopolist" in bread; Jill and June must bid against each other to buy Jack's bread, and must compete with each other in selling butter to Jack.
Now, the question for Jack, Jill, and June is this: At what rate should they exchange bread and butter? Contrary to the anti-trust mentality, there is no right answer to that question. The answer depends on Jack, Jill, and June's respective preferences for bread and butter, and on their respective negotiating skills. But of one thing we can be certain, Jack, Jill, and June will strike bargains that makes all of them better off than they would be in the absence of trade -- if they are left alone by government.

How can that be so if Jack is a "monopolist"? Doesn't he have an "unfair" advantage in his dealings with Jill and June? No. Consider:
  • Suppose that Jack and Jill (and June, as well) prefer bread and butter in the ratio 1/3 loaf: 2/3 pound. Before June enters the picture, Jack and Jill cannot both have their preferred combination of bread and butter. Jack would like to trade 1/3 loaf to Jill in return for 2/3 pound, and Jill would like to trade 1/3 pound to Jack in return for 1/3 loaf. Neither trade will fully satisfy both parties, so they must strike a compromise that leaves both of them better off than if they did not trade, but not as well off as they would like to be (with respect to the ratio of bread and butter).
  • When June enters the picture, all parties can have their preferred combination of bread and butter, and they will (if no one interferes). Jack, as the only breadmaker, is not in a superior position with respect to Jill and June. He makes something that they want, but they also make something that he wants. (A "natural monopolist" does not live by bread alone.) And so, Jack must bargain with Jill and June in order to maximize his satisfaction.
  • If Jack tries to bargain with Jill and June by withholding all of his bread, he must accept the fact that he will not have any butter to put on it. If Jack tries to charge Jill and/or June more for his bread than they are willing to pay, they simply will not pay it.
  • What's likely to happen if Jack withholds bread or demands more than Jill and June are willing to pay? Jill and June will learn to make bread for themselves, as if Jack doesn't exist. They will have some bread with their butter; Jack will have no butter with his bread. Who's worse off now, Jack?
  • If Jack persists in his holdout, he isn't guilty of a crime, he's merely guilty of choosing to accept a reduced standard of living. That's a personal preference, not a crime. The same result (for Jill and June) would obtain if Jack were dead. No crime there. Jack is guilty of a "crime" only if he prevents Jill and June from making bread, or if he forces them to give him butter on terms they wouldn't accept voluntarily.
(UPDATE: Have I stacked the deck by the example I used? No. See the addendum, below.)

The only kind of monopoly that harms consumers is a legal monopoly, one that is operated or regulated by government. Such a monopoly isn't harmful per se, it's harmful because the government's operation or regulation of the monopoly ensures that it cannot and will not respond to price signals. A natural monopolist (like Jack the breadmaker) must bargain with his customers, and must be alert to the possibility that his customers will turn to substitutes and near-substitutes if he doesn't bargain with them. But when government operates and regulates whole sectors of the economy (e.g., telecommunications and health care), price signals are practically meaningless -- there is no bargaining -- and substitutes are hard to come by (near-substitutes will be regulated, of course).

The only real monopoly, then, is one that is operated or regulated by government. It is that kind of monopoly -- not Microsoft or Wal-Mart (for example) -- which ought to be broken up or fenced in by the trust-busters.
ADDENDUM: I contrived a special case to illustrate the general point that "the consumer always prefers more to less." That is, the introduction of June, who brings additional butter to the table (so to speak), gives everyone the option of enjoying more butter. No one can be worse off than before, and at least one person can be better off. But suppose that instead of the outcome I sketched above (Jack, Jill, and June each end up with 1/3 loaf of bread and 2/3 pound of butter) June is willing to give Jack 2/3 of her pound of butter in exchange for 1/3 loaf of bread, a deal with which Jill chooses not to compete. The result: Jack (who starts with 1 loaf of bread) has 2/3 loaf of bread and 2/3 pound of better (extra bread for a rainy day), Jill (who starts with 1 pound of butter) has no bread and 1 pound of butter, and June (who starts with one pound of butter) has 1/3 loaf of bread and 1/3 pound of butter (a light eater). Jack and June are, by definition, happy with the outcome of the trade (June wouldn't make the deal with Jack if that weren't the case), but Jill is unhappy because she'd prefer to have 1/3 loaf of bread and 2/3 pound of butter, as before. Three points:

1. The new result has everything to do with differences of taste between Jill and June -- and nothing to do with Jack's so-called monopoly power.

2. To say that Jill has somehow become a "victim" of Jack's so-called monopoly power is to give a privileged postition to Jill. Why are Jill's preferences any more important than Jack's or June's? There's no way to assign values to Jack, Jill, and June's satisifaction, let alone to sum such values and determine that "society" is somehow better or worse off if Jill doesn't get her way.

3. If June's entry into the butter-bartering market leaves Jill hankering for bread, Jill might be able to earn some bread by making jam instead of butter. She would then have something to offer both Jack and June. In other words, the price system is sending a signal to Jill; it's up to her to interpret and act on that signal. That signal would not be sent if a "benevolent" government, acting at the behest of Jill's political action committee, were to step in and dictate the terms of trade between Jack, Jill, and June (according to Jill's preferences). The result would be to make Jill better off while making Jack and June worse off. That's what happens when interest groups are able to use the power of government to satisfy their preferences.