A Spontaneous Order: Monopolies and Cartels
By RadCap
Consider purchasing a copy of A Spontaneous Order: The Capitalist Case For A Stateless Society
The notion of a “free” or an “unhampered” market is a conception of a market operating quickly, spontaneously, and unpredictably. It is a market where every person can negotiate the terms of every exchange he makes and privately owns every good he intends to trade. Taxes, tariffs, quotas, price restrictions, mandated licensure, labor regulation, and intellectual property never exist in this market. Everyone is free to copy and remix others’ work, acquire cheaper materials, and produce any good. With the absence of aggressive barriers to entry into any industry, competition becomes fierce and unrelenting. Without occupational licensing or securities regulations or taxes by which to abide, even small discrepancies in customer satisfaction can allow newcomers to topple established giants. Operations that produced the same service indefinitely would be rare and generally unsuccessful. These dynamic markets organically emerge from the free, spontaneous interplay of people.
This environment is vastly different from what exists today, thus one must relieve himself of the prejudice generated by his experience of the current paradigm if he wishes to fully comprehend the contrasting merits of truly free markets. The salient characteristic of such markets is the absence of systemic aggression. Such aggression is what enables genuine consumer and worker exploitation, and is indeed worthy of vigorous opposition. Surprisingly, the most powerful and destructive perpetrator of aggression is the State itself. To mask this ugly truth, the State has cleverly disguised itself as the protector of the weak, poor, indigent, and disenfranchised. Moreover, it claims to be a necessary, if not sufficient, institution to carry out this purported role. To complete this deception, the State and its sympathizers have taken great strides to indict the unfettered market as the primary culprit of the commoner’s tribulations (contrary to the truth). One such manner in which the State inflicts great harm upon us is by its manipulation of competitive markets.
Competition
In a free market, all businesses are competing for consumer patronage. Competition exists between all firms in every industry. For example, one who sells ice cream competes not only with Ben and Jerry’s, but also with movie theaters, as one can always choose not to purchase ice cream and instead attend the cinema.
This is the true meaning of cost: the foregone next most-favored course of action (a.k.a opportunity cost). Should one choose to spend the afternoon having a sundae at an ice cream parlor, he cannot also spend it at the theater. One cannot be at both places at the same time. Hence, the price and attractiveness of the movie is relevant to one’s decision when choosing to buy ice cream, not merely the price and attractiveness of the ice cream itself. There are two types of competition: active and potential. Active competition is the businesses or competitors that actually exist today. Potential competition, on the other hand, consists of those businesses or competitors which may manifest should a given business’ services or products satisfy consumer demands less and less.
Defining Monopoly
There is much confusion over what constitutes a monopoly. A common definition of monopoly is “a firm that is the single provider of a particular good or service.” This definition, however, is useless for a number of reasons. Defining a monopoly as a single provider implies the smallest differentiation of a product or service could, in turn, bestow upon the creator a monopoly over its provision. For example, Jackie may have a monopoly on purple polka dotted peppermints or Joe on magnolia-flavored popsicles. Even with regards to homogeneous goods such as wheat, one could still hold a monopoly on “Robinson Wheat” and Joe could hold a monopoly on “Joe Wheat,” as the wheat produced could be differentiated by how it was grown, what fertilizers or nutrients were added, etc. This definition of monopoly does not yield us any pertinent or useful economic information as it renders virtually everyone a monopolist.
The term “monopoly” itself evokes negative feelings, but to what did the term “monopoly” originally refer? A monopoly originally meant an exclusive legal privilege to produce or sell a given product or service, granted by the King. It was a privilege given to favored producers or guilds for them to produce without the nuisance of competition. Should any upstart break from the privilege, the King’s might would be summoned. Thus, a monopoly is a creation of the State. Murray Rothbard explains:
Monopoly is a grant of special privilege by the State, reserving a certain area of production to one particular individual or group. Entry into the field is prohibited to others and this prohibition is enforced by the gendarmes of the State.[1]
Using this definition, consumers are justified in opposing monopolies as they imply the threat or use of aggression to uphold and maintain, and therefore constitute a distortion of natural market dynamics. Without the Statist apparatus of compulsion, there could be no special grants given to certain businesses. Free entry is the default condition for all industries, and, as such, monopolies created by the power of the State could not exist in a truly free market.
Natural Monopoly
In the words of Thomas Di Lorenzo:
A natural monopoly [a single service provider] is said to occur when production technology, such as relatively high fixed costs, causes long-run average total costs to decline as output expands. In such industries, the theory goes, a single producer will eventually be able to produce at a lower cost than any two other producers, thereby creating a ‘natural’ monopoly. Higher prices will result if more than one producer supplies the market.[2]
Some commonly cited examples of these so-called “natural monopolies” include utility providers such as gas, water, or electricity companies. The concern regarding the manifestation of such “monopolies” is that they may charge exorbitant prices with economic impunity. Should they take advantage of their position, however, there always exists potential competition which may serve to temper their behavior. For the sake of argument, however, let us assume that a single provider of a given good or service does arise. As the absence of aggressive barriers to entry into any industry is inherent in free markets, the threat of a potential competitor will be much stronger relative to the case in which the State imposes artificial barriers, and sometimes even prohibitions, on competition in various industries.
Let’s entertain the worst case scenario: A water company decides to triple its rates without a corresponding increase in the cost of production, how do market participants respond? In the first place, future, potential customers would be deterred from moving to this town due to these exorbitant rates, and current residents are incentivized to move elsewhere. This would, of course, result in a loss of business for the water company. Moreover, the consumer will be incentivized to act more conservatively with his water. Perhaps husbands and wives will take showers together, decrease how often they water the lawn, or install rainwater collectors in their backyard. How the conservation is accomplished is irrelevant. Less water will be used, and a decrease in the usage of water translates into a decrease of revenue for the water company. Worse yet, even if the water company decides to revert back to its original rates, its customers may have grown fond of these water conservation efforts and continue their practices nonetheless, thereby permanently lowering the income of this water company.
However, if the water company maintains these exorbitant prices despite the preceding events, then a competing water company from a neighboring town may decide to move in and start operations so long as the benefit of an alternate provider outweighed the costs and inefficiencies of establishing redundant infrastructure. If, in response to the presence of a new competitor, the old water company decides to return to its lower rates, the customers’ trust in it will have nevertheless been undermined. Consumers may choose to switch over their services to the new water company even if it does charge marginally higher prices, so long as it can demonstrate a long history of stable and predictable prices.
Furthermore, a common practice before developing any land in an area is to make contractual agreements with surrounding utility companies regarding fixed pricing. This type of reassurance will help encourage prospective developers to build homes and businesses on this land. Finally, in order for a water or electric company to achieve such a “monopoly” status, it would have first been required to gain the trust of their customers and to have provided a more satisfying service than their actual or potential competitors. The likelihood of this company fundamentally changing the very business practices that made it so successful in the first place is relatively low. Of course, this is all speculative to some degree, but the preceding hypothetical demonstrates the means by which individuals in the market may effectively deter, prevent, and mitigate activity that is harmful to the consumer. This same line of reasoning may be applied to any other firm that enjoys a large share of a given industry.
Cartels
A cartel is a group of individual firms in like-industries which decide to coordinate their practices as a means to maximize profits. These coordinating efforts can take the form of setting production quotas or “fixing” prices. From this definition, one may surmise a few inherent weaknesses of a cartel and why such an arrangement, if intended to secure extra profit by maintaining prices above the market rate, is almost assured to be temporary and tenuous in a purely free market.
The first and most obvious complication in any cartel is determining unanimously amongst the individual members exactly where the prices for their goods or services should be set and/or how much each member firm should be permitted to produce. Of course, the more efficient members are likely to be the most uneasy about such an arrangement as they would likely resist any restrictions on their own production for the sake of the less efficient member firms. Thus, at the soonest feasible opportunity, it is likely that these more efficient members will emancipate themselves from the cartel in pursuit of greater profits. Further, under such an arrangement, all the members will be tempted to “cheat” by either lowering their agreed upon prices or increasing their agreed upon production as a means to secure a larger share of the market outside of officially established lines. Finally, even assuming a cartel is able to successfully coordinate the actions of its members and to reconcile all of their disparate interests, there would still be the issue of potential outside competition. The main purpose of a cartel is to coordinate with other firms in the same industry so as to generate greater revenue for their services than they could otherwise earn. However, the higher the prices – or the lower the production limit the cartel sets for its members – the more vulnerable the cartel becomes to outside competition undercutting the cartel’s prices and “taking away” its valuable customers.
The difficulties of coordinating efforts among independent firms, combined with the potential for outside competition, renders the consumer-unfriendly cartel an unlikely market arrangement. It is important to remember that cartels today do operate outside market forces in a genuinely exploitative capacity, but they are only able to do so by purchasing and acquiring influence over the State. Only through the application of State-mandated price ceilings, price floors, regulations, occupational licensure, minimum wages, taxes, and even explicit grants of monopoly over certain industries, can a given firm or cartel exploit the consumer. Exploitation of the consumer only exists in this arrangement because the State is able to insulate a given business from market forces via legislation. Conversely, in a purely free market, the survival of these businesses would be predicated on how well they could satisfy the desires of the consumer relative to existing and potential competition. Where there is an absence of aggressive barriers to entry, there can be no exploitation. Finally, there are no private property rights violations associated with cartelization, as it merely represents the pooling of resources on an inter-company scale. Having property rights over resources entails the right to pool them with the resources of others in a voluntary manner.
Cartel Production Restriction
One danger often pointed out as being possible in an unfettered market is the act of a cartel restricting production as a means to keep the price of a given good higher than it otherwise would be. The critics of this method are correct insofar as the purpose is concerned: to maximize profits. However, this objective is no different than any other market activity.
Take rice, for example. If a cartel of rice producers in combination creates two hundred tons of rice in a year, but comes to learn that one hundred tons would yield the greatest profit, then it will naturally begin to release only one hundred tons of rice into the market. This sort of “collusion” is deemed as predatory by many mainstream economists, for had the cartel released all two hundred tons, then the larger supply would have translated into lower prices per unit for the consumer, leaving him ostensibly better off than had the cartel restricted their production to one hundred tons.
However, the materials and/or labor required to produce two hundred tons will exceed the materials and/or labor required to make the one hundred tons. The excess resources will now be freed up and available for use in the production of other demanded goods or services. Thus, the influx of these additional resources being funneled into more valuable sectors of the economy, other things equal, will actually cause a rise in the overall standard of living. Therefore, on net there is no restriction of production. In fact, the act of the rice cartel reducing its particular overall output will have resulted in a greater net production of wealth, as this would permit the excess resources to be allocated to more profitable ends. This same line of reasoning is equally applicable to a single large firm which decides to decrease its production.
Potential Benefits of Mergers or Cartelization
It should be noted that large firms or cartels in free markets are likely to yield a positive effect for the consumer, otherwise they would either dissolve or be out-competed by more agile newcomers. First off, such large firms (or grouping of firms) are able to take advantage of greater economies of scale. This is the principle that states: with more resources and capital goods at one’s disposal, the easier it becomes to maximize the efficiency of productive output.
This is true for a number of reasons, the first of which is the possibility of bulk purchasing. Typically, buying in bulk yields a lower price per unit of whatever it is being bought, because the seller of said good is typically happier with a larger guaranteed purchase at a lower price than he is with taking the risk and the extra time of making more sales of smaller quantities at higher prices. Moreover, the larger the firm, the more it is able to benefit from the division of labor, specialized machinery, lower overhead costs per unit of output, advertising, access to cheaper credit, established lines of transportation and logistics, etc.
Further, with access to greater amounts of capital, a cartel or recently-merged firm can afford to invest in more productive capital goods which were once prohibitively expensive. Once this firm is able to enjoy the benefits of greater production afforded by the newly acquired capital goods, the employees will in turn be able to produce more with the same amount of labor, increasing their labor productivity. This would create the tendency to command higher wages for employees and/or to offer the consumer lower prices without negatively affecting one’s profit margin.
How Startups May Compete With Large Firms
The difficulty for any one person to enter into a given industry is diminished insofar as the current provider(s) are not sufficiently satisfying consumer demands, by either producing faulty (or undesired) products/services or by charging prices that are “too high.” Whenever this is the case, there will be a large demand for an alternative. If the number of unsatisfied consumers becomes substantial, it would become clear that an alternate provider could make a great deal of money by “taking away” customers from the incompetent, ossified firms.
To overcome the difficulties of breaking into established markets, an entrepreneur who has a spectacular and compelling business model may seek “venture capital.” There are many wealthy investors who are looking for ways to earn a positive yield as opposed to having financial capital sit idle. In such an environment, investing in an entrepreneur with a solid business plan could prove to be an enticing and lucrative option. Alternatively, an entrepreneur may take out loans or sell shares of his company as a means to raise the funds required for its creation.
In many cases, entrepreneurs are competing with the current incompetent firm or cartel in the same industry. However, it may very well be the case that the overall dissatisfaction of how this product or service is being offered would generate an impetus for someone to invent a technology that renders it obsolete. For instance, the invention of a hydro-powered hover car may render fossil fuel-based automobiles obsolete due to lower maintenance costs, cheaper fuel, and shorter transit times.
Technological developments, however, do not necessarily have to be in the form of different products which make the former obsolete. They could very well be developments that permit alternate means of production which prove to be far more cheap (i.e. efficient). There are a myriad of ways in which one may take on an incompetent firm in a capital-intensive industry. In a free market where there are no aggressive barriers to entry in any industry, thus the threat of economic exploitation via business practices is virtually nil. In fact, it is complete economic liberty that is the greatest defense against exploitation and predation. Take, for example, the notion of “predatory” price cutting. The idea that any form of price cutting could be “predatory” is absurd from the start, because it implies that some sort of injustice can be committed by a firm deciding to lower the prices of its goods or services relative to its competitors. The owner of any given good, or the provider of any service, has a right to charge whatever price he wants for whatever it is he is selling, and likewise the consumer has the right to either purchase or not purchase whatever is being sold.
The common claim is that a large firm will take advantage of its economies of scale and lower its prices to a level that its smaller competitors cannot afford to maintain, thereby running them out of business. This “cutthroat” firm will then proceed to raise its own prices to exorbitant levels that were previously tempered by the presence of competitive forces. Without State support of monopoly privileges, however, there is always competition, whether between firms in other industries or from potential future competition. It is never possible to price one’s goods or services without taking into consideration, at the very least, the potential of future competing producers being attracted by higher selling prices.
Furthermore, the smaller businesses who can’t afford to sell their goods or services at such a low price, even temporarily, could cease operations and buy up its competitors’ now cheap goods. A smaller firm could then sit on the inventory until the larger firm decides to raise its prices back to normal levels, thus defeating the purpose of starving the small firms. This “predatory price cutting” would also allow the consumer, at least temporarily, to enjoy a discount bonanza. The money the consumer saves could then be used to satisfy various other desires, increasing his standard of living. This large “predatory” firm would, in the long run, be shooting itself in the foot by using such a foolish method to attempt to secure a greater share of the market. Moreover, even if the firm is able to offer these prices without suffering any losses then so much the better. The other businesses which fail and liquidate will free up resources to be used by more efficient firms, in either the same or a different industry. Once again, the result of this would be an overall increase in the overall standard of living for consumers.
The State as Ultimate Monopoly
Anyone who would advocate for State intervention as a means to break-up and prevent the formation of monopolies (in this context defined as “single provider”) would be caught in a contradiction, as the State itself is the greatest and most exploitative monopoly of all.
The State has a legal monopoly on the right to use aggression against others in the form of taxation and compulsory edicts (legislation). Not only must “customers” pay into its operation without regard to their consent, but they must surrender to the rules its internal processes determine at all times. Additionally, the State has a monopoly on the provision of security, and has anointed itself as the ultimate arbiter in all conflicts, including those conflicts which involve its own agents. It maintains this monopoly by the threat and application of aggressive force, and thus meets Rothbard’s criteria for monopoly.
Agents of the State are motivated by profit and self-interest just like any given businessman. However, what separates the businessman from the State is that the former has to persuade you to pay for whatever is being offered, whereas the latter demands its citizens pay for its “services,” and unilaterally alters the price and scope of the “services” offered. Moreover, if payment towards an institution (the State) is guaranteed, then its services will tend to diminish in quality and increase in cost. The only thing that tempers the power of the State is its need to maintain perceived legitimacy. Thus, if one’s aim is to eliminate systemic, monopoly exploitation, then the perceived legitimacy of the State must be undermined. Various means may be employed to this end, including widespread education, social outreach, peaceful parenting, the development of the counter-economy, the use of crypto currencies, the promotion of traditional western values, secession, and the formation of free enclaves outside the grip of the State.
References
[1.] Murray N. Rothbard, “Monopoly and Competition” in Man, Economy, and State: A Treatise on Economic Principles ; with Power and Market: Government and the Economy (Auburn: Ludwig Von Mises Institute, 2009), 669.
[2.] Thomas J. Dilorenzo, “The Myth of Natural Monopoly” in The Review of Austrian Economics 9.2 (1996): 43-58.
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