Being pro-markets, not pro-business

Being pro-business risks supporting incumbent firms against new entrants – this is not good.

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Economists are generally in favour of markets as ways to organise activity. Introductory microeconomics teaches students about how a competitive market brings demand and supply together efficiently: consumers get choice in what to buy, and companies are forced to be cost-efficient, or they go out of business.

“Competitive markets” means there is a large number of buyers and sellers, large enough that nobody can influence the price. This is a reasonable assumption on the consumer side – retail customers usually are very small relative to total demand so they have no market power – but on the producer, or supply side, it’s a much less realistic assumption. Genuinely competitive markets are rare, perhaps found only in commodity markets where a barrel of oil is a barrel of oil, regardless of where it came from.(Even this is not strictly accurate because oil varies by sulphur content, among other things, and of course there is some monopoly power through OPEC, but that has diminished in recent years.)

Competitive markets are what social scientists call an ideal type, something that is not necessarily real but helps to fix ideas and provide a benchmark for actual, messy reality. Both theory and experience over centuries suggest that the benefits of competitive markets are real: when customers face a single choice, they cannot switch suppliers if they’re unhappy with the price or service, and there are good reasons to think that monopoly firms tend to invest and innovate less than firms in competition.

The irony is that from a company’s point of view, competitive markets are a terrible outcome, because it makes only the minimum required return to stay in business i.e. just the cost of capital. Economists therefore largely view corporate strategy as the question of how to generate returns above the cost of capital, which means by definition creating products that allow a firm to have some degree of market power, escaping the tyranny of being a price taker. This means some form of barrier to entry: brands, technology, reputation or patented knowledge.

It was often said that GE (General Electric), in the days when it was a large and influential company, aimed to be either number one or number two in every market in which it competed. If it didn’t have this position, it would either acquire other firms to build market share, or sell to somebody else. GE was, in other words, quite correctly committed to uncompetitive markets, in its favour, on behalf of its shareholders. GE, for many years the world’s most valuable company and among the most admired, now has a share price around $12, compared with its 2000 peak of just under $60, which shows that what is good for the market is not necessarily good for any one particular company.

What economists understand, but often don’t communicate very well in teaching about markets, is that it is the drive for these higher returns that leads to all the things consumers value: new, useful products provided at affordable cost. This is therefore a search for (some degree of) monopoly power. If companies had no chance of getting higher returns they would just focus on survival and we would have a static, competitive market lacking any drive towards improvements.

So a real market will, at any time, have some elements of monopoly, but ideally a countervailing process of competition. One company invents a new product, or a cheaper version of an existing product. Other companies, seeing the high returns that company makes, or fearing they will be pushed out of business, respond by copying or even improving on the new product. This dynamic of competition, temporary monopoly, barriers to entry and then successful new competition, is what makes markets work well for the economy.

Another paradox is that if companies invest in new ideas only to see them immediately copied by competitors, then they will quickly lose any incentives to innovate. So we allow a legally codified form of monopoly for certain types of intellectual property in the form of patents. Samsung is perfectly at liberty to copy Apple’s innovative smartphone technology so long as it doesn’t infringe patents (and vice versa for Apple).

It’s difficult to get the balance exactly right, but most market-driven economies have some kind of mechanism for ensuring that competition is effective and doesn’t get permanently strangled by either powerful companies or by governments that might favour particular companies (either because they own them or because they receive favours from them). This mechanism is usually either the state or a state agency charged with promoting competition, or what the US calls anti-trust (after the first monopolies in the late nineteenth century were set up as so-called trusts).

Being pro-business is not the same as being in favour of free markets

Governments or political parties sometimes describe themselves as “pro-business” in the sense that a thriving business sector is good for jobs, incomes and taxes. The risk is that policy can end up being good for existing businesses, at the expense of new entrants which bring competition. The two main sources of competition are foreign companies, in the form of imports, and new start ups. Unsurprisingly, existing companies are often inclined towards protection from imports, which means foreign companies competing in their market. But if imports are blocked or made more expensive by tariffs, that comes at the expense of consumers. There is an immediate cost in the form of higher prices and a longer term cost in the form of less competition.

As for start ups, big companies are always on the look out for a bright new entrepreneur who might come up with a product that “disrupts” their market. They will argue for regulations that protect them from new entrants (although they won’t describe it that way, they will always talk of protecting consumers). And in many cases they will buy up the new entrants before they get too dangerous. Alphabet (Google’s parent company) and Facebook are two companies which dominate their industries, and both have the means and will to buy any company that threatens to challenge them. Start ups often aim for precisely this outcome, as it can be a very lucrative exit – just ask the founders of WhatsApp.

Both Google and Facebook offer services that are, as far as I can tell, happily accepted by most customers, who of course pay nothing (in financial terms) for the services. But we will never know what new products or ideas might have flourished, in the absence of these two monopolists crushing of any threats to their dominant positions.

There is a counterargument that monopolies, free from the immediate threat of competition, can afford to invest in more speculative long term innovation which might bring more important breakthroughs. People often point to ATT, which for many years was one of the two powerful technology monopoies in the US, the other one being IBM. It is true that ATT invested heavily in Bell Labs and gave away patented knowledge free, but that was largely a result of a deal with the US Department of Justice for allowing it to continue with its nationwide monopoly on telephone services. The DoJ eventually changed its mind and broke up ATT, ushering in a wave of telecoms competition and innovation which is only now beginning to fade as the industry re-establishes its monopoly power. IBM’s near monopoly on mainframe computers was destroyed by the invention of the personal computer, ironically by IBM itself.

Venture capitalist and Cambridge economist Bill Janeway emphasises in a recent review of two books about the history of Silicon Valley, that the current wave of digital technology has its roots in the ending of those two corporate monopolies:

“We are now living through another era defined by the dominance of tech giants and the state’s virtual abdication of concern for the consequences of that dominance. It is worth remembering that it was litigation initiated by the US Department of Justice’s Antitrust Division that created the open space from which the digital revolution and its leading players could arise.”

Yet that wave has now consolidated into its own set of monopolies. At present there is little evidence of a willingness by the US government to do much about it.

The optimistic view is that even the strongest incumbents eventually succumb to new technologies. After years of dominating the PC market, Microsoft saw the new mobile phone operating system market largely taken by Apple and then Google. But we’ll never know whether PCs might have evolved differently if Microsoft had been forced to give up its dominant position earlier (as it was in a limited way by forced unbundling of its browser from the operating system).

Evidence of rising monopoly power (see for example my discussion of Thomas Philippon’s book The Great Reversal) across many sectors of the US has raised concerns that the balance of policy is now too much towards protecting current business and not enough about preserving the benefits of a dynamic, competitive market.

The new Chicago view

Some people may be aware of the Chicago “school” of economics, long associated with support for markets and scepticism about state intervention. Milton Freeman was the most famous of that school.

But on today’s University of Chicago website you will find a link to the excellent blog of the Stigler Centre, named after a highly distinguished professor of free market economics and 1982 Nobel prize winner, George Stigler. That blog regularly draws attention to a lack of competition in American markets and tries to emphasise the need for protecting the benefits of markets from the power of existing businesses: pro-markets, not pro-business.

One Response to Being pro-markets, not pro-business

  1. Thanks! i wish everybody in Chile reads this post!
    Chile has long been seen as a free market economy.
    Nevertheless, when you have three supermarkets, three pharmacies and three everything, is more a pro-oligopoly (pro-bussines) than a free market economy.
    So, I understand why people are so upset from an economic point of view. But free market is not the responsible but the state incapable of coping with oligopolies capturing the economy.

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