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Monopoly Isn’t Always What We Think It Is

Writing a few days ago in The New York Times, David Leonhardt began his op-ed column on monopolies observing the Boston Tea Party of 1773 occurred in opposition to the Tea Act of 1773, which granted a legal monopoly over tea in the Americas to the East India Company. Writing earlier in the month, also in The New York Times, Columbia Law Professor Tim Wu began his op-ed on monopolies noting economic concentration in 1930s Europe and its role in the rise of fascism. Increasing market concentration in the U.S. is worthy of attention, but neither Leonhardt’s nor Wu’s arguments apply as straightforwardly as they suggest to indict increasing market concentration in the U.S. today.

Both exemplify monopolies created or facilitated by government. Today we call this “rent seeking” or “crony capitalism.” It is decried as much on the Right as on the Left. Leonhardt’s example of the British-government created monopoly over colonial tea exemplifies crony capitalism. Parliament passed a law that granted the East India Company, itself a quasi-governmental entity, a legal monopoly over tea in the colonies. The result? A reduced supply of tea and a higher price than would have existed with a free market. Government protection was critical to the monopoly power exercised by the East India Company.

So, too, the nations of continental Europe practiced a form of state capitalism throughout the first half of the 20th century (and after the War as well, even if in chastened form). Capital might be held in private hands, but governments had a cozy relationship with big capital, one which resulted in government protection and facilitation.

While often treated as synonyms, government involvement can be used to distinguish between “capitalism” and “market systems.” Coined and popularized by critics, notably Karl Marx, “capitalism” suggests a system that seeks to advance the interests of capital owners at the expense of workers and consumers. Market competition, in contrast, exploits capital owners in pitting them against each other. The market’s invisible hand pits capital owners against each other; self-interest leads capital owners to produce more at lower cost than they would without market competition, with the benefits spilling over to the consumers. To be sure, workers also compete against each other in market systems as in capitalist systems. The difference between the systems, however, inures to the benefit of workers. In market systems, the benefits of production are socialized—that is, made available to everyone—via price competition rather than captured by capital owners. Labor benefits primarily because most of us derive most of our income from our labor. So lower prices and greater supply generated by competition between capital owners benefits labor asymmetrically relative to capitalist systems in which capital is asymmetrically protected but labor competes against itself.

Leonhardt and Wu engage in rhetorical legerdemain by equating monopolization that results from crony capitalism with monopolization that results from the market competition. Before explaining, let me hasten to add that I don’t deny the existence significant levels of crony capitalism in the U.S. and the problems it creates. What I deny—and this is what creates the problem in crafting a policy response—is that market concentration is a useful proxy to measure market power.

The demonstration of this is straight forward. It is easy to conceive of a monopolist—a firm that produces 100 percent of a good in a given market—who exercises no market power at all. One does not need actual competition to induce lower prices and greater supply created by free markets. With low barriers to entry, mere potential competition forces the business owner to keep prices low and supplying all of the good consumers desire to purchase. If the business owner were to attempt to increase price above the level of the competitive market actual competitors would enter the market. In these situations, the firms’ owners have no market power to leverage despite being the only firms in given markets, i.e.,“monopolies.”

To be sure, this is a limiting case. I don’t suggest that all monopolies reflect the price and supply of competitive equilibria. But the possibility creates the policy and legal problem: monopoly qua market concentration is a necessary condition for the exercise of monopoly power but, as the example above demonstrates, is not a sufficient condition.

This is why Leonhardt’s and Wu’s rhetorical glissando from state monopolies and state capitalism to their indictment of market concentration in today’s economy is so pernicious. Indeed, crony capitalism is a problem in today’s economy. It is possible that the Left and Right could make common cause on this issue. But not by treating market concentration at the proxy for monopoly power. Crony capitalism is by definition politically-connected capital. Without refined measures of identification, renewed antitrust enforcement would likely take disproportionate aim at harmless monopolies, those effectively replicating competitive equilibria, and would overlook markets in which politically well-connected capital exercises real monopoly power.

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