Chapter 10. Monopoly Versus Freedom of Competition

CHAPTER 10

MONOPOLY VERSUS FREEDOM OF COMPETITION

1. The Meaning of Freedom and of Freedom of Competition

If there is anything for which capitalism is more strongly denounced than its competition, it is its alleged lack of competition and tendencies toward monopoly. These denunciations stem in large part from a failure properly to understand the meaning of freedom of competition and of monopoly. The terms are usually understood in the light of the anarchic rather than of the rational concept of freedom. 1

According to the rational concept of freedom, of course, freedom means the absence of the initiation of physical force—in particular, on the part of the government. Viewed in a positive light, freedom is the freedom to do whatever one is otherwise capable of doing, unconstrained by the initiation of physical force.

Applied to the realm of competition, if a man possesses only a few thousand dollars of capital or no capital at all, freedom of competition for him does not mean the ability to enter into competition with General Motors. It does mean the ability to do whatever he is capable of doing with the few thousand dollars of capital he has (or with his abilities unaided by any capital)—without being stopped by the government. It means, for example, that if he can afford to buy a taxicab or a liquor store and judges that that is what is best for him to do, he will not be stopped from doing it by licensing laws. It means that if he is capable of working at a job and can find an employer willing to hire him, he will not be stopped from working by minimum-wage laws or by laws giving coercive powers to labor unions—in both of which cases a part of the supply of labor is forced into unemployment by wages rates being forcibly raised above the market level. And if a man (or a company) does have the capital required to compete with General Motors, and wishes to compete, freedom of competition means for him that he will not be stopped by a tariff or by antitrust laws preventing mergers and the growth of big business. It means, for example, that Toyota and Nissan will not be stopped and that if U.S. Steel, Exxon, Boeing, or IBM want to enter the automobile business, they will not be stopped.

Freedom of competition does not mean that one is automatically able to compete—that one automatically has the necessary knowledge, capital, or whatever else may be required to compete. It means only that insofar as one does have the means of competing, one will not be stopped from exercising those means by the initiation of physical force.

The fact that freedom of competition does not guarantee that one will be able to compete—the fact that freedom in general does not guarantee that one will be able to do whatever it is one would like to do, because freedom does not by itself supply the necessary means— does not reduce freedom to the status of a trivial luxury capable of being enjoyed only by the wealthy, as the Marxists claim. Freedom, including the freedom of competition, is a vital necessity for everyone. It means, in essence, the freedom of opportunity—the freedom to exploit the opportunities one already has, and so later on be capable of enjoying greater opportunities. 2 It means, for example, that an impoverished black youth is able to

take a low-paying job, if that is the best he can find, and then with the experience and skill he gains from that job go on to something better. It means that he is able to keep the income he earns from that job and, if he wishes, save it to buy a taxicab or any other kind of business he can afford and so further increase his ability to earn money. Freedom, thus understood—as the freedom of opportunity—is vital to everyone. 3

Not only does everyone need freedom for himself, but he also needs freedom for others because he enormously benefits from their freedom. Everyone in the world is vastly more prosperous because Thomas Edison and Henry Ford and all the other great inventors and industrialists had the freedom to implement their ideas and bring their products to the market. The general gains from the freedom of lesser men are no less real. 4 For example, there is a gain to everyone who uses such services as those of barbers and tailors if those best able to provide such services are free to provide them. The freedom of all is a condition in which every industry can be carried on by those best suited in the world to conduct it. It is a condition in which each can be supplied by the best choice of suppliers. This, indeed, is the meaning of the freedom of competition: that every industry and occupation should be legally open to everyone who judges that he is equipped to succeed in it and who wishes to try and that then the buyers should be free to choose among them.

High Capital Requirements as an Indicator of Low

Prices and the Intensity of Competition

In connection with this discussion, it should be realized that the existence of high capital requirements as a condition for being able to compete does not constitute a “barrier to entry” in any legitimate sense, despite the frequency of the claim that it does. The fact that in present conditions it may take a billion dollars or more to build a competitive-sized automobile factory or steel mill does not represent a violation of the freedom of entry or competition. On the contrary, it is the result of the fact that in order to be profitable, it is necessary to produce at low costs, thanks precisely to the freedom of competition. The high capital is necessary only in order to produce on a large scale and with the use of capital-intensive methods of production, both of which are means of achieving low costs of production. If the achievement of low costs of production were not necessary, then neither would be the substantial sums that must be invested to reduce costs. High capital requirements would not exist.

What makes it necessary to achieve low costs of production is the fact that others, who employ large sums of capital and who thereby achieve low costs of production, sell at correspondingly low prices, which makes it impossible to succeed in the business while producing at the high costs resulting from the lack of sufficient capital. In the simplest possible terms, the high capital of General Motors and the other major automobile companies does, indeed, stop people with capitals as limited as those of neighborhood grocers from producing automobiles. This is as it should be. In order for people to be able to succeed in the automobile business with such limited capitals, automobiles would have to be produced without the aid of substantial machinery or the use of such things as moving assembly lines (which require a very large volume of output). As a result, they would have to be produced at an extremely high cost, comparable to the cost that existed in the early years of the industry. And thus they would have to sell at correspondingly high prices.

It also follows from this discussion that in order to achieve the competitive advantages of the possession of a large capital, a firm must sell at prices that reflect its low costs of production. If it does not, then it opens the door to firms with smaller capitals and higher costs of production, that can then succeed in the business and possibly accumulate the capital necessary themselves to achieve the lower level of costs. Thus, high capital requirements are the result of the freedom of competition, which results in low costs of production and low prices, and which necessitates the possession of a substantial capital where that is the means of achieving low costs and low prices.

High capital requirements are an illustration of the principle that under the freedom of competition and the freedom of entry the only way one keeps others out of a field is by producing better and more economically. Where the freedom of competition and the freedom of entry are violated, on the other hand, it is the better, more economical producers, including those with larger capitals, who are kept out—by means of the initiation of physical force.

2. The Political Concept of Monopoly and Its

Application

Consistent with the concepts I have expounded of freedom in general and of freedom of competition in particular, is what I call the political concept of monopoly. According to the political concept of monopoly, monopoly is a market, or part of a market, reserved to the exclusive possession of one or more sellers by means of the initiation of physical force by the government, or with the sanction of the government.

Monopoly exists insofar as the freedom of competition is violated, with the freedom of competition being

MONOPOLY VS. FREEDOM OF COMPETITION 377 understood as the absence of the initiation of physical force as the preventive of competition. Where there is no initiation of physical force to violate the freedom of competition, there is no monopoly. The freedom of competition is violated only insofar as individuals are excluded from markets or parts of markets by means of the initiation of physical force. Monopoly is thus a market or part of a market reserved to the exclusive possession of one or more sellers by means of the initiation of physical force. It is thus something imposed upon the market from without—by the government. (Private individuals—gangsters—can initiate force to reserve markets only if the government allows it and thereby sanctions it.)

Thus, monopoly is not something which emerges from the normal operation of the economic system, and which the government must control. That mistaken view is based on the economic concept of monopoly, which will be considered later in this chapter. The economic concept of monopoly is the corollary of the anarchic concept of freedom and its implication that private individuals can violate the freedom of speech or press by their mere refusal to provide others with the material means for spreading their ideas and can violate the freedom of competition by virtue merely of their possession of larger capitals and superior abilities. 5 Rationally understood, monopoly is external to the normal operation of the economic system and is, as I say, imposed by the government or with the government’s sanction. It is, as it was originally understood, an exclusive grant of government privilege, such as was extended by English monarchs in earlier centuries to the British East India Company and to various guilds of producers or merchants.

As subsequent discussion will show, the leading examples of monopoly rationally understood, that is, according to the political concept of monopoly, are exclusive government franchises, licensing laws, tariffs, the operation of minimum-wage and prounion legislation, government-owned or government-subsidized enterprises, a socialist society, and, however surprising, the antitrust laws.

Monopoly Based on Exclusive Government Franchises

Exclusive government franchises reserve markets to the exclusive possession of the holders of the franchises, and do so by means of the government’s initiation of force. Leading examples of this category of monopoly are electric, gas, and water service, cable television, local telephone service, and, in many localities, local bus service. In each case, no one but the holder of the government’s franchise is legally allowed to sell the service in question in the particular market. Anyone else who might wish to sell the service in that market is

stopped by law and the threat of physical force that stands behind the law. Since the provision of such service does not represent an act of force, stopping its provision by means of the use of force represents an initiation of force—an act of aggression—on the government’s part.

In connection with monopoly in the form of exclusive government franchises, what is essential is not the fact that there is only one supplier. There might well be just one supplier in these cases under the freedom of competition. What is essential to monopoly is that physical force is initiated in order to keep out of the market sellers who might otherwise wish to be in it—that the determination of the fact that there is just one seller, and which particular one seller, is made by means of the initiation of physical force, not by the freedom of competition. Under the freedom of competition, Alcoa was for many years practically the only seller of aluminum ingot in the United States. Nevertheless, it was not a monopoly, according to the political concept of monopoly. This was because its position did not rest on the initiation of physical force, but on its ability and willingness to produce and sell its aluminum at prices that were profitable to it, but yet too low for any potential competitor to be profitable.

It is possible, indeed, likely, that economies of scale associated with most or all of the cases presently falling under the category of exclusive-government-franchise monopoly would make possible a situation similar to that of Alcoa. Like the case of Alcoa, a single electric or gas company providing service in a given area would not constitute a monopoly, if, in order to be in that position, it offered its customers lower rates than any other potential supplier offered. What would be crucial is that under the freedom of competition, precisely this is what it would have to do, if it wished to be the sole supplier. Indeed, in order to become the sole supplier, it would almost certainly have to offer its customers contractual guarantees concerning its rates, so that they would not have to fear temporary arbitrary increases in the period in which competitors did not yet have the time required to enter the field. In other words, to become the sole supplier of gas or electricity and so forth, under the freedom of competition, a firm would have to offer a longterm, contractually guaranteed price that was below what its potential competitors were prepared to offer.

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To guard against possible misunderstanding, it is necessary to say explicitly that exclusive private franchises, such as the right to own and operate a Coca Cola bottling plant, or a McDonald’s hamburger restaurant, do not represent any kind of initiation of force. The name and formula of Coca Cola and the name, supplies, and counseling provided by McDonald’s are the private property

of these concerns, and thus they have the right to determine who is and who is not to receive the use of that property. It would be an initiation of force—theft—for anyone to use that property against their will.

The government, on the other hand, should not own any property whose use it may give to some and withhold from others, because it is properly nothing more than the agent of the people—of each and every person equally. Apart from what is required for such things as police stations, courthouses, and military bases, which are necessary for the carrying out of its rightful and strictly delimited functions, it certainly should not, and for the most part does not, own the land of the country. The citizens individually and in private volunatary associations are properly the owners of the land and all that is upon it. They alone have the right to determine who can and who cannot use their private property. In denying anyone the right to undertake economic activity, the government simply initiates the use of force.

Licensing Law Monopoly

Licensing laws create monopolies by virtue of initiating force to reserve markets to the exclusive possession of the license holders. Examples of monopoly based on licensing laws are the occupations of accountant, barber, beautician, contractor, dentist, lawyer, liquor store owner, optician, pharmacist, physician, psychologist, teacher, and taxicab driver. Only the holders of the licenses are legally allowed to pursue the field in question. All others are excluded by means of the initiation of physical force.

Of course, licensing laws are defended, on the grounds that they are necessary to public health or safety, or some other such high purpose. But the fact is, they keep out of fields suppliers who otherwise would be in them—suppliers with whom the public would be glad to deal voluntarily, without any form of force or fraud being present. Their effect is always to deprive the buyers of services they could have had, to raise the price of the services they are allowed to receive, to elevate the incomes of the license holders, and to depress the incomes of those who are excluded from the licensed fields and forced to crowd into other, less-well-paying fields.

It may well be the case that licensing sometimes does serve, as its supporters often claim, to raise the minimum level of competence and expertise in a field and thus to guarantee to the buyers a higher level of service than they would have received in its absence. But even if this is true, it is not by any means an advantage to the buyers. It merely means, in many cases, that buyers are forced to buy a higher level of service than they want or need and, if they cannot afford the higher level of service, are forced to do without the service they could have had. The result on this score is comparable, in essence, to a law that would require that the minimum quality of automobiles on the road be no less than, say, that of a five-yearold Chevrolet of average quality. While such a law would undoubtedly raise the average quality level of the cars that remained on the road, it would also operate to prevent many people from driving—namely, those who could not afford anything beyond the quality of the cars they presently drove and whose cars were below the quality of the average five-year-old Chevrolet.

In just this way, medical licensing—the field in which licensing might be thought to be more necessary and proper than in any other—has the paradoxical effect of depriving the poor of medical care altogether.

In the absence of medical licensing, it would not be the case that barbers and butchers would be able to compete as doctors, any more than they can compete in the automobile or steel industry. Competition would establish educational, performance, and other requirements. And it would still be fraud to claim a degree, or any other form of private certification, that one did not have. The new competition in medicine would come from people who today must be content to be registered nurses, pharmacists, paramedics, biologists, and so forth, but who could become qualified to practice important aspects of medicine presently monopolized by the licensed physicians, and do so with a high degree of competence.

These people are present in the ranks of those arbitrarily rejected by today’s monopolistically restricted medical schools, or who are deterred from even trying for admission to today’s medical schools. They would be able to provide medical care to many who today cannot afford medical care, and even if the medical care they provided was less complete than that provided by most of today’s practitioners, it would certainly still be far superior to no medical care at all. Moreover, in serious cases beyond their competence, they could make referrals to doctors of greater expertise than themselves. At the same time, in necessary cases, the poor would be better able to afford the services even of the more qualified doctors, since those services too would be rendered less expensive by the new competition. For many people who had had to use them would also turn to the less expensive services of the new competitors to varying degrees. This would operate both to reduce the price of the more qualified doctors’ services, bringing them more within reach of the poor, and to make their time more available to the poor, since it would no longer be in as great demand by the middle class and the wealthy.

In many cases, licensing actually serves no legitimate purpose whatever. It is nothing more than a pretext for imposing arbitrary requirements on prospective suppliers, its only real purpose being to keep the supply down

and the price up. For example, requiring barbers and beauticians to take year-long courses on dermatology can have no other purpose but to discourage people from becoming barbers or beauticians and thus to keep up the price of the services of those who do become barbers or beauticians.

Where, as in medicine, and even in home building, there is a legitimate purpose in licensing, that purpose can be achieved without licensing. People want to know with whom they are dealing. That is why they attach so much importance to brandnames and why customer good will is so important. In dealing with doctors and home builders—especially if they could not take for granted the approval of an allegedly all-wise, all-knowing government, bestowed through the conferral of a license— people would insist on an established reputation or on strong endorsements from those with established reputations and whose judgment they trusted. And, of course, insurers (and in home building, lenders as well) could impose their own, additional requirements. Indeed, it is even possible to imagine that the very same employees of the present medical licensing boards, and the very same building inspectors who now work for the government, would stay on as employees of private certification agencies and continue to perform all the legitimate substance of the work they presently perform.

There would be one essential difference, however, that would constitute a fundamental and major improvement. That would be that no one would be compelled to accept the judgment of government officials or of any other group of people. With private certification, not only would the supply of a service be greater and the price correspondingly lower, but, no less important, there would permanently be more chances for new ideas being tried, and thus improvements would come far more rapidly than is possible today. Under private certification, not only would there almost certainly be more than one certification agency in any given occupation, but the individual would always have the right to step outside the system and decide entirely for himself. It would not be necessary, as is now the case, that before trying a new cure for a disease, or a new method of constructing a building, a person would have to wait upon the pleasure of any group of government officials to approve it. If, to take a particularly outrageous example, a person has heart disease, or has suffered a stroke, he could freely buy medications whose effectiveness has already, long-since been proved in Western Europe, to the satisfaction of large numbers of American doctors. Neither he nor his physician would have to fear the licensing power either of a state’s medical licensing board or of the federal government’s Food and Drug Administration. If an individual is dying of cancer, and cannot be cured by methods endorsed by the present medical establishment, he could freely accept the responsibility of turning to something different.

It is no doubt true that under the freedom of competition, some individuals would act irresponsibly and at the first opportunity turn to quacks. The existence of such people, however, is no reason for denying freedom to everyone else, who would use it to great advantage. Moreover, under freedom, stupidity of choice serves as its own punishment!

If the misuse of freedom by the ignorant and the foolish is what is feared, then a better case can be made for the licensing of politicians and government officials than of doctors or the members of any other profession or trade. This is because here, when people turn to charlatans, the consequences are suffered by all. But, of course, there can be no such thing as the licensing of politicians and government officials, for who would license them, but other politicians and government officials? And what could be more dangerous than to allow politicians and government officials to have such power?

The existence of freedom carries with it the possibility that people will make wrong and even foolish choices. But there is no alternative. That possibility exists with or without freedom. The great advantage of freedom is that each individual has the right to make his own choices and need not be bound by the ignorance or stupidity of others. The alternative to freedom is settling matters by force, and here the ignorant and the stupid have the greatest chance to control the outcome and to compel all to go with them. Indeed, the use of force is the only way that those who are knowledgeable and intelligent can be made to follow the lead of those who are ignorant or stupid. The choice, in other words, is not one between people making foolish choices on their own when they live under freedom and wise choices when they live under the control of government officials. The real choice is between at least those who are intelligent and wise making wise choices under freedom, and thereby setting an example for all others to follow, and those who are intelligent and wise being compelled to follow the will of the ignorant and stupid when the initiation of physical force takes the place of freedom.

The premise of a free country is that the citizens are intelligent enough to run their own affairs and, in the time left over from their own affairs, the affairs of their government as well. Citizens who are not qualified to pass judgment on the qualifications of their doctor or building contractor (or on the qualifications of the experts whose advice they accept) are even less qualified to pass judgment on matters of foreign policy or domestic policy. This is certainly not a plea to deprive such citizens of the right to vote—for the reasons just explained (though

it certainly can be taken as a good argument for limiting the questions that people have the power to decide by vote, that is, as an argument for limited government). On the contrary, it is a plea simply that people retain and enlarge their freedom of choice in the economic area and, by the natural method of gaining from their right choices and suffering from their wrong choices, be led to make all of their decisions as conscientiously and as wisely as they can.

Before leaving the subject of licensing monopoly, it is necessary to observe that probably far more important than breaking the licensing monopoly presently enjoyed by physicians would be breaking the licensing monopoly presently enjoyed by hospitals. People justly complain of the enormous costs of hospital stays. These costs could be radically reduced by allowing the freedom of competition in hospital care. The cost of hospital stays to patients is enormously higher in many cases than corresponds to the actual cost to the hospitals of providing their services. A thousand dollars a day for a hospital stay is often far out of line with the hospital’s own costs that are necessary to provide the service together with an allowance for a competitive rate of profit. Under the freedom of competition, physicians and profit-seeking hospital administrators would be free to cash in on the high profits that could be made by opening their own hospitals. They would be free to concentrate on offering the presently most profitable types of care. The effect would be a decline in the price of such hospital stays to a point corresponding to the actual costs of providing them together with an allowance for the going rate of profit. At the same time, the freedom of competition would permit hospitals to cut their costs of operation and thus to bring rates down to levels reflecting still lower levels of actual cost. 6

Today there is a great deal of justified outrage over the enormous and ever increasing cost of medical care, and, in response, people assert a right to medical care. But their idea of a right to medical care is a right consistent with the anarchic concept of freedom, that is, an alleged right which is to be implemented without regard to the willingness of others to cooperate. The government is to take money from the taxpayers, at the point of a gun, to implement this alleged right to medical care and it is to hold a gun to the heads of physicians and hospitals to make them supply medical care on the terms and by the methods it imposes. This is a total corruption of the concept of rights. It is, as Ayn Rand would describe it, the assertion of an alleged right to enslave. 7

What needs to be done to solve the medical crisis is to understand the concept of the right to medical care consistently with the rational concept of freedom and the political concept of monopoly. The right to medical care rationally means the right to all the medical care one can afford to buy and chooses to buy from any willing provider.

The medical crisis exists because of a repeated pattern of violation of the right to medical care properly understood. Individuals want to buy medical services from willing providers whom the government excludes from the medical professions by licensing laws. It violates the right of these individuals to buy, and of these providers to sell, medical care. Thus the government monopolizes the medical profession on behalf of its license holders. This makes medical care scarcer and more expensive. The government practices the same policy of exclusion and monopolization in the case of hospitals, again making medical care scarcer and more expensive. The government does exactly the same thing in the case of medications, through the Food and Drug Administration, which creates a systematic monopoly of the drugs and treatment methods it approves by forcibly excluding from the market all other drugs and methods of treatment.

The violations of freedom and individual rights practiced by the government in the pursuit of its policy of medical monopoly are powerfully reinforced by its policy of violating freedom and individual rights in forcing some citizens to pay for the medical care of others. In the face of pervasive monopoly, the policy of pouring ever more taxpayer money into medicine simply represents steadily enlarging the demand in the face of an artificially restricted supply, with the inevitable result that prices continually rise. This process is further powerfully compounded by the fact that medical care is made substantially or even entirely free to large numbers of recipients, who then have no reason to limit the amount of it they use, which, of course, leads to correspondingly large government expenditures to pay for it and to higher rates for paying patients, to whom a substantial part of the burden is shifted. 8

The solution to the medical crisis is not the implementation of a vicious alleged right to medical care whose actual meaning is a right to enslave, but the implementation of the rational right to medical care. That is, to end the government’s policy of medical monopoly (and, of course, its policy of forcing some citizens to pay the medical bills of others). It is to make the government recognize the citizen’s actual right—his rational right— to obtain medical care from any willing provider and thus to stop the government’s forcible exclusion of willing providers from the market. 9

Tariff Monopoly

Protective tariffs represent the use of force to make foreign producers sell their goods at a higher price than domestic producers and/or less profitably than domestic

producers. As such, they represent legislation on behalf of monopoly, in that they attempt to reserve the market, or a larger share of the market, to the exclusive possession of domestic producers.

Protective tariffs (and licensing laws) highlight the fact that monopoly, according to the political concept, is not limited to the case of sole producers protected by the initiation of physical force. It applies equally to cases of very large numbers of producers whose market is protected by the initiation of physical force. A tariff monopoly can serve to protect tens of thousands of small, inefficient domestic producers against foreign competition. For example, a protective tariff on wheat in France has the effect of giving a monopoly of the French wheat market, or of a larger share of that market, to French wheat growers. The monopoly of these producers is no less a monopoly merely because of their large number. The market, or their part of the market, is reserved to them by means of the initiation of force. More efficient foreign producers are correspondingly denied the freedom of competition.

The Monopolistic Protection of the Inefficient Many

Against the Competition of the More Efficient Few

Both tariffs and licensing laws make possible monopolies shared by large numbers of inefficient, high-cost producers. Such monopolies are no less monopolies when the more efficient, lower-cost producers who are forcibly kept out are small in number—even when there is only just one very large, more efficient, lower-cost producer who would otherwise gain the market that is presently monopolized.

The New York City taxicab industry provides a good example of the monopolistic protection of the inefficient many against the competition of the more efficient few.

The number of taxicabs in New York City that can cruise the streets for hire has been forcibly limited since 1937, at slightly below 12,000. Since that time, it has been a legal precondition of operating such a taxi, that one possess a small metal medallion, issued by the city government of New York and affixed to the hood of the cab. To operate a taxicab, one must not only know how to drive and be able to afford to buy a cab. One must possess a further item as well: the precious medallion, which signifies the government’s permission that one can do what one already can do. If one does not possess this medallion—this fifth wheel of taxi driving, in terms of its actual physical relationship to the ability to operate a cab—one is in violation of the law and subject to arrest. In this way, the city government of New York reserves the market for taxicabs that cruise the streets, to the exclusive possession of its license holders and excludes all others by the initiation of force.

These medallions, it should be noted, now sell for a price well in excess of $100,000 each. The price of a medallion is the measure of the additional annual income that is to be made by virtue of operating a taxicab at the higher level of rates caused by the licensing requirement and the consequent artificial scarcity of cabs. More precisely, the price of a medallion is the discounted present value of the additional income that is to be made year after year thanks to the monopoly privilege conferred by the possession of the medallion. It is equal to the principal that is necessary to make the additional annual income yield the going rate of profit and interest. If, for example, the additional annual income derived from owning a taxicab with a monopoly privilege is $10,000, while the going rate of profit and interest is 10 percent per year, then $100,000 appears as the value of possessing that privilege year after year. In effect, $100,000 is the amount of capital necessary to make the $10,000 additional income stand as a 10 percent rate of return on capital. The price of the medallion is $100,000, because any lower price would make it possible to earn an above-average rate of profit by owning such a taxicab.

If the licensing requirement for taxicabs were abolished, more cabs would cruise the streets and their competition would drive rates down. In the face of lower rates and the elimination of the extra income presently conferred by the possession of a medallion, the pressure to reduce the costs of operating a taxicab would intensify. This would strongly favor fleet operation over individual operation. It would mean the replacement of thousands of very small, relatively inefficient cab companies, consisting of a single cab and owner-driver, by a relatively small number of much larger, more efficient taxicab companies operating substantial fleets of cabs. The fleets would enjoy such competitive advantages as the ability to keep their cabs on the road for three successive shifts a day, seven days a week; the presence of resident mechanics to minimize down-time for repairs; and the possession of spare cabs, to take the place of those out of operation for repair. Such advantages would enable them to gain vastly greater use from each cab in any given year, and not to be put out of operation—as would an owner driver—by the breakdown of any given cab.

The probable effect of fleet competition would be a decline in taxicab rates to the point where it was simply not economically possible to operate a cab as an individual owner-driver. In this way, the freedom of competition would operate, in this instance, to replace a large number of small relatively inefficient producers with a relatively small number of large, efficient producers.

It is true that it is possible to obtain the economies of fleet operation in New York City even under present circumstances, and that there presently already are some

substantial fleets. But the system of monopoly privilege eliminates the pressure for cost reductions and thus the adoption of the economies fleets provide. It makes it possible to operate successfully even with relatively inefficient methods. It also stops the fleets from expanding in any other way than by buying additional medallions and thus raising their price still further. In these ways, the system of monopoly privilege in the New York City taxicab industry protects the inefficient many against the competition of the more efficient few.

A similar phenomenon existed in many parts of Europe with respect to the competition of department stores and chain stores, and may still exist in some places. In order to protect large numbers of small merchants from their competition, the establishment of these stores was discouraged or simply prohibited. Here again was a case of monopoly in favor of the inefficient many against the more efficient few.

The implication of this discussion is that monopoly exists, and the freedom of competition is violated, not because there happens to be just one seller in a market, when all have the legal right to enter, but when there are millions in the market, and all but one are allowed to enter, with that one otherwise able and willing to enter. In such a case, the market is reserved to the exclusive possession of all but that one. It is monopolized against him. It is monopolized against him even if his entry were to result in his displacing all of the many who are in the market now and thus in his becoming the sole seller. For example, a monopoly would exist in the automobile market even if it were comprised of thousands of small automobile companies and everyone in the world were allowed to enter it with the single exception of the original Henry Ford! Such exclusion of Ford would constitute a monopoly, in violation of the freedom of competition. It would constitute a monopoly even if Ford’s entry were to mean that he would then become the sole seller of automobiles, which fact would not constitute a monopoly.

In every case, whether a particular monopoly represents the initiation of force to protect one firm against the competition of many firms or many firms against the competition of a few firms or even just one firm, its effect is to protect the less efficient against the more efficient and to raise the price to the buyers of the good or service in comparison with the price that would exist under the freedom of competition.

Monopoly Based on Minimum-Wage and Prounion

Legislation: The Exclusion of the Less Able and the Disadvantaged

Minimum-wage and prounion legislation operate to reserve labor markets to the exclusive possession of the reduced number of workers who can be employed at the higher wage rates such legislation establishes. Minimum-wage and prounion legislation forcibly exclude from the market the additional number of workers who could be employed at the lower wage rates that the freedom of competition would establish. Such legislation also tends to reserve labor markets to the exclusive possession of the more skilled workers, by virtue of impairing the ability specifically of the less skilled workers to compete through the acceptance of lower wage rates. For as we saw in the last chapter, the acceptance of lower wage rates is the essential means by which those who are less skilled are able to compete with those who are more skilled. 10

Minimum-wage and prounion legislation undermine the ability of the less skilled to compete with the more skilled in two ways. As in the case of the bricklayers able to lay different numbers of bricks per hour, with every forced increase in the wages of less skilled labor relative to the wages of more skilled labor, the ability of the less skilled to compete with the more skilled who are already present in the occupation is reduced. 11 Thus, for example, being able to accept a wage rate of five dollars an hour allows the worker who can lay only twenty bricks per hour to compete with a worker who can lay forty bricks per hour and who earns ten dollars an hour. Requiring that the worker who is capable of laying only twenty bricks per hour be paid more than five dollars an hour destroys his ability to compete.

In addition, with every forced increase in wage rates, the jobs of the less skilled become attractive to a larger number of more skilled workers, who otherwise would not have considered them. This is because standing outside of almost every occupation is a continuum of more skilled workers who could perform that occupation more efficiently than the people who presently perform it. In a free labor market, they do not attempt to perform it because the wages they receive in their present occupations are higher than those they could obtain in the less skilled occupation, even with their advantage in efficiency. But with every forced increase in the wages of the relatively less skilled occupation, such as results from minimum-wage or prounion legislation, the field is made more attractive to the more skilled workers.

Thus, for example, to the extent that a bricklayers’ union could impose a minimum scale above five dollars an hour, the effect would be not only to undermine the ability of the twenty-brick-an-hour workers to compete with the more skilled, more efficient bricklayers already in the field, but to attract into the field an additional number of more skilled, more efficient bricklayers who presently work in other fields. For as the union raised the minimum hourly pay scale, the average cost per brick

laid would also rise, and as that happened, bricklaying would become a more attractive occupation to workers presently employed elsewhere. For example, a thirty-cent cost per brick laid would mean that a worker capable of laying forty bricks an hour could earn twelve dollars an hour as a bricklayer instead of ten dollars an hour, which is the rate corresponding to a twenty-five cent cost per brick laid. In the same way, a thirtyfive cent cost per brick laid would mean that such a worker could now earn fourteen dollars an hour, and so on.

In these ways, the effect of minimum-wage and prounion legislation is not only to reduce the number employed, but to exclude specifically those who are less skilled. Thus, such legislation monopolizes labor markets specifically against this group.

It should be realized that prounion legislation has this effect even though it tends also, or even predominantly, to raise the wage rates of more skilled workers as well as those of less skilled workers. In bringing about a rise in the wages of more skilled workers, prounion legislation operates against the interests of less skilled workers in two respects. First, it operates against the interests of the less skilled or less efficient workers within whatever higher-skill category it raises wage rates. If, for example, it raises the wage rates of carpenters or plumbers, it operates to prevent the less skilled or less efficient carpenters or plumbers from being competitive through the acceptance of lower wages than the more skilled or more efficient carpenters or plumbers, for it establishes a minimum scale that is above the wage rates that are necessary for these workers to be competitive. Second, it operates to reduce wage rates and/or cause unemployment among groups of wage earners in skill categories below the ones in which it forces wage increases. This latter effect comes about because of a spillover of the workers who are displaced, into lower-skill fields.

For example, the lower-skilled carpenters or plumbers who are displaced must turn elsewhere for employment. They must turn to fields with lower skill requirements on the whole than carpentry or plumbing, such as driving a taxicab or waiting on tables. Their turning to such other fields increases the supply of labor in those fields and tends to cause a fall in wage rates in them. If the fall in wage rates in those other fields is allowed to occur, then the effect is that the less skilled carpenters and plumbers, and the other workers already in the occupations they enter, must take lower wage rates than they could have had under the freedom of competition. In other words, the monopoly legislation raises the wage rates of some workers and reduces the wage rates of others. If, however, prounion or minimum-wage legislation prevents a fall in wage rates in those other fields, then the effect is greater unemployment in those fields. And that unemployment will tend to be concentrated among the least skilled people capable of performing those jobs. For the displaced carpenters and plumbers, if they are able to apply their presumably greater capacity for acquiring skill to the new occupations they turn to, will render some of those already in those fields less skilled by comparison. These others will then become the workers unemployed in those fields. And they, in turn, if they do not themselves simply join the ranks of the unemployed, will have to turn elsewhere, with a repetition of the same results on a still lower rung of skill.

In these ways, prounion legislation and minimum-wage legislation tend in the last analysis to do the most harm to the least skilled members of the economic system. At every stage, it is the less skilled against whom the labor markets are monopolized by minimum-wage and prounion legislation.

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Minimum-wage and prounion legislation do not handicap exclusively the less skilled. In creating an artificial surplus of workers and the necessity of choosing among them, they also create an opportunity for the play of such factors as personal favoritism, cronyism, and racial and other forms of group prejudice. With the ability to compete by means of lower wage rates eliminated, wherever there are no discernible differences in skill among the applicants for jobs, it is such factors that tend to determine the decision of who will be employed. (And insofar as the decision of who is employed is made by labor unions rather than employers, such factors can easily outweigh differences in skill.)

Factors of this kind would not play a role in a labor market governed by the freedom of competition. In such a labor market, competition would reduce wage rates to the point where all could be employed, including those who labored under any form of social prejudice and who would be employed at a somewhat lower wage than others—to the extent necessary to offset the prejudice.

It should be realized that the freedom of competition makes it possible for people to overcome the handicap not only of a lower degree of skill, but also of such a thing as being the victims of prejudice. From an economic point of view, racial or ethnic prejudice can be taken as the equivalent of a mistaken and, indeed, irrational presumption that the members of some group are uniformly of a lower degree of skill than the members of other groups. In a free labor market, the existence of prejudice by itself—in the absence of the initiation of physical force by the government or by private groups acting with the sanction of the government—would not stop the employment of the members of the disadvantaged group. They would be employed, but, temporarily, at wage rates somewhat lower than other workers doing the same kind

of work. The discount in their wages would compensate for their presumed lack of ability.

As we saw in Chapter 6, to the extent that in fact the members of this group were as good workers as the members of other groups, any discount in their wages would serve to make their employment particularly profitable, thereby creating an incentive for their greater employment, and thereby tending to eliminate any discount in their wages. We also saw that the same principle would apply to the entry of the members of any group against which prejudice exists into the higher levels of employment. 12 In addition we saw that this sequence of developments cannot occur if it is stopped by the initiation of physical force, such as that practiced by bigoted local governments in the arbitrary exercise of their powers, or by organizations acting with the sanction of such governments, such as the Ku Klux Klan. 13

In the Northern United States, racial prejudice does not appear to have been a major policy of local governments, and equal pay for equal work has long since become the rule of the market in the occupations where blacks are already accepted. Here what has held blacks back is precisely such measures of allegedly enlightened and liberal government intervention as minimum-wage and prounion legislation. This legislation works against blacks in particular not because that is the motive or intent of its authors, but because blacks, for historical reasons, are disproportionately represented in the ranks of the unskilled, and are thus disproportionately forced into the ranks of the unemployed by this legislation. Furthermore, minimum-wage and prounion legislation causes blacks not only to be unemployed, but to remain permanently low skilled. It condemns them to a lifetime of unemployment and poverty, in which they cannot gain their first job because, given their existing low level of skills resulting from such factors as lack of education, they would have to accept wages below the legally prescribed minimum. And because they cannot obtain their first job, they are prevented from raising their level of skills through experience gained on the job, and thus becoming capable of being employed later on at a wage greater than the minimum wage. As things stand, unable to develop their skills through employment, they remain permanently incapable of performing work even as valuable as the minimum wage. And so they must remain permanently unemployed.

However surprising and however paradoxical it may appear, the fact is that the whole panoply of government intervention constitutes virtual monopoly legislation against the poor and the disadvantaged. 14 Precisely they are the ones whom it excludes from the market. The effect of this monopoly legislation against the poor and disadvantaged is to throw them into unemployment and keep them from ever demonstrating their abilities in the higher levels of employment. Thus, it both perpetuates their lack of skills and maintains the existence of prejudice against them.

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An important phenomenon paralleling the exclusion of the poor and the disadvantaged from the labor market by the kinds of government intervention discussed here is, of course, their exclusion from the market for medical services, as the result of government licensing requirements, which was described earlier in this section. A further major example of the harm done to the poor by government intervention is their exclusion from the housing market, and its manifestation in the growing phenomenon of homelessness. Zoning laws, government building codes, the compulsory withdrawal of land from development, laws that compel home builders to deal with labor unions and thus to suffer the artificially high wage rates and inefficiencies imposed by the unions, rising property taxes, rent control, urban renewal—all of these are ways in which the government causes either an increase in the cost of building and operating housing or a decrease in the existing supply of housing. The people who can least afford the higher costs imposed are, of course, the poor. Efforts to deal with this problem through rent control destroy the profitability of maintaining the rental housing of the poor in particular, since such housing offers the least margin for absorbing the rising costs resulting from inflation and the growing volume of government regulation. The result is that such housing is the first to be abandoned by landlords, and the poor are then left to live without running water, heat, or plumbing. At the same time, urban renewal prides itself on physically tearing down the “blighted” areas that represent much of the housing of the poor. 15

Homelessness (in the cases in which the homeless are not psychotic and actually prefer to live in the streets) is a consequence of the above factors coupled with government health and safety requirements setting minimum standards for housing. In a growing number of cases, the poor are simply unable to afford housing that meets the government’s standards. The government then forcibly dispossesses them from housing that it considers substandard. At that point, they simply have nowhere to go—they are homeless. Just as in the case of medical licensing, the government’s action is analogous to passing a law—in the name of a high sounding phrase like public safety—banning all cars from the road that are more than five years old. Such a law would primarily stop poor people from being able to have a car. The minimum standards for housing do the same for housing.

Ironically, the low quality of the housing occupied by the poor is in large part the direct result of government efforts to impose minimum standards. The imposition of

these standards in any given locality and the corresponding expulsion of the poor from that locality serves to make the housing problems in surrounding localities all the worse, as a larger number of poor people are forced to compete for the diminished supply of housing that still remains open to them. Because of minimum standards imposed by various localities, poor people who might have had some kind of apartment to themselves, are forced to live elsewhere, under still worse conditions— perhaps in someone’s garage. If the housing market were free of government interference, they would not have to live in a garage, or even in the housing they are presently driven from before they get to the garage—but in housing considerably better than that and tending to get better still, with all the improvements a free economy is capable of achieving over time in housing and all other lines. Instead, however, they are driven into the streets.

Government-Owned and Government-Subsidized

Enterprises as Monopoly

Government-owned and government-subsidized enterprises represent monopoly, in that markets or parts of markets are reserved to their exclusive possession by means of the initiation of physical force. Government-subsidized enterprises, of course, are a category which includes all government-owned enterprises, inasmuch as the initial resources of government-owned enterprises are provided by the government and their subsequent losses are covered by the government.

The funds of all enterprises supported by the government are obtained by means of the initiation of force against the taxpayers, who certainly do not pay taxes voluntarily for such purposes. At the same time, the subsidies make possible those enterprises’ possession of markets, or parts of markets, to which other suppliers are denied access. Competitors of the subsidized enterprises cannot gain their markets even if they are more efficient and offer better products, for the subsidized enterprises are enabled to sell their products at a loss, and even to give them away free of charge. Thus, government-subsidized enterprises are monopolies: their markets are reserved to them on a foundation of the initiation of force against the taxpayers, which then makes possible their ability to retain their markets despite the economic superiority of competitors.

The monopoly position of government-owned enterprises, and other government-subsidized enterprises, can be buttressed by the initiation of force against parties other than the taxpayers—above all, the initiation of force directly against competitors or potential competitors. The government-owned postal service in the United States is an example of this phenomenon. Here, in order to limit its losses, the government prohibits important categories of competition, such as the delivery of first class mail, which apparently would be highly profitable to competitors at the government’s present rates. It simply declares most of the roads of the United States to be “post roads,” and then prohibits the carrying of private first-class mail over the post roads. Whoever would carry such mail would be in violation of the law, and would face the threat of fines and imprisonment.

An even more important example of monopoly than the postal service, in the category of government-owned or government-subsidized enterprises, is the public education system. The total absence of tuition charges in the public elementary and secondary schools, and the substantially lower tuition charges in the public colleges and universities, which tax-financed subsidies make possible, enable the public education system to retain the far greater share of the education market despite its clear inferiority in comparison with private schools.

As the result of the subsidies the government system receives and thus its ability to charge prices below cost— indeed, no price at all—it is not sufficient that a private school or college simply be perceptibly better in order to induce customers to give it their patronage rather than the public system. To take advantage of the superiority of the private schools, students or their parents must be prepared to pay the full tuition in order to gain what is merely an improvement on what is offered in the public system for nothing or for very little. In effect, they are placed in a position in which to choose a private school or college, they must pay the full price for what, from their perspective, is not the full product, but only a qualitative increment in the full product, because they already have the basic product from the public system for nothing or for very little.

In these conditions, before people will switch from the public schools and colleges to the private schools and colleges, they must regard the mere superiority of the private school or college as so great that it justifies paying the whole price of the education. In effect, this requires that to obtain a customer, a private school or college must be able to offer a doubled product for just one tuition. To be competitive with the subsidized school system, it must offer one part of its product, equal to what the government provides, for free. It can earn tuition revenue only on the other part of its product, which must be judged to be of such importance as to justify the payment of the whole tuition. And it must produce this doubled product at no greater cost than the tuition it is able to charge for the mere part of it—indeed, at an even lower cost, to the extent it wants to have a profit.

This is unfair competition. It is unjust, immoral competition. It is competition based on the initiation of force. It is not the competition of a free market, but the practice

of monopoly—the excluding of competitors by means of the initiation of force.

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In the long run, public education does not, as its supporters believe, make it possible for students to obtain education who would otherwise not obtain education. On the contrary, it serves to deny education to students who would otherwise have obtained it.

In making it impossible for private schools to be commercially successful, it prevents all those improvements in quality and efficiency from coming into being that would take place in education under the competitive quest to make profits and avoid losses, and which would eventually bring a much higher quality education within the reach of all than is now available even to the wealthiest. In addition, it precludes any significant competitive barrier to deterioration in the education it itself offers.

Because it is financed by subsidies, public education has the potential to decline in quality all the way to the point where it becomes clear to most people that what it offers is no longer worth even a zero price. Only at that point does private education achieve a decisive competitive advantage in the mass market and threaten the public school system and its bureaucracy with economic extinction.

Thus, the consequence of public education is the prevention of improvements in education and, ultimately, the destruction of such education as exists. For these reasons, its ultimate effect is to deprive people of education who could have obtained it, not to promote education.

What public education accomplishes is that education is supplied without the benefit of the incentive of profit and loss in an environment of freedom of competition. If education had to operate in the same basic economic context as the automobile industry or grocery business, a powerful incentive would exist to improve quality and reduce costs. For this would be the way to increase profits. Any school or chain of schools that introduced any perceptible improvement in education would have a substantial increase in its profits. Students and their parents would want to deal with it, not its less efficient competitors: it would be giving them more for their money. Similarly, if it succeeded in cutting its costs and could operate profitably at a lower level of tuition, it would also enjoy a large expansion in business, as a larger part of the market came to prefer to deal with it, because its tuition charges were now lower than its competitors’.

In response to the competitive pressure of the loss of business to the schools which improved their quality and efficiency, all the other schools would be compelled to improve their quality and efficiency, or else be driven out of business. As the schools in this latter group caught up, it would no longer be possible for the schools that had introduced the improvements to continue to make exceptional profits. To go on making exceptional profits, they would now have to introduce further improvements, with the same ultimate results. Thus, the basis would exist for continuous improvements in quality and efficiency, for the benefit of the buying public. All of this is simply the operation of the uniformity-of-profit principle applied to education. 16

But, of course, with public education, there is no incentive of profit and loss. There is nothing to be gained within the system by introducing improvements; nor is there anything to be lost within the system in failing to match the performance of others. A loss of students, whether it results from an improvement in the performance of other schools or from a decline in the performance of one’s own school, does not mean a loss out of the school superintendent’s pocket or out of the pocket of anyone who sits on the local school board. At the same time, the public schools’ shield of a zero or minimal tuition charge greatly reduces the volume of any additional business that any private school could obtain by virtue of improving its quality or reducing its costs within the range of what is presently feasible. As matters stand, the potential market for commercially successful private education is confined to an extremely narrow one, constituted by the children of the very well-to-do, who can afford to pay the whole price of an education for an incremental improvement.

Commercial private education is seriously hampered by the existence of costly legal requirements mandating such things as a school’s provision of a cafeteria, gymnasium, library, and so forth, and limiting its ability to adopt more economical educational methods in still other respects as well—for example, requirements concerning class size, the ratio of full-time faculty to students, the minimum education of faculty, and the number of hours of in-class instruction. Its development is still further hampered by the fact that the present hostile environment fosters the tradition of noncommercial private education, in which even private education is largely subsidized— by wealthy individuals and religious organizations. In this environment, commercial private education is faced with obstacles that may simply be too great for it to overcome. It is greatly limited both in its ability to reduce costs and improve quality and in the additional market it can gain should it manage, despite all obstacles, somehow to do so. Thus, under present conditions, it is virtually impossible for it to develop the momentum of progressive improvement that would characterize it under the freedom of competition. Indeed, under present conditions, it is next to impossible for it to attract the kind of talent that would be capable of achieving major improvements in

the first place. For those who are capable of accomplishing something are not prepared to waste their time in futile efforts to move an uncomprehending bureaucracy.

The position of private education today, and that of education as a whole, is analogous to what the position of the automobile industry would be if the production of all the low-and medium-priced models were in the hands of the government, which subsidized their production to the point of giving these models away for nothing—indeed, of compelling every adult to accept one for nothing—while the privately owned portion of the automobile industry were confined to the production of very expensive models, and essentially prohibited from cutting its costs. In such circumstances, the only significant force that could operate in favor of the growth of the private automobile industry would be the total collapse in the quality of the government’s automobiles. Just so, the only significant factor operating in favor of the growth of private education today is the continuous decline in the quality of public education.

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In addition to public education and the postal service, government ownership of railroads, bus, and subway lines, and enterprises producing electric power, such as the Tennessee Valley Authority, represents cases of monopoly. The market of these enterprises too is reserved by the initiation of force against the taxpayers in order to provide subsidies that enable them to sell at prices below those that private competitors must charge. Government-owned roads and highways must also be placed in this category.

The Antitrust Laws as Promonopoly Legislation

However surprising it may seem, the antitrust laws constitute promonopoly legislation. They reserve markets to the exclusive possession of all but those who in a state of freedom of competition would occupy them. They monopolize markets precisely against the most capable and efficient firms, which, in their absence, would be able to be in those markets, and which instead, because of their existence, are today forcibly excluded from them. They prevent the capable newcomer from entering an industry—for example, they would almost certainly operate to prevent General Motors from entering the steel industry in any significant way. They prevent the capable firms within an industry from acquiring the markets of the less capable ones by absorbing them in mergers, by buying them out, or by driving them out. Ironically, while endless complaints are made about such things as high capital requirements and lack of technological knowledge as “barriers to entry,” no voices are raised to complain about the antitrust laws’ forcible exclusion from markets of precisely those firms which do have the capital and the technological knowledge required to enter them. In serving forcibly to exclude from markets precisely those firms which have the ability to enter and compete in them, the antitrust laws constitute a major violation of the freedom of entry and the freedom of competition. As such, they are among the most important instances of promonopoly legislation.

In the last analysis, what has prevented the antitrust laws from being identified as promonopoly legislation, and has allowed them to be regarded as antimonopoly legislation instead, is the irrationalist mentality underlying the anarchic concept of freedom. This irrationalist mentality places the unreal world of arbitrary desires above the real world of competence and ability. Its concept of the violation of freedom is frustration of arbitrary desires by facts of reality. It does not see as a violation of freedom the frustration of competence and ability by the initiation of physical force. Thus it holds that the existence of such things as high capital requirements are a violation of freedom of competition and a support of monopoly, but does not see as a violation of freedom of competition and a support of monopoly the forcible exclusion from markets of those who do possess the necessary capital and otherwise meet the requirements of reality. Precisely such forcible exclusion from markets is the essence of the operation of the antitrust laws.

The misguided economic rationale behind the antitrust laws will be dealt with later in this chapter.

Socialism as the Ultimate Form of Monopoly

The most extreme form of monopoly imaginable is socialism. A socialist society represents monopoly carried to its ultimate limits. The government of such a society forcibly appropriates all the means of production and thereafter forcibly reserves the entire market of its country to its own exclusive possession. Whoever attempts to compete with it is automatically held to be guilty of the crimes of misappropriating state property and of sabotaging the national economic plan, since the means of production he must use have arbitrarily been declared to be the property of the state and to be required for use in the state’s national economic plan. 17 Concentration camps and firing squads are held in constant readiness to deter such competitors and protect the state’s monopoly. 18

3. Further Implications of the Political Concept of Monopoly: High Costs Rather than High Profits

In addition to the fact that monopoly can represent the protection of the inefficient many against the competition of the more efficient few or even just one, it follows from much of the preceding discussion that monopoly

does not have any necessary connection with high profitability. There are, of course, instances of monopoly which can be associated with high profitability. Monopolies based on exclusive government franchises would be a leading case if they were not at the same time subjected to rate controls. Licensing monopolies are also cases in which profits tend to be artificially high.

But the monopolies made possible by tariff protection, government subsidies, and the antitrust laws often do not result in any exceptional profitability on the part of the monopolists. (And the monopolies based on minimum-wage and prounion legislation, of course, relate to wage income rather than profit income.) These are cases in which monopoly is established primarily for the purpose of protecting high-cost producers. The same is often true in the case of licensing monopolies as well: for example, the cases of the New York City taxicab industry and the small merchants of many European countries who obtained protection against the competition of department stores and chain stores. In many of these cases, the monopolists would be in the position of having to accept exceptionally low profits or even sustain losses in the absence of the government’s help. In the case of government subsidies, they are enabled to afford to go on sustaining losses. Such monopolists turn to the government precisely because their profits would otherwise be exceptionally low or negative. Thus the high monopoly prices that result in these cases serve as much or more to cover the monopolists’ high costs, due to inefficiency, as to provide an exceptionally high rate of profit. And, of course, in the case of government-subsidized enterprises, the monopoly prices charged may actually be very low or even zero.

Patents and Copyrights, Trademarks and

Brandnames, Not Monopolies

Patents on new inventions, copyrights on books, drawings, musical compositions, and the like, and trademarks and brandnames, do not constitute monopolies. True enough, they reserve markets, or parts of markets, to the exclusive possession of the owners of the patents or copyrights, or trademarks or brandnames, and they do so by means of the use of physical force inasmuch as it is against the law to infringe on these rights.

None of these rights represent monopoly, however, because none of them is supported by the initiation of physical force. In all of these cases, the government stands ready to use physical force in defense of a preexisting property right established either by an act of personal creation or by the fact of distinct identity. A new invention, or book, drawing, or song, and so forth is the product of a definite individual or group of individuals and belongs to him or them on the same basis that a farmer’s crop or a corporation’s product belongs to him or it—namely, the right of having created it. A trademark or brandname belongs to its creator on the same basis as his own name—in order to distinguish the distinct identity of the individual and his actions from that of all other individuals and their actions, and thus to be able to assign individual responsibility for the good or bad that is done.

The fact that the government is ready to use force to protect patents and copyrights is fully as proper as that it stands ready to use force to protect farmers and businessmen in the ownership of their physical products and to come to their rescue when they are set upon by trespassers or attacked by robbers. In both cases, it does nothing more than protect the rights of producers to their products. In protecting trademarks and brandnames, it does nothing more than when it protects individuals from impersonation by others. It acts to enable them to be recognized for the good or bad they do, and thus to gain or lose accordingly.

The existence of patents and copyrights, and trademarks and brandnames, like all other protection of property rights, serves to increase the supply of goods and services—by making it possible for those who are the cause of the increase to benefit from the improvements they make. It thus serves to reduce prices and to increase everyone’s buying power as time goes on. 19

It is true that at any given time, taking for granted the existence of the most recent batch of improvements, introduced in the expectation that those responsible would benefit from them, it might be possible to achieve a temporary acceleration in the increase in the supply of goods and services by abolishing patents and copyrights. Such a temporary increase would be comparable in its ultimate significance to the abolition of the property rights of any other group of producers, such as storekeepers and manufacturers, and allowing mobs to sack their shops and warehouses. A very short-lived gain would be followed by a permanent loss of future supplies—in this case, further new inventions and new ideas. This is because no one would invest years of effort and perhaps millions of dollars of capital in the development of a new invention only to find that as soon as he brought it to market, a competitor who purchased a working model would have the benefit of all that effort and capital just for the price of the working model, and that he, the innovator, would probably be unable to profit from his efforts because of the rapid fall in the price of the product that would follow in such a situation. Ultimately, the prevalence of such conditions would cause not only the cessation of further economic progress, but also actual economic decline, as the result of the inability to offset the operation of the law of diminishing returns in mining

and agriculture, something which it is possible to do only on the basis of continuing technological progress. 20

The same basic principle would apply to the abolition of trademarks and brandnames, which would result in producers losing the incentive to increase or even maintain the quality of their goods, inasmuch as their goods would be rendered indistinguishable from those of everyone else, and consumers would thus have no way of singling them out for purchase. For example, imagine what conditions would be like if every soft-drink manufacturer could call his product “Coca Cola” if he wished, or if every computer manufacturer could sell his machines as made by IBM. All the efforts of Coca Cola and IBM, and of every other producer who tried to distinguish his product by its superior quality, would be wasted, because the buying public would have no way of distinguishing his product from the rest and thus no way of giving it the preference it deserved. Thus, there would no longer be any special profit in producing a superior product. The result would be that no one would attempt to produce a superior product. By the same token, no loss would attach to producing inferior products that were rendered indistinguishable, with the result that major declines in the quality of products would ensue.

Thus, contrary to monopoly, patents and copyrights, and trademarks and brandnames, operate to increase supplies and reduce prices, while their abolition would result in the opposite. Indeed, their existence must be considered a requirement of the freedom of competition, and their abolition as constituting the establishment of monopoly! Their existence upholds the fundamental freedom of individuals to be secure in their property and to compete on that basis. Their abolition would reserve markets to the dull and incompetent by means of the initiation of force against the intellectual property of those who had new ideas and something better to offer. Their abolition would thus serve to establish the monopoly of the dull and incompetent by forcibly depriving the intelligent and competent of the benefit of their intelligence and competence, and thereby forcibly excluding them from the market.

Because patents and copyrights protect intellectual property, their duration must necessarily be limited. It must be long enough to make it worthwhile to bring new products and new creations to the market, and yet not so long that the thinking of later generations is progressively hobbled by ever growing royalty payments to the descendants of inventors and authors. The present law of seventeen years for patent protection and the lifetime of the author plus fifty years for copyright protection seems to provide just about the proper balance between the rights of the creators of today and those of the thinking men and women and the creators of the future. 21

All Monopoly Based on Government Intervention;

Significance of Monopoly

According to the political concept of monopoly, all monopoly is based on government intervention, which restricts the freedom of entry and competition. The significance of monopoly is that it forcibly bars from the market sellers who would otherwise be capable of being in the market. It thus restricts the range of choice buyers have in suppliers and compels them to deal with less efficient suppliers and to accept higher costs and poorer quality than a free market would require them to accept.

I have shown how monopoly in the form of licensing laws is a principal cause of the growing crisis in medical care, and that to solve the crisis in medical care it is essential to assert the rational right to medical care, that is, the right to medical care from willing providers. This means demanding the abolition of all aspects of medical monopoly imposed by the government, which is what keeps people from willing providers of medical care.

I have shown how monopoly in the form of minimum-wage and prounion legislation operates systematically to exclude the less able and the disadvantaged from employment by depriving them of the means of competing through offering to work for lower wages. I have also shown how monopoly in the form of government-owned and government-subsidized enterprises retards economic progress and can destroy economic progress previously achieved, and that this is particularly true in the case of public education today. And, of course, I have shown how protective tariffs and antitrust legislation constitute monopoly.

On the basis of what I have shown, the program of the announced enemies of monopoly should not be, as it has been for many years, the breakup of big business or the government’s growing control over big business. Rather, it should be the progressive elimination of government intervention into the economic system. This is what violates the freedom of competition and constitutes monopoly. Political progress should no longer be measured by the ever increasing hobbling of competence and ability by the threat of physical force, but by the steady disappearance of the initiation of force and thus the progressive opening up of the world to competence and ability. Such should be the profreedom, antimonopoly politics of the future. It should stand alongside of, and be an integral part of, the advocacy of economic progress and an industrial society.

4. The Economic Concept of Monopoly

In sharpest contrast to the political concept of monopoly is the economic concept of monopoly. The economic concept of monopoly holds that monopoly emerges from

the normal operation of the economic system—not on the basis of the initiation of physical force, but on the basis of mere economic circumstances, and that it nonetheless produces evils of such magnitude that the government must suppress or control it by means of force.

According to the economic concept of monopoly, monopoly exists whenever there is only one supplier of a given good in a given territory. That supplier is said to have a monopoly and to be a monopolist. The economic concept of monopoly considers the “oneness” of the seller to be the essential fact, and makes no distinction between cases in which such a seller has achieved his position by virtue of providing better goods and services at lower prices than anyone else, or has achieved it by means of physical force. No matter how he has achieved his position, it is assumed that it is a position which automatically and inherently gives him the power to inflict great evil. At the same time, the only consideration that the economic concept of monopoly gives to cases in which markets are served by more than one seller is insofar as it can construe them as somehow essentially similar to markets served by only one seller. It gives absolutely no consideration to markets in which large numbers of sellers are present all of whom are protected against the competition of more efficient outsiders. It does not consider this case to constitute monopoly in any sense.

The economic concept of monopoly can be construed in such a way that it embraces hardly anything or almost everything, depending on how broadly or how narrowly one defines a good. For example, if one considers the good “beverage,” then all suppliers of water, milk, fruit juice, coffee, tea, cocoa, and soft drinks qualify as competing producers. If one considers the narrower good “soft drink,” or the still narrower good “cola” beverage, then the number of suppliers correspondingly diminishes. Finally, if one considers the specific good “Pepsi Cola,” or “Coca Cola,” the case appears as one of monopoly, for there is ultimately just one supplier of each of those goods, namely, the Pepsi Cola Company or the Coca Cola Company. On a sufficiently narrow definition, almost everything appears as a case of monopoly.

The economic concept of monopoly has been the dominant concept for several generations. Even the classical economists held an important aspect of it, in believing that monopoly can arise in the market itself. As the classical economists used the term, monopoly applied to goods whose supply—for any reason—was incapable of further increase. Such goods—for example, wines produced on land of a special quality that exists only in a very limited extent, and paintings and statues by old masters—even though produced or sold by a substantial number of suppliers, were held to represent monopolies.

Indeed, all cases in which prices were determined by the competition of buyers for a fixed, limited supply were held to represent monopoly prices. 22 Competitive prices were held to be those established by the competition of the sellers, based on the possibility of an increase in supply through additional production. 23

In the later nineteenth century and the first three decades of the twentieth century, the economic concept of monopoly in its present form was in vogue. But the concept was usually used in such a way as to imply that monopoly was a comparatively rare phenomenon—limited essentially to the cases of public utilities and local public transportation, which were thought to constitute “natural monopolies,” in the sense of offering major economic advantages by virtue of being provided by a single source. In this category were electric, gas, water, sewage, and telephone service, and subway, bus, and trolley car lines. Cases in which towns or cities happened to be served by only one railroad, or in which villages were too small to have more than a single general store, were also identified as monopolies. Apart from such cases, the rest of the economic system was assumed to be characterized by “free competition.”

In the decades between the end of the Civil War and the start of World War I, growing fears were expressed about the potential spread of monopoly to all branches of industry, coming about through the continued growth of big business, especially as exemplified in the trust movement and the waves of mergers that accompanied it. Despite these fears, monopoly was still thought to be relatively rare in actual practice, for it was unusual for any firm, however large, to have achieved a full 100 percent of the business of any given industry.

Since the 1930s, the economic concept of monopoly has come to be interpreted in ways that make almost the entire economic system fall under the heading of some form of monopoly or other. What has made possible this vast extension of the concept is the introduction of the concepts of “oligopoly” and “monopolistic competition.”

“Oligopoly” is supposedly characterized by the existence of a relatively small number of sellers in a given market. The U.S. Bureau of the Census uses socalled four-firm and eight-firm concentration ratios, according to which markets are classified as oligopolistic depending on the percentage of domestic sales of an industry made by the four or eight largest domestic firms in the industry. “Oligopoly” is held to exist in cases in which the four largest firms account for as little as 5 or 10 percent of the industry’s sales. 24 Depending on the circumstances, an oligopolist is held to behave either exactly as a “monopolist” would behave in terms of the price he charges and the output he produces, or to occupy some middle ground between a monopolist and a “pure

MONOPOLY VS. FREEDOM OF COMPETITION 391 competitor.” 25 In the former case, oligopolists are held to be guilty of “collusion” by the mere fact of anticipating one another’s responses to changes in price. 26

The concept of “monopolistic competition” is supposed to describe cases in which there are a large number of sellers of only slightly dissimilar products. This concept clearly implies that an element of monopoly is present to whatever extent one product is different from another. The unique elements of the product constitute its “monopolistic” aspect. At the same time, such products are in competition with one another. Hence, the notion of “monopolistic competition.” According to this notion, the Pepsi Cola and Coca Cola companies are, indeed, monopolists, but, at the same time, competitors.

The concepts of “monopolistic competition” and “oligopoly” are actually indistinguishable, both in theory and in practice. As examples of “monopolistic competition,” Samuelson and Nordhaus cite the competition between Pepsi Cola and Coca Cola, Newports and Kools, and Hondas and Toyotas—examples which would equally well fit under the heading of “oligopoly,” because of the large market shares of these firms. 27 Indeed, even small retail establishments, such as restaurants, drug stores, and dry-cleaners—more popular examples of “monopolistic competition”—can also be classified under “oligopoly,” since there are only a few specimens of any of these categories in any given neighborhood or small town or city. Similarly, cases in which products may be physically identical, such as the cold rolled steel sheet produced by “oligopolistic” steel firms, are nonetheless likely to be accompanied by important differences in such things as terms of financing, delivery schedules, customer assistance, and so forth provided by the particular supplier.

In any case, these two concepts of “oligopoly” and “monopolistic competition” embrace virtually all industries except the few that are called “pure monopoly.” All that is now believed to remain in the realm of free competition—or “pure” or “pure and perfect competition,” as it has come to be called—is little more than wheat farming and the production of other agricultural commodities. These are the cases in which an enormous number of individually insignificant producers turn out perfectly homogeneous products and thereby satisfy the leading requirements of such “competition.” Of course, when one allows for the existence of government farm-subsidy programs and the limitations on agricultural production the government imposes, in order to limit the costs of the programs, it turns out that even most of agriculture no longer can properly be classified as falling under the head of genuine competition, but must be described as controlled by government-organized cartels.

The virtual disappearance of full-bodied competition from the intellectual horizon of contemporary economics—a disappearance caused by the adoption of fundamentally flawed concepts—has led to efforts to reconstruct economic history, so that it can simultaneously conform both with the state of contemporary economic theory and with the generally accepted observations made in the past as to the prevalence of competition. Accordingly, the myth has grown up of the existence of a past golden age of competition before the Civil War, when, allegedly, “pure and perfect competition” was the norm. Only since then, the story goes, have we fallen from grace. This reconstruction of economic history in turn is used as a basis for explaining away much of the procapitalist economic thought of the early nineteenth century. It is claimed that the economists of that time were living in a world of pure and perfect competition and developed economic theories applicable to that world, and that, accordingly, their system of thought does not apply to the economic world that has come into being since their time.

The fact is, of course, that there never was an economic world characterized by the existence of vast numbers of sellers competing in the same market. It may be that prior to the Civil War, when each small town still had to be largely self-sufficient, because of a still undeveloped transportation network, the total number of iron foundries, meat packing establishments, and so forth, in the United States as a whole substantially exceeded the number that existed some decades after the Civil War. But this reduction in the total number of producers in many industries in the country as a whole was accompanied by a substantial increase in the number of producers in those industries in actual competition with one another in any given market. Improvements in transportation, in the form of railroad building and the growing use of steam-powered steel ships, made possible a radical increase in the area over which any given productive establishment was able to compete. Thus, at the same time that hundreds or even thousands of small, inefficient plants in an industry were being replaced with a much smaller number of largescale, efficient plants, the number of firms actually competing in any given market increased rather than decreased.

It should not be necessary to say that no serious economic defense of any aspect of capitalism was ever based on the assumptions of socalled pure and perfect competition. The classical economists’ theory that prices are determined by the costs of production did not presuppose any specific minimum number of producers. It presupposed only the ability of producers to increase supplies by increasing production. Indeed, their theory of prices can be taken as regarding precisely what contemporary economics denounces as “oligopoly” and “monopolistic competition,” as the normal state of affairs, in

which both competition and the determination of price by cost take place.

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Now that the meaning of the economic concept of monopoly has been explained, it is possible to turn to an analysis of the alleged significance of the concept. As will be shown, the consequences of monopoly are alleged to range from the most dire and extreme, in the earlier formulations of the doctrine, to what must be regarded as absolutely trivial, in the formulations presented by contemporary economic theory when it cries “monopoly” because of the absence of “pure and perfect competition.” (It must be remarked that the triviality of the consequences of “monopoly” is not evident to the economists who support the pure-and-perfect-competition doctrine, although even they now have some awareness of the actual facts. 28 )

5. The Alleged Tendency Toward the Formation of a Single Giant Firm Controlling the Entire Economic System: A Rebuttal

The Marxian doctrine on monopoly is that capitalism is characterized by the progressive concentration of the means of production in fewer and fewer hands. In the words of Marx himself:

Success and failure both lead here to a centralization of capital, and thus to expropriation on the most enormous scale. Expropriation extends here from the direct producers to the smaller and the medium-sized capitalists themselves.

It is the point of departure for the capitalist mode of production; its accomplishment is the goal of this production. In the last instance, it aims at the expropriation of the means of production from all individuals. With the development of social production the means of production cease to be means of private production and products of private production, and can thereafter be only means of production in the hands of associated producers, i.e., the latter’s social property, much as they are their social products. However, this expropriation appears within the capitalist system in a contradictory form, as appropriation of social property by a few . . . . 29

The meaning of this passage is that if left unchecked and allowed to run its full course, capitalism is headed for the day when one company and one individual or small clique of individuals will become the sole owner of the world. Ford and General Motors will merge with Toyota and Honda; General Electric, IBM, and AT&T will merge; U.S. Steel and Bethlehem will merge, as will Exxon, Mobil, and Texaco. And the combinations resulting from these mergers will combine into still larger combinations, which ultimately will sweep up all remaining independent concerns into one Supercombine that owns all the capital in the world.

This is the wellknown scenario of the bigger fish swallowing the smaller fish, and in turn being swallowed by still bigger fish, until only one gigantic fish remains. This process of the growing concentration of capital is supposed to be inevitable, and is what allegedly makes the coming of socialism inevitable. The growing concentration of capital under capitalism supposedly constitutes the creation of the structural framework of a socialist society. Seen in this light, all that socialism represents is a mere changing of the Board of Directors of the Supercombine. Instead of the Board being composed of men who will operate the social apparatus of production in the narrow interest of a handful of dominant individuals and families, it will be composed of men of nobler character, who will operate the apparatus of production in the interest of all members of society. (To illustrate this analysis, one may imagine that on the last day of capitalism there is a board of directors of the Supercombine that is subservient to the grasping, fist-pounding General Bullmoose—the cartoon character in the old L’il Abner comic strip by Al Capp. And then, on the first day of socialism, that board is replaced by the likes of such warm-hearted and public-spirited souls as Ralph Nader, Jane Fonda, and Tom Hayden, who will proceed to run the world for the benefit of all mankind.)

Of course, argue the socialists, it is not necessary to wait for capitalism actually to run its full course. Socialism can come into being sooner, and spare the world much suffering. What is important, say the socialists, is that the coming of socialism is in accordance with inexorable principles of economic development: socialism is hatched out of the womb of capitalism, as it were.

This view of the inherent tendency of capitalist development underlies support for the antitrust laws. It is believed that the antitrust laws are necessary in order to forestall the adoption of socialism. In the eyes of their supporters, they forcibly prevent the growing concentration of capital and, at the same time, the growth of “monopolistic abuses” and dissatisfaction with capitalism.

The same view underlies all the rather sinister books and articles that periodically appear and which describe in detail alleged cabalistic schemes of wealthy individuals and families to gain control of the economic system through devices ranging from interlocking directorates of corporations to intermarriages of heirs and heiresses.

Incompatibility With the Division of Labor—Socialism as the Only Instance of Unlimited

Concentration of Capital

Now any fear that there is a tendency in capitalism toward the concentration of all ownership in the hands of one man or one corporation, or any other such narrow

MONOPOLY VS. FREEDOM OF COMPETITION 393 group, is absurd. Such a development would contradict the very nature of the gains derived from the division of labor and its corollary the division of knowledge. It would thus be against the self-interests of everyone, including even the handful of capitalists who were supposed to gain from it.

The truth is that such a state of affairs exists only under socialism. It is established and maintained only by the initiation of physical force. Nothing less than a Communist revolution, which forcibly seizes all the means of production and places them in the hands of the state, is capable of accomplishing it, and nothing less than the continued existence of a thoroughly repressive regime is capable of maintaining it. Despite its ownership of all the means of production in the Soviet Union, the Soviet government was able to prevent the development of competition only by means of the most repressive measures: to limit, let alone stop, the competition of the black market, it found it necessary to resort to draconic penalties, imposed by administrative tribunals, on the basis of evidence supplied by secret informers. There can be no doubt that had the Soviet government abandoned its repressive measures merely to the point of allowing its citizens to homestead unoccupied land in Siberia and produce there whatever they might be capable of producing, its monopoly position would have been completely broken. Indeed, such economic concentration as characterized the Soviet Union must be maintained not only by the resort to physical force, but also by the prevalence of a spirit of self-sacrifice on the part of the ruling group.

To illustrate this last point, let us imagine that in the separation between the Russian government and the Russian Communist Party, the latter had been allowed to take with it, as its own private property, all of the inhabited land of Russia and all of the factories, farms, mines, and stores that it possessed until recently in its capacity as the effective government of Russia. It would have retained title, we may assume, as the Catholic Church and the feudal lords retained title in earlier centuries to the vast properties they had originally obtained on the basis of the initiation of physical force.

If this had happened and the members of the Communist Party wished to act on behalf of their own material self-interests, or even merely to increase the wealth of the Communist Party Corporation, their first step would have been to place much or even most or all of their property into the possession of others. They would have sold out to them on credit if necessary.

They would have done so because if they consulted their own material self-interests, they would have realized how far they were from being omniscient and even how far they were from possessing the knowledge required to grow a sufficient quantity of grain to avoid starvation. By placing a major portion or even all of their property in the ownership of others, its effective employment could be so greatly increased, so much more could be produced, that the Communist Party as a private corporation would soon have found itself materially much better off owning 20 or 25 percent of a greatly expanded Russian economy than 100 percent of the then existing Russian economy. And as time wore on, its relative significance in the Russian economy would have continued to decrease, though its absolute wealth might have continued to increase.

None of this is to advocate in the least that Russia should have been or should be desocialized in this manner. The Communist Party and its members have no right to anything. It is merely to make the point that anyone truly following his self-interest knows that it is to his self-interest that there exist other people able to act and produce without being dependent on the use of his property and thus on obtaining his consent—that is, that there exist other people capable of acting and producing without being limited by the limits of his knowledge. (Along these lines, of course, an essential advantage resulting from the end of socialism is the reestablishment of markets for all goods and services and thus of the price system, economic calculation, and economic planning— vital features which socialism lacks. 30 )

Indeed, although it has taken a different form, what is going on today in the former Soviet Union and throughout the Communist and formerly Communist worlds is precisely the growing realization that an all-embracing economic monolith is not in the interests even of those who are in charge of it. The great mass of present and former members of the Communist Parties around the world, extending high up into the ranks of the various central committees, will all be far more prosperous under capitalism than under socialism, even though they have been the ones in charge of the monolith. Finally, they appear to have come to understand this fact, and for some time have been seeking ways to dismantle socialism and establish capitalism, and to varying degrees are succeeding in doing so.

The entire experience of socialism confirms the fact that monopoly is a political phenomenon, not an economic phenomenon.

Inherent Limits to the Concentration of Capital

Under Capitalism

In order to show further why there is no tendency toward an ever increasing concentration of capital under capitalism, it is necessary first of all to elaborate on the fact that beyond a point concentration of capital runs counter to the division of knowledge.

No businessman or team of businessmen is capable of

possessing the knowledge required to succeed in more than a few industries. There is simply too much to know. For this reason, there is the phenomenon of bad mergers—acquisitions that do not fit into a company’s areas of expertise and which thus turn out to reduce profits rather than add to them. Such illfated acquisitions must later be “spun off”—divested—if they are not to constitute a continuing drain on the profits of the company’s sound operations.

It is not possible—in the absence of government intervention that seriously undermines normal profit-and-loss incentives—to overcome this problem through the formation of conglomerates, with separate divisions each under the control of businessmen with the necessary knowledge of the particular area of specialization. A businessman with confidence in his own ability to succeed in an industry he knows and understands, and in which his income is determined exclusively by his own success or failure, would not be willing to exchange such a position for one in which he receives a much smaller share of the profits of a conglomerate, which are the outcome of the success or failure of many others, whom he is unlikely to consider as capable as himself.

Similar considerations operate to frustrate the combination of firms even within the same industry. Imagine, for example, an industry composed of 10 firms, each presently doing 10 percent of the industry’s business, and owned by individuals each of whom expects that under his management his firm will grow to the point of doing 40 percent or 50 percent of the industry’s business. It is not possible to merge such firms. To make the merger appear worthwhile in comparison with the anticipated gains from remaining independent, each of the 10 would have to be given 40 percent or 50 percent of the stock of the resulting combination—or 4 or 5 times the value of the combination in all.

It is not necessary, of course, that all of the firms in an industry hold such an optimistic view of their prospects. So long as there are any firms who believe they will enjoy a substantial increase in the share of the industry’s business they will do if they remain on their own, it is probably not possible to offer them terms that would make merging appear worthwhile.

Furthermore, it should be realized that when mergers take place that are successful—that is, succeed in realizing important economies—a major consequence is the formation of new and additional capital. The stockholders in such a combined enterprise enjoy higher incomes, can save more, and the value of their shares of stock is increased. The result is that these stockholders are now in a position to finance the launching of new firms—not, most likely, in the same industry in which the merger has occurred that underlies the increase in their wealth, but in other industries. Yet if successful mergers take place throughout the economic system, a consequence will be the formation of new firms throughout the economic system, and thus in most or even all of the industries which have experienced mergers. In effect, successful mergers in the oil, steel, and cement industries, say, result in the formation of additional capital which makes possible the launching of new firms in, say, the automobile, aluminum, and chemical industries. Later on, successful mergers in one or more of these industries, or in other industries, result in the formation of additional capital that makes possible the launching of new firms back in the oil, steel, and cement industries. 31 Thus, the very process of successful mergers is itself the source of the formation of new firms and thereby operates to limit the concentration of capital.

In addition, it should be realized that an enormous number of new small firms is started every year in a capitalist economy with or without the aid of capital generated by the process of successful mergers. Over the years, some of these firms enjoy great success and grow into medium and even giant-sized firms. One has only to think of the present-day American computer industry or the present-day Japanese and Korean automobile and steel industries. The continuous formation and success of new companies makes it possible for mergers to go on as a regular phenomenon, without being accompanied by any actual increase in the overall degree of concentration of capital in the economic system. While the merged firms represent more capital in the hands of fewer firms, the growth of new firms represents more capital outside the hands of the merged firms. Thus, the proportion of the total capital of the economic system in the hands of the merged firms does not grow. 32

Government Intervention as Limiting the

Formation of New Firms

It must be pointed out that the formation and growth of new firms would take place on a much greater scale than at present precisely under conditions of laissez-faire capitalism. A major potential source of the formation of new firms in virtually every industry is key executives of the existing firms who believe that they could do better on their own. If not for the personal income tax, such executives would be able to accumulate far more personal wealth in their present positions. In the absence of restrictions on stock trading based on “inside” knowledge, their accumulations of personal wealth would be greater still. 33 In such conditions, it would be possible to start even new domestic automobile and steel companies requiring an initial investment of a billion dollars or more. A group of a half-dozen or a dozen key executives of existing automobile or steel firms might well have a

collective personal net worth of several hundred million dollars. On the basis of that equity, combined with their knowledge and experience, they would be in a position to raise any necessary additional capital from outside sources, such as banks or a public stock offering. This potential competition, of course, is aborted by the government intervention—most notably, the progressive personal income tax—which prevents the accumulation of the necessary personal wealth by these individuals. And then, of course, the very same people who advocate such government intervention denounce capitalism for the fact that no one has the capital to start such new firms!

Taxes and other government regulations undermine the formation and growth of new firms also by virtue of the amount of time and effort they require firms to devote to the paperwork and other regulatory procedures that are imposed. Small firms just starting out simply cannot afford the staffs of accountants, lawyers, lobbyists, and others that are necessary to cope with the burden of government regulation. The established, large firms are in a much better position to do so. Here again are important instances of promonopoly policy, this time, on behalf of the established, large firms.

The Incentives for Uneconomic Mergers Provided by the Tax System

Besides preventing the formation and growth of new firms, the tax laws have also encouraged mergers that lack a genuine economic basis. Until 1981, firms that had been profitable in their existing lines of business were given an incentive to branch out into different lines of business in which they did not possess any special competency, as a means of reducing the tax burden of their major shareholders. Paying out the profits from their existing lines of business in the form of dividends would have imposed a federal income tax rate of 50 percent on stockholders in the top bracket. On the other hand, using those profits to buy the assets of another firm served to increase the company’s assets and the price of its common stock. Upon selling their stock at a higher price (provided it had been held for a year or longer), stockholders had only to pay the capital gains tax of 20 percent. Such an arrangement, which had prevailed for many years, obviously favored giving stockholders their profits in the form of capital gains rather than dividends, and, as a means of accomplishing this, the use of profits for acquisitions which otherwise would not have been made.

By the same token, such considerations provided an incentive to the owners of successful small and medium-sized concerns to sell out to larger firms rather than continue on and attempt to grow further on their own. To enjoy the fruits of their success by paying themselves large dividends, they would have had to pay the 50 percent federal income tax. But by selling their shares, either for cash or in exchange for shares in the acquiring company, they could obtain capital-gains treatment on whatever portion of their firm’s profits they wished to enjoy.

And, of course, the tax laws provide an incentive for acquiring firms which have accumulated losses over the years. When such a firm is acquired, its losses are subtracted from the profits of the acquiring firm, and thus the corporate income tax that must be paid by the acquiring firm is correspondingly reduced.

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The preceding remarks are not intended in any way to provide an argument for raising the capital gains tax or for restricting the ability of businesses to reduce their shareholders’ tax burden through mergers or through buying firms that have accumulated losses. Anything which serves to reduce the taxes paid by business firms and their stockholders serves to increase substantially the supply of capital funds available and thus to promote capital accumulation and economic progress. The achievement both of this vital end and of the elimination of the incentive to uneconomic mergers would be served if income tax rates were reduced below the capital gains tax rate. The incentive to acquire loss-making concerns merely for tax purposes would be eliminated entirely, and the incentive and means for accumulating capital would be increased enormously, if the whole system of income taxation were simply abolished.

In Defense of “Insider Trading”

In connection with market processes limiting the concentration of capital, I have made favorable reference to stock trading by corporate executives based on their inside knowledge. Inasmuch as a great deal of scandal has become attached to the phenomenon of “insider trading”—as though it represented some sort of heinous crime—it is necessary to say something further, in defense of the phenomenon.

There is absolutely nothing wrong with insider trading, even in situations in which corporate executives might sell the stock of their own company short (provided, of course, that they did nothing to cause the negative developments that could be expected to reduce the price of their company’s stock). Insider trading does not make the “insiders” rich at the expense of any shareholder who continues to hold his shares. If the insiders profit by buying in advance on their inside knowledge of favorable developments, the effect is simply that the stock price starts to rise sooner. Whoever has decided to hold the stock gains that much sooner. Some who were planning to sell the stock, upon seeing the rise caused by

the insiders’ buying, may be persuaded to hold it instead; people in this group enjoy gains they would otherwise not have had. Whoever had made up his mind to sell his shares is enabled to sell them at a better price, thanks to the demand for them coming from the insiders.

The only parties who have any possible basis for complaint are those who do not have any strong conviction about the company’s future prospects and who are induced to sell at the higher price the insiders bring about, and those who were planning to buy and who must now do so at a higher price. The complaint of people in the first group is that they accepted what they thought was a good price at the time and somehow have a right to the same gains they would have had if they had known better or had had more confidence in the company’s future. The demand that the insiders must work for the “stockholders” actually means that those who see the value of becoming stockholders, or of increasing their holdings, must work for the benefit of those who do not see the value of continuing to be stockholders. It is a demand that they work for the least committed, least loyal of the stockholders, who upon the first opportunity cease to be stockholders and who are no longer stockholders when the inside news finally becomes public knowledge. There is no good reason why the interests of the insiders should be sacrificed to the interests of such people. As for the buyers who pay a higher price, their only complaint can be that their gain is less than it might have been. But many of them may well be buyers in the first place only because they observe the rise in the stock price brought about by the insiders’ buying.

If the insiders sell in advance on the basis of their inside knowledge of negative developments, they are not responsible for the loss that is suffered by those who continue to hold the stock. That loss would come in any case, when the bad news finally became public knowledge. Only it would come more precipitously and dramatically, rather than being preceded by declines caused by the insiders’ selling. As matters stand, the insiders’ selling and the lower price it causes provides a clue to other stockholders to begin selling and to potential buyers to abstain from buying. Those who decide to buy in any case, are enabled to buy at a lower price.

The opposition to insider trading is actually based on nothing more than malicious envy—envy of those who profit by knowing what they are doing, by those who lack knowledge and who demand profit nonetheless. Ironically, their claims are upheld with righteous indignation by the very people who regard all stock market activity as pure gambling and all the gains made in the stock market as unearned and undeserved. Indeed, if the gains of the insiders, who know what they are doing, must be transferred to those who do not, the latter will not be able to keep those gains for very long. For they will have no basis on which to argue for the retention of their unearned, accidental gains from society as a whole. If knowledge is not an adequate basis for earning a profit that others do not earn, the mere accident of owning the right stock at the right time can hardly be such a basis. The attacks on insider trading proceed from a fundamentally anticapitalistic perspective. Their purpose is not to benefit any alleged group of victims, but to defame and ultimately destroy capitalism.

6. Economically Sound Mergers

Despite the fact that government intervention today encourages many economically unsound mergers, conditions often exist in which mergers are economically sound. By making possible an increase in the scale of a company’s operations, they often achieve important economies of the kind previously described in the discussion of the gains from the division of labor, and which, appropriately, are termed economies of scale. 34 For example, by virtue of concentrating a larger quantity of work of the same type in the same place, they make it possible for smaller individual steps in the production of a product to come to have to be performed with such frequency that they can constitute the full time jobs of workers. For example, 100 automobile companies each turning out 10 automobiles a day, cannot make full-time, eight-hour-a-day jobs out of individual steps in producing an automobile that require less than 48 minutes of labor time. But a single automobile company, turning out 1,000 automobiles a day in the same factory, can make full time jobs out of individual steps requiring as little as .48 minutes of labor time. This represents the establishment of a substantially higher degree of division of labor and achieves important economies of learning and motion.

Similarly, larger-scale production frequently makes it possible to adopt machine methods which would be uneconomic on a smaller scale of production. For example, it probably does not pay for two companies to install machines of the kind that they will each use only 40 percent of the time. Still less would it be likely to pay four companies to install machines of the kind that they would each use only 20 percent of the time. But one company, producing twice or four times the volume would use such machines 80 percent of the time, at a correspondingly lower unit cost of the machine’s services. Thus the adoption of machine methods is favored by a larger scale of operations.

Mergers can achieve important economies in cases in which companies carry complementary product lines, which can easily be sold by the same sales force. For

example, if many of the customers of steel companies frequently need both steel sheet and iron castings, it is probably more economical for both products to be provided by one company than for each of two companies to provide only one of the products.

Mergers can also achieve important economies in connection with advertising and the raising of capital. For example, newspaper and television advertising are more economical if what is advertised is available throughout the area reached by the advertising. On this basis, it pays chain stores to engage in advertising which would not pay neighborhood shops. Larger firms, resulting from mergers, are also able to carry on their financing on a larger scale. As a result, other things being equal, they can borrow money at lower interest rates, since the lender can spread the administrative costs of making the loan over the larger sum lent. Similarly, sufficiently large firms, with sufficiently large financial requirements, can justify listing on a stock exchange and thus obtain the more economical access to capital that that makes possible.

Perhaps the single most important gain achieved by mergers is the ability of more competent individuals to gain control over the management of additional capital. If there are two firms each with the same capital, but one is run by more competent people than the other, the extension of the management of the former to the assets of the latter, will result in the combined firm producing more than was produced by the two individual firms separately. Even apart from economies of scale, two railroads merged under the management of Vanderbilt, or two oil refineries merged under the management of Rockefeller, resulted in more than twice the respective production of the two outfits in isolation, simply because the acquired assets were managed better in the hands of their new owner. It should be obvious from this point in particular that the economies provided by mergers can go far beyond the economies of scale achieved in individual larger-sized factories or other productive establishments. There is very good reason for a more competently run firm to own far more than just one optimum-sized plant in its industry. Its ownership of additional such plants results in more being produced from them than would be the case if they were owned by less competently run firms. It is necessary to stress this point in view of the widespread belief that economies of scale provide the only economic justification of mergers. 35

The Trust Movement

The preceding discussion helps to explain an important part of the economic history of the late nineteenth and early twentieth centuries—the phenomenon of the socalled trust movement. The trusts were the earliest method devised for accomplishing corporate mergers.

Prior to the Civil War, the formation of corporations was an extremely difficult and costly process. A special act of a state legislature was necessary. Corporations were confined largely to railroading and insurance. In the years following the Civil War, with recognition of the growing need for large aggregations of capital, requiring the participation of such a large number of investors as to make traditional partnership arrangements unwieldy and impractical, the process of incorporation was radically simplified and the ability to incorporate was made easily available to everyone.

In the period following the Civil War, corporate law did not immediately provide a mechanism whereby one corporation could be combined with another one. The trusts were a device for accomplishing that purpose. Under a trust arrangement, the stockholders of separate corporations turned their shares over to trustees, who then had the power to vote the shares and run the corporations. By assembling the shares of two or more corporations in the hands of the same trust, it was possible to operate the corporations as a single unit and thus achieve a merger.

Despite the sinister connotations of the word, the trusts played a major role in improving the efficiency of the economic system, and thus in raising the general standard of living. Their success in rapidly increasing production was instrumental in bringing about a generation of steadily falling prices in the years 1873–1896. (The fall in prices came to an end with major discoveries of gold in Alaska and Australia, and the development of processes which made possible the commercial exploitation of a vastly increased portion of South Africa’s deposits.) In every case, the rise of the trusts was associated with a vast increase in production and improvement in the quality of products. The era of the trusts was the era of America’s most rapid economic progress and the transformation of the country into the world’s foremost industrial producer and economic power. The development of the trusts was indispensable to these achievements.

The fact that the actual result of the trusts was more production and lower prices, not less production and higher prices, which is the result one would expect if the trusts had been the monopolists their critics claim them to have been, is confirmed even in the adverse decision of the U.S. Supreme Court in 1911, which broke up the Standard Oil Trust. In its decision, the Court admitted: “Much has been said in favor of the objects of the Standard Oil Trust, and what it has accomplished. It may be true that it has improved the quality and cheapened the costs of petroleum and its products to the consumer. But such is not one of the usual or general results of a monopoly; and it is the policy of the law to regard, not

what may, but what usually happens. Experience shows that it is not wise to trust human cupidity where it has the opportunity to aggrandize itself at the expense of others.” 36 Ironically, of course, the leading “evidence” that is usually cited on behalf of the terrible effects of the trusts and of private “monopoly” in general is precisely the alleged record of the Standard Oil Trust!

Apart from the special business talent that was characteristic of the men who formed the trusts, and the advantages to be had by virtue of that talent being in charge of a larger volume of capital, a fundamental economic factor that favored the formation of the trusts— indeed, made their formation vital—was the major improvements in the transportation system that had been going on for several decades, and which sharply accelerated following the Civil War. The decades following the Civil War were a period of enormous railroad building, and also of the rapidly growing use of steam-powered steel ships. These developments brought about a radical reduction in transportation costs and the ability to transport quickly and economically, to practically everywhere in the country and to much of the world, goods whose transportation prior to that time had been extremely expensive and for all practical purposes simply out of the question as far as most locations were concerned.

These improvements in transportation favored larger-scale manufacturing and processing. They meant that the lower manufacturing and processing costs of larger-scale plants would outweigh transportation charges over a wider radius, and thus that the adoption of larger-scale manufacturing and processing methods was now economic in a vast number of situations in which it had not previously been economic. The following hypothetical example will serve as an illustration.

Imagine that in a small-scale plant, manufacturing cost is $10 per unit of product, while in a largescale plant, thanks to the operation of the kind of factors explained above, manufacturing cost can be brought down to only $1 per unit, provided the facility operates at a sufficient percentage of its capacity. Assume that initially, however, transportation costs are 50¢ per mile per unit. Under these conditions, transportation charges more than offset the manufacturing cost advantage of the larger-scale plant in every case in which it is located more than 18 miles further away from the market it must serve than is the smaller-scale plant. The total cost per unit of providing the product from a smaller-scale plant located on the spot, and thus without its having to incur transportation charges, is $10 per unit—its manufacturing cost. But that is exactly the total cost of providing the product from a larger-scale plant located only 18 miles away, when one adds to its $1 manufacturing cost per unit, transportation charges of 50¢ per mile times 18 miles. Indeed, in every case in which the larger-scale plant is located more than 18 miles further away from the market than is the smaller-scale plant, the closer, smaller-scale plant actually has the cost advantage. The smaller-scale plant located, say, 5 miles from the market it must serve, has a total, delivered cost of $12.50 per unit. The larger-scale plant located, say, 30 miles from that same market has a total, delivered cost of $16 per unit.

In such circumstances, it is doubtful that the larger-scale plant can compete successfully against smaller-scale plants even when it is located in the same immediate vicinity. This is because it must find the volume of business necessary to enable it to operate at a sufficient level of its capacity within too small a radius. It may well be the case that when confined to such a narrow radius, the volume of business it can attract is so small that at the low level of operation it is able to achieve, even its manufacturing cost turns out to be no lower than that of the smaller-scale plant. Indeed, a larger-scale plant that must operate at, say, only 5 or 10 percent of its capacity, may well have higher manufacturing costs than a smaller-scale plant operating at 80 or 90 percent of its capacity.

Such results are not unlikely. Any inability to find a sufficient volume of business within the narrow radius enjoined by the high transportation charges diminishes the manufacturing-cost advantage of the larger-scale plant and forces it to find its market still closer to its gates, which then compounds the problem of finding a sufficient volume of business. For example, if the larger-scale plant could find sufficient business within an 18-mile radius to operate at no more than 25 percent of capacity, even though it charged prices corresponding to manufacturing costs at an 80 percent or 90 percent operating rate, its manufacturing cost per unit would be substantially greater than $1—perhaps $4. In that case, to operate economically, it would actually have to find a sufficient volume of business to support 25 percent operation within a radius of 12 miles, not 18 miles, for its actual manufacturing cost advantage over the smaller-scale plant is reduced to $6 per unit from $9 per unit. If it cannot do that, then the same story repeats itself, and it is driven to having to find an adequate market even closer to its gates, at a still lower percentage of capacity, and at correspondingly higher manufacturing costs per unit. The probable outcome is that it cannot operate economically at all.

But now imagine that, thanks to radical improvements in railroading and ocean shipping, transportation cost is reduced to a mere 1¢ per mile per unit. Under these new conditions, the larger-scale plant has an advantage in total, delivered cost per unit extending over a radius of 900 miles! Wherever its distance from the local market is less than 900 miles further away than the small-scale

plant, it has the lower total delivered cost. In these circumstances, the larger-scale plant will almost certainly find a sufficient volume of business so that it can operate at a level of capacity high enough to achieve its manufacturing economies. Indeed, probably at least several such plants will be required.

The much maligned trusts were precisely the means of achieving the replacement of high-cost, small-scale plants with much lower-cost, largescale plants. They accomplished this by merging large numbers of small firms, with small-scale facilities, into a smaller number of larger firms, with largescale facilities. They built the larger-scale facilities by pooling the profits and replacement funds of the smaller concerns, and as they built them, they dismantled and closed down the outmoded small-scale facilities. For example, Standard Oil is reported to have acquired 123 refineries, of which it dismantled at least 75, while producing a greatly increased volume of oil products in only 20 separate facilities. 37 In accomplishing such results, the trusts brought into being largescale manufacturing and processing centers serving national and world markets at radically reduced costs and prices. For example, they developed Cleveland as the major oil-refining center, Pittsburgh as the major steel-producing center, and Chicago as the major meatpacking center.

The historical distortions surrounding the trusts totally ignore their actual accomplishments and substitute for the facts nothing more than the implications of moral and economic doctrines that are themselves totally unfounded—above all, the implications of the vicious doctrine that one man’s gain is another man’s loss. On the basis of this depraved doctrine, the trusts are damned a priori, precisely by virtue of their great success.

7. The Predatory-Pricing Doctrine

An economic doctrine that has played a major role in the condemnation of the trusts and in the fear of big business in general is the doctrine of predatory pricing. According to this doctrine, a large firm, because it is “big and rich,” and possibly operates in many different markets at the same time, can afford losses which a small firm cannot, because the latter is “small and poor.” On this basis, it is held to be in the interest of the large firm temporarily to slash its price and sell at a loss, in order to force the small firm also to sell at a loss. Because it can afford the loss while the small firm cannot, the argument goes, it will be able to drive the latter out of business, and, as soon as it has done so, raise its price to a higher level than ever before. New competitors will be kept out, the doctrine claims, by the fear of being ruined by a repetition of predatory price cutting. Thus, it is held, the predatory large firm succeeds in unconscionably gouging the helpless public, which, in simple innocence, has taken the large firm’s lure of a temporarily lower price as children sometimes take candy from an evil stranger, only to suffer greatly later on from its mistake, when its only protection, the small and poor firm, has been eliminated.

The belief in the validity of this doctrine is so powerful that all the achievements of big business in reducing prices and improving quality are regarded as having no reality. They are all seen as being merely a prelude to this kind of gouge. Conditions will be normal, the doctrine’s adherents believe, only when big business and the rich do what it is absolutely certain that their nature impels them to do and, indeed, makes them enjoy doing, namely, make life miserable for everyone else.

Despite the evident psychological bias that underlies its acceptance—namely, envy carried to the point of unreasoning fear and hatred of others’ success—it is necessary to examine the predatory-pricing doctrine as though it were advanced in all good faith and honesty. Proceeding in this way, a series of major difficulties with the doctrine must be pointed out.

First, it should not at all be taken for granted that the large, rich firm is even in a position to impose a price reduction below the small firm’s costs. At the lower price it asks, there will be an increase in the quantity of the good demanded. The large firm can make the lower price effective only if it is in a position to supply this additional quantity demanded. Whether or not it can do so depends on how elastic the demand for the product is in response to the price reduction—i.e., on how much the quantity of the product demanded expands—and also on how much unused productive capacity the firm has on hand and that is available for the particular market concerned. If its capacity is insufficient to meet the larger quantity demanded, it has no means of compelling its small competitor to sell at the lower price it asks. For in this case, customers who come to it in order to obtain the lower price must be turned away. They will have to deal with the smaller firm. Indeed, it is even possible that the effect of the large firm’s action could actually be to raise the price received by its small competitor. This will occur insofar as its lower price attracts a new and additional quantity demanded which is met with supplies that are now made unavailable for satisfying the firm’s regular quantity demanded. In this case, the item actually becomes scarcer for the firm’s regular customers, and they will now have to turn to the smaller firm, where their competition will actually drive up the price. 38

If the large firm does have the capacity to meet the additional quantity demanded at the lower price, and thus to satisfy a substantial portion of the customers of the

smaller firm as well as all of its own customers, then, of course, it can impose the lower price. The smaller firm will have to meet it if it wishes to keep its customers.

But even so, to the degree that the demand for the product is elastic, the large firm must go to the expense of possessing this necessary additional capacity. And then, of course, if it should actually succeed in closing down the small competitor and thereupon raise its price, which is its presumed plan all along, it must continue to maintain this additional capacity even though it no longer uses it in production. This can be an expensive proposition.

A further, much greater difficulty arises. If it is the case that as soon as the small competitor is driven out, the large firm can sharply increase its price, while so long as the small competitor remains in business the price is held below the level of his costs, then usually unrecognized but nonetheless extremely powerful interests are created on behalf of the continued existence of the small competitor. The obvious interests, of course, are those of the small competitor himself, who wants to stay in business, and those of the industry’s customers, who pay much less so long as he is in business, and so much more as soon as he is driven out of business. A less obvious interest in the continued existence of the small competitor is that of the industry’s suppliers and that of the producers of products that are complementary to the industry’s products.

If, for example, a predatory-pricing policy were to be followed in the oil industry (as many believe was actually the case in the late nineteenth century and the early years of the twentieth century under Rockefeller’s Standard Oil Company), the consequence would be that the business of the suppliers of oil rigs, drills, pipeline, and tank cars would sharply increase every time a small competitor existed who was being driven out by Standard Oil, and sharply decrease every time Standard Oil succeeded in driving him out. The same would be true of the business of the automobile industry and its suppliers, which is increased by a low price of gasoline and reduced by a high price of gasoline. The obvious question arises, if Standard Oil were to follow such a policy, why shouldn’t the suppliers of the oil industry and the producers of products complementary to oil products, like automobiles and steel, deliberately subsidize a small competitor of Standard Oil, for the very purpose of making Standard Oil sell at a sharply lower price?

Going still further, if it is the case that the large firm has only to be confronted with a small firm in order to slash its price, people are placed in a position in which they can use that very knowledge to profit by forming small competing firms. All they have to do is first go out and take a substantial short position in the stock of the large firm, and in the product it sells. They can do so in the knowledge that they have the power to drive down the price of its stock along with the price of its product while it proceeds against their new company by means of slashing the product’s selling price and its own profits. And as a kind of frosting on the cake, as it were, as soon as they have taken their short positions, they can publicly advertise the formation of their new company and urge everyone to delay his purchases of the product in anticipation of the sharply lower prices their entry will precipitate. This will immediately reduce the business of the large firm, enable the owners of the new firm to profit right away on their short positions, and when their firm actually appears in the market, the quantity of the product demanded may be so increased, thanks to the postponement of purchases, that the large firm may not even be able to meet it. The result of this last is that for a time the small firm may even be able to sell at prices that are highly profitable despite all the efforts of the large firm.

Of course, apart from all of these considerations, there is the very simple and obvious question of why all the customers are ready to deal with the large firm if they know that as soon as it succeeds in driving the small firm out, it will sharply increase its price. In reality, buyers take steps to protect themselves from arbitrary price increases. In addition to the simple refusal to give all their business to such a firm, a further major protection is prices that are set by contractual agreement. Such prices can altogether eliminate the ability even of firms that constitute the sole source of supply to profit from arbitrary price increases. I will say more about this shortly.

There is yet a further and particularly vital matter that the predatory-pricing doctrine ignores and which must now be pointed out. This is the fact that to the extent that the big and rich firm is larger in the same market, it must take the price cut and the resulting loss on a correspondingly larger volume than the small and poor firm. It cannot cut the price only to the customers of the small firm, because that leaves the small firm free to cut price by a much smaller amount to an equal number of customers of the large firm. If the small firm is not to be able to sell to anyone except at the low price imposed by the large firm, the large firm must make that low price available to all of its own customers as well as to the customers of the small firm. This means that if—to introduce an element of personality into the example— “Big John” (viz., Rockefeller), who does 90 percent of the business in a given market, wants to cut price in order to inflict a loss on “Little Joe,” who does 10 percent of the business in that market, he must suffer the resulting loss on his 90 percent share in contrast with the latter’s 10 percent share. Assuming that he has the same unit costs, this means nothing less than that he must take a

loss that is nine times as large! It is difficult to see the advantage constituted by nine times the wealth and nine times the business if money is lost at a rate that is nine times as great. 39

Indeed, when matters are seen in this light, it even turns out that the smaller, poorer firm may be in a better position to withstand losses than the larger, richer firm. If, for example, while Little Joe’s market share was only one-ninth as great as that of Big John, his capital was more than one-ninth as great—say, two-ninths as great— then he would actually be in a position to sustain losses for a longer time than Big John! And if Little Joe is an innovator and produces a superior product at the same cost as Big John’s product, or has lower units costs of production than Big John for an equally good product, then his position is virtually impregnable. In this case, by cutting price Big John can suffer immense losses, while Little Joe merely earns lower profits, and Big John must suffer even greater losses before he can impose any loss whatever on Little Joe. (Such a situation is very often the case in reality, though it is hardly ever considered by the supporters of the predatory-pricing doctrine or, for that matter, by almost anyone else in contemporary economic theory.)

Of course, Big John’s larger capital can often be expected to give him economies of scale which Little Joe does not possess. In recognition of this fact, the predatory-pricing doctrine’s supporters may wish to modify their position that it is greater wealth and size in and of itself that enables the larger firm to sell at lower prices. They may wish to say that Big John can afford to sell at lower prices because he has lower costs, which permit him to continue to be profitable even while Little Joe earns no profits, or, indeed, suffers losses. There is certainly nothing objectionable in Big John selling at lower prices in such a case. But even here, it should be realized that in selling at lower prices, the more efficient, larger firm must still at least reduce its own profits by a multiple of any loss it inflicts on its small competitor, which makes it extremely unlikely that it could pay to cut prices for the purpose of driving the small competitor out.

For example, let us imagine that Big John has a cost per unit of 80¢, while Little Joe has a cost per unit of 90¢ and needs a price of $1 per unit in order to earn a competitive rate of profit on his capital. If Big John sets his price at $1 per unit, and sells 9 units for every 1 that Little Joe sells, then he makes $1.80 in profit for every 10¢ that Little Joe makes. If now, he slashes his price below Little Joe’s cost, to 85¢, say, then for every 5¢ of loss he inflicts on Little Joe, he reduces his own profits by 15¢ per unit times 9 times the number of units, viz., by $1.35. The damage he does himself in this case, in terms of the reduction in his own profit, is 27 times the loss he inflicts on Little Joe. To describe the situation in more conservative terms, the reduction in his own profit is still 9 times the reduction in Little Joe’s profit, which goes from plus 10¢ to minus 5¢. But however it is described, this hardly seems to qualify as an intelligent method of doing business. On the contrary, it seems to have more in common with a policy not merely of shooting flies with an elephant gun, but of perversely singling out for such shooting, flies that reside on one’s own nose! From the perspective of the smaller firms in competition with such absurdly managed large firms, it would simply be a case of “the bigger they come, the harder they fall.”

Furthermore, in order to drive Little Joe out of competition, or, more correctly, Little Joe’s plant capacity, Big John must sell not merely below the latter’s total costs, but below his operating costs (together with an allowance for earning a competitive rate of profit on the working capital that must be tied up in meeting the operating costs). Little Joe’s operating costs are his costs merely on account of such things as labor, materials, and fuel. Such costs as depreciation on plant and equipment and interest paid on capital borrowed for investment in plant and equipment do not enter. So long as Little Joe, or whoever else may come to own Little Joe’s plant, can sell merely for more than these costs plus an allowance for earning a competitive rate of profit on the working capital that must be tied up in meeting them, it pays him to remain in operation. To whatever extent Big John charges a price that is higher than this, Little Joe or his successor is also able to recover a portion of the original investment in the plant and equipment.

To drive out Little Joe, Big John must not only set his price below this level, but he must also hold it at this low level for as long as Little Joe’s plant capacity lasts. Even if Little Joe himself should be driven out of business, because he is unable to meet interest or principal payments, say, continued operation of his capacity will pay the creditors who take over his assets, or those to whom the creditors sell the assets. This is the case, because, as stated, this way they will at least be able to earn the rate of profit on the working capital—and more besides, to whatever extent Big John charges a price that more than equals the costs of operating Little Joe’s plant plus allowance for a competitive rate of profit on the working capital that must be tied up. (From the perspective of a later owner who acquires Little Joe’s plant at the bargain prices of a bankruptcy sale, practically all such additional proceeds may constitute profit. 40 )

If Big John does not want to wait until Little Joe’s capacity has worn out before he raises his price, he may consider buying Little Joe out. Given the enormous financial burden of holding his own price down for so many years, while waiting for Little Joe’s capacity to

wear out, it would certainly be much more sensible to buy Little Joe’s capacity even at a premium price—above what Little Joe himself had paid for it. Of course, if this is what Big John were to be accused of, it would represent a dramatic reversal of the predatory-pricing doctrine. Now, instead of being accused of eliminating his competitors by charging ruinously low prices, he would be accused of eliminating them by buying them out at premium prices for their assets. 41

But neither method can actually pay Big John if his goal is to profit by imposing arbitrarily high prices. This is because both methods imply that later on, once Little Joe’s capacity is out of the way by one method or the other, it is absolutely necessary for Big John to charge a premium price merely in order to recoup the reduction in profits he has sustained or the premium price for Little Joe’s assets that he has paid. But any premium price he charges in the future, after Little Joe’s capacity is out of the way, will only serve to attract new competitors, to whom the premium price will offer the prospect of a premium rate of profit. Because of its highly self-destructive nature, and for all of the other reasons explained, these competitors cannot be kept out by the fear of still more predatory pricing. The fact is that the permanent, longrun price that Big John can obtain is limited by the costs of production—the full costs—of potential new entrants, together, of course, with an allowance for the competitive rate of profit on their capital. 42 These costs set an objective limit above which the price cannot be maintained in the absence of legal protection from competition—namely, that provided by monopoly according to the political concept. As a result, Big John cannot in fact later on charge the premium price that is necessary to recoup the profits he must forgo or the additional expense he must incur.

Thus, even if Big John were able to succeed in driving out his smaller rival or rivals, he would have very little to gain by doing so. His gain would merely be their share of the market, at selling prices not significantly higher than the selling prices that prevailed before he began his effort to drive them out. In terms of our previous example, all that he could gain by years of selling his own 9 units at a loss, or at least at a profit of much less than 20¢ per unit, while he was keeping Little Joe’s capacity out of operation, is a profit of an additional 20¢ on the extra unit he was finally able to supply in place of Little Joe. For his price could not significantly exceed the $1 that prevailed before he cut in order to drive Little Joe out.

More Than One Firm in an Industry as the Normal Case

A major implication of the preceding discussion is that it normally does not pay a firm to attempt to gain the entire market even of the particular industry in which its comparative advantage lies. In the great majority of cases, of course, it is simply not possible for a firm to gain the entire market of its industry—it is not in a position to outcompete all the other firms, and there are other firms in its industry whose interests are not served by merging with it. But even apart from these factors, even if the firm in question is the most efficient in its industry, once it achieves a certain relative size, whether 60 percent, 80 percent, or 90 percent of the industry’s market, gaining the remaining share of the market simply does not constitute enough of a prize to make it worthwhile.

If the remaining, relatively small share of the market is all that is to be gained, it does not pay the large firm to cut its price and reduce its profits on its much greater volume. Its actual interest will lie with the highest price it can obtain that is consistent with its small competitors (and potential competitors) not being able to make enough profit to accumulate the capital required to become more efficient and thus to offer it serious competition. In other words, its interest will lie with setting its price not too far above the full costs of its less efficient competitors or potential competitors, and making the highest possible profits it can by reducing its own costs of production as far below theirs as possible. So long as no one else can make substantial profits at the price it charges, it has no incentive to reduce its price further for the sake of gaining their small volume of business. Its policy will be to allow its small competitors to survive on the most favorable terms short of their rapidly accumulating capital. It will reduce its price only insofar as it perceives a likelihood of the costs of production of its competitors or potential competitors falling. (Sooner or later, in a free economy, this will happen, and it will have to reduce its price. But then, if it manages to retain a cost advantage by having further reduced its own costs of production— which it is motivated to do—it will cut only to the point of once again preventing others from rapidly accumulating capital.)

The exception to this rule of the large firm not disturbing its less efficient small competitors is the case in which, by charging a price below their costs, a vast expansion in the total market of the industry can take place, from which it will be able to benefit substantially. If, for example, at a selling price of 85¢ rather than $1, the quantity demanded of the industry as a whole expands by a factor of two or three, and Big John is meanwhile able to achieve further economies of scale and reduce his unit cost to 75¢ or even 70¢, then, indeed, it will pay him to undercut his small rivals and drive them out of business (or buy them out). But his motive here is not to gain the piddling volume of his small competitors,

in order then to jack up his price to a higher level than ever before. On the contrary, it is to gain the vast increase in the market of the industry as whole, which can only be done by charging a permanently lower price.

But even in this case, becoming the sole producer would not pay if the large firm’s cost advantages are of a kind that can be patented and thus shared with other producers in exchange for royalty payments. For then, the firm could make additional profits on 100 percent of an expanded market without having to accumulate by itself all the capital required to supply the market.

If the only substantive gain from price cutting is the volume of business presently carried on by one’s competitors, then it follows that it is more efficient small firms that have much more to gain by following an aggressive pricing policy than more efficient large firms. A large firm, with 90 percent of the market, has only the 10 percent share of its rivals to gain. But a small firm, with 10 percent of the market, has the 90 percent share of its rivals to gain. Such a small firm will be much more intent on expanding its share of the market than the large firm.

Thus, this discussion has demonstrated further inherent limits to economic concentration under capitalism, even within a given industry.

And in the light of this discussion, it should come as no surprise that historical research has now established that the old Standard Oil Company (for which, of course, the “Big John” of our examples was a standin) never actually engaged in a policy of predatory price cutting. 43

“Predatory Pricing” in Reverse:

The Myth of Japanese “Dumping”

It is ironic in the extreme, that after generations of claims about the predatory-pricing powers of the Big Johns of the world versus the helpless Little Joes of the world, the enemies of capitalism have now done a complete about-face. Now, at least in the case of Japan, they claim to fear the predatory-pricing powers of Little Joes against Big Johns. This new doctrine is manifest in the claims that the economic success of Japanese firms, that only a few decades ago were economically insignificant in comparison with their American counterparts, is the result of Japanese “dumping”—i.e., selling below cost, i.e., “predatory pricing.” Yes, now we are asked to believe that the piddling Toyata and Nissan corporations of the 1950s and 1960s, and the piddling Nippon Steel Corporation of the same period, and their piddling counterparts in numerous other industries, have driven out of business or come close to driving out of business one American industrial giant after another. Poor General Motors, poor U.S. Steel, poor whoever—so the story goes—they could not stand the losses inflicted on them by year after year of “dumping” by Japanese firms that were only a fraction of their size.

No, it may be said, not dumping on the part of small Japanese firms acting on their own, but dumping made possible by subsidies provided by the Japanese government, guided by its nefarious Ministry of International Trade and Industry.

Such a tale of Oriental intrigue would deserve to fail even as a Charlie Chan story. What it overlooks, of course, is that the resources at the disposal of the Japanese government have been entirely dependent on the success of Japanese business, which has not operated at losses in its export trade but at very high profits, based on a combination of low costs of production and high quality of products. The Japanese firms may often have sold below the costs of their unionized and otherwise hamstrung American competitors, which came more and more to be managed by incompetents whose leading skill lay in such things as pacifying government regulators rather than in successfully running a business. But rarely if ever did they sell below their own costs.

Only to a fascistic-type mentality imbued with a belief in government omnipotence can it seem reasonable to attribute the success of the Japanese economy to the guidance and subsidies of a government ministry. 44 The truth is, to whatever extent the Japanese government has diverted Japanese businesses from the path they would have followed strictly on the basis of profit-and-loss considerations and has provided them with subsidies, the success of Japanese business has been less than it otherwise would have been. This is the case because such interference only serves to make firms earn lower profits than they otherwise could have earned and makes it possible for inefficient producers to survive by covering their losses on the basis of taxes taken from the profits of efficient producers. Given the enormous success of the Japanese economic system, such interference, while it may have existed to some extent, could not have been very significant. The success of the Japanese economy is attributable to those elements of it that are consistent with freedom and profit making, not to violations of freedom, not to the earning of lower profits rather than higher profits, and not to the payment of subsidies to cover losses. 45

The Chain-Store Variant of the

Predatory-Pricing Doctrine

The predatory-pricing doctrine must be examined further insofar as it is the case that the larger firm is larger by virtue of its presence in more than one market—for example, chain stores that compete with local merchants, or conglomerates that compete with smaller firms in a variety of different industries. In such cases, of course, if

the larger firm were to slash its price for the purpose of making its smaller rival run at a loss, it would not have to suffer a reduction in its own revenues and profits in proportion to its overall greater size, but only in proportion to its greater size in the particular market concerned.

Here, the argument goes, the large firm is able to cover its losses in the particular market out of the profits it earns in all its other markets. It is able to bring overwhelming resources to bear, and thus not only to drive out its small rivals in one market at a time, but also to keep out all potential new entrants by the mere threat of dipping into its vast treasury and inflicting losses on them.

It was popular at one time to accuse the A&P Company, which for many years was the largest retail grocery chain in the United States, of having followed this policy against neighborhood grocers. The accusations seem to have died down in the years since the company lost that eminent position as the result of a competition that the supporters of the predatory-pricing doctrine must judge to be virtually incapable of having occurred.

An essential fact that must be pointed out in cases of this kind is that the far greater part or, indeed, almost the whole of the profits and capital of the “big, rich firm” is irrelevant to its ability to sustain temporary losses in driving its smaller, poorer rivals out of business. The truth of this proposition can be understood by imagining that on the one side is A&P, with $1 billion of total capital invested in a thousand stores nationwide, and on the other side a small grocer and his wife, with perhaps only $50,000 of capital invested in their one little store.

This case, of course, is similar to the cases we have already considered, insofar as in slashing its price A&P will have to suffer a reduction in revenues and profits perhaps twenty times as great as the reduction in revenues and profits it can impose on the small store. (This ratio is implied in the fact that A&P’s assumed overall total of $1 billion of capital is supposed to be invested in a thousand stores. The resulting $1 million average investment per store is twenty times larger than the assumed investment of the small grocer and his wife. To the extent that the larger investment implies a larger volume of business, the losses of A&P must be a multiple of the losses of the small competitor.)

The special fact that must be recognized in the present case, however—a fact that would be critical even if in the particular local market the two firms had invested the same amount of capital and did the same volume of business—is that almost all of A&P’s billion and the profits it may make in its other 999 stores are irrelevant to what it can afford to lose in this particular location. To demonstrate this conclusion, it is only necessary to assume for the moment that A&P can actually succeed in driving out its small rival or rivals and thereafter keep out all new rivals by the mere threat of ruining them. If it really could do this, it would forever after earn a premium profit in this one location. But precisely that is the point—it would be a premium profit in only one location. Such a premium profit is surely quite limited— perhaps an additional $100,000 per year, perhaps even an additional $500,000 per year, but certainly nothing remotely approaching the profit that would be required to justify the commitment of A&P’s total financial resources.

And now the question arises, just how much is it worth temporarily losing in order to secure such an extra profit? The temporary loss must be regarded as an additional investment, made for the purpose of later on adding to profits.

True enough, A&P has $1 billion in capital, and its total annual profits may be on the order of $100 million or even $200 million or more. But it could never pay to temporarily lose—to invest—sums of such magnitude for the sake of earning an extra $100,000 or $500,000 a year, even if these latter sums could be earned every year thereafter forever. Each individual branch of a business must be judged on the basis of its own profitability and must be profitable in its own right, if the investment in it is to be justified. The measure of how much it pays temporarily to lose in order to increase profits later on, is provided by the going rate of profit on capital in the economic system. If the going, average rate of profit or interest is, say, 10 percent a year, then a $500,000 annual amount of profit or interest can be made by the investment of $5 million. This sum—$5 million—is then the upper limit of what it pays temporarily to lose, in order to eliminate competitors in this one location. By the same token, if the extra permanent annual profit in this one location will only be $100,000 then the most it pays temporarily to lose in eliminating competitors is $1 million.

These sums—$5 million and $1 million—are the respective capitalized or present values of $500,000 and $100,000 a year forever, if the annual rate of return on capital is 10 percent. To the extent that it is necessary to lose sums larger than these in order to secure the $500,000 or $100,000 higher profits every year, the effect is that the firm ends up earning a below-average rate of profit on its capital in this investment. It earns less on the capital in question than it readily could have earned. The investment is a bad investment.

It cannot be stressed too strongly: all of A&P’s billion of capital and all of its tens or hundreds of millions of total annual profits beyond these $5 million or even just $1 million of capital are simply irrelevant to its ability to make a worthwhile investment in this case. A&P cannot afford to regard more than these strictly limited sums as

available for a temporary loss. If it loses any more than these sums, its investment is a poor one even if it succeeds in its alleged goal of driving out and keeping out everyone else and becoming the “monopoly” supplier in the area. This is because in such conditions it would end up earning a below-average rate of profit despite its having secured a local “monopoly.” For example, if it temporarily loses $2 million in order thereafter to earn an additional $100,000 a year in profits forever, and actually succeeds in earning such profits while the going rate of return is 10 percent, the result is that it ends up earning only a 5 percent rate of return when it could have earned a 10 percent rate of return. Exactly the same result applies if it temporarily loses $10 million in order to end up earning an additional $500,000 a year forever.

An equally important implication of these facts is that everyone contemplating an investment in the grocery business who has an additional $5 million or even just $1 million to put up is on as good a footing as A&P in attempting to achieve such additional profits. For it simply does not pay to invest additional capital beyond these sums. In other words, the predatory-pricing game, if it actually could be played in these circumstances, would be open to a fairly substantial number of players—not just the extremely large, very rich firms, but everyone who had an additional capital available equal to the limited capitalized value of the “monopoly gains” that might be derived from an individual location.

And this very circumstance helps to explain why a policy of predatory pricing cannot be pursued, even in limited areas, one at a time. For what must happen if a company such as A&P were to attempt it? It loses, let us imagine, $500,000 in eliminating the competitors who were on the scene when it made its initial appearance in the area. Now, if the capitalized value of becoming the sole seller is $1 million, it can afford to lose only an additional $500,000; if the capitalized value is $5 million, it can afford to lose an additional $4.5 million. But in either case, what is its position in comparison with any outside entrant who has his full $1 million or $5 million available?

Such an outsider is now in a position in which, from the point of view of ending up with an investment that at least yields the going rate of return, he can afford to lose more than A&P for the prize of becoming the sole seller. Of course, if he pursues this policy, he in turn will find himself in the same position in relation to still another outsider—all of which means that there is no way of actually securing the kind of premium profits imagined in this example, and that all that can result from the attempt is the pouring of money down a bottomless well. As we have seen before, whoever would attempt it, would find himself in the position of having made a larger-than-necessary capital investment, which he would later need to recover through higher-than-necessary prices and more than a competitive rate of profit, but would be unable to recover in the actual conditions of the market. The capital he expended in the effort to achieve the illusory extra profits would place him in the same position as someone who had constructed his store or bought the land for it at an unnecessarily high price. This is certainly not a formula for growing rich.

Contract Pricing

As I have said, it should not be thought that after having gone to the expense of driving its initial rivals out of business in a particular market, a very large firm might be able to secure premium profits by a policy merely of threatening to lose whatever sums might be required to inflict losses on potential new competitors and thus keep them out by sheer intimidation, with the result that it would not be put to the actual expense of major losses very often. If it is going to charge prices higher than those at which outsiders would be profitable, it will often be put to the test, and suffer accordingly—usually to a considerable multiple of whatever losses it may be able to inflict on its smaller competitors. In fact, it is often extremely easy to overcome any such attempt at intimidation. Apart from everything else I have described, all that would need to be done is for a competing supplier to sell his product under longterm contract.

Such a competitor can offer a price that is equal to his cost plus an allowance for the going rate of profit. And he can offer it for the life of his plant. (If he already has a plant and were the object of predatory price cutting, it would pay him, if necessary, to enter such an agreement at any price above his operating costs plus allowance for the going rate of profit on his working capital.) The contract can give the buyers the right not to buy from him—if the alleged predator firm or anyone else is currently charging prices low enough to make dealing with them more attractive. In this case, all that need be required of the buyers is that they pay a relatively modest penalty charge for the units they do not take—a charge just sufficient to cover the supplier’s costs of being in the business and earning the going rate of profit on the capital he must tie up.

Such a charge would exclude any cost of materials or direct labor, since no product would actually change hands, and all but a skeleton level of administrative overhead. In terms of our earlier example of Big John and Little Joe, a new Little Joe, contemplating entry into the field against Big John, could make a contract in which he agrees to sell a unit of his product at $1 for the life of his capacity, and to accept a fee of, say, 20¢ for each unit not bought. The 20¢, or whatever the comparable figure might be, would cover Little Joe’s depreciation charges,

the cost of maintaining a minimal organization in being, and the profit on the capital invested in the plant, which might have to function sometimes on a standby basis only. (If Little Joe is already in the business, then, depending on his operating cost, it might be worth his while to agree if necessary perhaps to a price as low as 90¢ or even 85¢, and a penalty charge of as little as 10¢ or even 5¢, since his investment in plant has already been made and it represents the lesser loss to accept such terms than simply to go out of business.)

Under such an arrangement, the small competitor’s position is made secure, and the buyers are able to place a permanent upper limit on the price they have to pay. If Big John is to obtain their business, he must offer a price that is lower than Little Joe’s by more than the penalty charge, which means that he ends up financing the penalty charge. (He ends up financing it, because once his price falls below Little Joe’s by the amount of the penalty charge, the buyers save in the lower price as much as they pay in the penalty charge.) If Big John does not wish to price that low in order to obtain their business—if he wants their business at a price close to Little Joe’s full price—the only way to obtain it is by offering it on a permanent basis. This means that Big John will have to offer longterm contracts with a specified price. In that way, upon the expiration of the life of Little Joe’s capacity, he might obtain the latter’s business if his longterm contract price is lower than little Joe needs to make replacement worthwhile. But, for the reasons explained, it is unlikely that it will pay Big John to reduce the price on his vastly greater volume in order to obtain Little’s Joe’s modest share of the market.

At the retail level, contract pricing might take the form of customers joining a buyers’ club, for which they pay a flat fee that defrays the seller’s costs of staying in business and that guarantees them the right to buy the item at a low price. It is worth noting in addition that at the retail level elements of consumer tastes and preferences enter which almost always establish niches of small competitors that are impossible to dislodge even with substantially lower prices that are permanent. For example, there are all kinds of small stores that have stayed in business through offering greater convenience and more personal service and so forth, despite much lower prices being charged by the chain stores and department stores. Starting from this relatively secure base, such stores are in a position to take away a substantial volume of business from the chains and department stores, should the latter significantly increase their prices.

The Predatory-Pricing Doctrine and the Inversion of Economic History

As previously indicated, the implication of the predatory-pricing doctrine is that real costs and prices both in retailing and everywhere else have tended to increase because of the alleged monopolistic character of the chain stores and of big business in general. In the view of the predatory-pricing doctrine, the development of chain stores and big business does not have any basis in greater economic efficiency, but serves only as a means of raising prices. The implication of the doctrine is that from the point of view of the consumers, the days when all that existed were local general stores, whale oil, and blacksmith shops were the good old days. These days have passed because those suppliers were put out of business by predatory pricing. Now all that exists is price gouging.

It is difficult to imagine a view of things more at odds with the facts. But this is the view implied by the predatory-pricing doctrine. It totally ignores the efficiencies of the chain stores and of big business in general, and that the firms which became big did so by providing better products at lower costs of production. Typically, such firms did not start out as big businesses, but became big businesses on the basis of the high profits they earned by virtue of their greater efficiency and which they constantly plowed back. And those firms which began as the result of mergers of already existing firms grew much further—both in terms of the quantity and quality of their output and in terms of their efficiency and capital investment. It is impossible to reconcile the actual economic expansion—the constant increase in capital invested and the constant fall in real costs and prices—throughout the domain of big business over the last five generations, with the contention that big business achieves high profits by means of high prices based on diminished production.

The Myth of Predation With Respect to Suppliers

A notion similar to the predatory-pricing doctrine is the belief that large firms are in a position to deprive their small competitors of access to vital supplies. By means of threatening to withdraw their own business, or by means of bribery, they allegedly induce such suppliers either to refuse to deal with the small firm or to do so only on terms that are unprofitable to it.

The fallacy present in this belief is essentially similar to that which exists in the predatory-pricing doctrine. It overlooks the fact that if the large firm seriously wished to pursue such a policy, it would have to make dealing with it rather than the small competitor more profitable to every actual and potential supplier to whom the small competitor might turn, and to offer more to them not only than the small competitor is currently capable of doing, but also is potentially capable of doing in the future.

It must be realized that the small competitor only needs to find one supplier, and that to stop him from

doing so, the large firm must close off every actual and potential supplier. Moreover, to whatever extent the small firm offers the prospect of becoming larger and thus of offering more business to a supplier as time goes on, it is the profit on that volume of business that the large firm must exceed in its offers.

Furthermore, when one takes into account the fact that the purpose of the large firm in driving out the small firm is supposed to be to sharply increase the price of the product, the position of the small firm must be regarded as all the more secure. This is because the prosperity of the industry’s suppliers then depends on the continued existence of competitors to the large firm. As previously explained, if the large firm were actually to be capable of succeeding in raising the price, the effect would be a smaller quantity of the product demanded and thus less demand for the product or service of the suppliers. In other words, the suppliers’ market depends on the continued existence of the small firm in these conditions. And that is why, indeed, they can be assumed to be an actual ally of the small firm, rather than a partner in its destruction.

While the multiple of cost to the large firm is increased to the degree that its small competitor has access to a larger number of suppliers or potential suppliers, it should not be assumed that if there are only few suppliers or potential suppliers, this represents any kind of advantage to the large firm. On the contrary, even if there were only some definite, delimited number of suppliers or potential suppliers who would need to be secured against the small firm, the large firm would be unable to take comfort in that fact. The consequence would be that any one of the suppliers or potential suppliers with sufficient capacity to meet the requirements of the small firm would be in a position to demand a lion’s share of whatever additional profits might be earned by virtue of the absence of the small competitor and the consequent alleged ability to charge substantially higher prices. In other words, since the large firm’s extra profit would depend on the cooperation of all of the suppliers and potential suppliers, each of them would be in a position to demand the greater part or almost all of the presumed extra profits.

The Myth of Standard Oil and the

South Improvement Company

In the light of the above, one can regard the story of Standard Oil and the South Improvement Company as a historical fable, at least as far as the interpretation goes that is usually placed upon it. According to a typical account, in a widely used textbook of economic history:

In 1870 Standard Oil was producing about 10 per cent of the country’s output of refined oil. This quickly increased to 20 per cent by an ingenious and notorious scheme involving the South Improvement Company in 1872. Refiners associated with the South Improvement Company were to receive rebates, presumably for acting as “eveners” in the oil traffic pool formed at the same time among the Pennsylvania, New York Central, and Erie Railroads. The open rate on crude oil by rail from the oil regions in western Pennsylvania to Cleveland was to be 80 cents per barrel, and the open rate on refined products from Cleveland to New York City was to be two dollars ($2.00) per barrel. Thus the combined open rate was $2.80. The open rate was the same to all shippers, but the members of the South Improvement Company were to receive a secret rebate of 90 cents (40 cents on crude and 50 cents on refined products). In addition to a rebate on all their own shipments, members of the South Improvement Company were also to receive the same rebate on all petroleum shipped by their competitors. Thus the harder their competitors worked, the more money Rockefeller and his associates would make. . . .

Armed with this contract, Standard representatives bought out most of their competitors. Within three months twentyone of twenty-six Cleveland refiners went out of business. Their plants were either junked or put into use by Standard Oil producers. Although the agreement was signed between the railways and the South Improvement Company the scheme never actually went into operation so far as railway rates were concerned. Yet it was fully effective in achieving its purpose: the elimination of competition. 46

The meaning of these passages is that Standard Oil somehow managed to obtain an arbitrary discrimination in railroad rates in its favor, for the purpose of eliminating its competitors. Interestingly, the passages note that at the time Standard was not even a particularly large firm (it had only 10 percent of the market), and the railroads did not actually increase rates to Standard’s competitors, but cut them to Standard. Apart from a reference to “acting as ‘eveners,’” the meaning of which is left unexplained and which is dismissed contemptuously, no explanation is offered of why the railroads would do such a thing. It is apparently thought to be sufficient merely to conjure up an aura of big business and sinister machinations, and to let it go at that.

Without having investigated the historical facts, but approaching the matter with a framework of a knowledge of economic principles, I am confident that if the actual facts were known, an entirely different interpretation would have to be placed upon the episode than the one in the above passages. My confidence is comparable to that of a natural scientist upon hearing a tale of some miracle. He knows automatically that a rational explanation is to be found.

If the episode occurred at all (and the admission that “the scheme never actually went into operation” indicates that perhaps even this should be questioned), then I would offer the following hypothesis. Namely, that Standard Oil devised a plan for regular largescale ship—

ments of oil and oil products which substantially reduced the railroads’ costs of transportation and, at the same time, gave promise of a substantial increase in the total volume of shipments. In return, Standard deservedly received the rebate. It received a rebate on its competitors’ shipments as well, insofar as its transportation plan made it possible for the railroads to save money on their shipments by tying them into Standard’s plan. The basis for the buyout of most of its Cleveland competitors was probably the fact that the transportation plan could be made more effective by making their volume directly subject to its control. On the basis of prospective major cost savings in transportation, Standard was able to buy out the competitors at prices profitable to them. 47

8. Marginal Revenue and the Alleged “Monopolistic Restriction” of Supply

The doctrine of an alleged tendency toward a growing concentration of capital in fewer and fewer hands— whether it is to be achieved by means of mergers or by means of predatory price cutting—can now be judged to have been laid to rest. Yet the economic concept of monopoly advances another claim, that is less sweeping, but still quite serious. This is the doctrine that to the degree that a firm is large relative to the size of the market it serves, it is motivated to restrict its production to a quantity of product that is less than what in some sense it “should produce.”

The following example provides an illustration of this doctrine in its comparatively more reasonable form. Thus, let us imagine an industry in which there is only a single firm—an out-and-out “monopolist,” according to the economic concept of monopoly. At present, this firm produces an output of 100 units of product, which it sells at a price of $15 per unit. Its cost of production is $8 per unit. Thus, its sales revenues are $1,500, its total cost is $800, and its profit is $700. The firm is considering the question of whether or not it should produce and sell a second 100 units of its product. If it does, it will have to reduce its selling price to something less than $15. Let us imagine that $9 will be the price necessary to attract buyers for a total of 200 units. We can assume that the firm’s cost of production per unit will remain at $8.

I have chosen to assume that the price will have to be $9 and that the cost per unit will remain $8 because these figures imply that the production of the second 100 units, if considered in their own right—that is, independently, apart from the effect on anything else—is profitable. The second 100 units will bring in sales revenue of $900 and will be produced at a cost of $800. Thus, they will bring in a net profit of $100, which can reasonably be assumed to constitute a sufficient amount of profit to constitute the going, competitive rate of profit on the capital which must be invested in their production. Consequently, by the ordinary standard of profitability, this second 100 units should be produced.

Nevertheless, argue the supporters of the economic concept of monopoly, our firm will find it unprofitable to produce them. This is because it must consider something besides the profitability of producing the second 100 units in their own right. It must also consider the effect on its profits of having to sell the quantity it is already selling, namely, the first 100 units, at the reduced price of $9. This aspect of the situation represents a $600 reduction in its profits. This is because instead of selling those first 100 units at a price of $15, and thereby bringing in sales revenues of $1,500, it now must sell those first 100 units at a price of only $9 and thus earn sales revenues of only $900. Given its total cost of $800 to produce the first 100 units, this means that the profit it earns on them falls from $1,500 minus $800 to $900 minus $800, viz., by $600.

This fact, it is held, far outweighs the fact that the sale of the second 100 units nets a profit of $100, for the gaining of this $100 profit requires the simultaneous reduction of $600 in the profits already being earned on the first 100 units. And thus, the effect of expanding its production from 100 to 200 units is, for this “monopoly” firm, to reduce its overall, total profit from $700 to $200—an overall, net reduction of $500 in its profits. As a result, it is held, it will not produce the second 100 units. It will prefer instead to keep its output at 100 units and its price at $15. And the buying public will thus be correspondingly deprived. Table 10–1 summarizes all the relevant data.

The table includes the headings “Marginal Revenue” and “Marginal Revenue per Unit.” Marginal revenue is the change in total revenue that accompanies a change in quantity produced and sold. In this case, it is $300. In selling 200 units at $9 per unit, instead of 100 units at $15 per unit, our firm would end up increasing its total sales revenue by only $300, because the $900 received for the second 100 units of its product would be accompanied by a $600 reduction in the revenues received for the sale of its first 100 units. Marginal revenue per unit is simply the total marginal revenue, in this case $300, divided by the additional number of units, in this case 100 units.

The relevant consideration for our firm in deciding whether or not to increase its production—and, indeed, for any firm that must reduce the selling price of its product in order to sell a larger quantity of it—is not, it is held, whether the new selling price exceeds the unit cost of the additional products by enough to provide a competitive rate of profit. The relevant consideration is,

MONOPOLY VS. FREEDOM OF COMPETITION 409

Table 10–1

Marginal Revenue and the Alleged Incentive of a “Monopoly” Firm to “Restrict” Its Production

Total Marginal

Quantity Price

Revenue Revenue

100 $15 $1,500 —

200 $9 $1,800 $300 allegedly, whether or not the marginal revenue per unit, rather than the price, exceeds the unit cost of the additional output. The marginal revenue per unit takes into account the drop in price on the quantity that is already being sold. In the present case it is $3, reflecting the combined effect of receiving a selling price of $9 on the increase in quantity sold from 100 to 200 units and having to accept a price reduction of $6 on the initial 100 units.

This belief, that marginal revenue, rather than price, is the relevant item for a firm to compare with its cost in deciding whether or not to expand output can be called the marginal-revenue doctrine.

It is on the basis of the marginal-revenue doctrine that it is held that to the degree that a firm is large relative to the market it serves, it is correspondingly less motivated to expand its production. To the degree that the firm is large, it is argued, the more will its marginal revenue per unit accompanying any increase in its production fall short of the selling price that accompanies that additional production. For it will experience the fall in price that is associated with its additional production on a correspondingly larger initial quantity. Thus, the more strongly will it be motivated not to expand its production, despite the fact that by the standard of the profitability of the additional output considered in its own right, output should be expanded.

A “monopolist,” it is held, has the least incentive to expand, for he must experience the price reduction on the full quantity of the product presently sold. But a firm that initially produces and sells only half, or even a tenth, of the total output of an industry, can also have a powerful incentive not to expand its production, according to the marginal-revenue doctrine.

This last claim can be illustrated by imagining that the initial output of the industry is 10 times larger than previously assumed—1,000 units instead of 100. Our firm produces 100 units out of the 1,000 and is contemplating whether or not it should produce 200 units. If the

Marginal

Unit Total

Revenue Profit

Cost Cost per Unit

— $8 $800 $700

$3 $8 $1,600 $200 production of this second 100 units for our firm, which at the same time is the production of an eleventh 100 units for the industry as a whole, should necessitate a reduction in the selling price of the industry’s product to $9, then, it is argued, everything would be just as before from the perspective of our firm. It would allegedly not expand its output because doing so would require too great a reduction in the selling price of the quantity it was already selling.

From the point of view of the supporters of the marginal-revenue doctrine, the only difference between this case and the first case is that the demand curve of the industry is now less elastic. In the first case, it takes a doubling of the output of the industry to necessitate a price reduction of 40 percent. In the present case, it takes an increase in the industry’s output of only 10 percent to necessitate a price reduction of 40 percent. The percentage change in the quantity demanded of the industry’s product relative to the percentage change in the price of the product necessary to achieve that percentage change in quantity demanded—which is the definition of elasticity—is one-tenth as great in the present case.

However, given the same elasticity of demand for the product of the industry as a whole, it follows from the marginal-revenue doctrine that the smaller the size of the firm relative to the industry, the greater will be its incentive to increase its production. If we retain the assumption that our firm initially produces 100 units out of an industry total of 1,000, and that the elasticity of demand for the product of the industry as a whole is no lower than it was in our first example, then a 10 percent increase in the industry’s supply, brought about by a doubling of our one particular firm’s supply, will cause perhaps only a 4 percent reduction in the industry’s selling price—viz., from $15.00 to $14.40. (The assumption here is that a 10 percent increase in the industry’s supply necessitates a price reduction only one-tenth as great as a 100 percent increase in the industry’s supply—in this case, 4 percent instead of 40 percent. 48 ) Thus, in this case, it supposedly

pays the firm to double its output, for it now takes in $2,880 in sales revenues (200 x $14.40) and, with total costs of $1,600, it earns a substantially increased profit of $1,280 instead of $700.

Given the elasticity of demand for the product of the industry, the elasticity of demand for the product of an individual firm, it is held, is inversely proportionate to the smallness of its size in the industry as a whole. To the degree that the firm is small, what appears as a large relative increase in its own production is nevertheless a small percentage increase in the production of the industry as a whole, and thus results in a reduction in selling price that is correspondingly small. For instance, in the present example, a 100 percent increase in the firm’s own output constitutes a mere 10 percent increase in the output of the industry as a whole and necessitates a reduction in selling price only in accordance with the 10 percent increase in the overall supply of the industry, not a doubling of the supply of the industry. If the firm initially represented 1 percent of the industry instead of 10 percent, then, it is argued, a doubling of its supply would constitute only a 1 percent increase in the industry’s supply and would thus be accompanied by the still more modest price reduction accompanying this much lesser increase in the industry’s supply. And thus the incentive of the firm to increase its production would be greater still. It is on this basis that contemporary economic theory has long preceded the environmental movement in subscribing to the cliché that “big is bad and small is beautiful”—at least when it comes to business.

It should be observed, however, that there is an important and paradoxical difference between the contemporary economist’s and the ecologist’s attachment to this cliché. What the contemporary economist is actually criticizing the large firm for is its failure to produce still more and thus to become larger still. What he is applauding the small firm for is its presumed readiness to produce more and thus to become larger. There are two elements of paradox present in this. First, if the large firm did produce all that it is supposed to produce—if, for example, in our initial illustration the firm did produce the 200 units and accept the price of $9—it would then be denounced as a monopoly. Thus, it is denounced as a monopoly if it does produce the extra 100 units, and denounced as monopolistically restricting supply if it doesn’t produce the extra 100 units. It is in the same position as the poor Russian worker under the Soviet regime, who was guilty of spying if he came to work early, sabotage if he arrived late, and of having a capitalist watch if he came on time. Second, if it is the case that the large firm will not produce the extra units, and the small firm or new entrant will, then the whole alleged problem simply disappears. The large firm ceases to be relatively so large, as it holds its production steady and small firms expand or new entrants appear. As far as it exists, such behavior on the part of the large firm would simply be one more reason why there is normally more than one firm in an industry.

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The marginal-revenue doctrine is usually not presented in such relatively simple and therefore clear terms as it has been presented here. In particular, no special stress is normally laid on the production of the additional units being profitable in their own right. Thus, the implications of that fact are rarely if ever considered. It is simply established that there are circumstances in which a large firm, especially a “monopolist,” could gain more by producing less. But because it has stressed this aspect, the preceding exposition suggests a profound and very obvious difficulty with the marginal-revenue doctrine.

This difficulty can be seen clearly even in the seemingly strongest case in favor of the marginal-revenue doctrine, namely, that of the socalled out and out monopolist, in which there is just one seller. The difficulty is that unless this firm produces a product which others are simply physically unable to produce, or, more likely, are forcibly prevented from producing by the government (rightly so in the case of patents and copyrights), its actual choice is not such as between producing and selling 100 units at a price of $15 or 200 units at a price of $9, but between 100 units at a price of $9 or 200 units at a price of $9. Apart from the exceptions just mentioned, so long as the second 100 units are profitable in their own right, they will be produced. The only question is whether they will be produced by the firm that is already producing 100 units or by another firm. In the latter case, the first firm ends up selling at $9, but only 100 units instead of 200 units.

The principle here is that where competition is physically possible and is peaceful—that is, in which the same or a similar good is capable of being produced by others without violation of anyone’s intellectual property rights— and is legally free, the decision of any seller or group of sellers to produce less, or not to produce at all, cannot lastingly establish a selling price that is above the cost of production, plus allowance for the going rate of profit, of potential competitors. Under such conditions, it is impossible for anyone to charge prices significantly higher than would be required for a potential new entrant into the industry to make a competitive rate of profit—except in the case of temporary scarcity, and except to the extent that one’s product may be of premium quality over his.

If one does charge a price above the point an outsider needs to be profitable, the outsider enters, and, for the reasons explained in the preceding section, one cannot then reverse field and resort to the policy of driving him

MONOPOLY VS. FREEDOM OF COMPETITION 411 out by means of ruinous prices. One simply loses volume and must accept the lower price he will charge. The upper limit to one’s price, therefore, is set by the cost of production of potential new entrants. If one goes higher than their cost plus an allowance for the competitive rate of profit they would require, one loses more and more volume, until one is finally driven out oneself or accepts the fact that one cannot exceed this limit in price.

One’s price may certainly be lower than this limit, and will be whenever one has a lower cost of production than the outsiders and it is more profitable to charge a lower price. But it cannot be higher. As previously stated, the cost of production of potential new entrants constitutes an objective given that limits one’s price. One’s only choice is to sell either a smaller volume at that cost-limited price or a larger volume at that cost-limited price or a still larger volume at a lower price. But one cannot get a higher price.

If one allows for the time that may be required for new firms to enter a field, one can say that irrespective of the elasticity or inelasticity of the demand for the product of an industry as a whole, the elasticity of the demand for the product of any individual firm, however large, is virtually infinite if it charges a price above outsiders’ costs plus allowance for the going rate of profit. At such a price, or just below it, it can potentially sell the full quantity demanded at that price. Above such a price, it will sell little or nothing.

In the face of competitors already in the field, the pressures for a price limited by outsiders’ costs are all the more intense. The pricing of the whole group of present producers must be limited by this consideration even if they were formed into a single combination. Acting separately and independently, however, the acceptance by any of them of the need to make his price conform to the cost of production places the others under a powerful immediate pressure to limit their price in the same way. For whoever charges more than the cost-limited price will immediately lose substantial volume to those who do not (unless his product is of such premium quality over theirs as to justify the premium price he charges).

To state matters further in terms of the concept of elasticity of demand, one must say that under the freedom of competition the elasticity of demand for the product of any individual company or group of companies at a price above outsiders’ costs plus allowance for the going rate of profit, is determined by the sum of the elasticity of demand for the product of the industry as a whole plus the elasticity of supply of competitors and potential competitors. That is, at such a price, the quantity of the firm’s product that is demanded falls not only in accordance with the amount by which quantity demanded from the industry falls, but also by the amount by which the supply provided by competitors and potential competitors increases, for their sales will be made at its expense. And thus, while the demand curve facing the industry as a whole may be almost perfectly inelastic, or, indeed, actually be perfectly inelastic, the demand curve facing any individual firm in the industry tends to be perfectly elastic at a price above outsiders’ costs plus allowance for the going rate of profit. 49

Competitors’ and Potential Competitors’ Costs—Ultimately, Legal Freedom of Entry—as Setting the

Upper Limit to Prices in a Free Market

The implication of the preceding discussion is that in a free market, prices of products are normally determined by cost of production—if not one’s own cost of production, then at least that of competitors or potential competitors, which cost product prices must not exceed by more than an amount of profit sufficient to provide the going rate of profit. It is further implicit in the preceding discussion that legal freedom of entry is the essential foundation of competitive price determination. For it is legal freedom of entry that is necessary to make possible the threat of new entrants, whose costs determine the upper limit to almost every industry’s prices.

In contrast, the elasticity or inelasticity of demand— that is, the extent of the willingness of buyers to pay higher prices for smaller quantities of the product—usually does not enter into the determination of prices, and, as will be demonstrated later in this section, plays only a limited role even in the cases in which it does enter. 50 The demand for many goods is extremely inelastic, meaning that if it were possible to achieve even modest reductions in their supply, sharply higher prices could be obtained. All kinds of spare parts, manufacturing components, inexpensive supplies, and necessities fall into this category. Imagine how much every buyer of spark plugs, fan belts, fuel pumps, carburetors, nails, screws, paper clips, bread, and table salt would be willing to pay even for the marginal unit he now buys, if he had no choice. Certainly, it would be a substantially higher price than he does pay in most such instances. Every spare part, if priced on the basis of its own marginal utility, would be worth the full value of the product it restores to operation: e.g., the marginal fan belt or carburetor would have the value of the marginal automobile. And even in the cases in which the present marginal unit might not bring a higher price, a very slight reduction in supply would so elevate the importance of the marginal unit as to bring about a sharply higher price.

Imagine for the moment that because of a very slight reduction in its production and supply, the amount of table salt annually consumed had to be reduced by as little as 1 percent, indeed, by just .1 percent, of what is

presently consumed. Consider how high the price of table salt would have to rise from its present level to make buyers economize on their use of table salt even to this extremely modest extent—to be careful to get more of the salt on the food rather than elsewhere on the plate or on the table cloth. The price of table salt might very well have to go up by a factor of five or ten times or more, to make people conscious of this need to economize on its use, given how cheap it now is.

It should be obvious that what the buyers would be willing to pay for table salt—or any of the other goods mentioned—if its supply were the least bit smaller, is totally irrelevant to the price they actually do have to pay for it in all normal circumstances. Its actual price is set within the much lower limit determined by the cost of production plus competitive profit of potential new producers. And were there only one seller of table salt rather than the comparatively small number that presently exist, and he were subject to the legal freedom of competition, its price would be determined no differently.

Perhaps the most powerful factor operating to keep prices in line with cost of production, irrespective of the elasticity of demand for the product, is the existence of formal or informal contractual arrangements. Prices set by contract are routinely ignored in economic theory, except as an alleged impediment to the adjustment of prices to the currently prevailing market forces. Nevertheless it is vital to recognize the role of contractual arrangements in removing the relative inelasticity of demand as a factor influencing price determination and in making cost of production the determinant of price.

Because of the ability to enter into contractual agreements, buyers can safely rely on small numbers of sellers— indeed, even just one seller—to serve as their source of supply, no matter how inelastic the demand for the good in question may be. The prices set under the contracts are cost-limited prices, in that they are limited at least by the costs of other potential suppliers, and are normally below the prices required by those other potential suppliers for the latter to be sufficiently profitable. (That is why the contracts are made with the particular suppliers they are made with, and not with other, merely potential suppliers.) Although limited by cost, such prices can easily be made to reflect the operation of current market forces, by being allowed to vary with one or more of the prices that enter into the supplier’s current costs, and which he is not in a position to determine. For example, a contractually determined price of electric power might contain a provision for variability with the price of coal; a contractually determined price of components or supplies might contain a provision for variability with the price of the principle raw materials used in their production.

The setting of prices by contract, on the basis of cost, prevents the possible inelasticity of demand for the product from being a factor in setting prices because the sellers are unable to obtain any higher price on whatever quantities they have agreed to sell under contract. Indeed, it may well be the case that the contractual arrangement gives buyers the right to purchase a variable quantity at the contractual price, with the result that, in effect, there are buyers who hold options on additional supplies at contractually set prices. In the face of such contractual arrangements, it may simply be impossible for the seller or sellers to reduce the market supply at all. And to the extent that it may still be possible for them to do so—only temporarily, of course—they are placed in a position in which the major beneficiary of their action would not be themselves, but the buyers who have the right to buy at contractually fixed prices.

To illustrate these points, let us consider once more our example of the ability to sell 200 units at a price of $9 and 100 units at a price of $15. Let us imagine that the firm producing the first 100 units has decided to forestall the entry of an outside firm and itself to produce and sell all 200 units at the price of $9. Thus, it is the sole supplier of the full competitive quantity at the competitive price.

Contract pricing prevents this firm from deciding from time to time to cut production back to 100 units in order to raise the price back up to $15. Even if only half of its output—100 of its 200 units—is sold at a contractual price of $9, it loses any motivation to cut back its production. If it did decide to produce 100 instead of 200 units, then, even without any competitor entering the field, the effect would be that it would sell 100 units at $9 instead of 200 units at $9, because those 100 units would be bought by the contract holders at a price of $9. Contract pricing operates to make the demand curve facing this firm perfectly elastic even in the immediate moment. Because of contract pricing, its choice in the immediate moment is reduced to whether it should sell 100 units at $9 or 200 units at $9.

And if for any reason this firm did produce only 100 units, the only possible beneficiaries of the resulting market price of $15 would be the firm’s customers who held contractual rights. They would buy the product at the contractually fixed price of $9 and would be able to sell it at the higher open-market price of $15. In these conditions, it bears repeating, even the short-run interest of our firm is to produce and sell 200 units rather than only 100 units. (It should be observed that if our firm decided to produce any intermediate amount of output, between 100 and 200 units, it would gain any higher price only on the quantity it produced in excess of 100 units, while its customers who had contracts gained the rise in price on their 100 units. The profits earned by the cus—

tomers on their 100 units could be used to finance a new competitor or new sources of supply under their own, direct control. The result would be that if our firm did decide to reduce its production below 200 units, it would set the stage for being faced with a new competitor or with a permanent reduction in the quantity demanded from it because its customers developed their own sources of supply—or it would end up having to sell a still larger portion of its output under contract. Or some combination of all three possibilities would result. In any event, the firm would not be able to repeat the procedure and would probably find it inadvisable to resort to it in the first place.)

This example illustrates the fact that in a free market, with substantial portions of output sold under contract, there need be no danger even of short-run arbitrary increases in price—even in situations of the most highly inelastic industry demand and in which there is just one supplier. Thus, even if there were just one producer of table salt, it would probably not be possible for him even temporarily to take advantage of the inelasticity of demand for table salt. His customers—grocery-store chains and wholesale jobbers who distribute to small retail grocers—would almost certainly obligate him to deliver at a contractually set price, limited by the cost of production of other potential producers, a quantity of table salt that, at their option, actually exceeds the quantity that is demanded from them at a normal retail or wholesale price of table salt. In such circumstances, even in this extreme case it would be impossible for the supplier to restrict the supply and raise the price.

Indeed, the fact that the price of table salt and of other goods with a comparably inelastic demand does not periodically shoot up in an effort to exploit the high inelasticity of demand can probably be explained only by the existence of contractual arrangements. For even when such goods are supplied by ten or twenty suppliers, in the absence of extensive formal or informal contractual arrangements, any one of the suppliers would probably be physically capable of reducing the industry’s supply by the relatively tiny amount necessary to make its price skyrocket. Contractual arrangements, however, tie the price to cost on such a volume of output that no producer is in a position to reduce the supply below what the market demands at the cost-determined price, or would find it profitable to do so even if he were temporarily capable of doing so. Typically, a reduction in production by any one producer can be offset by an increase in production by others. And even if it cannot, it would not pay him.

The role of cost of production, rather than elasticity of demand, in the determination of prices is further evident in such cases as an excise tax increase on cigarettes. Cigarettes are a good that is faced with a highly inelastic demand and which is produced by only a handful of firms. When the excise tax on cigarettes is increased, the price of cigarettes is correspondingly increased. At the higher price there is very little reduction in the quantity of cigarettes demanded, and the tobacco industry’s pretax sales revenues sharply increase. The tobacco industry raises its price when the excise tax is increased because that is a factor raising the costs of doing business of all producers and potential producers.

In the absence of such a factor that increases costs to everyone, the tobacco industry would not be able to raise its price, despite the fact that if it could succeed in doing so all the firms would have sharply higher sales revenues and profits. By the same token, if the excise tax on cigarettes is reduced, or some other development occurs which broadly reduces the cost of providing cigarettes, the price of cigarettes must be correspondingly reduced.

The reason is that the existence of exceptionally high profits not based on any special advantage in cost of production or premium in quality would be an invitation for the entry of one or more new cigarette companies, including all kinds of house brands marketed by retailers. The ability of a tobacco company to retain the volume of business it does with many of its major customers, such as wholesalers and supermarket and drugstore chains, is contingent on the price it charges being reflective of the cost of production on the part of such other potential producers. It is clear that this is a case in which price is governed by cost of production, not by the elasticity or inelasticity of the demand for the product.

It is implicit in the present discussion that a major factor that directly ties the prices of products to their cost of production is the potential competition which can take place between producers at different stages of the productive process. If, for example, the tobacco companies were to raise or keep up the price of cigarettes without any objective foundation in the form of higher costs for all potential competitors, their action would be contrary to the interests both of their customers—wholesalers and retailers of cigarettes—and of their suppliers—most notably, the tobacco growers. The higher price they charged would be perceived as an unnecessarily higher cost of doing business by the cigarette wholesalers and large retailers, who would be on the lookout for lower-cost sources of supply. At the same time, when passed forward to the consumer, the higher price would result in some reduction in the quantity demanded of cigarettes and thus in some reduction in the demand for and price of cigarette tobacco. Thus, tobacco growers would have a powerful interest in the reduction in the price of cigarettes to the consumer, in order to restore the demand for and price of their tobacco leaf. If the tobacco companies

414 CAPITALISM want to avoid giving the tobacco wholesalers and retailers a motive to move backward, and the tobacco growers a motive to move forward, into cigarette manufacturing, they must keep the price of cigarettes below the level of outsiders’ costs plus allowance for the competitive rate of profit. The same principle applies, of course, to producers at different stages in the productive process in all other industries. 51

Ricardo and Böhm-Bawerk on Cost of Production

Versus the Elasticity of Demand

The much-maligned doctrines of the eminent classical economist David Ricardo on the subject of cost of production as a determinant of prices should be taken as the basis for the critique of the marginal-revenue doctrine rather than support for Marxism. In a letter to Malthus, he writes in criticism of Say:

He certainly has not a correct notion of what is meant by value, when he contends that a commodity is valuable in proportion to its utility. This would be true if buyers only regulated the value of commodities; then indeed we might expect that all men would be willing to give a price for things in proportion to the estimation in which they held them, but the fact appears to me to be that the buyers have the least in the world to do in regulating price—it is all done by the competition of the sellers, and however the buyers might be really willing to give more . . . they could not, because the supply would be regulated by the cost of production . . . . 52

This and similar passages are perfectly correct if understood not as presenting a universal and primary proposition, but one which is descriptive of conditions in the case of reproducible goods for which the demand is highly inelastic. In such cases, the valuations of the buyers are, indeed, clearly rendered irrelevant. The freedom of competition prevents the sellers from exploiting the inelasticity of demand and obtaining a price that would come up to the marginal valuation of the product by the buyers (or their marginal valuation of a slightly reduced supply). Competition sets the price at the much lower point corresponding to the cost of production of the item.

Observe. There is no necessary implication here that cost of production can make anything more valuable than corresponds to its marginal utility, but only that it can make something less valuable than corresponds to its direct marginal utility. Understood in this way, Ricardo’s doctrine is perfectly reconcilable with the views of Böhm-Bawerk, despite the latter’s espousal of the seemingly totally contradictory proposition that “price is actually limited and determined by the valuations on the part of the buyers exclusively.” 53

In advancing this proposition, Böhm-Bawerk has in mind merely the personal, subjective valuations of the sellers. These he rightly dismisses as a determinant of prices, on the grounds that in modern conditions of division of labor, in which goods are produced in quantities far beyond any possible personal requirements of their producers, the marginal utility of almost the whole supply of most goods is virtually zero to the sellers. 54 Determination of price by cost of production, however, is something very different than its determination by the personal, subjective valuations of the sellers. Indeed, Böhm-Bawerk himself demonstrates precisely how determination of price by cost of production is fully consistent with determination by the marginal utility of products to buyers, and is actually an essential aspect of that determination.

Because so many who claim to be Austrian economists have apparently never read Böhm-Bawerk on this vital point, I quote him at length:

Up to this point in our discussion the law of the value of production goods was developed subject to the simplifying hypothesis that every group of means of production admits of utilization only to one very definite purpose. That hypothesis is in real life only very rarely in agreement with the facts. It is preeminently production goods, far more than consumption goods, which are characterized by egregious heterogeneity. The overwhelming majority of them will be capable of service in several productive fields, some are adaptable to thousands of such productive services. Examples are iron, coal, and above all, human labor. Of course, we have to take these factual circumstances into account in conducting our theoretical investigation. We must observe what modifications, if any, affect the law that the value of a group of goods occupying remote orders is governed by the value of their product.

Let us alter the order of the presuppositions of our typical example accordingly. Someone possesses a rather large supply of means of production of second order (G 2 ). From each of these groups he can produce at will a consumption good of the category A, or one of category B or finally, of category C. He desires, of course, to take advance measures toward balanced provision for his various wants, and will therefore draw simultaneously on various parts of his supply of means of production to produce consumption goods of all three categories. And he will produce amounts in each in accordance with his needs. If there is genuinely balanced provision, the quantities produced will be so regulated that needs of approximately equal importance depend upon the last specimen in each category, and that thus the marginal utilities are approximately equal. In spite of that it is not impossible that there will be differences— possibly even quite considerable differences—in the marginal utilities because, as we already know, the gradation of concrete wants occurring in any one category is not always either uniform or continuous. The first stove in my room will afford me a very considerable utility, say one we might designate with an index of 200. A second stove will afford no utility at all. I shall most emphatically call a halt in providing stoves when I have a single specimen with its

marginal utility of 200, even though in other areas provision for needs may see a dropping off of the average of marginal utility to as little as 120 or even 100. And so it is permissible and necessary, if our example is to be true to nature, to assume that the marginal utility of a specimen will be different in each of the categories A, B and C. Let us call it 100 for A, 120 for B and 200 for C.

Now the question arises, “What is the value, under these circumstances, of a group of means of production, G 2 ?”

We have had so much practice with selective decisions of a similar nature that we can give the answer without hesitation. The value will be equal to 100. For if one of the available groups of means of production should be lost, the owner would naturally shift the loss to the least sensitive area. He would not curtail production in category B where he would be sacrificing a marginal utility of 120, and certainly not in category C where the sacrifice would go as high as 200. He would quite simply produce one specimen fewer of category A where the reduction in wellbeing is only 100. Let us express it in general terms. The value of a unit of means of production is governed by the marginal utility and the value of that product which has the least marginal utility among all those products for the making of which the unit means of production could have justifiably been used.

All the relations which we had declared to be plainly in force with regard to the value of means of production and their products under the simplifying assumption of only a single possible disposition, are therefore generally valid as between the value of means of production and value of its least valuable product.

And what is the situation with respect to the other categories of products, B and C? That question brings us to the origin of the “law of costs.”

If under all circumstances the marginal utility attainable by a good within its own category were determinative, then the categories B and C would have to receive a value divergent not only from that of category A, but also from the value of its costs G 2 . B would then have a value of 120, C a value of 200. But here we are confronted with one of the cases where, through substitution, a possible loss in one category is transferred to another, and as a result, the marginal utility of the latter becomes determinative for the other as well. Thus, if a specimen of category C is lost, it is not necessary to forgo the marginal utility of 200 which the specimen would have delivered directly. Instead, it is possible to convert one unit of the means of production G 2 into a new specimen C, and in its place rather produce one specimen fewer in that category in which the marginal utility, and hence the loss in utility is least. And indeed that possibility becomes a reality. The category in question in our example is the category A. Because of the opportunity which production offers for substitution, a specimen C is therefore not valued in accordance with its own marginal utility of 200, but in accordance with the marginal utility of the least valuable related product, the product A; its value is therefore 100. The same applies, naturally, to the value of category B, and would apply generally to every category of good which is “productionally related” to A, and of which the direct marginal utility is also greater than that of category A.

This leads to some important consequences. The first is that in this way the value of goods having a higher individual marginal utility occupies the same rank as the value of the “marginal product”; 55 and hence also the same rank as the means of production from which both emanate. The identity which exists in principle between “value” and “costs” therefore obtains in this instance as well. But it is to be carefully noted that here the coinciding is brought about in quite a different way from that which was followed in the case of costs and marginal product. In the latter instance the two coincide because the value of the means of production accommodates itself to the value of the product. The value of the product is the determinant factor, the means of production is the factor that is determined. In our present case it is the other way around, and it is the value of the product that must do the accommodating. Ultimately it accommodates only to the value of another product. But initially it accommodates also to the value of the means of production from which it emanates and which brings about its substitutional connection with the marginal product. The transmission of value proceeds, so to speak, along a broken line. First it goes from the marginal product to the means of production, fixes the value of the latter, and then ascends in the opposite direction from the means of production to the other products which it is possible to produce from them. In the end product, then, the products of higher immediate marginal utility derive their value from their means of production. Let us translate the abstract formula into terms of concrete practice. Good B or good C is, in general, a product of higher immediate marginal utility. If now we consider what good B or C is worth to us our first response is, “Just exactly as much as the means of production are worth to us from which we can at any moment replace the product.” If we then inquire further and ask how much the means of production themselves are worth, we arrive at the marginal utility of the marginal product A. But on innumerable occasions we can spare ourselves this further inquiry. Time and again we already know the value of the goods that comprise the cost, without any necessity for working it out from its foundation and proceeding onward from case to case. And on all these occasions we simply determine the value of products by their costs, and in doing so we are taking advantage of an abbreviation which is as accurate as it is convenient.

And now the whole truth about the celebrated law of costs is revealed. It is indeed quite correct to say that costs govern value. Only it is imperative to remain aware of the limits within which this “law” is valid and of the source from which it derives its virtues. In the first place it is only a particular law. It is valid only so long as the possibility is present of furnishing, through production, substitute specimens in any quantity and at any time they are desired. 56 If there is no possibility of substitution, then in the case of each product, value must be determined by its immediate marginal utility in its own category. In that case its value no longer coincides with that of the marginal

416 CAPITALISM product and of the intermediate means of production. Therein lies the explanation of the empirically established principle that the law of costs is valid only for the goods that are “reproducible at will,” and that it is a law of only approximate validity. For it does not bind the goods over which it holds sway to slavishly meticulous adherence to costs. On the contrary, it permits fluctuations above and below such costs, depending on whether production at the moment lags behind demand or outstrips it.

A second and still more important consideration is that even where the law of costs is valid, those costs are not the final, but only an intermediate cause of the value of goods. In the last analysis, they do not give value to their products, but receive it from them. That is clear as crystal in the case of production goods for which there is only one productive use. Surely no one will wish to deny that it would be erroneous to assert that Tokay wine is valuable because Tokay vineyards possess value; everyone will concede that the truth is the other way around, and those vineyards have a high value because their product is highly valued. It is just as hopeless to deny that the value of a quicksilver mine depends on that of the quicksilver, the value of a wheatfield on that of wheat, the value of a brickkiln on that of brick, and not vice versa. Only because of the manysidedness of most cost goods is it possible for the situation to present the opposite appearance. As the moon reflects the light of the sun upon the earth, so do the manysided cost goods reflect the value which they receive from their marginal product on their other products. 57

What Böhm-Bawerk has shown in these passages is that when the price of goods such as fan belts, or anything else whose own, direct marginal utility is extremely high, is determined on the basis of cost of production, precisely then is its value determined on the basis of marginal utility—the marginal utility of the means of production used to produce it, as determined in other, less important employments. The buyer of a fan belt, or whatever, does not pay a price corresponding to the value he attaches to his car, but a much lower price corresponding to the marginal utility of the materials and labor required to produce fan belts or whatever—a marginal utility that in turn is determined by the marginal utility of products other than fan belts or whatever. As Böhm-Bawerk develops the law of diminishing marginal utility, it is no more surprising that the price of vital components and parts, or any necessity, is in conformity with its cost of production rather than its own direct marginal utility than it is that the marginal utility of the water on which our physical survival depends is no greater than the utility of the marginal quantity of water we use. Determination of price by cost is merely a mechanism by means of which the value of supramarginal products is reduced to the value of marginal products. The only complication is that the marginal products in this case are physically different and lie in other lines of production.

Views on costs very similar to those of Böhm-Bawerk are expressed by Friedrich von Wieser, another leading member of the early Austrian school of economists. Wieser flatly declares “. . . on the whole, the cases where costs directly determine value predominate.” 58

It should be clear that the notion that cost of production has no significant explanatory role in economics does not come from Böhm-Bawerk and Wieser. It comes from Jevons. It was Jevons who held that the only possible connection between cost of production and price was through the intermediary of variations in supply and that every price is actually determined by the specific demand for and supply of the individual good in question. 59

The principle actually elaborated by Böhm-Bawerk leads to the surprising conclusion that in one important respect the direct determination of price by cost, rather than by supply and demand, goes even beyond what Ricardo maintained. Namely, it exists even in cases of products like vintage wines, which are capable of being produced only in limited quantities. Ricardo described the prices of such goods as an exception to the general principle and as being determined by supply and demand rather than by cost of production. 60 It is true that the price of vintage wines is not determined by their cost of production. It is no less true, however, that the retail price of such wines is also not determined by the supply and demand for them retail store by retail store.

The actual fact, which is in accordance with the essentials of Böhm-Bawerk’s view, is that supply and demand and marginal utility determine the wholesale price of such wines—often at an actual auction, where the bidders are the major distributors, whose bids are limited by the prices they expect the ultimate consumers will be willing to pay. The wholesale price that is determined thus reflects the full range of consumer demand for the wine, not just the demand at any one retail location. The wholesale price, in turn, is then normally the immediate determinant of the retail price at all the individual retail locations. (The retail price, of course, may differ somewhat from location to location, depending on special circumstances). In effect, determination of price by cost is simply determination by supply and demand and by marginal utility operating across the whole of the relevant market or markets, not just the narrow market immediately concerned. Cost is what communicates to the narrow, individual market the state of supply and demand and marginal utility in these broader markets.

If contemporary economists had a greater familiarity with the writings of Ricardo and Böhm-Bawerk, they might not find themselves in the embarrassing position of writers such as Samuelson and Nordhaus, who, after devoting chapter after chapter to developing a theoretical analysis that is entirely dependent on the concept of

marginal revenue, are surprised to find that it is largely irrelevant to the real world and that they have no theory to explain the actual facts of pricing. Thus, in describing the actual pricing decisions of businesses, Samuelson and Nordhaus must write:

Here is where the surprise comes:

Armed with the information about sales and costs, you will almost surely never set your price by an MR [marginal revenue] and MC [marginal cost] comparison. Rather, you will generally take the calculated average cost of a product and mark it up by adding a fixed percentage—5 or 10 or 20 or 40 percent of the average cost. This cost-plus-markup figure then becomes the selling price. Note that if all goes as planned, the price will cover all direct and overhead costs and allow the firm a solid profit.

Investigators of actual business pricing policies have testified that corporations often do follow the above-described practice of quoting prices on a “costand-markup”

basis. Case after case shows that markup pricing is the norm in imperfectly competitive markets. 61

It is one of the great tragedies of contemporary economic theory that it has lost sight of the role of cost of production as the direct determinant of prices of most manufactured or processed goods precisely under normal conditions of free competition, which contemporary economists such as Samuelson and Nordhaus erroneously call “imperfect competition.” If a firm can assume that its own costs of production are no higher than its competitors’ or potential competitors’, then in setting its prices in conformity with its costs—that is, above its costs only by enough to earn the going rate of profit—it ensures that it is not likely to be undersold to any great extent, or to attract newcomers to its field. If it can assume that its own costs are significantly below those of its competitors, then, as already explained, it will want to set its price not too far above its competitors’ costs, as a maximum, so that they are not in a position to accumulate much capital and expand at its expense, and also in order not to provide an incentive for others to enter the industry. (If a firm’s costs are above those of its competitors, then except to the extent its product may be of premium quality over theirs, it must simply match the prices they set. It will continue to do so, so long as it is less unprofitable for it to remain in business than to withdraw from the field.) Only in the exceptional conditions in which the quantity demanded at a price determined by cost outruns the ability to produce from existing capacity, does the price lose its connection with cost of production and rise to a point determined by the demand for and limited supply of the specific product, that is, become governed by the direct marginal utility of the product. Even then, the demand and price are usually restrained by the prospect of return to normal conditions in the not too distant future.

In the absence of knowledge of the connection between prices and costs, and on the basis of the prevailing fallacy that the price of each and every product must be determined by the specific demand for and supply of the product—by its own independent marginal utility—contemporary economics is driven to the expectation that without the presence of a vast number of individually insignificant firms, sellers will be in a position to exploit the product’s elasticity of demand. Largely, on this basis, it denounces most branches of industry as “imperfectly competitive,” because they allegedly do not possess a sufficiently large number of sellers to avoid this.

In essence, it is on this basis that it regards big business per se in a way that should be reserved for one or a few firms operating under monopolistic legal protection against competition, but not when operating under the freedom of competition. And then, of course, in the last analysis, it finds that its theory simply does not fit the facts and that it has no applicable theory. Yet it retains the notion that most of the economic world is “imperfectly competitive” and that big business is inherently “monopolistic.”

Pricing Under Patents and Copyrights

Patents and copyrights place the producers who hold them in a position in which they alone decide the quantity of their product that is produced—or at least the quantity of it that is produced by means of their method of production. So long as the patent or copyright lasts, others are simply prevented from producing the good, or, at least, producing it by means of the patent or copyright holder’s method of production. 62 Nevertheless, as previously explained, patents and copyrights are in no sense a violation of the freedom of competition, but a vital safeguard of it. They protect the intellectual property rights on the basis of which free competition takes place. 63 Moreover, in most cases, they do not fundamentally or radically alter the connection of prices with costs of production that has been explained in the preceding pages and in Chapter 6.

What patents and copyrights protect comes under the heading of something new that is more efficient: namely, new, more efficient methods of producing goods that are already being produced and new, more efficient methods of satisfying needs that are already being satisfied in other ways, by different goods. (Of course, patents and copyrights can exist on products and methods of production which do not represent any form of improvement— for example, a copyright on a book no one wants to read or buy, or a patent on a method of production that is more expensive rather than less expensive to use. In such cases, as soon as the fatal flaws are recognized, the patents and copyrights do not protect anything. From that point on, no one seeks to produce such products or use

such methods of production. Nor would anyone do so, if they lacked patent or copyright protection. In this sense, patents and copyrights serve to protect only things which represent improvements, which people would appropriate and put to use if not prevented by the patent or copyright from doing so.)

Insofar as patents and copyrights protect more efficient methods of producing a good that is already being produced, viz., methods of reducing its cost of production, the price of the good is still limited by the cost of producing it by the older, less efficient methods. The patent or copyright merely operates to prevent the price of the good from being reduced immediately to correspond to the lower level of cost made possible by the new method of production.

Ultimately, the price will drop to that point—when the patent or copyright expires—and, most likely, it will drop to some significant extent almost immediately, because the holder will want to take advantage of his lower costs to expand the quantity he sells. But even if the price does not drop at all for the time being, the reinvestment of profits made by virtue of the cost-cutting improvement will operate to increase production and reduce prices somewhere else in the economic system.

As an illustration of this last point, the reinvestment of the profits made by virtue of cutting the cost of producing razor blades, say, in the production of other goods, such as shaving cream and after-shave lotion perhaps, operates to expand the supply and reduce the prices of these other goods. Such a case would be likely to arise in an industry like razor blades, where the demand was highly inelastic and a firm that already accounted for the great bulk of the market would find it unprofitable to cut its price, no matter how substantially it had reduced its cost of production—until it was confronted with the ability of others to produce at the lower cost. What is crucial, of course, is that because of the system of patents and copyrights, the incentive exists to go on developing and introducing improvements in production, and thus for cost of production and price to go on falling in the long run.

If what the patent or copyright protects is an improvement in the methods of satisfying a need that previously had been satisfied by other goods less effectively, then the price of the new good is still limited by the prices and costs of production of the older goods that satisfy the need less effectively. Here, the patent or copyright enables the holder to obtain a premium in the price of his product in comparison with the prices of the older goods serving the same need—a premium that corresponds to the degree of improvement that is perceived as attaching to the use of his product rather than the older products. It is implicit in the nature of such a premium that the source of the patent or copyright holder’s income is the provision of a positive value that the buyers regard as worth more than the premium in price. And thus, once again, there is an immediate gain to the buyers, namely, the extent to which they value the improvement above the premium in price that they pay for it. Eventually, of course, when the patent or copyright expires, the buyers will buy the improved product at no higher price than the original product (except to the extent that its cost of production may be higher), and their gain will be correspondingly greater.

Precisely the newness of patented or copyrighted products typically leads to the practice of setting their prices on the basis of cost of production, though with the addition of a substantially greater-than-usual profit margin. Because patented and copyrighted products are necessarily new, and their potential markets, therefore, largely unknown and undeveloped, the producers of such products more often than not have little or no reliable basis for estimating the elasticity of demand for their products. In such circumstances, it is highly reasonable to price the product in some standard way that is both generous to the producer and yet, at the same time, does not elevate the price too greatly to the buyer, and then attempt to make very high profits by selling the largest possible volume at the price so determined. This is the typical procedure, for example, in the publishing industry, the recording industry, and the motion picture industry, all of which have the perfect legal right to charge whatever price they wish for their unique copyrighted products, but nonetheless appear to follow a defined pricing pattern in which high profits are made not through inordinately high prices, but through high volume at prices that are not all that far above the total cost of production per unit.

Thus, the rewards of innovation that are protected by patents or copyrights typically turn out to be a relatively modest part of the price of the product—perhaps just an additional 10, 20, or 30 percent added to what would constitute a normal profit margin. Financial success comes when this relatively modest additional part of the price is multiplied by a substantial number of units. A very high rate of return on capital then results from the multiplication of the high profit margin by a high capital turnover ratio.

The same principle seems to apply in the pharmaceutical and computer software industries, with the principal difference being that the combination of relatively high costs of research and development and relatively narrow markets often necessitates the charging of much higher prices, in order to cover the resulting high unit costs. In such cases, unexpectedly large quantities demanded, which, of course, serve to reduce unit costs correspondingly, tend to be followed by price reductions, in efforts to reach

wider markets and to forestall potential competition from comparable products and methods of production that could be developed without infringement of the patents or copyrights in question.

In such price reductions, a process takes place in which the proceeds of an extremely high profit margin and rate of profit are reinvested in order to earn a larger amount of profit on the strength of a lower profit margin and rate of profit applied to a greater volume of sales and quantity of capital invested in the production of the good (or more advanced versions of the good). As stated, the existence of such a process also helps to guard against others being tempted to enter into competition through the development of comparable new products or methods of production of their own, which even patent or copyright protection cannot prevent. This last objective, of course, is further secured to the extent that as the result of its reinvestment, the firm is able to achieve reductions in unit costs and improvements in product quality stemming from the adoption of more capital-intensive methods of production. This serves further to increase the capital requirement of any potential competitor and thus further to reduce the likelihood of the actual appearance of such a competitor. The practice of reinvesting a substantial portion of any very high rate of profit in the further production of the extremely profitable product, and then earning a lower rate but larger amount of profit in the production of that good, makes sense for any business. It is the way to transform a temporary bonanza into greater and more lasting success.

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In connection with patented life-saving drugs, it is necessary to explain the benevolent role that can be played by the ability to practice price discrimination between classes of buyers with substantially different levels of income. In the case of patented life-saving drugs, every potential buyer whose life depends on the drug can be assumed to be willing, if necessary, to pay his entire life’s savings to obtain the drug. Because of this, it may appear that the price of such a drug would necessarily be set at a point at which the marginal buyer at least, would have to pay away his life’s savings. If the price were set in this way, then only buyers with income and wealth substantially greater than that of the marginal buyer would be able to avoid paying away their life’s savings or something close to it, while all those potential buyers with income and wealth below that of the marginal buyer would simply die for lack of the ability to afford the drug.

Fortunately, where price discrimination can be practiced, it is more profitable for the drug company in such a case both to charge substantially less to the marginal buyer and, at the same time, to offer its product at a substantially still lower price to the broadest possible class of buyers with wealth and income less than that of the marginal buyer. Indeed, it is entirely possible that no buyer will have to pay away his life’s savings, thanks to the existence of a variety of different prices geared to individuals of substantially different wealth and income.

Thus, for example, the full price of a year’s supply of the drug might be, say, $20,000 in money of 1993’s buying power. At that price only a small minority of individuals could afford it without being bankrupted. If, however, the drug company can control the distribution of the drug to patients by means of the cooperation of physicians and hospitals, perhaps in conjunction with offering somewhat different versions of the drug, it is in a position to charge such a price only to those who can afford it, while offering a substantially lower price to the broad mass of people who otherwise could not afford it. And it could offer a substantially still lower price to physicians and hospitals who purchased the drug on behalf of charity patients. Where price discrimination is possible, it pays to offer the lower prices to gain access to additional segments of the market. At the same time, the existence of the lower prices for lower-income individuals operates to prevent the price paid by individuals in higher-income segments of the market from approaching the limit set by their marginal valuation of the drug when what is at stake is their very lives.

Today’s sometimes outlandishly high price of patented prescription drugs is the result, I believe, of a combination of the existence of a system of collectivized medical costs, and the inability to practice price discrimination. 64 To the extent that the market for medical care comes to be made up of buyers for whom price is no object, because they are covered by the kind of private medical insurance policies that have prevailed for the last several decades, or by government programs, the price that it is profitable to charge is correspondingly increased. This is because to that extent the higher price does not operate to reduce the quantity of the drug demanded. Thus the incentive is created to charge a higher price. At the same time, various prohibitions against price discrimination serve to prevent the offering of lower prices to those who lack private insurance and are outside of the government programs. Today, if a drug company offered a lower price to anyone, the government and many or most of the private insurance companies would almost certainly demand that they too obtain the benefit of the lower price. (This observation, made with respect to the domestic market of the United States, is confirmed by the recent furor caused by newspaper reports of the availability of lower drug prices in Mexico, a foreign country.) Thus, the offering of a lower price to any segment of the market, at least within the present-day

United States, does not pay. And thus the result is that everyone in the United States is confronted with artificially higher drug prices.

In addition, of course, when discussing today’s drug prices, one should not overlook the role that is played in raising drug prices by arbitrary FDA regulations that delay and inhibit the introduction of new drugs. Such regulations are responsible for the average new drug that is introduced having a development cost, and thus price, far in excess of what market conditions require.

Contract Pricing and Radical Privatization

The fact that prices can be set contractually, and thus eliminate all possibility of the exercise of arbitrary power by private individuals in setting their prices, has major bearing on the potential for future privatization. Because of it, it is possible to imagine a day when virtually every good or service but the administration of justice and national defense is provided by unregulated, profit-seeking private businesses. 65 For example, it is possible to imagine such things as electricity, water, and gas being carried from various points of supply over major trunk lines and various major branch lines, and large individual users, such as major factories or apartment complexes, and associations of small users, such as neighborhood associations of property owners, entering into contracts with the suppliers who offered the best terms. Different suppliers would periodically connect or disconnect their major branch lines with or from local networks of wires and pipeline owned by the large individual users or property owners’ associations. Essentially the same principles, of course, apply to sewage lines and to telephone service as well, except that in the case of telephone service, modern technology has or soon will make it possible to connect any two points economically without the use of wires. The ability to transmit to and from a given space satellite either is or soon will be all that is required to link any two locations.

(Despite the rationalizations offered on behalf of the present system of exclusive government franchises and rate controls, or outright government ownership, there is no reason to fear continuous largescale disruption because of tearing up of streets to lay wire or pipe. Any modern city with five or ten main avenues could, if necessary, easily support five or ten major branch lines of each type running underneath—with just one of each kind per avenue. Any local area parallel to any of these major branch lines could easily be connected just by running a single minor branch line to it from the major branch line, and be disconnected merely by shutting off that minor branch line.)

Property owners and voluntary associations of property owners could obtain fire-protection services on a contractual basis, after examining competing bids. Such protection would undoubtedly be required by insurers and mortgage lenders, and might even be provided under their auspices. 66 Private fire fighters could (and should) be authorized to put out fires on the property of individuals who did not subscribe to their services, whenever it appeared to be a matter of life or limb or a danger existed to the property of a subscriber or other requestor of protection. In such cases, it could be made the legal obligation of the property owner(s) in question to pay for the service under a preestablished, publicly known and legally sanctioned set of rates. In cases in which individuals had subscribed to a fire-fighting service, but it was slow to arrive, with the result that it became necessary to use the services of another fire-fighting company, the delinquent fire-fighting service could be legally obliged to pay the bill, plus, perhaps, a preestablished penalty charge. Of course, preestablished cross-billing arrangements would almost certainly exist between fire-fighting companies for cases in which it was necessary for one such service to call upon the assistance of other such services.

Pricing under longterm contract makes it possible to see the day when highways, bridges, and tunnels will be privately owned and operated and supported by tolls, unregulated by the government—even in situations in which only one such road, bridge, or tunnel is feasible. Today, it may be difficult to imagine such an arrangement. This is because one starts in the middle, with a vast population already dependent on the existence of the facility. One then projects the existence of the facility under private ownership, with the owners free to charge whatever tolls they wish. Naturally, in such a situation, the owners would be able to practice a form of extortion against everyone else in the vicinity. But had the facility been private from the beginning, before the area came to be dependent on it, its owners would have had to provide contractual guarantees of permanently reasonable rates as the precondition of any subsequent development that would create a dependence on the facility.

In the overwhelming majority of cases, of course, there is more than one route connecting any two points, and very often many routes. Almost always there is the potential for at least several routes and the potential for more routes than currently exist. In such cases unregulated private ownership could probably be adopted even without any provision for longterm contractual guarantees. In perhaps the worst imaginable case, such as a single company somehow being given ownership of all the major bridges and tunnels entering Manhattan Island, the result could not be nearly as serious as the disruption which occurs whenever there is a major transit strike by labor unions. Such a company might charge substantially

higher tolls, which would reduce the flow of traffic in and out of the city through its facilities, but by no means threaten the lifeblood of the city, as does a transit workers’ or garbage collectors’ strike. Unlike the striking unions, such a company would not be able to resort to physical force to stop competition. And such a company would have competition from the very first, if it set its tolls too high.

Its tolls would be limited not only by the economization on transportation into and out of the city that would take place in response to its higher tolls, but also, from the very first, by the costs of providing ferry service and bringing in more supplies by ship or helicopter. Such competition could begin immediately, if necessary, even if it meant having to use small private boats. But within a very short time, regular largescale ferry boat service could be in operation if the tolls were high enough to make it attractive. And the same technological expertise which made it possible for the United States Army Corps of Engineers to construct temporary bridges spanning major rivers in Europe in World War II, would make it possible for private enterprise, using improvements in such technology that have been developed since then, to construct substantially better temporary bridges just as fast or faster.

The fact is that New York City and many other major cities are desperately short of transportation facilities as the result of government ownership, with its gross inefficiencies and high costs of construction and maintenance and the policy either of not charging tolls at all or charging tolls that are inadequate in the face of the limited capacity of the facilities. In such a situation, the establishment of private ownership, whether in the hands of just one company or however many companies, might very well be accompanied by a substantial increase in tolls. But this would be followed by a desperately needed increase in the supply of transportation facilities. Within in a few years, permanent new bridges would exist, along with additional tunnels and roadways. Such high tolls as might exist on the present facilities would provide the incentive and, no doubt, to some considerable extent, the means of financing the new facilities, as profits made on the present facilities were reinvested. The net effect would be a radical improvement in the state of transportation and, once the supply of transportation facilities became adequate, tolls that reflected no more than the costs of construction and maintenance plus an allowance for the going rate of profit. At the same time, the costs of construction and maintenance would tend to be the most economical possible and to go on falling in real terms.

Private Streets

Two problems must be discussed in connection with the kind of radical privatization described above. The first is that of the efficiency of toll collection, especially if private ownership were to be extended to secondary roads and even to city streets. The second is that of the principle of eminent domain, which can be related to almost all of the above areas of privatization.

It would obviously be absurd to stop traffic every block or two in order to collect a toll. A similar problem arises even on major highways, such as the freeways in Southern California, where there is an entrance and exit every one or two miles. Conventional methods of toll collection in such circumstances would be extremely costly as well as time consuming. Fortunately, modern technology is or very soon will be capable of dealing with the problem easily and efficiently. Computer scanning equipment will be capable of reading an automobile’s identification at the point of entry and exit from any given body of roadway and thus provide the input for an itemized monthly bill of toll charges. Even so, in the case of residential, neighborhood streets, with little or no through traffic, in which the streets serve merely for people to get to and from major thoroughfares, it may well be found that it is sufficient for local property owners’ associations to maintain the streets and finance them by means of dues charged under some form of covenant arrangement among the property owners.

If the owners of thoroughfares also own the property on either side of them (which is a reasonable assumption in the case of city streets or local roads), and seek business from the passing traffic, then their interests would probably be served by the absence of tolls, in order to encourage the passage of traffic by their establishments. Such toll-free thoroughfares would be appropriate for people going shopping. But they will necessarily be relatively slow moving. Toll thoroughfares will be appropriate for through traffic. Here the tolls will limit the traffic and thus make possible more rapid movement. At the same time, they will make the provision of such thoroughfares worthwhile, since the property owners on either side will not be able to gain from the passing traffic itself. The tolls charged on these thoroughfares, of course, will be limited by the fact that slower moving toll-free thoroughfares remain available as an alternative.

Eminent Domain

It is usually taken for granted that the ability to construct roads, railroads, pipelines, and so forth, depends on the existence of the principle of eminent domain, according to which the government has the right to take private property against the will of its owner when its use is necessary for such purposes. The existence of eminent domain is thought to be required in order to prevent a comparative handful of property owners, or even a single individual owner, from arbitrarily and capriciously mak—

ing the construction of such vital facilities either altogether impossible or at least uneconomic, by means of preventing the completion of a route or causing it to take a grossly distorted path.

The principle of eminent domain presents an apparent dilemma. On the one hand, it is presented as a necessary safeguard of the possibility of rational action that depends on the cooperation of large numbers of individuals any one or small number of whom is capable arbitrarily of frustrating all the rest. On the other hand, it appears to constitute a clear violation of the principle of individual rights and thus to have no place in a capitalist society. The apparent dilemma is heightened by the fact that the basis of the existence of individual rights is precisely the provision of safeguards for rational action. Rights protect individuals from the initiation of physical force in order that they can then be free to follow the judgment of their own minds. Moreover, it is necessary to uphold the individual’s rights precisely against majorities, and above all against overwhelming majorities.

In an intellectual and cultural environment rational enough to establish a society approaching consistent capitalism, the principle of eminent domain could almost certainly be dispensed with. There would still be irrational, capricious individuals, to be sure, but their number would almost certainly not be great enough to constitute a significant barrier to the accomplishment of any important cooperative venture. Occasionally, perhaps, it might be necessary to have an extra bend in a road, or to make a detour here and there in the course of a pipeline, in deference to the principle of individual rights even when individuals chose to exercise their rights capriciously. Such instances would be minimized not only by the relatively small number of capricious property owners in such a society, but also by the fact that in such a society, rights-of-way for roads, railroads, pipelines, and so forth would be acquired far in advance of the time of actual construction. In the absence of eminent domain, the laying out of such rights-of-way far in advance would be understood to be a precondition for an area’s future development. Thus the problem posed by capricious individuals arbitrarily refusing to sell their property or the right of passage through it would be minimized. Communities would be formed with provision for such rights-of-way included in the deeds of the buyers who later might be affected. Where such provision had failed to be made, still, sellers would usually not be asked to part with their property immediately, but only, in effect, to sell an option on its later purchase or use, probably a generation or more in the future. With the necessity of planning long range for the acquisition of rights-of-way, prospective buyers could wait and buy such rights from more reasonable heirs if necessary.

In the present intellectual and cultural state of society, the principle of eminent domain is probably necessary, though not in its present form. One can easily imagine groups of “environmentalists” buying up strips of land in the path of every possible right of way for all kinds of vital roads and pipelines, for no other purpose than to prevent economic development, and succeeding by means of a refusal to sell at any price. A legitimate basis for the principle of eminent domain in such a case can be found in the same source as the legitimate basis for not according full rights to children, or, perhaps closer to the mark, the insane.

Happily, apart from the possible case of the “environmentalists,” the far greater part of the seeming dilemma posed by eminent domain could be eliminated as a practical matter even now. All that would be necessary would be the adoption of two very simple measures. The first is to restrict the role of eminent domain to its traditional sphere in the United States, which is precisely such projects as road and pipeline construction, in which a vast stretch of property is required for an indivisible use. (In recent years the principle of eminent domain has come to be extended to the seizing of private property from some owners in order to turn it over to other owners who then employ it in essentially the same way, such as the operation of a department store or the use of the land for residential housing. This is a purely arbitrary redistribution of property, and potentially constitutes a far worse problem than any arbitrary refusal of individuals to sell their property.)

The second necessary measure is to provide sufficient payment to those whose property is sought. The overwhelming majority of property owners will be glad to sell if they receive a price for their property that is significantly higher than what they could otherwise obtain for it, and which more than compensates them for any loss of income they may suffer by having to part with it. It is one thing to announce that a road is scheduled to pass through someone’s living room, and that his house is to be taken from him at half its actual value. It is something very different if he will be offered two or three times the current value of his house. In the latter case, instead of dreading such economic developments, people would actually vie for the privilege of having their property become the scene of them. This explains the radical difference between people’s reactions that presently accompany receiving a letter from the government notifying one of plans to build a road through one’s property and, say, a letter from an oil company notifying one that it is likely that one’s property contains a petroleum deposit and that the company is interested in drilling wells on it.

This reform, which is immediately practicable, would

remove from the actual operation of the principle of eminent domain almost all of its vicious character. It would reduce the principle to forcing people to take what almost any rational person would be more than glad to take. Thus, the element of actual force would virtually disappear. And this indeed is how the phrase “just compensation” should be interpreted in applying the Fifth Amendment protection of the United States Constitution “nor shall private property be taken for public use without just compensation.”

Such an interpretation would provide a powerful incentive to limit resort to the power of eminent domain and to guarantee that where it was used, the project had major economic value indeed. Furthermore, it should be obvious that the actual limitation of the principle of eminent domain in this way would be much more likely if accompanied by the privatization of the areas in which it was employed. Businessmen are used to paying for what they receive, not taking it, as the government does. And the government is more likely to act as an impartial judge when an outside, private party requests the use of eminent domain, rather than one of its own branches.

Once such a reform had been made, a constitutional amendment could be enacted totally abolishing eminent domain as of, say, fifty years from the date of the amendment’s enactment. This would provide sufficient time to assemble rights of way for all necessary projects thereafter on a strictly voluntary basis.

9. Cartels

Cartels are associations of independent producers of a good who agree to limit their production of it in order to obtain a higher price on the resulting smaller supply. The prevailing belief is that cartels are an evil of capitalism, serving to establish arbitrarily high prices to consumers, and would be a characteristic feature of the economic system in the absence of government intervention to prevent their formation.

The fact is that apart from the handful of cases such as diamonds, in which there are very few physical sources of supply, the only time cartels can succeed under capitalism is when they serve merely to reduce the extent of losses, i.e., raise a price from a point of more severe losses to a point of less severe losses or modest profits. This is because, in addition to the problem of deciding which producers must curtail production how much, which is difficult enough in itself (as frequent newspaper reports about the OPEC oil cartel attest), profitable cartels have two further problems, which tend to make their continuation impossible.

There is first the problem of controlling the reinvestment of the profits. If the firms are profitable and want to reinvest their profits, the industry will expand and the cartel’s price will crash in efforts to find buyers for the additional output. At the same time, the independent reinvestment of the profits may well enable some of the firms to be profitable at the lower prices, while those firms which did not reinvest—or reinvest as much or as skillfully—suffer major losses. In order to prevent the breakdown of the cartel in this way, it would be necessary for the cartel to control its individual members’ reinvestments—something which the mere formation of a cartel is not sufficient to accomplish. Second, and more importantly, a profitable price attracts outside entrants to the field, which not only makes the cartel’s price crash, but also deprives the cartel’s members of volume they could have had. It is the same case we saw in the last section in connection with attempts to produce less in order to sell at a higher price. If the higher price is profitable to outside producers, the effect is that one ends up selling less at a price that is no higher than the costs of such outsiders plus an allowance for the going rate of profit, when one could permanently have sold more at that price. 67 Furthermore, while it is possible to imagine cartels enjoying a brief period of premium profitability by means of jacking up prices, it should be realized that pricing under contract operates to make even this impossible after it happens once or twice in a field—assuming that it actually does happen.

However, if a cartel exits that is not particularly profitable, these two problems of controlling the reinvestment of profits and attracting the entry of outsiders do not arise, and thus the cartel may succeed. In such a case, there are no significant profits to reinvest and thus there is no problem of having to cut the price to sell an expanded output. And there is nothing to attract outside entrants into the field. In the light of these facts, the following passage from a prominent antitrust textbook should not be surprising: “We even have evidence suggesting that large firms caught engaging in illegal collusion earn lower profits than other large firms. Perhaps collusion is most commonly attempted in situations where some adversity has depressed profits below a normal level.” 68

In such circumstances, it is difficult to see what objection can be made to the formation of a cartel. It is a voluntary association that harms no one and may actually benefit everyone, by virtue of preventing unnecessary losses to producers and thereby enabling them to maintain a level of capacity that will be present to prevent prices from shooting upward when demand for the product revives, as it generally does sooner or later.

As indicated, the one area in which profitable cartels can be formed with a strong likelihood of continued success is in the field of mining, in cases in which the

known, commercially exploitable deposits are few in number. In such cases, the formation of a unified group of producers is a matter of relative ease and, more importantly, the entry of outsiders in response to a higher price is impossible, because the necessary deposits are simply not available to them. The leading examples of this kind are diamonds and mercury.

Even in such cases, it must be kept in mind that the prices that can be charged are still limited by the cost and price of various substitutes, which, however imperfectly, can be used in place of the item for various purposes. For example, manmade diamonds are a substitute for natural diamonds as a cutting tool in many industrial processes. It is even possible that additional deposits of the item exist, which would be capable of commercial exploitation at a sufficiently high level of prices. Quantities of mercury found naturally in sea water are an example. The price charged by the cartel must take such competition or potential competition into account and must be lower than the price that would make significant competition from such quarters profitable.

Moreover, the progressive nature of the economic system under capitalism creates an unremitting downward pressure on the real price charged even by such a cartel. Improvements in the efficiency of producing substitutes and the development of new substitutes, along with the progressive reduction in the real costs of exploiting submarginal deposits, make it necessary for such a cartel to continue to improve its own efficiency of production in order to be able to maintain its profitability in the face of declining real prices for its product. Thus, since the start of the Industrial Revolution, the price of the average diamond, the price of an ounce of mercury, and of almost any other good that a free market would subject to cartelization has substantially fallen generation by generation relative to the income of the average person, along with the fall in the real price of virtually all other goods that have been in existence over the same period of time. Diamond rings and thermometers, for example, have become progressively more affordable. If the producers of the cartelized goods had not improved their efficiency over the decades, their profits would long since have disappeared and they would no longer be in existence, because in that case their customers would have turned to alternative sources of supply that had grown progressively cheaper in real terms. It is as necessary for the diamond or mercury cartel to operate with modern methods of production as it is for producers in any other branch of industry, and to go on improving those methods so long as the producers of substitutes can improve their methods of production, so long as new substitutes can be developed, and so long as the real costs of exploiting submarginal deposits can be reduced.

What is true of the price of such a cartelized good is that at any given time it is higher than would be the case if the same known physical quantity of the good were found in widely scattered deposits. The effect of this higher price is to slow down the rate at which the limited known supplies are consumed. Thus, von Mises is correct in describing the higher prices charged by the cartels as tantamount to a form of conservation. 69 Only after the fact of improvements in the production of substitutes or in the ability to exploit submarginal deposits is the price (relative to people’s incomes) reduced and the rate of consumption increased. Over time, of course, the improvements in methods of extraction introduced by the producers of the cartelized good themselves operate to increase the economically useable supply that their mines provide.

Cartels and Government Intervention

Cartels as an economic problem are the result of government intervention, and where they are formed or maintained on this basis, they represent part of the genuine and very serious problem of monopoly. Three leading instances of such cartels are the largely unacknowledged cartelization of major portions of agriculture in the present-day United States, the OPEC cartel in oil, and the cartels of Imperial Germany before World War I. The U.S. government’s enforced restriction of agricultural output for the purpose of reducing its outlays under the farm subsidy program has already been dealt with. 70 So too has the OPEC cartel and the vital dependence of its success on the policies of the U.S. government, above all, price controls on oil and environmental legislation. 71 Thus, it is only necessary here to deal with the case of the Imperial German cartels.

As von Mises shows in Human Action, the German cartels in the decades prior to World War I—the classic case of widespread cartelization of industry—were the result of Bismarck’s Sozialpolitik. This policy of social security and allegedly prolabor legislation raised production costs in Germany relative to those in other countries, which had not adopted such legislation. In the absence of further measures, the result would have been that German manufacturers could not have sold profitably either at home or abroad. The consequence of that would have been both mass unemployment and the inability to pay for imports of vitally needed foodstuffs and raw materials which could not be produced domestically.

To prevent these consequences, the German government enacted protective tariffs and encouraged the formation of domestic cartels, which could thus sell at high prices in the German market. The extra, monopoly profits thus reaped in the domestic market permitted the subsidization of German exports, which could then be

MONOPOLY VS. FREEDOM OF COMPETITION 425 sold abroad at competitive prices, which were below those at home—a phenomenon described by foreign manufacturers as “dumping.” 72 (Although von Mises does not mention it, a further necessary aspect of the German government’s policy was an increase in the quantity of money, in order to make possible the larger total expenditure necessary to employ the same number of workers at higher wage rates and to buy the same-sized domestic product at higher prices.) The overall effect of Sozialpolitik on the German workers, of course, was that their real, take-home wages were reduced, inasmuch as domestic prices had to rise by enough to cover all the additional costs imposed on employers—the costs not only in the form of higher wage rates, but also in the form of contributions to the social insurance programs.

Thus, it should be clear that the Imperial German cartels were the result of government intervention designed to offset the destructive consequences of prior government intervention. They were not the product of capitalism or the free market.

10. “Monopoly” and the Platonic Competition of Contemporary Economics

After having devoted so many pages to the discussion of the alleged significance of the economic concept of monopoly—ranging from the alleged tendency toward the formation of a single giant firm controlling the entire economic system, on down through the alleged gouging of buyers left and right in this or that particular circumstance, by this or that particular means—it may be found somewhat astonishing that in the hands of contemporary economic theory, the economic concept of monopoly has been absolutely trivialized. Indeed, the substance of the objection that is raised when contemporary economic theory sounds the cry of “monopoly” is actually nothing more than a condemnation of business for refusing to sustain unnecessary losses. This fact is not obvious, but it is the unmistakable implication of contemporary economics’ doctrine of “pure and perfect competition.” This doctrine is a central element of contemporary economic theory and is the standard by which it and the Antitrust Division of the Department of Justice decide whether an industry is “competitive” or “monopolistic,” and what should be done about it if they find that it is not “competitive.” 73

“Pure and perfect competition” is totally unlike anything one normally means by the term “competition.” Normally, one thinks of competition as denoting a rivalry among producers, in which each producer strives to match or exceed the performance of other producers. This is not what “pure and perfect competition” means. Indeed, the existence of rivalry, of competition as it is normally understood, is incompatible with “pure and perfect competition.” If that is difficult to believe, consider the following passage in a widely used economics textbook: “By way of contrast, intense rivalry may exist between two automobile agencies or between two filling stations in the same city. One seller’s actions influence the market of the other; consequently, pure competition does not exist in this case.” 74

While competition as normally, and properly, understood rests on a base of individualism, the base of “pure and perfect competition” is collectivism. Competition, properly socalled, rests on the activity of separate, independent individuals who own and exchange private property in the pursuit of their self-interest. It arises when two or more such individuals become rivals for the same trade. The concept of “pure and perfect competition,” however, proceeds from an ideology that obliterates the existence of individuals, of private property, and of exchange. It is the product of an approach to economics based on what has aptly been characterized as the “tribal premise,” viz., the collectivist view that the individual human being is a cell in a greater organism: Mankind, the State, the Nation, or the Tribe. 75

The tribal premise dominates contemporary economic theory, and is accepted not only by the enemies of capitalism, but even by its supporters. The link between the concept of “pure and perfect competition” and the tribal concept of man, is a tribal concept of property, of price, and of cost.

According to contemporary economics, no property is to be regarded as really private. At most, property is supposedly held in trusteeship for its alleged true owner, “society” or the “consumers.” “Society,” it is alleged, has a right to the property of every producer and suffers him to continue as owner only so long as “society” receives what it or its professorial spokesmen consider to be the maximum possible benefit. As another supporter of the “pure-and-perfect-competition” doctrine declares in his textbook: “At any point in time a society possesses a pool of resources either individually or collectively owned, depending upon the political organization of the society in question. From a social point of view the objective of economic activity is to get as much as possible from this existing pool of resources.” 76

According to the tribal concept of property, “society” has a right to 100 percent of every seller’s inventory and to the benefit of 100 percent use of his plant and equipment. The exercise of this alleged right is to be limited only by the consideration of “society’s” alleged alternative needs. Thus, a producer should retain some portion of his inventory only if it will serve a greater need of “society” in the future than in the present. He should produce at less than 100 percent of capacity only to the

extent that “society’s” labor, materials and fuel, which he would require, are held to be more urgently needed in another line of production.

The ideal of contemporary economics—advanced half as an imaginary construct and half as a description of reality, with no way of distinguishing between the two— is the contradictory notion of a private-enterprise, capitalist economy in which producers would act just as a socialist dictator would wish them to act, but without having to be forced to do so. 77 In accordance with this “ideal,” contemporary economics tears the concepts of price and cost from the context of individuals engaged in the free exchange of private property, and twists them to fit the perspective of a socialist dictator. It views the system of prices and costs as the means by which producers in a capitalist economy can be led to provide “society” with the optimum use and “allocation” of its “resources.”

A price is viewed not as the payment received by a seller in the free exchange of his private property, but as a means of rationing his products among those members of “society” or the “sovereign consumers” who happen to desire them. Prices are justified on the grounds that they are a means of rationing, superior to the issuance of coupons and priorities by the government. Indeed, rationing itself has been described by Nobel Laureate George Stigler as “non-price rationing,” prices allegedly being the form of rationing that exists under capitalism. 78

Similarly, a cost, according to contemporary economics, is not an outlay of money made by a buyer to obtain goods or services through free exchange, but the value of the most important alternative goods or services “society” must forgo by virtue of obtaining any particular good or service. A typical textbook formulation is:

The social cost of using a bundle of resources to produce a unit of commodity X is the number of units of commodity

Y that must be sacrificed in the process. Resources are used to produce both X and Y (and all other commodities). Those resources used in X production cannot be used to produce

Y or any other commodity. To illustrate with a simple example, think of Robinson Crusoe living alone on an island and sustaining himself by fishing and gathering coconuts. The cost to Crusoe of an additional fish is measured by the number of coconuts he has to forgo because he spends more time fishing. 79

On the basis of this concept of cost, contemporary economics holds that the only relevant cost of production is “marginal cost.” As a rule, and roughly speaking, for the concept can only be approximated, “marginal cost” is held to be the cost of the labor, materials, and fuel required to produce an additional unit of a product. Their value is supposed to represent the value of the most important alternative goods or services that “society” forgoes in obtaining this additional unit. 80 (Marginal cost depends on the context. It is always the extra cost that must be incurred from a given, present starting point, and varies with this starting point. For example, the extra cost of producing an automobile is typically the cost of labor, materials, and fuel, because normally one may take for granted the existence of the automobile factory and its equipment. But if the production of an additional automobile requires an additional automobile factory, then, in that context, the marginal cost of an automobile would include the whole cost of the factory as well. By the same token, if the automobile has already been produced and is sitting in the auto company’s lot, the marginal cost becomes merely the cost of shipping it. If it has already been shipped to a dealer and is in his lot, the marginal cost is hardly anything at all.)

It must be stressed that the concept of “marginal cost” normally excludes the cost of existing factories and machines. The reason for this exclusion is that these assets are “here,” they were paid for in the past and, therefore, their cost does not constitute an additional cost from the present moment forward. Accordingly, their cost is not regarded as a concern of “society” in the present.

Marginal cost is supposed to be the measure of the value of alternative goods forgone, because the prices of the factors of production that remain to be purchased and which constitute marginal cost are supposed to be determined by the value of the alternative goods whose production must be forgone. For example, the prices (wages) of the labor, materials, and fuel required to produce and ship an additional automobile are supposedly determined by the value of the refrigerators, television sets, or whatever other goods cannot now be produced because the factors of production required to produce them will be used to produce an additional automobile instead. 81

All prices, according to this collectivist, tribal view, should be scarcity prices, that is, prices determined by the necessity of balancing a limited supply against a comparatively unlimited demand.

Supply, in the context of this doctrine, means the goods that are here—in the possession of sellers—and the potential goods that the sellers would produce with their existing plant and equipment, if they considered no limitation to their production but “marginal cost.” Demand means the set of quantities of the goods that buyers will take at varying prices. Every price is supposed to be determined at whatever point is required to give the buyers the full supply in this sense and to limit their demand to the size of the supply.

The essence of this theory of prices is the idea that every seller’s goods and the use of his plant and equipment belong to “society” and should be free of charge to “society’s” members unless and until a price is required to “ration” them. Prior to that point, they are held to be

MONOPOLY VS. FREEDOM OF COMPETITION 427 free goods, like air and sunlight; and any value they do have is held to be the result of an “artificial, monopolistic restriction of supply”—of a deliberate, vicious withholding of goods from “society” by their private custodians. After that point, however, the value they may attain is limited only by the importance that buyers attach to them.

On this view, every price is supposed to be an index of the intensity of “society’s” need or desire for a good— an index of the good’s “marginal social utility.” Production should be carried to the point of price equals marginal cost, it is argued, because only then is production at an optimum. So long as price is greater than marginal cost, it is claimed, “society” is in a position to obtain a good that it values more at the expense of other goods that it values less. For the price of the good is held to be the measure of its value, while the marginal cost is allegedly the measure of the value of the alternative goods that must be forgone in order to make the factors of production available for an expanded production of the good in question. By the same token, if the price of the good is less than its marginal cost, then “society” would supposedly gain by curtailing the production of the good in question and expanding the production of other goods that employ the same factors of production.

In the words of Samuelson and Nordhaus: “Only when prices of goods are equal to marginal costs is the economy squeezing from its scarce resources and limited technical knowledge the maximum of outputs.” 82 “Price,” they declare, in the previous edition of their textbook, “is the signal that consumers use to indicate how much they value various goods. Costs, and particularly marginal costs, are the indicators of how much of society’s valuable resources each good’s production utilizes: scarce land, sweaty labor, and other resources that could produce other goods.” 83

But, despite all this, what does the “imperfect competitor”—viz., the “monopolist,” the “oligopolist,” or the “monopolistic competitor”—do, according to Samuelson and Nordhaus?

Does it produce goods up to the point where their social cost—as measured by MC [Marginal Cost]—is equal to what the last unit of the good is worth to society—as measured by market P [Price] resulting from consumer money votes? No. The imperfect competitor is contriving to keep its output a little scarce. It is contriving to keep P above MC because in that way it sets MR = MC [Marginal

Revenue equal Marginal Cost] and thereby maximizes its profit. So society does not get quite as much of A’s [the

“imperfect competitor’s”] good as it really wants in terms of what that good really costs society to produce. 84

The following series of examples will help to illustrate the alleged crime of the “imperfect competitor.”

We can begin by imagining a simple fishing village.

The fishing fleet goes out and returns with an enormously successful catch. The catch is so large that it exceeds the ability of the local canning and freezing plants to process it and the local human and cat population to consume it before it spoils. In these circumstances, the rationing theory of prices holds that fish are a free good; they are not scarce; their marginal social utility is zero. Hence, no just basis exists for a price being charged for fish; they should be given away for nothing.

The fishermen, we can be sure, have a different view of things. They face ruin with a price of fish that is too far below their costs, let alone zero. (And, incidentally, if the fishermen are ruined, the longrun effect will be a smaller-sized fishing fleet, a smaller longrun average catch of fish, and a higher longrun average price of fish to the buyers.) If the fishermen can come to an understanding among themselves, they will throw back part of their catch in order to make the remaining supply command a positive price that is not too far below their costs or is modestly above their costs. If they succeed in doing so, however, the tribal-rationing theory denounces them for a “monopolistic restriction of supply.”

Exactly the same type of crime is held to be committed every time an inventor, or any other intellectual creator, earns something by virtue of the ideas he has created— indeed, so much as covers any part of the costs he has incurred in developing his work. As von Mises points out, the ability of ideas—of formulas, recipes, and techniques of all kinds—to render service is potentially unlimited. 85 The only physical limit to their ability to render service at any given time is the availability of the physical factors of production. On this basis, the rationing theory of prices must view ideas as inherently free goods and the existence of any prices being charged for their use as the result of a “monopolistic restriction of supply.”

This conclusion follows because if the physical factors of production are available in any desired quantity to produce more of a product, in accordance with a given idea, then the supply of the product can be increased and its price will fall. This can continue until the price falls all the way to the point that it covers only the cost of the physical factors of production together with the going rate of profit on the capital invested in the physical factors of production. If the lack of the necessary physical factors of production is what limits the production of a product, then the price of the limiting physical factor or factors of production will rise to reflect the high price of the product. Either way, nothing will remain for the service rendered by the idea.

If and to the extent that something does remain for the use of the idea, it is held to be the result of an “artificial scarcity” having been created in the use of the idea. The owner of the idea, whether it is patented, copyrighted, or

is a trade secret, restricts its use below the limit set by the availability of the physical factors of production, in order to secure a price for the use of his idea (or an allowance for the use of his idea in the price of the product it serves to produce). In effect, like the fishermen who throw back some fish, he holds down the number of times his idea is used in order to secure a price on the use of it that he does allow. 86

Finally, and, for present purposes, most importantly, the same kind of crime is held to take place in connection with the use of existing plant and equipment. According to the tribal-rationing theory, fixed costs, notably, the depreciation cost of plant and equipment and interest paid on capital invested in plant and equipment, are only properly recoverable as and when the use of the plant and equipment becomes “scarce.” Any allowance in the price of the product for fixed costs, other than in the case of the use of the plant and equipment being “scarce,” is also supposed to rest on a “monopolistic withholding of supply.”

This notion can be illustrated by assuming the existence of plant and equipment with some definite capacity to produce—for example, the capacity to produce one million units of product per month. This capacity to produce can be construed as representing a supply of one million service-units of plant and equipment. If the quantity demanded of the product that the plant and equipment helps to produce is less than a million units a month at any price greater than the marginal cost of a unit, then, according to the tribal-rationing doctrine, no just basis exists for any allowance for plant and equipment being charged in the price of the product. This is shown in Table 10–2, where it is assumed that marginal cost is constant at $8 per unit and that, even at a selling price as low as $8 per unit, the quantity demanded of the product is less than a million units.

Under the assumptions made in Table 10–2, if the product were to be sold at a price of $10, the quantity of the product demanded would be only 500,000 units. If the owners of the plant and equipment kept the price at $10 and went on supplying only 500,000 units, then they would be in the position of receiving an allowance of $2 in the price of the product for a service-unit of plant and equipment (viz., the product’s selling price of $10 minus the marginal cost of $8). This, it is held, would be “inefficient”—viz., unjust, according to the perspective of collectivism. With a supply of 1 million service-units of plant and equipment and a requirement for only 500,000 such service-units, there is no scarcity of service-units to justify such a price, it is held. Efficiency and justice, it is claimed, demand that the implied allowance for a service-unit of plant and equipment be reduced.

Now this will be accomplished if the price of the product is cut from $10 to $9. But, as Table 10–2 shows, even at a price of $9, the quantity of the product demanded, and thus the number of service-units of plant and equipment required, grows only to 600,000. The service-units of plant and equipment are still not scarce. Even if the selling price of the product is reduced all the way to $8—the marginal cost—and the implied allowance for plant and equipment is correspondingly reduced all the way to zero, the quantity of the product demanded—and thus the quantity of service-units of plant and equipment required—still grows only to 700,000. Thus, the tribal-rationing theory concludes, plant and equipment in this case simply are not scarce and therefore deserve no allowance in the price of the product.

Such an allowance would be deserved only if at a price above $8, the quantity demanded of the product, and thus the requirement for service-units of the plant and equipment, were greater than a million units. In that case, the plant and equipment’s service-units would be scarce and deserve an allowance in the product’s price. The allowance would be necessary to reduce the quantity of the product demanded to a million units. Such an allowance could be anything, it is implied. It need have no fixed limit. It would be whatever is required to reduce the

Table 10–2

The Implications of Price Equal Marginal Cost for the Recovery of Fixed Costs

Quantity of Product

Price Supplied and Demanded

500,000 $10 600,000 1$9 700,000 1$8

Implied Allowance in Marginal

Product Price for Use of Cost

Plant and Equipment

$8 $2

$8 $1

$8 $0

quantity of the product demand to equality with the limited capacity available to produce it. Thus, if at a price of $8, 5 million units of the product were demanded and a corresponding requirement for 5 million service-units of plant and equipment existed, and it took a price of $50 to reduce the quantity of the product demanded—and the requirement for service-units of plant and equipment— to a million units, that supposedly would be perfectly acceptable. (In actual practice, of course, one may be certain that most proponents of the doctrine would soon be crying for price controls, if the selling price came to exceed the full costs by any substantial amount.)

As stated, in all circumstances in which the owners of plant and equipment recover any part of their investment, short of the services of their plant and equipment being in a state of scarcity, they are accused—just like the fishermen and the owners of intellectual creations—of monopolistically withholding a part of their supply from the market in order to obtain a price on the portion they do allow to enter the market. Automobile plants, steel mills, and all other lines of business which are able to recover their fixed costs at less than capacity operation, are denounced for monopolistic restrictions of supply. This is the implicit substance of all the attacks made against “oligopoly” and the alleged refusal of “oligopolists” to cut prices in the face of a decline in demand. (Similarly, the attacks made against “monopolistic competition” can be understood as attacks on the ability to profit from a “contrived scarcity” of the services of intellectual creations, such as a product’s distinctive features and its brand name.)

Proponents of the tribal-rationing theory may not agree with my claim that their doctrine calls for no recovery of fixed costs short of capacity operation. They almost always assume that marginal cost continuously rises, starting from a very low percentage of capacity operation, and that in the relevant range of operations, it already exceeds average variable cost. 87 (Average variable cost can be understood as the average cost per unit on account of labor, materials, and fuel.) On these assumptions, an equality of price with marginal cost is compatible with some or even full recovery of fixed costs, short of the point of 100 percent capacity operation of the whole firm or even single factory. For in this case, when price is equal to marginal cost, it is equal to the marginal cost only of the present marginal unit; it simultaneously exceeds the lower marginal costs of all the earlier units. Out of that excess can come coverage of fixed costs.

Unfortunately for the proponents of the tribal-rationing theory, marginal cost does not continuously rise. The law of diminishing returns, which is the basis presented for the assumption that it does, is not in fact an adequate basis for such a conclusion. 88 The law of diminishing returns implies merely that at some point more plant and equipment is required if the output per unit of labor and other variable factors of production is not to decline. 89 It is entirely consistent with the law of diminishing returns that prior to full capacity operation of a plant, or a level of operation not far short of full capacity operation, marginal cost is constant. Indeed, this is the typical case in manufacturing and processing. To confirm this conclusion, one need only imagine a dress factory, say, with rows of workbenches and sewing machines. So long as there are empty workbenches and idle sewing machines, there is no reason for assuming that the employment of additional labor, and the use of additional materials and fuel, will be accompanied by diminishing returns.

A reasonable basis for assuming a rise in marginal cost as output levels increased would be if the firm owned machinery (or whole factories) of different ages, representing earlier and later models, and thus of marked differences in efficiency. It might be imagined that, say, 20 percent of its capacity was in the form of the newest and most efficient machines, which enjoyed the lowest marginal cost per unit; that a further 60 percent of its capacity was in the form of somewhat older and less efficient machines, which necessitated production at a higher marginal cost; and that its final 20 percent of capacity was in the form of still older, still less efficient machines, which necessitated production at a still higher level of marginal cost. Similarly, it might well be the case that the addition of a third shift would entail a higher level of marginal costs, because of the need to pay a somewhat higher level of wages in off hours. But none of these cases implies continuously rising marginal cost. They imply a marginal cost that rises in two or three steps and at each step stays constant over the range of that step.

In such conditions, the only modification or, more correctly, elaboration, that needs to be made to the statement that the rationing theory of prices requires the achievement of capacity operation before fixed costs can justly begin to be covered is that capacity operation must be achieved for the particular grade of capacity concerned. For example, in order for the fixed costs on the most efficient 20 percent of our dress company’s machinery to justly begin to be covered, according to the rationing theory of prices, that factory must be operating at a level equal to at least 20 percent of capacity. If it is, the service-units representing that grade of capacity are in a state of scarcity. By the same token, the only way that fixed costs on the machines representing the next 60 percent of capacity can justly begin to be covered, according to the rationing theory of prices, is if the factory is operating at a level equal to at least 80 percent of its capacity. At that point, the service-units representing this

430 CAPITALISM grade of capacity are in a state of scarcity.

It thus turns out, upon analysis, that the tribal-rationing theory can be understood as an attempt to apply the Ricardian land-rent doctrine to the determination of the value of the services of plant and equipment. It should be recalled that according to Ricardo, rent commences on land of the first quality only when all of it is under cultivation and it becomes necessary to resort to the cultivation of land of the second quality, and that rent commences on land of the second quality (and correspondingly increases on land of the first quality) when all of it, in turn, comes under cultivation and it becomes necessary to resort to land of the third quality. 90

The essential point remains that compensation for produced capital goods is being made to depend on an absolute scarcity of their services and that any attempt by their owners to obtain compensation short of such a scarcity is denounced as a monopolistic restriction of supply. In our example of the dress factory, which certainly represents a typical case when modified to have three grades of capacity, the tribal-rationing theory holds that efficiency and justice demand that the firm earn nothing toward the replacement of the great bulk of its machinery whenever it operates below 80 percent of capacity. (And to earn anything toward the replacement of the factory itself, it would probably have to operate at a full 100 percent of capacity—unless it were fortunate enough short of that point to have some machinery in operation of such inefficiency that “rents” on its more efficient capacity were high enough to leave something over for the replacement of the plant itself.) If despite the absence of these conditions the firm does earn something on the bulk of its capacity, it is denounced for monopolistically restricting the services of its plant and equipment and the supply of its products.

The Doctrine of Pure and Perfect Competition

To understand the view of competition held by contemporary economics, all one need do is take such alleged monopolistically contrived scarcities as those just described, as the standard of the kind of evil that competition is supposed to prevent. If one follows this procedure, one can grasp the nature of “pure and perfect competition” and how it is a product of the tribal view of property, of price, and of cost.

Competition in contemporary economics is viewed as the means by which prices are driven down either to equality with “marginal cost” or to the point where they exceed “marginal cost” only by whatever premium is necessary to “ration” the benefit of plant and equipment operating at full capacity.

This is not competition as it exists in reality. The competition which takes place under capitalism acts to regulate prices simply in accordance with the full costs of production and with the requirements of earning a rate of profit. It does not act to drive prices to the level of “marginal costs” or to the point where they reflect a “scarcity” of capacity. The kind of “competition” required to do that, is of a very special type. Literally, it is out of this world. It is “pure” and “perfect.”

No one has ever defined “pure and perfect competition”—the procedure is merely to present a list of conditions which it requires. A fairly full list of these conditions is presented by Professor Clair Wilcox (who is not an advocate of capitalism) as if it were a definition of “pure and perfect competition.” He writes:

The requirements of perfect competition are five: First, the commodity dealt in must be supplied in quantity and each unit must be so like every other unit that buyers can shift quickly from one seller to another in order to obtain the advantage of a lower price. Second, the market in which the commodity is bought and sold must be well organized, trading must be continuous, and traders must be so well-informed that every unit sold at the same time will sell at the same price. Third, sellers must be numerous, each seller must be small, and the quantity supplied by any one of them must be so insignificant a part of the total supply that no increase or decrease in his output can appreciably affect the market price . . . . Fourth, there must be no restraint upon the independence of any seller or buyer, either by custom, contract, collusion, the fear of reprisals by competitors or the imposition of public control. Each one must be free to act in his own interest without regard for the interests of any of the others. Fifth, the market price, uniform at any instant of time, must be flexible over a period of time, constantly rising and falling in response to the changing conditions of supply and demand. There must be no friction to impede the movement of capital from industry to industry, from product to product or from firm to firm; investment must be speedily withdrawn from unsuccessful undertakings and transferred to those that promise a profit. There must be no barrier to entrance into the market; access must be granted to all sellers and all buyers at home and abroad. Finally, there must be no obstacle to elimination from the market; bankruptcy must be permitted to destroy those who lack the strength to survive. 91

To summarize these conditions: uniform products offered by all the sellers in the same industry, perfect knowledge, quantitative insignificance of each seller, no fear of retaliation by competitors in response to one’s actions, constant changes in price, and perfect ease of investment and disinvestment.

To understand the alleged need for all these conditions and what they would mean in reality, it is necessary to project them on a concrete example. This is usually not done at all, and is never done fully—if it were, neither the theory of “pure and perfect competition” nor the rationing theory of prices could be propounded. So I shall use an example of my own, which will not be of a kind

used by their supporters, but which will express accurately the meaning of these theories.

Imagine a movie theater with 500 seats. The picture is about to go on; the projectionist, the ushers and the cashier are all in their places. “Society” has the alleged right to the occupancy of 500 seats. If they are not all occupied for this performance, no future satisfaction can be obtained by any storing up of the use of the seats for a future time. The seats, the theater, the film, the necessary workers are “here.” “Society,” supposedly, “has them” and now it demands the full benefit from its alleged property.

If the film is not run, the only thing that “society” can save is the electric current which might be made available elsewhere, or the coal which must be consumed to generate the current. The costs of the theater, the film, the workers are all “sunk costs”—“water over the dam,” as the textbooks say—and, since “bygones are bygones,” the only thing which counts for “society” now is the cost of the electric current.

The theater, according to the tribal-rationing theory, should charge an admission price which will guarantee the sale of 500 tickets for the performance. If droves of people are standing in line for admission, it should raise the price to whatever point is required so that only 500 people will be able to afford it. If all the people in line have identical incomes, the same medical disabilities, and natures of equal sensitivity, such a price, supposedly, will mean that the 500 people who want to see the film most, will see it. If they are unequal in these respects, that is already supposed to be an “imperfection” in the justice of the “market mechanism.”

If, however, there are few people standing in line, the theater should begin reducing its admission price. It must keep on reducing its admission price until it has attracted 500 customers. If an admission price of only 2¢ is required to get this many customers, then, supposedly, that is what should be charged, provided only that the revenue brought in at the box office covers the cost of the electric current.

If the theater persists in charging its standard price of, say, $5, at which it sells less than 500 tickets, then, according to the tribal-rationing doctrine, it is guilty of “administering” its price and, of course, of “monopolistic restriction of supply.” It is engaged in a process of “price control”—in violation of the “laws of supply and demand”—and in creating an “artificial scarcity” of seats by “monopolistically” withholding a portion of its supply from the market to maintain a high price on those seats for which it does sell tickets.

If the theater cannot sell 500 tickets even at 1¢ per ticket, then, according to this theory, it must either open its doors for free or cancel the performance. In this case, a theater seat is, allegedly, a free good—it is no longer “scarce” in relation to the demand for it, and so there is no longer any need for a price because there is no longer any need to ration theater seats. If there are 100 people who want to see the movie and who are prepared to make it worth the theater owner’s while, he should perhaps run the film—contemporary economics would hold—provided he sells the remaining 400 tickets at whatever price is required to unload them, including zero. This, however, would be another “imperfection” in the “market mechanism”—price discrimination. The “ideal solution” in such a case, it is alleged, would be to have the government nationalize the theater, charge nothing and subsidize the loss. 92

In the process of adjusting its price to attract customers, the theater must not, of course, send anyone out in the street to tell people about the movie it is playing or the price it is charging. That would be another “imperfection”—advertising. Advertising, according to this theory, is a wasteful and vicious means of “demand creation”—it makes the “consumers” act differently than they really want to act. So, as the theater is reducing its price, it must be careful not to be too obvious about it. Simply changing the price in the cashier’s window should be enough.

However, while advertising by the theater is an “imperfection,” “perfection” requires that all potential customers of the theater possess perfect and instantaneous knowledge of its price changes and of the picture it is showing. It is another “imperfection” in the operation of the “market mechanism” if people about to enter other theaters, or riding in their automobiles, or making love, do not receive instantaneous communication of the price changes, so that they may speedily alter their plans. And, presumably, it is an “imperfection” if they have not already seen all the movies many, many times—to be perfectly informed about them.

Because the theater owner wants to “maximize his profits,” he will not act in accordance with the theory’s tribalistic precepts. However, he would, it is argued, if knowledge were perfect and automatic, if people did race back and forth between theaters in response to penny price differences, and if a number of further conditions were also fulfilled. If, for example, there were 401 identical theaters in the same neighborhood, all showing the same movie, and all in the same position with regard to empty seats, then, it is argued, the cunningly clever, “profit-maximizing” businessman would reason as follows: “At my standard price of $5, I can sell only 100 tickets today. But if I charge $4.99999 . . . 9 (it is a standard assumption of the theory that all economic phenomena are mathematically continuous and thus capable of treatment by calculus), I can sell all 500 tickets. For in response to this insignificant price change, which

432 CAPITALISM is infinitely close to my present price, I could attract away one customer from each of the 400 other theaters. This would be very good for me, and none of the other theater owners would really notice the loss of just one customer, and thus no one would match my lower price. So that is what I will do.”

The same thought, however, will be racing simultaneously, it is assumed, through the heads of the other 400 theater owners, and so everyone’s price will be trimmed just so much, and no one will end up with any additional customers drawn from other theaters. Each theater may attract one percent of an additional customer who otherwise would not have gone to the movies, but that is all.

The same process is repeated at the infinitesimally lower price, as each theater owner seeks to “maximize his profit,” led by the idea that his insignificant price change will draw an unnoticed amount of business from each of many competitors, who will not reduce their prices in response to his action. This process of infinitely small price reductions is supposedly performed with infinite rapidity—presumably through the “automatic market mechanism”—and so, instantaneously, the price is brought down to the point where everyone’s theater either is jammed to capacity or must close its doors.

According to the theory of “pure and perfect competition,” the large number of sellers is the main condition required to drive prices either to “marginal cost” or to the point where they reflect a “scarcity” of the capacity that is “here.” If the individual seller were a significant part of the market and were in a position to handle a major part of the business done by his competitors, then, supposedly, he would never cut his price because he would know that as a result of his action others will lose so much business that they will have to match his cut and that he will thus be left basically only with the lower price. When there are a large number of small sellers, every price cut is also matched, but, the argument is, not because of one’s own price reduction, but because the other sellers are led to cut their prices independently, guided by exactly the same thought.

The significance of all sellers having an identical product is supposed to lie in the greater responsiveness of customers to price changes. If each theater is playing a different movie, customers are not likely to shift their business among the various theaters in response to infinitesimal price differences, and so a theater owner will have less incentive to trim his price. The significance attached to perfect knowledge is similar.

This portrait of the economic world of perfection is not yet complete, however. There remain two other major requirements if “society” is to derive the maximum benefit from its “scarce resources.” It must be possible, as Professor Wilcox puts it, for investment to “be speedily withdrawn from unsuccessful undertakings and transferred to those that promise a profit. There must be no barrier to entrance into the market . . . .” This condition would be achieved if movies were shown in tents, with projectors using candle light instead of electricity. Then, whenever demand changed, theater owners would merely have to unfold or fold up their theaters, and light or blow out their candles.

This would be “perfection,” but not quite in its full “purity.” For in addition, “the market price,” as Professor Wilcox says, “uniform at any instant of time, must be flexible over a period of time, constantly rising and falling in response to the changing conditions of supply and demand.” This would be achieved if, after leaving the theater and going to a restaurant for dinner, one were not given a menu, but were seated in front of a ticker tape—and were offered a futures contract on dessert; and if afterward, on leaving the restaurant and walking back to one’s apartment, one would not know whether one could afford to live there that night, or whether the rentals of penthouses had collapsed. Only then would the world be “purely perfect.”

Implications of Marginal-Cost Pricing

It should be obvious that the “purely perfect” world of pure and perfect competition would be an utter chaos. If prices had to constantly be set equal to marginal cost, not only would firms routinely be prevented from charging prices high enough to cover their fixed costs, but many firms would routinely be prevented from charging any price at all! Consider how many cases there are like movie theaters. Consider how often not only movie theaters, but also athletic stadiums, concert halls, and opera houses have empty seats. Consider how often airplanes, trains, and buses travel with empty seats. What is the marginal cost of admitting or carrying one more customer in these cases? What is the marginal cost of providing electricity or telephone service? What is the marginal cost of using any invention one more time? A price equal to marginal cost in any of these cases would have to be zero or not very far above zero.

The supporters of the pure-and-perfect-competition doctrine may or may not be aware of the frequency with which their doctrine calls for a price of zero or almost zero, but they are prepared to deal with such cases. According to Samuelson and Nordhaus, in their treatment of “ideally regulated pricing” in connection with public utilities:

If P = MC [price = marginal cost] is such a good thing, why shouldn’t the regulators go all the way and make the monopolist lower P until it is at the intersection point of the

DD [demand] and MC curves [viz., where price equals marginal cost] . . . ?

Actually, requiring P = MC or marginal-cost pricing is the ideal target for economic efficiency. But one serious problem arises. A firm that has declining cost and produces where price equals marginal cost, will be incurring a chronic loss. . . .

Firms of course will not operate for long when they are

running at a loss. Hence the ideal regulatory solution requires the government to subsidize the decreasing-cost producer, presumably by funneling tax revenues to the firm. 93

Thus, in the view of Samuelson and Nordhaus, and of the socalled mainstream of contemporary economics that they represent, in cases in which marginal-cost pricing entails a chronic loss, it is still the ideal; the loss should be supported by a permanent government subsidy. This is in the name of “economic efficiency”—efficiency by the absurd standard that all that counts for efficiency is providing “society” with something it allegedly values more at the expense of something it allegedly values less, irrespective of who is sacrificed, of what coercion is involved to provide the taxes to cover the losses, of the notorious inefficiencies of government subsidies (and government ownership), and irrespective of the utter shortsightedness of using marginal cost as the criterion and assuming that anyone could be benefitted by a policy that makes it impossible for an economic activity to sustain itself.

In the allegedly ideal world of price having to be set equal to marginal cost, there would be a radical reduction of productive capacity relative to the supply of labor and materials, and an even more radical reduction in capacity in cases in which marginal cost is zero or close to zero. In such a world, of course, there could be virtually no private research and development whatever, because of the zero marginal cost of using the results of research and development and thus the alleged obligation to charge nothing for its use. (Presumably, according to Professors Samuelson and Nordhaus, the government would conduct all research and development on the basis of tax revenues—in the name of “efficiency.”) As for fixed productive capacity of any kind, after a series of losses, its supply would be cut back to the point where whatever capacity remained would be operated at 100 percent often enough so that it could be replaced. At those times, the price of the product or service would be high enough and the profits great enough to compensate for the losses incurred when having to sell at marginal cost.

This would be a world largely incapable of making adjustments to changes in demand through changes in supply. To the degree that less capacity existed, increases in demand would more quickly run up against a physical inability to expand supply. Such a world would be full of major production bottlenecks. In such a world, the government would actually lack the power to provide any substantial subsidies—it would be impoverished along with the citizens who had to support it.

To term such a world “economically efficient,” as such writers as Samuelson and Nordhaus repeatedly do, is to adopt a standard of efficiency by which the economy of Soviet Russia was more efficient than that of the United States. In Soviet Russia, of course, there was less of everything than in the United States, but what there was, was used more fully. In Soviet Russia, the citizen wore his single suit everyday (assuming he was rich enough to own a suit). In the United States, the citizen has long had the idle capacity of several suits. Just so, with regard to plant and equipment. Under capitalism, the normal state of production requires the possession of extra machines and plant capacity in every industry, to meet every foreseeable change in demand. This is not a “waste,” not any more than the fact that the consumers under capitalism own more clothes than the ones they happen to be wearing. But such a desirable state of affairs would not be possible if producers had to sell at prices equal to marginal cost whenever they operated short of the full capacity of the plant and equipment concerned.

Ironically, what the “pure-and-perfect-competition” doctrine seeks is the abolition of competition among producers. Its “ideal” is a state in which producers are unable to take business away from other producers. If a producer is operating at full capacity, he cannot meet the demand of a single additional buyer, let alone compete for that demand. He cannot compete for additional business if he is operating merely at the full capacity of a given grade of plant and equipment and his idle capacity is of a kind whose operating cost is greater than the currently prevailing price. And if he is not producing at full capacity even of a given grade of plant and equipment and is charging a price equal to his “marginal cost,” he still cannot compete for the business of any additional buyers because he is forbidden to “differentiate” his product or to advertise it. Thus, the normal competition of capitalism—the competition of producers for customers, based on an ability to expand production—would give way to a competition of consumers for meager, essentially fixed supplies of goods, in which the only way anyone could have more of a good would be by virtue of someone else having less of it. The only relief from this state of affairs would be when a higher price succeeded in covering the higher marginal cost associated with additional production.

Such competition, a competition largely resembling that of animals for a fixed stock of prey, is what the pure-and-perfect-competition doctrine regards as ideal. However ironic it may be, the pure-and-perfect-competition doctrine seeks to establish as the competitive ideal precisely conditions resembling the law of the jungle.

When it denounces capitalism for a lack of competition, what it is denouncing is the fact that under capitalism, competition is the diametric opposite of the law of the jungle: it is a competition of producers in the production of wealth, not of consumers in the consumption of wealth.

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The doctrine of “pure and perfect competition” marks the almost total severance of economic thought from reality. It is the dead end of the attempt to defend capitalism on a collectivist base.

Ironically, that attempt took hold in economics in the late nineteenth century (and has been gaining influence ever since) through the efforts of Victorian economists to refute the theories of Karl Marx on the subject of value and price. The rationing theory of prices was advanced as the alternative to the Marxist labor theory of value. The irony is that the “pure-and-perfect-competition” doctrine is to the left of Marxism.

Marxism denounced capitalism merely for the existence of profits. The “pure-and-perfect-competition” doctrine denounces capitalism because, as shown, businessmen refuse to suffer unnecessary losses. The argument of the supporters of “pure and perfect competition” is not that businessmen make excessive profits through any kind of “monopoly,” but that they are “monopolistic” in refusing to sell their products at a loss—which they would have to do if they treated their plant and equipment as costless natural resources that acquired value only when they happened to be “scarce.”

The fact that the pure-and-perfect-competition doctrine is, indeed, essentially an attack against business for refusing to accept unnecessary losses is borne out by the wellknown study of Prof. Arnold Harberger. 94 In an attempt to measure the socalled deadweight welfare loss from “monopoly” in manufacturing in the United States, Harberger found that it turned out to be extremely small. Samuelson and Nordhaus write:

Harberger’s finding shocked the economics community. He found the welfare loss from monopoly was slightly less than 0.1 percent of GNP. In today’s economy, it would total about $5 billion. One economist quipped that, if we believe this study, economists would make a larger social contribution fighting fires and eradicating termites than attempting to curb monopolies.

Many studies have refined and criticized Harberger’s original findings. . . . After reviewing all these subsequent analyses, a careful recent survey concludes:

“It appears that the deadweight welfare loss attributable to monopolistic resource misallocation in the United States lies somewhere between 0.5 and 2 percent of gross national product, with the estimates nearer the lower bound inspiring more confidence than those on the high side.” 95

Thus, despite all expectations, it now appears to be an established fact that the problem of monopoly is a relatively small one by any standard. This, of course, does not stop Samuelson and Nordhaus, or the writers of all the other textbooks dealing with “microeconomics,” “industrial organization,” and “antitrust policy” from continuing just as before in making “monopoly” versus “pure and perfect competition” the sum and substance of their theoretical analysis. They report findings such as Harberger’s and then proceed to ignore them.

But there is a simple reconciliation between the “empirical” findings concerning the insignificance of the “monopoly” problem and the overwhelming preoccupation with it on the part of contemporary economic theory. This is the fact that a critical assumption of the socalled empirical studies appears to be that marginal cost can be assumed to be equal to total average cost plus an allowance for earning the competitive rate of profit. At any rate, this is how Samuelson and Nordhaus’s graphical depiction of the measurement problem shows matters. 96

Now if one takes marginal cost as this high, and thus uses as the measure of monopoly merely what amounts to profits earned at above-average rates, then indeed, the measure of monopoly will be small. (And even then, it will be far overstated, for it will include for the most part above-average rates of profit made by virtue of reducing costs of production, improving the quality of products, and successfully anticipating changes in consumer demand. Only a modest portion of above-average profits results from actual monopoly privilege.) The reason that, despite the insignificance of monopoly profits when computed in this way, they loom so large in contemporary economic theory is precisely the fact that, whether it is aware of it or not, contemporary economic theory is actually concerned with “monopoly” as the means of avoiding losses. This is what it sees everywhere and denounces everywhere, while the “empirical” studies, such as Harberger’s, automatically preclude such measurement by virtue of their assumption that marginal cost is equal to total average cost plus an allowance for earning the going rate of profit.

The Alleged Lack of “Price Competition”

The “pure-and-perfect-competition” doctrine distorts the facts of reality to a greater extent than did the traditional critiques of capitalism. Those critiques recognized that competition is a fundamental element of capitalism, but they denounced it. Capitalism, they claimed, is ruled by the “law of the jungle,” by the principles of “dog eat dog” and “the survival of the fittest.” The “pure-and-perfect-competition” doctrine proceeds from the same base as these earlier critiques, and is in full agreement with them in their objections to such characteristics of the process of competition as the continuous improvement in products, the variety of products, advertising, and the

existence of idle capacity. Both schools regard all these characteristics of competition as a “waste” of “society’s scarce resources.”

But the “pure-and-perfect-competition” doctrine regards these characteristics as “imperfections” and attacks capitalism on the grounds that capitalism lacks competition. Every industry, it asserts, is “imperfectly competitive” (with the barely possible exception of wheat farming). Every industry is guilty of “monopolistic competition” or “oligopoly.” 97

The competition that capitalism is accused of lacking—as a result of “monopolistic competition” and “oligopoly”—is called price competition. The nature of price competition, as contemporary economists see it, is indicated in the following quotation: “Analytically, the crucial thing about an oligopoly is the small number of sellers, which makes it imperative for each to weigh carefully the reactions of the others to his own price, production, and sales policies. The result is a strong pressure to collude to avoid price competition or to avoid it without formal collusion.” 98

Capitalism is accused of lacking price competition on the following grounds: if there are few sellers in a market, any seller who cuts his price must take into account the fact that the other sellers will match his cut—so he may be better off if he refrains from price cutting; thus prices will not be driven down to the level of “marginal cost” or to the point where they “ration” the benefit of “scarce” capacity.

Consider the denial of facts entailed in the accusation that capitalism lacks price competition. Every decade, since the beginning of the Industrial Revolution, commodities have become not only better, but also cheaper— if not always in terms of paper money (the value of which has been repeatedly reduced by the inflationist policies of governments), then in terms of the labor and effort that must be expended to earn them. What is it that has made producers lower their prices for the last two hundred years? Obviously, it is price competition.

Price competition exists even in the midst of inflation. Even under inflation, every firm is still interested in improving the productivity of the labor it employs. To the extent a firm succeeds in doing so, it is able to hold its price increases below the wage increases it must pay. Other firms in the same line of business which have not succeeded in raising the productivity of the labor they employ, or not to the same extent, must nevertheless keep their price increases in line with these price increases. The result is that if these firms wish to remain as profitable as before, ultimately, indeed, even to remain profitable and in business at all, they must further increase the productivity of the labor they employ. They simply cannot afford to fall too far behind. This, of course, is price competition. It is a phenomenon known to virtually every businessman, but it is essentially unknown to contemporary economists, because of their arbitrary definition of price competition as the process of equalizing price with marginal cost. Their arbitrary definition simply blinds them to the existence of actual price competition. All that they look for in the world is what complies with their absurd definition; they have eyes for nothing else.

Actual price competition is an omnipresent phenomenon in a capitalist economy. But it is completely unlike the kind of pricing envisioned by the doctrine of “pure and perfect competition.” It is not the product of a mass of shortsighted, individually insignificant little chiselers each of whom acts to cut his price in the hope that his action will not be noticed by any of the others. The real-life competitor does not live in a rat’s world, hoping to scurry away undetected with a morsel of the cheese of thousands of other rats, only to find that they too have been guided by the same stupidity, with the result that all have less cheese.

The competitor who cuts his price is fully aware of the impact on other competitors and that they will try to match his price. He acts in the knowledge that some of them will not be able to afford the cut, while he is, and that he will eventually pick up their business, as well as a major portion of any additional business that may come to the industry as a whole as the result of charging a lower price. He is able to afford the cut when and if his productive efficiency is greater than theirs, which lowers his costs to a level they cannot match.

The ability to lower the costs of production is the base of price competition. It enables an efficient producer who lowers his prices, to gain most of the new customers in his field; his lower costs become the source of additional profits, the reinvestment of which enables him to expand his capacity. Furthermore, his cost-cutting ability permits him to forestall the potential competition of outsiders who might be tempted to enter his field, drawn by the hope of making profits at high prices, but who cannot match his cost efficiency and, consequently, his lower prices. Cost efficiency is the foundation of the ability to take business away from others in the field, insofar as one’s own cost reductions exceed theirs. Thus price competition, under capitalism, is the result of a contest of efficiency, competence, ability.

Price competition is not the self-sacrificial chiseling of prices to “marginal cost” or their day-by-day, minute-by-minute adjustment to the requirements of “rationing scarce capacity.” It is the setting of prices—perhaps only once a year—by the most efficient, lowest-cost producers, motivated by their own self-interest. The extent of the price competition varies in direct proportion to the size and the economic potency of these producers. It was

firms like Ford, General Motors, and A & P, and, more recently, the major Japanese producers—not a microscopic-sized wheat farmer or sharecropper—that have been responsible for price competition. The price competition of the rapidly growing Ford Motor Company early in this century reduced the price of automobiles from a level at which they could be only rich men’s toys to a level at which even a low-paid laborer could afford to own a car. Later on, the price competition of General Motors was so intense that firms like Kaiser and Studebaker could not meet it. The price competition of A & P was so successful that the supporters of “pure and perfect competition” have never stopped complaining about all the two-by-four grocery stores that had to go out of business. And in recent years, the price competition of firms such as Toyata, Nissan, Sony, Mitsubishi, and Nippon Steel has set a pace that even the very best of American producers have found difficult to follow.

Price competition, it must be observed, frequently forces some of the sellers in an industry to sell at a price that is equal to or not far above their marginal costs, yet, at the same time, is substantially above the marginal costs of the more efficient, more competitively capable firms. This is part of the process by which the more efficient firms gain the business of the less efficient firms, which will be unable to replace their assets and thus unable to continue in business on the present scale. Indeed, the more efficient firms typically sell at prices below the marginal costs of a substantial portion of the capacity of the less efficient firms. Such prices are what keeps that less efficient capacity from serving the market, and thus competitively reserves the market to the more efficient firms.

Considerations of this kind explain why, when an industry is confronted with a substantial drop in the demand for its product, the result is a fall in price even though the demand for the industry’s product is relatively inelastic and the industry is made up of few firms. What accounts for a price reduction that is consistent with rational self-interest in such circumstances is an inequality in the marginal costs of the different firms in connection with the capacity they had employed prior to the drop in demand. If the drop in demand idles capacity with a relatively low marginal cost of operation, while other firms continue to supply the market with capacity that has a relatively high marginal cost of operation, then it becomes to the self-interest of the firm with the lower-cost capacity to cut the price in order to make way in the market for its capacity. Cutting the price below other firms’ higher marginal costs is the means of eliminating the higher-cost capacity of those firms from the market. This is genuine competition in adverse circumstances.

Such competition takes place throughout the economic system in every recession. Yet contemporary economic theory is virtually incapable of comprehending how it can exist—that is, how prices can fall in the face of a drop in demand, or, indeed, under any other circumstances—apart from the conditions of “pure and perfect competition.” What blinds its vision here is its inheritance from Alfred Marshall of the notion of “the representative firm.” 99 It typically regards “an industry” as consisting of a mere multiplication of so many interchangeable, identical “representative firms.” It thus proceeds on the assumption that all the firms in an industry have exactly equal efficiency and equal costs. In such conditions, there is obviously no basis for competition: no one can have any rational basis for expecting to succeed by competing. The moment anyone cuts his price, the other producers, who are assumed to be equally efficient, cut theirs in response. The result is that the only possible gain for a producer in cutting his price is the gain that would exist if there were only one producer. On this basis, contemporary economics concludes that what it calls “oligopoly” is essentially the same in its effects as “monopoly.” For it appears to it that it will pay an “oligopolist” to cut his price only when it would pay a “monopolist.” 100

Competition, centering precisely on an inequality in the productive efficiency of firms, is the means by which continuous progress and improvement are brought about, in terms both of falling real prices of products and ever better products. Indeed, nothing could be more pure and perfect—in the rational sense of these terms—than the competition that takes place under capitalism. As the result of this competition, generation after generation, in industry after industry, one massive improvement in production succeeds another, and the best of the products of the past cease to be good enough for the present. At the same time, everything becomes more and more affordable to more and more people. This is what the whole of Part C of the preceding chapter and, indeed, the whole of this book has shown.

The ideal of the “pure-and-perfect-competition” doctrine, however, is a totally stagnant economy—the “static state,” as it is called—in which production and consumption consist of an endless repetition of the same motions. 101

It is in the name of this “ideal” that the supporters of “pure and perfect competition” attack the constant introduction of new or improved products, the ever-growing variety of products, and the advertising required to keep people abreast of what is being offered.

And only from the standpoint of this “ideal” can one declare that idle capacity is a “waste”—for only in a “static state” would there be no need for any unused capacity.

The supporters of “pure and perfect competition” are aware of the fact that their doctrine is inapplicable to reality. This does not trouble them. Their view is expressed by Professor Wilcox, who casually observes: “Perfect competition, thus defined, probably does not exist, never has existed, and never can exist. . . . Actual competition always departs, to a greater or lesser degree, from the ideal of perfection. Perfect competition is thus a mere concept, a standard by which to measure the varying degrees of imperfection that characterize the actual markets in which goods are bought and sold.” 102

This “concept” divorced from reality, this Platonic “ideal of perfection” drawn from nonexistence to serve as the “standard” for judging existence, is one of the principal reasons why businessmen have been imprisoned, major corporations broken up and others prevented from expanding, and why economic progress has been retarded and the improvement of man’s material wellbeing significantly undercut. This “concept” is at the base of antitrust prosecutions, which have forced businessmen to operate under conditions approaching a reign of terror.

The doctrine of pure and perfect competition is a leading manifestation of the influence of irrationalism and mysticism in contemporary economics. It can be taken as an illustration of the proposition that while unreality and nonexistence as such can have no consequences, those who are confused enough to advocate them, do. It belongs hopefully to the last, and certainly to the most convoluted and absurd phase of the denunciations of capitalism as a system of monopoly.

11. A Further Word on Cost of Production and Prices

The discussions of the marginal revenue and pure-and-perfect-competition doctrines make clear that the reaction to classical economics’ exaggeration of the explanatory role of cost of production as a determinant of prices has gone too far, in two respects.

First, cost of production operates to set many prices far below what they would be if they were determined on the basis of the direct marginal utility of the good concerned. This, of course, is the case with respect to some necessities and virtually all components and spare parts used in manufactured goods.

Second, cost of production operates to establish prices at a point that is above what they would be if producers did in fact have to regard their plant and equipment and intellectual property as not deserving to command an allowance in the price of the product because their renditions of service were not scarce. The fact that producers do not have to regard their plant and equipment in this way is, of course, what makes it possible for prices to be below the direct marginal utility of the specific goods concerned, because producers then have the productive capacity on hand immediately to make more of the goods available. And the fact that they do not have to regard their intellectual property in this way is what underlies their incentive and ability to go on introducing further productive innovations, which steadily reduce prices in real terms.

Thus, prices are very often lower than one would expect on the basis of the direct marginal utility of the product. At the same time, they are typically higher than corresponds to the marginal utility of the full available supply of the means of producing the product—viz., the full available supply of renditions of service that the plant and equipment and, even more, the knowledge of the requisite methods of production, is capable of providing. In both cases, prices are pulled toward cost of production—the full cost of production.

In the first case, they are pulled in a downward direction; in the second case, in an upward direction. In the first case, cost of production communicates the marginal utility of the means of production in other employments and pulls the marginal utility and price of products in specific industries down to conform with that wider marginal utility. In the second case, cost of production on the part of potential outside entrants, together with an allowance for the going rate of profit, sets the upper limit to which producers can raise the price of their product without encouraging outside competition—except insofar as their products possess premium quality. It thus limits the extent to which prices can exceed a correspondence to the marginal utility of the full available supply of means of production. As stated, and it cannot be too strongly stressed, such excess of price is an essential foundation for the cheapness of price in comparison with the direct marginal utility of many goods and for the progressive decline in prices in real terms.

Notes

1. For a discussion of the rational and the anarchic concepts of freedom, see above, pp. 23–26. See also above, p. 238.

2. On the subject of freedom of opportunity, see above, pp. 337–343.

3. For a critique of the contrasting notion of an “equality of opportunity,” see above, ibid.

4. Cf. above, p. 342, the discussion of the synergistic nature of the freedom of opportunity.

5. For a critique of the notion that the freedoms of speech and press can be violated in this way, see above, pp. 23–26. 6. Strictly speaking, in order for the freedom of competition to reduce hospital rates to a level corresponding to the necessary costs of providing hospital care, together with a competitive rate of profit, and then to reduce those necessary costs, more would be required than freedom from licensing. Freedom from other forms of government regulation that artificially increase costs would also be necessary. This is because today’s outlandish hospital rates do not rest on a foundation of exorbitant profits, but on a foundation of artificially created costs caused by government intervention in medical care. The freedom of competition that escape from licensing is to make possible must be understood as allowing the competitors to avoid all such artificial costs. Such costs include the practice of socalled defensive medicine in order to avoid irrational malpractice suits.

7. Cf. Ayn Rand, The Virtue of Selfishness (New York: New American Library, 1964), p. 129.

8. See above, pp. 148–150.

9. This theme is elaborated, along with an explanation of all aspects of the cause and cure of the current crisis in medical care in my pamphlet The Real Right to Medical Care Versus Socialized Medicine (Laguna Hills, Calif.: The Jefferson School of Philosophy, Economics, and Psychology, 1994). 10. See above, pp. 355–356.

11. See above, ibid.

12. See above, pp. 196–199.

13. See above, ibid.

14. For an account of its destructive effects on blacks in particular, see George Reisman, Capitalism: The Cure for Racism, a pamphlet (1982; reprint ed., Laguna Hills, Calif.: The Jefferson School of Philosophy, Economics, and Psychology, 1992), pp. 13–21.

15. See ibid., pp. 21–23.

16. On the uniformity-of-profit principle, see above, pp. 172– 187, especially pp. 176–180.

17. See above, p. 284.

18. For a demonstration that the existence of socialism serves to confirm the fact that monopoly is a political phenomenon, not an economic phenomenon, see below, pp. 392–393. 19. For elaboration of this point, see below, pp. 417–420. 20. See above, pp. 70–71.

21. For a discussion of the principles underlying the limitation of patent and copyright protection, see Ayn Rand, “Patents and Copyrights” in Ayn Rand, ed., Capitalism: The Unknown Ideal (New York: New American Library, 1966), pp. 126–128. 22. Cf. David Ricardo, Principles of Political Economy and Taxation, 3d ed. (London, 1821), chaps. 17 and 30; reprinted as vol. 1 of The Works and Correspondence of David Ricardo, ed. Piero Sraffa (Cambridge: Cambridge University Press, 1962), pp. 249–250, 384–385. (Where appropriate, from now on, specific page references to the Sraffa edition will be supplied in brackets.)

23. Ibid. See also chap. 1 [p. 12].

24. See Richard Caves, American Industry: Structure, Conduct, Performance, 4th ed. (Englewood Cliffs, N. J.: Prentice-Hall, Inc., 1977), p. 8.

25. See Paul Samuelson and William Nordhaus, Economics, 13th ed. (New York: McGraw-Hill Book Company, 1989), pp. 605–611.

26. Ibid., pp. 607–608.

27. Ibid., p. 612.

28. See, for example, ibid., p. 584, and below, pp. 432–434. 29. Karl Marx, Capital, 3 vols. (Moscow: Foreign Languages Publishing House, 1962), 3:430. Italics supplied.

30. See above, pp. 135–139 and 267–282 passim.

31. As later discussion of saving and capital formation will make clear, the extent to which successful mergers, or anything else which serves to increase real wealth and capital, are accompanied by an increase in the monetary value of invested capital in the economic system as a whole, depends on the rate of increase in the quantity of money. What is essential here is only that successful mergers result in the formation of more new capital in real terms, and thus in the basis for the formation of new and additional firms.

32. It must be noted that this conclusion is not contradicted by statistics alleging a growing concentration of the capital of the American economic system in the hands of the 200 or 500 largest corporations. At the same time that this phenomenon has been going on, foreign trade has become of greater importance and the capital of America’s major trading partners has increased much more rapidly than that of the United States. Thus, the ratio of the capital controlled by the 200 or 500 largest American corporations to the total capital employed in serving the American market has sharply fallen over the last generation! 33. For a defense of insider trading, see below, pp. 395–396. 34. See above, p. 127.

35. For an example of this error, see Samuelson and Nordhaus, Economics, pp. 571–572.

36. Ohio v. Standard Oil Co., 49 Ohio, 137 (1892).

37. Cf. John S. McGee, “Predatory Pricing: The Standard Oil (New Jersey) Case,” The Journal of Law and Economics, October, 1958, p. 144.

38. The situation here is similar to the case of partial price controls raising prices on the uncontrolled portion of the supply. See above, pp. 250–252 and 254–256.

39. Cf. Wayne Leeman, “The Limitations of Local Price Cutting as a Barrier to Entry,” Journal of Political Economy, August, 1956, pp. 331–332.

40. Cf. ibid., p. 330.

41. In fact, Rockefeller did buy out small competitors at premium prices, but not in order later on to charge higher prices— rather, in order to achieve the economies of larger-scale operations. In this way, the small competitors shared the gains of merging and achieving economies of scale. See John S. McGee, “Predatory Pricing.” See also Leeman, “Limitations of Local Price Cutting,” p. 332.

42. Leeman, “Limitations of Local Price Cutting,” pp. 332– 333.

43. Cf. John S. McGee, “Predatory Pricing,” especially p. 168. 44. This is the same mentality of state worship as is present when people credit government-sponsored research efforts with bringing about major advances in the production of civilian goods, in the process ignoring the essential context of the existence of a capitalist economic system with its profit motive and freedoms of individual initiative and competition, without which no civilian use would ever be made of any such research. (On this subject, see above, p. 277, especially n. 16.) It is the same mentality that is present above all in that combination of unsurpassed ignorance and arrogance that blithely ignores the economic planning that takes place every day under capitalism on the part of millions and tens of millions of private business firms and individuals, and regards economic planning as a capacity unique to the state, which is utterly incapable of planning an economic system and characteristically bungles whatever lesser planning it may undertake. (Concerning this subject, see above, pp. 137–139 and 269–273.)

45. For further analysis pertaining to the post–World War II success of the Japanese economy in comparison with the American economy, see below, pp. 622–629, where the United States can be thought of as the stationary economy depicted in Figure 14–4 on p. 624, and Japan as the progressive economy depicted in Figure 14–5 on p. 625. That analysis explains the role both of relative rates of saving and relative degrees of economic freedom in bringing about capital accumulation and economic progress. See also pp. 831–834.

46. Dudley Dillard, Economic Development of the North Atlantic Community (Englewood Cliffs, N. J.: Prentice-Hall, 1967), pp. 409–410.

47. An investigation of the actual facts concerning Standard Oil’s dealings with the railroads, undertaken by someone who understands the principles of sound economics, would make an excellent subject for a doctoral dissertation and subsequent book.

48. In reality, it is likely that the elasticity accompanying ten 10 percent increases in supply would not be uniformly one-tenth of the elasticity of a doubling of supply, but would show some variation, with some of the 10 percent increases in the industry’s supply being accompanied by lesser or greater price reductions, which, nevertheless, would cumulatively add up to a 40 percent reduction in price accompanying a doubling of supply.

49. Interestingly, Samuelson and Nordhaus show some modest awareness of the fact that potential increases in competitors’ output can increase the elasticity of demand facing a given firm. See Samuelson and Nordhaus, 13th ed., pp. 609–610. They seem utterly unaware, however, of the critical role played by outsiders’ costs.

50. See below, pp. 417–420.

51. Application of the principle to the oil industry was present in the discussion, back in Chapter 7, of the injustice of blaming the oil industry for the oil shortage or for any increase in the scarcity of oil. See above, p. 236.

52. The Works and Correspondence of David Ricardo, 11 vols., ed. Piero Sraffa (Cambridge: Cambridge University Press, 1951–1973), 8:276–277.

53. Eugen von Böhm-Bawerk, Capital and Interest, 3 vols., trans. George D. Huncke and Hans F. Sennholz (South Holland,

Ill.: Libertarian Press, 1959), 2:245.

54. Ibid., 2:244–245.

55. Böhm-Bawerk uses the term “marginal product” here to refer to a distinct product of a different type, not, as is the practice in contemporary economics, to the gain or loss of a product of a given type attributable to the presence or absence of a unit of a factor of production.

56. It must be pointed out that the existence of inventories, which can be drawn down in response to an increase in demand, before additional production succeeds in increasing supplies, and which can be temporarily built up in response to a decrease in demand, before production is cut back, makes it unnecessary that production be adjusted instantaneously to changes in demand. The extent to which demand is postponable also introduces a measure of flexibility in how quickly production must be adjusted to changes in demand in order to maintain a connection between prices and costs.

57. Böhm-Bawerk, Capital and Interest, 2:173–176. (The permission granted by Libertarian Press to quote this very long passage is gratefully acknowledged.) See also Capital and Interest, 3:Excursus 8, and Böhm-Bawerk’s untranslated article “Wert, Kosten, und Grenznutzen,” Jarhbuch für Nationalökonomie und Statistik, Dritte Folge, 3:328.

58. Friedrich von Wieser, Natural Value (London and New York: The Macmillan Company, 1893), p. 181n. See also Wieser’s Ursprung und Hauptgesetze des Wirtschaftlichen Werthes (Vienna: 1884), pp. 150–151.

59. See W. S. Jevons, The Theory of Political Economy, 4th ed. (London: Macmillan and Co., 1924), p. 165.

60. Ricardo, Principles of Political Economy and Taxation, chap. 1 [p. 12].

61. Samuelson and Nordhaus, Economics, p. 614.

62. It will be found that the substance of what is said here concerning patents and copyrights applies equally to trade secrets. The only difference is that in the case of trade secrets there is no fixed time limit within which competitive advantages must fall into the public domain. That time may come sooner or later than is the case under patents and copyrights. 63. See above, pp. 388–389.

64. On the subject of collectivized medical costs, see above, pp. 148–150.

65. These and any other possible exceptions all pertain to the use of physical force, which is the essential feature of government power. This is the one activity which, insofar as it cannot be entirely eliminated, must be tightly controlled and regulated, so that the only force used is the appropriate minimum necessary for defense and retaliation against the initiation of force. In a fully free society, government would be the only controlled and regulated institution.

66. Insurers and mortgage lenders would undoubtedly also require adherence to various safety precautions in the construction and maintenance of the properties they insured or lent money on.

67. See above, pp. 408–414.

68. Richard Caves, American Industry, p. 59.

69. See Ludwig von Mises, The Free and Prosperous Commonwealth, trans. Ralph Raico (Princeton: D. Van Nostrand Company, 1962), pp. 92–93; reprinted under the title Liberalism: A Socio-Economic Exposition (Kansas City, Kans.: Sheed Andrews and McMeel, Inc., 1978). The original, German-lan—

guage title of the book was Liberalismus.

70. See above, pp. 180–182.

71. See above, pp. 234–237.

72. See Ludwig von Mises, Human Action, 3d ed. rev. (Chicago: Henry Regnery, 1966), pp. 366–368.

73. Much of what follows originally appeared in my article “Platonic Competition,” The Objectivist 7, nos. 8 and 9 (August and September 1968); reprinted as a pamphlet (Laguna Hills, Calif.: The Jefferson School of Philosophy, Economics, and Psychology: 1991). References have been updated where possible.

74. Richard H. Leftwich and Ross D. Eckert, The Price System and Resource Allocation, 9th ed. (Chicago: The Dryden Press, 1985), p. 41.

75. See Ayn Rand, Capitalism: The Unknown Ideal, p. 7. See also von Mises, Human Action, pp. 41–46.

76. C. E. Ferguson, Microeconomic Theory, 5th ed. (Homewood, Ill.: Richard D. Irwin, Inc., 1980), pp. 173–174.

77. For an account of the origins of this alleged ideal, see von Mises, Human Action, pp. 689–693.

78. George J. Stigler, The Theory of Price, rev. ed. (New York: The Macmillan Company, 1952), p. 83.

79. Ferguson, Microeconomic Theory, p. 173.

80. Cf. Samuelson and Nordhaus, Economics, pp. 514–515, 526, passim.

81. Ibid., pp. 514–515, 524–527, 656–665.

82. Ibid., p. 552.

83. Paul Samuelson and William Nordhaus, Economics, 12th ed. (New York: McGraw-Hill Book Company, 1985), p. 518. 84. Ibid.

85. See von Mises, Human Action, p. 128.

86. Cf. ibid., pp. 364–365. Regrettably, as the passages cited here will show, von Mises, the greatest of the economic defenders of capitalism, in this instance himself implicitly accepts the tribal-rationing theory and its application.

87. See, for example, Samuelson and Nordhaus, 13th ed., p. 517, Figure 22–2 and the accompanying discussion.

88. See ibid., pp. 514–516, for a standard textbook presentation of the law of diminishing returns as the basis for continuously rising marginal cost.

89. On the nature of the law of returns, see von Mises, Human

Action, pp. 127–131.

90. See above, pp. 308–311.

91. Clair Wilcox, “The Nature of Competition,” reprinted in Joel Dean, Managerial Economics (Englewood Cliffs, N. J.: Prentice-Hall, Inc., 1951), p. 49. An essentially identical list of requirements appears in the much more recent textbook The Price System by Leftwich and Eckert, pp. 39–41.

92. For confirmation of this point, see below, in the next subsection, the discussion of Samuelson and Nordhaus’s notion of “ideally regulated pricing” in connection with public utilities. 93. Samuelson and Nordhaus, 13th ed., p. 590.

94. See Arnold C. Harberger, “Monopoly and Resource Allocation,” American Economic Review (May 1954), pp. 771–787. 95. Samuelson and Nordhaus, 13th ed., p. 584. In a footnote on p. 584, they attribute their quotation to “F. M. Scherer, Industrial Market Structure and Economic Performance (Rand McNally, Chicago, 1980), p. 464.”

96. See Samuelson and Nordhaus, 13th ed., p. 583, the diagram in Figure 24–6. On page 524 it is stated that cost includes the “opportunity cost” constituted by the possibility of earning a rate of return on one’s capital. These “costs” are counted in what is labeled “AC” [average cost] in Figure 24–6.

97. See above, pp. 390–391.

98. George Leland Bach, Economics, 6th ed. (Englewood Cliffs, N. J.: Prentice-Hall, Inc., 1968), p. 361. (Bach expresses the same view in the eleventh edition of his book, published in 1987, pp. 376–377, but not as succinctly.) See also the discussion of “Collusive Oligopoly” in Samuelson and Nordhaus, 13th ed., pp. 607–609.

99. See Alfred Marshall, Principles of Economics, 8th ed. (New York: The Macmillan Company, 1920), pp. 317, 342, 377, 459–460, 805, 809n.

100. Cf. Samuelson and Nordhaus, 13th ed., the previously referenced discussion of “Collusive Oligopoly” on pp. 607– 609.

101. For a valuable discussion of the influence of this “ideal” on contemporary economics, see von Mises, Human Action, pp. 250, 350–357.

102. Clair Wilcox, “The Nature of Competition,” p. 49, immediately following his alleged definition—the list of conditions quoted earlier.