How Anti-Trust Regulation Brings About Monopolies

Most Americans, and most economists as well, believe that antitrust regulation prevents monopolies and fosters competition. They believe consumers are protected by the government from big corporations that reduce their production in order to raise prices, or run smaller weaker companies out of business, so that they can enjoy high profits at the expense of the rest of society. This argument is fallacious.

The truth is that anti-trust laws exist in order to allow the creation of monopolies that could not otherwise exist: the government protects less efficient but politically favored companies from more efficient competition. The companies themselves are usually the ones to originate and promote the regulation. Companies use government power to prevent the mergers, acquisitions, expansions, or particular investments or production of rival firms so as to make them less competitive. In some cases, two firms that would have as small as a combined 3 percent market share in their industry have been prevented by the government from merging.¹⁰³ The government also prevents newer, smaller competitors from competing with larger corporations because the immense amount of time, money and hurdles required under regulation is often unaffordable to smaller companies that have not yet acquired as much capital as their larger competitors. The resulting failure of these small firms is, of course, the intention of the regulation.

Trust-Busting

But surely, you must be thinking, what about all the historical cases you’ve heard about concerning the large trusts (early forms of corporations) of the late 1800s that were broken up because of their monopoly control and presumed damage to citizens, right? The stories are myths... complete myths. Indeed, the government broke up these companies and destroyed or diminished their productive capabilities, but the trusts were not harmful economic entities; they contributed greatly to increased prosperity for all. It is true that some of those who owned or ran the trusts eventually asked the government for protection from competitors (regulation), and this is shameful. It is also true that many other companies became powerful and wealthy through government-assigned privileges. But without question, the trusts did not become large and successful by somehow “unfairly” competing in an otherwise free market.

Thomas J. DiLorenzo showed in the June 1985 issue of the International Review of Law and Economics¹⁰⁴ that the industries accused of being monopolies at the initiation of the Sherman Antitrust Act were expanding production four times more rapidly (some as much as ten times faster) than the economy as a whole for the entire decade leading up to the Sherman Act. These firms were also dropping their prices faster than the general price level (remember that prices fell during most of the 1800s). One of the senators in favor of antitrust laws at the time, Representative William Mason, admitted that the trusts “have made products cheaper, have reduced prices.”¹⁰⁵ Nonetheless, he argued that in accomplishing this, the trusts put honest competitors out of business, which implies that the trusts were dishonest and that they had engaged in wrongful acts by simply competing in business. He stated this because he, along with most congressmen at the time, wanted to protect less efficient companies in their districts from the more efficient competition of the trusts.¹⁰⁶ Economic policy actions are almost always taken for political reasons.

Similarly, Dominick Armentano found that of the fifty-five most famous antitrust cases in U.S. history, in every single one, the firms accused of monopolistic behavior were lowering prices, expanding production, innovating, and typically benefiting consumers.¹⁰⁷ He found that it was their less efficient competitors, not consumers, who were harmed.

As further evidence of the lack of any harm trusts caused individuals, economic historians Robert Gray and James Peterson pointed out that between 1840 and 1900, the proportion of national income received by workers remained unchanged: Labor received 70 percent and owners of capital, property, and materials received 30 percent. This means that companies did not gain at the expense of the public.

The most famous trust is probably that of John D. Rockefeller’s Standard Oil. The company refined oil that was mostly used in kerosene products (gasoline and automobiles were just being developed). The oil business was very small as compared to today. Standard Oil began as a smaller company, and grew in size through normal business competition — providing a better product at lower prices. As a result of its innovation and the competition it fostered, the price of refined petroleum fell from over 30 cents per gallon in 1869 to 5.9 cents in 1897.¹⁰⁸ Competition did in fact force many companies into bankruptcy, which is what happens to any company that fails to compete effectively. Still, such occurrences formed the basis of accusations of wrongdoing against Standard Oil in court. However, unlike most cases, companies that could not compete with Rockefeller were usually able to sell their assets to him. One man so benefitted from Rockefeller’s buying him out that every time he went out of business, he started a new oil company that Standard Oil could once again out-compete and buy out. He became very wealthy by having Rockefeller buy him out eleven times.¹⁰⁹ Even though Rockefeller outcompeted most companies, there were other companies that in fact gained ground on Standard Oil and prevented it from having a monopoly — in the free market, without government help.

What is a Monopoly?

A key way in which the government finds firms guilty of being monopolies is in defining monopoly in both vague and unrealistic terms. According to the government’s and government economists’ view, there should always exist a world they describe as having “pure and perfect competition,” in which there are numerous firms in an industry, selling identical products, each having a small market share, operating in fluid, continuous markets, where there is a constantly fluctuating market price, where no single firm has any pricing power, and where there are no barriers to entry of the market (of any kind, even those which are natural ones).

In government economists’ view, if this description of a marketplace does not actually exist, there instead exists a monopoly, duopoly, or oligopoly, with unnatural pricing and competitive powers. As we all know, industries with this profile rarely exist; which is why the government always has an excuse to find firms guilty of being monopolistic. Additionally, it is very difficult in many cases to determine exactly what the industry is. Does Coca Cola compete only with other soft drinks, or does it also compete with iced tea, fruit drinks, coffee, water, and beer? Depending on how the definitions are used, any firm could be a monopoly. For example, Wendy’s could be a monopoly even though so many other burger places exist, since only Wendy’s has a menu offering large square beef patties with baked potatoes offered as a side dish. In fact, companies normally compete in part by means of intentionally differentiating themselves. And in the bigger picture, all products compete with all products. For example, if you win the lottery, you might choose between a boat, an RV, and a diamond ring.

The reality of the case is that there can be very tight competition in different industries with five, two, or even one competitor. Additionally, there might exist only one business in an entire industry! But having only a single “monopoly” firm in an industry does not mean that it has the power to restrict output or raise prices. An industry, even with only one company, is competitive as long as competition is a threat. This is the case, for example, with the NFL, which does not act monopolistic in the least: it constantly creates new product attributes such as instant replay for questionable referee calls, and it expands supply by adding new teams. Additionally, it always has indirect competitors (the CFL, sitcoms, other forms of entertainment, etc.), and sometimes has direct competitors, such as the XFL football league which attempted to compete in 2001. But it always has the threat of competition.

In the same fashion, Alcoa was the only producer of aluminum ingot for many years, but did not constitute a monopoly in the traditional sense, because it did not prevent competitors from entering the marketplace, and its rate of profit, at 10 percent, was not an extremely large one.¹¹⁰ It earned its position in the marketplace by honestly and fairly out-competing other previously-existing firms. Nonetheless, the U.S. Court of Appeals found the company guilty of employing “superior skill and foresight”¹¹¹ that the court felt “forestalled” competition by less efficient businesses. Alcoa was accused of being “exclusionary,” since not all firms in its industry had equal skill and foresight.¹¹² In other words, Alcoa was guilty of outcompeting in the marketplace by offering a superior product at lower prices.

Conversely, harmful monopolies can exist while numerous companies operate in a market. In New York and many other cities, larger, more efficient taxi cab operators are prevented from competing against smaller, costlier ones through the government’s limiting of the number of licenses it sells (at over $100,000 each). Were supply not limited, profits would fall, and cost savings would be initiated; only the most efficient competitors would remain, and they would do so by being larger (like car rental companies). In the end, fewer firms would provide more, higher quality, and cheaper services. A harmful monopoly exists whenever government prevents even one competitor from entering a market.

Why Harmful Monopolies Can’t Exist in Free Markets

The reason that even a single firm cannot act monopolistic is rather simple. The higher the prices a company charges, the more profit it makes. The higher the profit, the more competition is invited into the market, as long as other firms are permitted to freely enter the market. The more firms that enter the given market, the more likely the existing firms will lose market share. Therefore, not only do existing firms (or a would-be monopolistic firm) try to prevent possible competitors by keeping the selling prices of their products not too far above costs, but they continually try to find ways to reduce their costs. For if existing firms remained inefficient, they would lose market share to new entrants who would come to take advantage of the fact that they could make larger profits by producing with lower costs than the current firms, while maintaining the same selling price, or even lowering the selling price. As long as even a sole competitor has the threat of a new competitor, it will sell for as low a price as possible, which it could achieve more easily with economies of scale that come from increased production.

It is for this reason that we have products that are very important to us, but that still sell for relatively low costs. For example, one would think that automobile batteries or the on/off switch to an air conditioning unit would cost thousands, since the overall machines could not function without these small parts. But instead of being expensive, these parts are easily affordable because they are priced based on their costs of production plus a reasonable profit;¹¹³ their costs of production, in turn, are based mostly on the market prices for each individual subcomponent, which themselves are based on cost of production resulting from supply and demand of the individual “factors of production,” along with the product’s “marginal utility.” If firms tried to sell these parts for more than potential competitors could sell them for, they would be facing stiff competition.

On that note, it should be pointed out that product prices on the retail side, which are largely based on the value that consumers attribute to their enjoyment of the product (marginal utility), can sometimes enjoy higher profit margins in cases where direct, comparable competition is impossible. For example, a restaurant whose particular ambiance, recipes, flavors, and taste of food, cannot be easily replicated by competitors could earn very high rates of profit. According to the government, the restaurant would constitute a monopoly even by providing such a great product that consumers go out of their way to pay the asking prices (which could still not be too high without causing a decline in the restaurant’s revenues and profits).

Since the key to the prevention of monopolistic practices is the freedom to compete, another argument government economists often put forth should be considered. This is that if the barriers to entry are too high, the market is not competitive. This thinking is wrongheaded. Just because one is free to enter a market does not mean that one has the means to do so. High capital requirements, typically seen as a barrier to entry, in reality just mean that in order to be profitable, the producers must operate with low costs. Many industries require this large scale and efficiency, which requires an immense amount of investment. The need for large investments and large scale is the reason that so many industries end up with only two or three firms. Would-be smaller competitors are not able to achieve such a high quantity of production and low selling prices.

Predatory Pricing

One of the most influential theories with regard to monopolies is that of so-called predatory pricing. Under this theory, a company, particularly a large, wealthy one, could temporarily slash its prices in order to undercut the smaller firms and drive them out of business, at which time the large firm would be able to reduce its production and raise its prices. The idea is that the large firm, more than the small, can afford to sell at a loss for a while, and then make up the loss later with its higher prices. After the large firm becomes the sole supplier in the industry, it is held, other firms will not attempt to compete for fear of incurring losses in the same way again. The list below comprises the primary reasons why this predatory pricing doctrine is completely unrealistic.¹¹⁴ Though the list is somewhat technical and infused with economic jargon, it is important at least to present these arguments to the reader, because the predatory pricing doctrine has such a profound influence on the world of political economics; it is a primary cause of harm to millions of consumers:

1. Though the large firm has more money, any loss incurred would be in the same proportion as that of the small firm; the large firm is thus hurt just as much (even if the marketplace in question is that of a particular operating location, and the large firm has many other locations to support the one location in question, it cannot afford to maintain an unprofitable operating location which reduces its overall profits).
2. If the relative proportion of capital of the small firm is larger than that of the large firm, it can afford to sustain losses for a longer period.
3. In order to recoup previous losses, the large firm has to raise prices to such a degree that their very large profits would attract new competitors that could even possibly compete at lower costs, due to the lack of losses to make up. But in fact it is restrained from raising prices due to this fact. Also, once the large firm succeeds, its new profits are limited because if it raises prices too high, demand will fall (since customers can choose to buy less or buy alternative products).
4. Depending on the remaining productive capacity of the large firm as well as the so-called elasticity of demand (the extent to which buyers will continue to buy more, less, or the same quantities at higher and lower prices), a lower price could cause increased demand which would drive the price higher because there would not be enough capacity to meet the new demand. If the large firm increases capacity in order to meet the new demand, it has to keep funding that new capacity after all market manipulation is complete. The resulting costs could outweigh the gains from possible higher prices later.
5. The large firm must sell below the variable operating costs, not the largely fixed total costs. As long as the small firm can produce above operating costs, it pays to continue operations. If much of the costs of the small firm are fixed, it might be able to profitably operate for quite a while.
6. Suppliers to the competing firms, who would be harmed by decreased demand resulting from the large firm’s future higher prices, would have an incentive to subsidize the small firm so as to prevent the large firm from raising prices.
7. Were the large firm really to try and continually lower prices to harm smaller firms, the small firm could profit by shorting the stock of the large firm every time it re-entered the market where the large firm was operating, making the money needed to support its other losses.
8. Were the now sole large firm to continually lower prices, every time small firms tried to compete, the small firms could encourage buyers to wait until they entered the industry and the large firm reduced prices. At this point the withheld demand would be so high that the small firm could sell at higher prices and profit.
9. Were buyers to see that only a single firm would be left, they would require contractual agreements in order to deal with such a price-manipulating company; otherwise, they would stand to be harmed financially.
10. If the small firm goes out of business, its assets are worth less. They can be bought at bargain prices in bankruptcy, thus offering a low cost basis with which the new small firm owner can be competitive.

The occurrence of any particular one of the above events would likely make attempted predatory pricing unprofitable. The reality is that the large firm would suffer extreme losses and would, in fact, be more profitable by sharing the industry with competitors.

Predatory pricing does not really occur, even though some economists like to pretend it does. Examples abound of supposed companies that engage in predatory pricing, but are instead simply better competitors. One example is the former A&P grocery store chain, which used to be a very prominent national chain that was accused of predatory pricing. But in the end, they were outcompeted, likely because they were prevented by government from offering their own private labels like grocery stores do today; the government saw that act as monopolistic at the time.

It should occur to readers at this point that companies can easily be held guilty by the government of raising prices too much on the one hand, and of lowering them too much on the other. They often are accused of at least one of these.

The Only Real Monopolies — Government Monopolies

The only way firms can be the sole company in an industry and not face the threat of possible competition is by having the government prohibit (i.e., threaten to use physical force) others from entering a particular market. Indeed, the government engages in such action; it is therefore instructive for us to look at the results of such efforts. The most common occurrences of true monopolies are in the areas of railways, telecommunications, water services, electricity services, mail delivery, and public schools. These are industries where frequent train wrecks (Amtrak), power blackouts, and water shortages (public utilities) occur, along with constantly increasing prices (post office and schools & universities), long lines, and poor services (post office), as well as underachieving students and dramatically increasing taxes and tuitions (schools and universities).

It is argued by government economists that most of these are “natural monopolies” where the existence of a single provider is more efficient than multiple providers. This argument, just like the predatory pricing argument, is not only fallacious, but is based purely on preconceived false notions, not on observation from reality. In fact, the theory was made up after the fact (i.e., it is a rationale for actions previously undertaken).

Before the government decided that government-imposed monopolies should exist, there was in fact competition in these markets; in most of them, there was more robust competition: Six electric light companies operated in New York City prior to 1890; 45 had a legal right to operate in Chicago in 1907; prior to 1905, Duluth Minnessota had 5 electric light companies, and Scranton Pennsylvania had 4. After monopoly regulation was implemented in these cities, prices (and profits) usually stayed the same or went up (this was during a period where prices were falling).¹¹⁵ University of Illinois economist Walter Primeaux found that those cities which allowed two or more competing utilities firms (some for over 80 years) had prices that were on average 33 percent lower than those that didn’t.¹¹⁶

Until the early 1900s, many large cities had at least two telephone companies. Once AT&T’s patents on telephone service expired in 1893, more than 80 competitors cropped up within a year, and by 1900, over 3,000 telephone companies existed.¹¹⁷ Prices fell dramatically and call volume increased exponentially. But upon the initiation of World War I, the government nationalized the phone company in the name of “national security.” Until it was again denationalized 80 years later, Americans faced punishingly expensive telephone service that made calling long distance a rare event. Once deregulation arrived again in the 1980s, prices fell dramatically; now, cheap long distance calls are made by all of us daily without our giving it a second thought. Many state telephone companies in foreign countries were forced into privatization in the 1990s as cell phones became competition: the rigid, overpriced hard lines could not compete with the cheaper, higher quality service of mobile phones.

The government’s antitrust department is a massive bureaucracy constantly searching for companies to harm. A prime example is its prohibiting RCA Corporation from charging royalties to American licensees in the 1950s, a practice deemed to be monopolistic. RCA instead licensed to many Japanese companies, which gave rise to the Japanese electronics industry, which ended up outcompeting the American industry.¹¹⁸ RCA was eventually bought by a Japanese company in 1990.

Pan American World Airways was destroyed by antitrust regulation because it was forbidden to acquire domestic routes, action that was deemed to be unfair competition to other airlines. Since it had no “feeder traffic” for its international flights, Pan Am also went bankrupt in 1990.

Examples such as these belong to the long list of harm done to companies, employees, investors, and mostly consumers by the federal government. Normal competition is often deemed anti-competitive by government bureaucrats; companies that are more successful than others are deemed to have an unfair advantage. Government officials and contributing Harvard and Yale socialist economists always believe that they know better than the marketplace what actions should be taken to please the most number of people in society, and they believe they know the exact prices that should be charged for thousands of products. Some economists have even gone so far as to argue that a company that creates an innovative new product from which consumers can benefit is a monopoly until competitors come along. Thus, the government, they say, should regulate companies’ research and development spending in such a way that all companies can produce new products in synch.¹¹⁹ In other words, it is argued that competition should be abolished, and companies should instead spend time and money lobbying the government for the right to produce the particular things that they want to produce with their own private property.

Typically, politicians call new monopoly regulation — as well as most other types of regulation — “deregulation” (most laws government passes are titled in ways that describe the opposite of what they are). Deregulation often involves the government’s setting prices at below-market prices, with the outcome that new companies will not enter the market to compete since they can’t make profits by charging market prices. When this happens, politicians and socialists say that deregulation has failed and that government control is needed. Regulation is regulation, not deregulation.

A typical way that government economists determine that a company is monopolistic is by assessing whether it is making “high” profits. Armies of economists are trained to be able to perform such “scientific analysis.” These economists take a snapshot of company data at one point in time, make assumptions to fill in the gaps, and determine whether profits are too high. But research has shown that when the same company data is studied over time, those with higher rates of profit tend to have profits fall to the average rate, while companies with lower rates of profit tend to see profits rise towards the average rate, just as was discussed with the uniformity of profit principle in Chapter 1.¹²⁰

Government should be kept out of the marketplace and companies should be allowed to compete without regulation. Unfair competition and exploitation of consumers is not possible. Successful companies can only run other competitors out of business, which, contrary to the government’s beliefs, is not an act which causes harm to society.