Market-Share Sophisms; C. Mayer

These conditions hold true on a free mar ket. But there are many influences in the real world that are not consistent with a free mar ket. Minimum-wage laws, the plethora of entitlements, union privileges, government grants, state-managed money, regulations, and a host of interventions change the pattern of production in unknowable ways from what might have been in the absence of these things. We can only imagine where some of the capital deployed in the steel industry would have gone had the U.S. government not protected it from foreign competition. Christopher Mayer is a loan officer at a bank in Maryland and an MBA student at the University of Maryland. What's the Market? Another complication is how a given mar ket is defined. Do manufacturers of corn flakes compete only against one another? Or do they also compete against makers of other ready-to-eat cereals? What about hot cereals?

What about bacon and eggs? The answers to those questions make a big difference for the market shares of companies. Regulators base their claims on arbitrary assumptions. What counts is how consumers see things. One final element that's often neglected in the analysis of market-share data: time. Mar ket positions are snapshots. They change. The market leaders of ten years ago are different from today's. They'll be different years from now. In a free market, the continued long term dominance of a firm reflects its superior ability to satisfy consumers. Size doesn't determine a firm's degree of control over prices and production. Large and small companies may produce in whatever quantity they wish and attempt to charge whatever price they wish. Ludwig von Mises got to the heart of the matter when he wrote that "What those who blame the economies of big-scale production for the spread of monop oly prices are trying to say is that the higher efficiency of big-scale production makes it difficult or even impossible for small-scale plants to compete effectively."

That inefficient firms are kept from the market is no vice. In fact, this is one of the market's virtues. But that doesn't mean small 35 36 THE FREEMAN/IDEAS ON LIBERTY • JUNE 1999 companies have no chance. Large firms are not always best at providing value to cus tomers. There may be diseconomies of scale that make it increasingly difficult to compete effectively beyond a certain size. This is not to deny certain advantages that large dominant firms enjoy. Large firms with deep pockets have the financial wherewithal to respond to opportunities and weather storms better than smaller, less well-capital ized rivals. A bountiful corporate treasury provides a margin for error that smaller firms may not have. This is not a market failure, but the reward for past successes. Calculation Problem There is something that limits the size of firms in the free market: the need for eco nomic calculation. The application of the calculation problem to private firms, an extension of Mises's refutation of socialism, was an important insight of Murray Roth bard in Man, Economy and State. Ronald Coase's analysis of the firm concluded that the free market would establish a size that tended to optimize transaction costs. (See Max More, "Small is Awesome," in the February 1999 issue of The Freeman.) But the problem of economic calculation is more fundamental.

While the economist can say little about the optimal size of a specific firm, he can say the market will tend to establish the best possible arrangement thanks to the calculation that market prices make possible. Imagine a firm that grew so big that it swallowed up the external markets for its inputs. In the absence of market prices for those inputs, the firm could not engage in economic calculation and thus could not know if it was deploying its capital in the most efficient manner. As Roth bard wrote, "When any of these external mar kets [for inputs] disappears, because all are absorbed in the province of a single firm, cal culability disappears, there is no way for the firm rationally to allocate factors to that spe cific area. The more these limits are encroached upon, the greater and greater will be the sphere of irrationality, and the more difficult it will be to avoid losses"(p. 585).

The upshot is we can let the free market take its course. Let us not worry about the alleged power of dominant firms and instead focus on creating an environment in which the free market is free to function. D We are helping FEE sell books over the Internet May We Help You? 3D RESEARCH http://fee.3dresearch.com web @ 3dresearch .com (724)-776-7384 Peripatetics The Permanent War by Sheldon Richman S ome years ago Stanley McGill, 93, mailed a check for $7,000 to the Internal Revenue Service. When he died, his daughter discov ered that Mr. McGill had made a mistake. The money should not have been sent. Marian Brockamp explained to the IRS that her father was senile and asked for a refund. The IRS said no. Requests for refunds must be made within three years. Mrs. Brockamp took the case to court-all the way to the U.S. Supreme Court. She lost. In the grand scheme of things, that was a small event. The Internal Revenue Service has done far worse in its time. It has harassed and tormented people. It has seized property and frozen bank accounts. It has ruined credit records. It has driven people to suicide. Nev ertheless, the Stanley McGill story sums up a great deal about the IRS and the American tax system. The IRS concedes that the $7,000 should not have been sent. Mr. McGill made a mistake. His daughter informed the IRS as soon as she discovered the error. No one ques tions the facts. But the IRS won't surrender the money. And the U.S. Supreme Court said the IRS doesn't have to.