Stop Stopping Price Cutting; D. Boudreaux

This predation theory was endorsed by MIT's Franklin Fisher, the government's chief expert economist in the Microsoft lawsuit. When asked on the witness stand to explain why Microsoft currently charges so little for its Web browser, Fisher testified that "while the [predatory pricing] campaign is going on, consumers are getting a better deal." But beware the future! Fisher affirmed Judge Thomas Penfield Jackson's suspicion that Microsoft is pursuing a strategy of "delayed gratification"-increasing its prospects for future profits by purposely earning unneces sarily lower profits today. (As an aside, I find it curious that many people who insist that Microsoft purposely sacrifices profits today in hopes of earning higher, monopoly profits tomorrow also allege that modern American Donald J. Boudreaux is president ofFEE. 4 capitalism compels business leaders to maxi mize short-run profits at the expense of long term growth.) Microsoft isn't the only firm accused today of predatory pricing. The U.S. Department of Transportation accuses major airlines of low ering their fares whenever their markets are entered by upstart carriers. The sole purpose of these fare cuts, the department alleges, is to run the upstarts out of the market so that the major carriers face less competition.

And so it has been for all of antitrust's his tory. From accusations in the l880s that Chicago meatpackers charged too little for their beef and pork, through accusations in the 1930s that A&P's low prices unfairly hurt mom-and-pop grocers, to accusations in the 1990s that Wal-Mart predatorily prices down town retailers into bankruptcy, antitrust has commonly been used to prevent entrepreneur ial firms from improving the lot of consumers. Sadly, the current harassment of Microsoft is simply the latest episode in 110 years of this anti-entrepreneur, anti-consumer campaign. What Is Predation? Is predation real? Yes-but not in the way that government and many economists believe. In my view, predation occurs only when a firm relies on force or fraud to harm its rivals. For example, if Microsoft dynamites Sun Microsystem's production facilities, that's predation. If Delta Airlines advertises vicious lies about Southwest Airlines' safety record, that's predation. If Barnes & Noble successfully lobbies Congress to ban on-line book selling-thereby bankrupting Ama- .

zon.com-that's predation. But it's not preda tion for a firm to offer consumers better deals. A firm is not a predator if the advantage it wins over its rivals results from voluntary consumer choices. None of this denies that each firm wants to be a monopolist. But desiring monopoly power is not akin to acquiring monopoly power. A chief justification for freemarket competition is that by seeking maximum profit, firms yield benefits-as if by an invisi ble hand-not only to their owners, but also to their suppliers and consumers. Competition is supposed to encourage firms to compete for consumers. It is supposed to encourage firms to try to "harm" their rivals by offering con sumers better deals and, therefore, attracting consumers away from rivals. That's how com petition works; that's the only way that com petition can work. It is theoretically possible that Acme Cor poration today offers deals so attractive to consumers that its rivals soon are bankrupted and, as a result, Acme tomorrow charges monopoly prices. But this possibility hardly justifies government policing against low prices.

First, this possibility is too remote. Not only does the historical record contain scant evidence of predatory pricing, but even suc cessful predators cannot count on their monopoly power lasting. The reason is that any market monopolized by a predatory pricer is one in which the "monopolist" today enjoys excessively high profits only because it earlier charged prices that were below its costs. That firm has no special cost or quality advantages. (If the firm did enjoy such advantages, it could have bankrupted its rivals without charging below-cost prices.) Entrepreneurs will surely sweep in rapidly to challenge that firm. Profits in such an industry are lowlying fruit. Second, there's nothing special about low prices to distinguish them from a million and 5 one other strategies that firms use to attract more business. Anything a firm does to attract more business-cutting prices, improving quality, or more intensely advertising its ser vices-"harms" its rivals. (Again, that's what competition is about!) There's no justification for singling out a firm's low prices as a source of potentially fatal harm to rivals.

Suppose, for example, that Delta Airlines seeks more business not by lowering its fares but instead by investing in safer aircraft (and advertising the improved safety of its fleet). Won't consumers then be more likely than before to fly on Delta? Of course-and a con sequence is that United, USAir, AirTran, and other airlines will suffer. If they can't tum to government, Delta's rivals can avoid losing customers only by following its lead by mak ing their airlines more attractive to con sumers. These other airlines might cut their fares, or they might also invest in a safer fleet, or they might improve the quality of their in flight service. They can compete with Delta in countless ways, all of which are to be expect ed-and applauded-in a market economy. Any airline that doesn't adequately respond to Delta's competitive move to increase the safe ty of its fleet might well go bankrupt. Indeed, it's remotely possible that Delta's investment in a safer fleet will bankrupt every last one of its rivals, leaving Delta with a monopoly.

Surely, though, no one would seriously argue that government regulators ought to have the authority to stop Delta from increasing the safety of its fleet. When firms cut prices (rather than use other methods) to compete, it is because in those cases price cutting is deemed to be the most effective way to satisfy consumers. In other cases, firms deem other methods to be best. Trusting bureaucrats and judges to second guess entrepreneurs on how best to please con sumers unleashes the possibility of a genuine (and dangerous) form of predation-namely, disgruntled rivals filing predatory pricing suits against entrepreneurial price cutters. All price cutting should be legal. D Invisible Hand Obsolete? It Just Ain't So! A llen Murray's Wall Street Journal article "Pushing Adam Smith Past the Millenni um" (June 21, 1999) purports to discuss the relevancy of Adam Smith's invisible hand for the 21st century. In reality, Murray is not talking about Smith or his invisible-hand metaphor at all. The assumption beneath his conclusion that "Smith's ideas will need some rethinking in the years ahead" is based on a false premise, namely, that Smith's ideas are valid only when markets conform to the world of perfect competition.

The validity of the invisible hand does not depend on market structures or "excludabili ty" in the provision of goods or any of the other "problems" addressed by Murray and associated with perfectly competitive mar kets. Smith was drawing out the implications of a Lockean world based on "natural liberty." In this world, property is privately owned and freely exchanged. The idea that in pursuing their own interest people will be led as if by an invisible hand to promote the well-being of others is a logical implication of this institu tional setting. In Smith's system of natural liberty, if someone wants to significantly advance his material wealth he must produce things that will advance the well-being of others, and hence society's wealth. If Murray wanted to investigate whether the invisible hand would be an appropriate metaphor for the 21st cen tury, he should have focused on the extent to which private property and freedom of exchange will be secure. Amazingly, this fun damental issue wasn't even raised.

6 Unrealistic Conditions Perfect competition is an unrealistic set of conditions which, when present in all markets simultaneously, leads to an economy operat ing with "perfect efficiency"-that is, with all firms producing at the lowest possible cost. These conditions include perfect knowledge by all market participants, many price-taking buyers and sellers, complete homogeneity within product lines, and zero transaction costs. When one or more of these conditions are absent, most contemporary economists argue that markets are "failing." The obscure and otherworldly conditions of perfect com petition are used as a benchmark to judge the success of realworld markets. Murray implicitly takes this benchmark, illegitimately equates it with the invisible hand, and converts the neoclassical theory of market failure into a theory of "invisible hand failure." With no textual reference, Murray characterizes Smith's views with the follow ing three statements: "In Smith's economy, if you consume a good, I cannot"; "In Smith's world [rapidly declining marginal cost] leads to monopoly"; and "In order for Smith's econ omy to work, sellers must be able to force consumers to become buyers and pay for what they use." This analysis all came about 150 years after Smith wrote and is integral to the world of perfect competition, not the world of The Wealth ofNations.

The invisible hand and perfect competition have little to do with each other. This is easily seen in the "problems" that Murray associates with the markets and technologies he expects will dominate the next century. He argues that "The cost to Microsoft of developing Win dows software may be huge; but the marginal cost of putting it on one more computer is vir tually zero." But this is only a problem within the realm of perfect competition, where effi cient pricing requires that firms sell at mar ginal cost-an illogical result for any realworld market. Under perfect competition, if marginal cost is zero, a positive price gener ates "market failure." But this has nothing to do with the invisible hand. The fact is, unless he uses force, a per son selling a product whose marginal cost is zero cannot sell to anyone who doesn't value it more than the price asked. No matter how far above zero the price, the seller-even one as powerful as Bill Gates-cannot make him self better off without making someone else better off. Nothing Murray says negates that fact.

Murray goes on to suggest that this zero marginal-cost world could lead to monopolies in industries where network effects are impor tant. He states that "in the network economy . . . tens of millions sharing the same e-mail system may have distinct advantage over those who don't. ... In Smith's world, that leads to monopoly." Murray conflates Smith's world with the world of perfect competition and presents no historical evidence to support his claim. Under Smith's natural liberty, this "monopolist" would still have to make others better off in order to make himself better off. And so long as there were no legal barriers to entry, he would always have to be concerned about innovations and potential competitors. Murray states that "the danger comes ... if the pace of innovation slows and temporary monopolies become more permanent." But this is only a danger in the absence of entre preneurial freedom. The real threat comes from governments that are likely to create barriers to entry with protectionism, franchis es, or regulations that allow large firms to operate free of any threat from the outside.

This real and historically relevant danger, which was Adam Smith's most important concern, goes completely unrecognized by Murray. Free-Rider Problem Finally, Murray frets about "the absence of excludability." His concern? "Digital data are cheap and easy to copy."To the extent that this is true, it may be too costly to exclude non7 payers from using software once it is in use. The theory of perfect competition suggests that this will cause the product to be "under produced." The "problem" is that the assumption of zero transaction costs is being violated. The costs of excluding free riders are too high. To the extent that these costs make production of the good less profitable, the good will not be produced. But, of course, this is true of trans portation costs, labor costs, and all other costs. Outside the world of perfect competi tion there is no logical reason for placing transaction costs in a separate category.To the extent that the good facing free-rider prob lems is not produced, resources are freed for other productive endeavors. Resources will flow to where the full costs of production, including transaction costs, are perceived to be less than the potential revenues.

Furthermore, Murray offers no historical evidence to support the underproduction hypothesis. Indeed, his point has been true of software from the beginning, and yet this is one of the fastest growing areas of com merce in the world. To some extent, "non excludability" has always been present for all kinds of products-radio and television broadcasts, books and magazines, fashions. Indeed, non-excludability to some degree may be the rule rather than the exception.Yet, those preoccupied with perfect competition seem unswayed by the lack of realworld ver ification of their theory. The invisible hand may not be an appropri ate metaphor for the workings of economies in the next century. But this would be for the same reasons that it has not been an appropri ate metaphor for most economies in the twen tieth century. Liberty and the invisible hand are corollary. If liberty is treated with the same disdain in the next century as it has been in the present one, then the invisible hand may indeed be a relic of days gone by.

-Ray CORDATa Lundy Professor of Business Philosophy Campbell University Buies Creek, North Carolina.