The Liberty Papers

Okay, we’ve had an ongoing discussion here at the Liberty Papers about monopolies, markets and Microsoft. The position presented on one side, a position taken by many libertarians and libertarian-conservatives, is that monopolies that are not directly created by government fiat are okay and we shouldn’t see them as bad. They are, in this line of thinking, natural and arise out of very good business practices and market forces. I’m going to argue that this is not the case and that all monopolies, of whatever origin, should be viewed with suspicion and distrust by those who describe themselves as libertarians, classic liberals, anarcho-capitalists, etc. There are, essentially, five types of monopolies.

1. The government created, or legal monopoly. AT&T was a legal monopoly, as are the police and fire departments in most cities. When the government directly intervenes and legally creates a market where only one competitor is allowed, that is a legal monopoly.
2. Natural monopolies are ones that arise because economies of scale, economic efficiencies and capital costs for competitors are such that one one competitor is able to satisfy the demands of the market. In a perfect free market this is impossible.
3. Monopolistic competition occurs when a single competitor in the market is powerful enough to act as a de facto monopoly. For example, at its height, Standard Oil controlled 64% of the oil market although there were more than 100 competitors in the market. Microsoft, today, is a monopolistic competition with control of 90% of the PC operating system market and more than 90% of the desktop office suite market. Companies in this position are able to take actions to maintain their position that a non-monopolistic competitor could not.
4. Coercive monopolies occur when competitors use activities that violate the principles of free market. Coercion is aimed at hiding information from the market or influencing consumers and competitors in order to maintain a dominant position in the market. It is often difficult to distinguish between good business practices and coercive practices.
5. Local monopolies exist when only one resource for a specific product exists in a given area, but not within the market as a whole. For example (and I’ll discuss it further down), Starbucks is a local monopoly at the Sacramento International Airport.

One of the questions that is important to answer, before we go further, is why monopolies are bad. Let’s start with this idea: free markets are about efficient allocation of scarce resources. The price you pay for a given product, let’s say a cup of coffee, in a free market reflects the value of that product to you, not the cost to produce the cup of coffee. If you had perfect information about the market for a cup of coffee, you would be able to purchase the coffee for its marginal cost. Marginal cost is the cost to produce one more unit of a given product. Since you don’t have perfect information, you will, instead, pay the lowest price that reflects the value of the coffee for you. Someone else may disagree with you about the value of the coffee and be unwilling to pay the price that you were willing to pay, feeling that they have a better use for the money than to buy a cup of coffee at the price you paid for it. This enables efficient allocation of resources, ensuring that you get your cup of coffee and I get my hamburger. Since there are, generally, never as many units of a given resource as there are people who want the resource, it is necessary to find a means to efficiently allocate resources. This is the goal of all economic systems. The great virtue of free markets is not that they are the best theoretical system, they aren’t. Their virtue is that, in practice, they work better to efficiently allocate resources than anything else we have tried.

The next idea we need to include, to understand monopolies, is something I talked about briefly already. Scarcity is the factor that drives markets. In any given market one of two things is true. There are more resources than consumers, or there are more consumers than resources. If there are more resources than consumers, then the resource cannot cost more than the marginal cost. Going back to our cup of coffee example, clearly there isn’t a scarcity of coffee shops (it seems like there’s one on every corner) so why can Starbucks charge more than $3.00 for a cup of specialty coffee that probably cost them no more $1.00 to produce? Because there is local scarcity, combined with your value for the product, to create a situation where Starbucks can sell the large iced mocha to you for more than its marginal cost. At Sacramento International Airport there is only one coffee shop in the concourse after the security checkpoints, a Starbucks. If you don’t like their prices, you either don’t buy their product or exit the concourse, go somewhere else, purchase your coffee and come back through security. This creates resource scarcity. Travellers typically place a higher value on coffee and Starbucks can charge $3.00 for that cup of coffee. If they didn’t have enough demand, they would lower the price until enough people valued the coffee at that price to sell enough units to produce a profit. It’s important to note that Starbucks had to compete with other coffee companies to acquire that location in the airport concourse. The company that owns the space found out, through the price that Starbucks was willing to pay, what the value of the location was to a coffee company.

I apologize for the couple of paragraphs on economics, but I think they were necessary to introduce the next idea. A monopoly is the ability to artificially manipulate scarcity and create inefficiency. In an inefficient market, fewer people are able to acquire a resource than would be able to without the monopoly existing. In a perfectly inefficient market, one person gains and everyone else loses. Bear in mind that a market only exists if the resources are needed and the resource consumer cannot acquire the resource for no cost. So, for example, there is no market for air. While air is certainly a resource that is needed, there is no cost to me to acquire air. If we lived on the moon, where oxygen would be difficult to produce, there would be a cost to me to acquire air. My option would be to produce it myself or purchase it from someone else. It is likely, with massive amounts of energy freely available on the moon, that the economy of the moon would be based on oxygen production rather than fossil fuels or other energy sources. But, that’s just speculation. The fact is, there is no market on earth for air because there is no cost to me to acquire more of the resource. In other words, the marginal cost is zero. If a market exists, the marginal cost is higher than zero. And this means that one, or more, consumers need the product and must pay for it. Otherwise a market cannot exist. This need (as opposed to want) may be the result of a localized situation, or a temporary issue, leading to the need. After all, when we look at coffee cup purchasers, we can say, in the long term, that they do not need that coffee. But in a localized, short term situation there is at least one consumer who needs it, whether that is due to being tired or having an addiction to caffeine, or because my boss told me to go buy coffee, or some other reason. I am now in a position where I must acquire the product, it is not a choice.

Let’s quickly distinguish between what a group of people, whether company or labor union or other organization, does and what a monopoly does. For ease, let’s call this a company, knowing the other groupings apply as well. In a free market you can increase the number of widgets you sell by increasing demand or decreasing price (see the value discussion to understand why). A company is formed to do this. This is not the same thing as creating artificial scarcity through violation of the free market, which is what a monopoly does.

The bottom line? A monopoly is bad, economically, because it creates inefficiency in the market. In fact, a monopoly represents a failure of the market. In an efficient market (remember efficiency is about allocation of scarce resources) a monopoly should not occur. When resources are not allocated efficiently, it means that everytime someone “wins”, everyone else is impacted negatively.

From a political perspective, monopolies are bad because they represent concentrations of power. Concentrations of power are threats to individual liberties. The basic idea of the US Constitution was to create competing concentrations of power to minimize those problems. Anarcho-capitalism views everything as a market. There is good reason to see the world this way since governments are another means of allocating resources. What has happened is that rather than treating old age retirement as a competitive market, we have given a legal monopoly to the government, and now the competitive market is for the political ideas that will lead to the most efficient allocation of taxation and tax distribution to provide for pensions to retirees. In other words, sometimes the resources in the market are ideas and people, rather than physical products or money. Because we place value on the end result, which is the collection and distribution of taxes, money enters politics, just as it does any other arena. Anarcho-capitalists suggest that a competitive market for politics would lead to a more efficient allocation of resources. That said, tehre is no reason to view a concentration of power differently based on whether it is “public” or “private”.

This discussion is meant to illustrate why concentrations of power and monopolies should be viewed as bad by free market proponents. It is not because we don’t like free markets that we oppose monopolies, it is precisely because we do like free markets. And monopolies mean the market is no longer free, it is no longer capable of the most efficient allocation of resources. Whether Microsoft, for example, did anything wrong in achieving its current monopoly, or not, is really, in many ways, beside the point. The situation now is that someone must acquire resources in a market where Microsoft artificially controls, and manipulates, scarcity. This means that it is possible for Microsoft to gain while everyone else in the market loses. The outcome of a free market is that everyone wins. I gain a resource for the value I place on it. The supplier makes a profit. That’s good for both of us. If, however, I must acquire the resource and the market is not competitive, I will end up paying more for the product than the value it has for me. While it is easy to argue that the average home computer user does not have to have a computer, and they are making a statement about the value of a Windows operating system when they do buy a computer, it is not so easy to argue that the average business user does not have to have a computer. In fact, most businesses find themselves, as consumers, in the position of being required to purchase a product from a sole supplier who is artificially manipulating resource scarcity in the operating system and desktop office suite market.

Microsoft is both a monopolistic competition and a coercive monopoly. They maintain, and indeed created, their monopoly through practices which violate free market principles, including collusion, theft, dumping and product tying, among other things. Because they are a monopolistic competition, they can artificially control resource scarcity over the entirety of the operating system and office suite markets, not just locally. In order to prevent the loss of their monopoly, they tie your office suite to other products, such as proprietary data formats and the operating system in order to make it as close to impossible as they can for you to not purchase their product. Dumping occurs when you sell a product below its marginal cost in order to put competitors out of a market. It is fairly clear that MS dumped IE by selling it at $0 in order to force Netscape out of the browser market. I could write for days about Microsoft’s business practices. I won’t, let’s just let it stand that just about everyone economist out there considers Microsoft a monopoly and considers a monopoly to be bad, not good. Since nearly all economists these days favor free markets, then I am hard pressed to wonder how you can be a free market proponent and yet find Microsoft’s business practice and monopoly to be “okay”, “acceptable” or “good”.