Monopoly and competition policy

(This policy bulletin is extracted from FMF Monograph Monopoly and competition policy, published by the FMF in 1996.)

Competition policyand its rationale

Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to, only so far as it may be necessary forpromoting that of the consumer. The maxim is so perfectly self-evident that it would be absurd to attempt to prove it. But in the mercantile system, the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce.

Adam Smith (The Wealth of Nations)

The power of demanding or refraining from demanding is “consumers’ sovereignty”.

 W H Hutt (Economists and the Public)

Efficiency and consumer welfare

Consumer welfare is greatest when society’s resources are allocated in the economy so that consumers are able to satisfy their wants as far as technological and physical constraints permit. In this way the wealth of the nation is maximised. Competition policy’s aim should be to help bring about this result.

There may be occasions when government wishes to achieve other objectives (e.g. to redistribute income or wealth, to promote the interests of historically disadvantaged people, or to encourage environmentally friendly production or consumption) but such alternative goals are not the objective of competition policy. Anti-trust authorities may note such goals, but they are in the bailiwick of other legislators.

Society’s total wealth depends, of course, on achieving overall efficiency in the production and distribution of goods and services. This overall efficiency is composed of allocative efficiency and productive efficiency. Bork (1993, p.91) claims that the “whole task of anti-trust can be summed up as the effort to improve allocative efficiency without impairing productive efficiency so greatly as to produce either no gain or a net loss in consumer welfare”. Allocative efficiency is achieved when resources are used in industries or for tasks where consumers value their output most. Productive efficiency is achieved by most effectively using resources in particular firms.

Economic theory shows us that a multiplicity of small firms in conditions of perfect competition and producing a homogeneous product (a totally unrealistic and undesirable situation) must achieve overall efficiency. That same theory shows what a single seller (a monopoly) must do in order to maximise profits – again the notion is unrealistic in practice. Alternative, real-life forms of industrial structure lie in between, and here conventional theory – even at an advanced level – is ‘little more than a guess’ about how firms will and do behave (Bork, p.92). Nevertheless, the polar theories are uncluttered, powerful and, even if imprecise, sufficiently adequate in their simplest forms to aid in prediction and explanation and so in policy formation.

Who evaluates – consumer or bureaucrat?

…Although Littlechild and Tullock come at the issue from different perspectives, together they highlight the problem of outsiders (bureaucrats and politicians) measuring consumer welfare.

Politicians and bureaucrats, no less than anyone else, pursue their own self-interest. Moreover, they do so in an institutional environment which makes it all too likely that their benefit will be at the expense of the public as consumer.

First, there is the role of information. The price mechanism provides consumers and businessmen with the information about shortages and surpluses that they need for their decisions. They also have the incentive to gather this information, which government officials do not have. The latter have no property rights in the gains created from exploiting a profitable trade, nor do they suffer directly the costs of error in misdirecting the flows of capital or labour. They will not be alert to the best opportunities and will be less likely to exercise caution in making unpromising decisions. Regulators can therefore be presumed to make damaging and harmful decisions much of the time.

Then, as Tullock showed, there is rent-seeking, that is the use of government power by interest groups and individuals to obtain special privileges for themselves. Successful rent-seekers gain above-market returns by successfully lobbying government for favours.

Lobbies representing small particular interest groups such as established firms, trade unions or professional groupings are likely to have a disproportionately large influence on government, whereas the interests of large groups, especially consumers, are likely to be under-represented. Competition policy decisions can be lobbied for or against. The ‘losers’ from faulty policy are invariably consumers and taxpayers. The reason for this is that any one policy will appear to them to have a very low cost as the cost is dissipated across consumers at large and is therefore not highly visible. Thus they tend not to organise in opposition since the incentive to individuals to do so is weak. However, to the beneficiaries of the policy (providers of labour and capital in the industry concerned), the benefits are both visible and worth organising for to obtain or retain. Since all (or most) will reason this way, the likelihood that large groups, such as consumers will organise effectively to counter partial and selective so-called competition policies targeted at benefiting specific producers is much less than the likelihood that a small group of producers will organise to obtain the policy outcome favouring them.

Lastly, policy can be shown to have perverse results. The status and success of bureaucrats are often measured by the resources at their disposal. Thus the creation, maintenance and expansion of policy is a ‘good thing’ in its own right for a civil servant. The politician, motivated by power and the desire to stay in office, will readily concur. The ‘benefits’ (e.g. ‘lower prices’, ‘preserved jobs’) from competition policy can easily be pointed to. Political support can be gained. The costs, in terms of alternative job opportunities lost which could otherwise have been created, or goods and services lost which could otherwise have been produced with the resources so used, are invisible and cannot be identified. It is not surprising that activist competition policies have an impressive record of failure and of inconsistency.

The safest conclusion for South Africa would be that there is a role for policy which aims at making markets work. It should do this by deregulating product and labour markets and at removing government-imposed entry barriers to industries and occupations. Nationalised enterprises should be privatised by restoring the rights of ownership to the citizens of the country. Displaced workers in declining industries can then be given training vouchers to be used for retraining in areas of their choice. And continued and expanded commitment to international free trade would make for a more competitive economic environment at home.

This Monograph can be downloaded here.

AUTHOR  W Duncan Reekie. This Policy Bulletin may be republished without prior consent but with acknowledgement to the author. As always the views expressed in this Monograph are those of the author's and are not necessarily shared by the members, directors or staff of the Foundation.

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