One of our government's roles is to protect the business environment from monopolistic behavior which undermines the free market. This is a necessary role to protect consumers and the efficiency of the free market. The Sherman Antitrust Act was the first law put into place allowing the federal government this enforcement. But, with the recent political environment of less government, at least in economic matters, we’re seeing several examples where lack of enforcement has likely led to harmful practices and market behavior.
There are many examples of monopolies being dealt with in US history. Well known ones include Standard Oil, AT&T in the 80’s, and Microsoft in the 90’s.
The bigger challenge in today’s economy is the oligopoly. When a single entity manages to get enough market power to break the efficiency of the market, it’s generally clear that for assessing blame, and it’s (relatively) clear to consumers. An oligopoly is a lot harder to see, because there isn’t a simple causal relationship in place.
The government was able to establish that AT&T was abusing its market power, and addressed it by getting AT&T to break up into the “Baby Bells.” It was clear that AT&T had enough market power on its own to justify these actions. How do you establish that market power is being abused when no single entity has enough market power to control the market on its own?
In the 70’s the OPEC countries formed a successful cartel, putting price controls in place which significantly raised prices. Yet, no single OPEC member could have done this alone (a good reason why the cartel didn’t last). It was clear that market power was being abused because the OPEC members weren’t secretive about it. For a similar situation in the U.S., this would be illegal, so there’s a greater incentive to stay covert. Hence, much harder to establish abuse of market power.
Today, and more importantly, in 2008, the financial industry was run by a couple very large banks. The bailout of these banks was justified due to these companies being “too big to fail.” Being too big to fail, as in being critical to the economy, so much so that the government will pay to avoid a complete failure isn’t in itself an abuse of market power. (There are other issues with this system, but market power abuse isn’t inherently one of them.)
These companies are still acting as an oligopoly though. In a competitive market, these financial companies should have to deal with a bunch of startups (in a free market, new entities are free to enter or leave). Another property we would expect to see if the financial industry isn’t operating as an oligopoly would be price pressure from competition from one another. Norm touches on this in this post. Showing that these firms are able to charge $3000/hr for their services in some cases. That’s quite a premium to see where there are neither new entities entering the market nor existing competitors undercutting that price.
Neil Barofsky, special prosecutor overseeing TARP funds was interviewed by Bill Moyers about his experience with dealing with the big banks. He makes a very good point about a market failure regarding bailout funding. Because there is a presumption of bailout, the big banks are seen as very safe investments, so they get preferential treatment and higher credit ratings as a result. He suggests that breaking up the big banks would be the best approach to this problem.
As I mentioned in my previous post, not a whole lot of restriction was put on the big banks that needed bailout money. As a long-term solution to this too-big-too-fail issue, establishing that the big banks are acting as an oligopoly, this might be a good way to create some more competition and reduce the market power of these big banks. At the same time, reducing the size of these entities would reduce the risk to the economy when one of them fails, thus not needing to bailout failing companies in the future.
This was a very thoughtful post, Zach, and I think you're dead on about the dangers of oligopolies.
ReplyDeleteIn the Old Days, there used to be such a thing as a "regulated monopoly" -- with the phone company being a leading example. The law recognized that some services were more efficiently provided by monopolies than by competition. AT&T, as a regulated monopoly, was able to extract a profit from providing services, but the amount of the profit was limited by law (while investors were allowed a nice stream of stable dividends).
Enter the world of the "free market" and the seven baby bells quickly became three or four and are now being further reduced. The oligopoly conditions now enable me to spend upwards of $200 a month on our family's telephone services -- a triumph for them, but hardly a winning situation for us.
Our old complaints about the imperious behavior of Ma Bell seem trivial by comparison!
Jill, thanks for the comment! I didn't realize that AT&T was actually considered a regulated monopoly. That does still fit in with the trend of less government and deregulation, but it probably made the case for breaking it up much easier.
DeleteI didn't have time to go deeper, but I'd suspect it's fairly complex to establish that a company is a monopoly and is abusing its position. I think that's part of the reason we haven't seen a successful, high-profile monopoly case in a long time.
Aloha Zach
ReplyDeleteI am glad you went down this path on your post. I also have been looking at oligopolies and the lack of oversight on them. I still think the oil industry is an oligopoly and we feel it with market speculation. Okay the oil industry is too big to fail because they amass a huge amount of profits. However, not all of their profits are a result of supply and demand, speculation comes into this.
I found a list of pros and cons of oligopolies:
• Pro: Prices in an oligopoly are usually lower than in a monopoly, but higher than it would be in a competitive market.
• Pro: Prices tend to remain stable because if one company lowers the price too much, then the others will do the same. The result lowers the profit margin for all the companies, but is great for the consumer.
• Con: Output would be less than in a competitive market and more than in a monopoly. Most competition between companies in an oligopoly is by means of research and development (or innovation), location, packaging, marketing, and the production of a product that is slightly different than the other company makes.
• Con: Major barriers keep companies from joining oligopolies. The major barriers are economies of scale, access to technology, patents, and actions of the businesses in the oligopoly. The government, such as limiting the number of licenses that are issued, can also impose barriers.
I can’t think of an example for #2 can you?
To me an oligopoly is a monopoly with only a couple of people that are allowed to join the fraternity….
Thanks!!
Hi Dorthy, you make some good points about what we should expect in a oligopolistic market. I trying to think of a modern scenario where prices are stable as a result.
DeleteI think Jill brought up a good example- cell phone carriers. None of the big carriers are really undercutting the others, and they're all raking in the profits. If the market were more efficient, we would expect to see the prices come down a bit. But, I think they know that they can collectively remain high and be better off as a result, even while sacrificing a bit of market share for themselves. Prices are stable, but high.
I didn't get a chance to dig into it, but I wanted to talk about the assumed oligopoly. These companies probably aren't explicitly meeting to set prices (and that is clearly illegal if it is happening). But, they don't have to, there are few enough competitors that they can keep an eye on each other and stay near their own (high) price average.
Zack- Thank you for this post. I believe that one of the biggest struggles we have in moving toward a more sustainable economy are the oligopolies that exist, financial sector and otherwise, pumping huge amounts of money in to the political arena to protect their positions.
ReplyDeleteIt dawned on me recently that revenue caps for corporations would be an interesting way to force a more competitive market. Can you imagine how different the economic landscape would be if no one company could have more than 10% of a given market? On one hand, I imagine it would be much more competitive because oligopolies wouldn't be in a position to control the market through predatory pricing, price fixing, lobbying for legislation that unduly favors then, etc.
However, conversely, would those firm that reach the revenue cap become lazy and quit pursuing improvements to their business since they've already achieved their revenue cap? I suppose it would likely drive them to look for further improvements in their operations in order to maximize profits. However, this might be done at the sacrifice of the quality of the product that they're providing. Although, if there are a number of other companies in the market based on the revenue caps, maybe it would stay competitive.