Part VI, Chapter 2

Alleged Causes of Inflation: Corporate Monopolies

The question before the house is whether inflation is caused, in whole or in part, by the exercise of private market power in the economy. So as to relieve what little suspense there may be, let me hasten to say that the answer to this question is “No.” Inflation is not produced by the assistant manager of the A&P store who marks out 43¢ on the can of beans and replaces it with 47¢. Its source is not to be found in the executive offices of the major oil companies—nor even in the exotic, air-conditioned chambers of the oil ministries of the oil producing states of the Third World. Nor is it to be discovered in the admittedly disconcerting, often violent, actions of the minions of George Meany. Even the God of the rainfall, the wind storm, and the wheat rust is blameless of visiting this affliction upon us.Where, then, must we look if we wish to find those who do in fact control the forces of inflation? To somewhat (but not too seriously) oversimplify, we need look no further than the Open Market Committee of the Board of Governors of the Federal Reserve System. Our fate is determined in the discussions and decisions of this group of reasonably intelligent, eminently well-meaning men of affairs.Admittedly, these men do not make their momentous decisions in a policy vacuum. As a creature of the legislature, they are operating under certain legislative commands; even more importantly, they are operating in an environment of public opinion, public expectations, and even public clamor. To paraphrase Mr. Dooley, even the Board of Governors of the Federal Reserve System reads the election returns. Thus, if you believe as John Maynard Keynes, Richard Weaver, and I do that ideas do have consequences, that today’s public clamor is in large part a product of the academic scribblers of years past, it is necessary to say that Open Market Committee decisions are only the
proximate cause of the inflationary pressures of the day; the real roots of the problem (and the hopes for its solution as well) are to be found in the cluttered closets where people like John Maynard Keynes, Ludwig von Mises, John Kenneth Galbraith, Walter Heller, Milton Friedman, et al., go about (or have gone about) their work. The regression equations developed by the research staff of the St. Louis Federal Reserve Bank may well be some part of the ammunition that will eventually bring down the walls of the inflationists. In other words, it is ideas, whether right or wrong, that finally count, and one of the most important of the mistaken ideas to be disposed of is the one under discussion here: the idea that market power produces inflation and the corollary policy implication that inflation can be reduced or controlled by direct intervention in wage and price setting.This call to intellectual and expository activity is really all that I have to pronounce here, but do not think that I shall relinquish the speaker’s stand so quickly. My bald, unsubstantiated statements surely require some elaboration—and, in addition, I must at least
seem to do more to qualify for the modest pay offered to speakers in these meetings.

Market Power and Inflation

The question of the relationship between market power and inflation can be disposed of quickly by definition alone—
if one accepts what I believe to be the most useful definition of inflation. In the tradition of Mises, I believe the most useful way to define inflation is as a situation in which the quantity of money is increasing more rapidly than the output of goods and services (or, more precisely, than the corresponding need for money). The wage and price increases which tend to follow from this are but the symptoms of the situation itself. Thus, if by draconian measures, all the wage-price-interest rate symptoms of inflation could be suppressed, the inflation would still be present, but its symptoms would be in general (though not universal) shortages of goods and services—in queues before the shops of the butcher, the baker, and the candle-stickmaker. As Allen Wallis has pointed out, for the housewife to encounter bare shelves at the fixed price is for her to suffer a fall in the purchasing power of her money just as real as for her to encounter full shelves but at higher prices.But doesn’t the use of market power by large corporations or by small firms acting in concert or by trade unions lead to reduced output of goods and services, thus producing the Mises effect by its impact on the T element in the equation (MV=PT)? In a word,
no. The exercise of market power can change (in fact, distort) the use of resources from what would have prevailed in the absence of that market power (e.g., fewer workers employed in construction and, because of that, more workers available for other employments). This could lead to some prices (housing, say) being higher than they would otherwise be, but, by the same token, other prices would be lower than they would otherwise be. There is indeed damage to the consumer interest from this state of affairs, but it is a damage different from (and to be corrected by different means than) the damage from inflation. In insisting that the bite of the rattlesnake does not cause cancer, I am not trying to say a kind word for the rattlesnake. I am only trying to direct the doctor to the correct diagnosis and medication of the ailment.But suppose one does not accept the Mises approach to defining inflation; suppose one finds it more useful to define inflation as “generally rising prices” or some more precise form of the same idea. Can inflation, so defined, be produced by the exercise of market power? Even with this definition, I would answer in the negative. This definition, by the way, is roughly the one used by most of those who call themselves “monetarists,” and who argue as I do that inflation is essentially a monetary phenomenon. Market power may indeed be used to cause some prices or wage rates to be higher than they would otherwise be, but if the total of dollars remains unchanged, this can in turn produce at worst a diverting of dollars from other goods and services, with associated downward pressure on the relevant prices and/or wage rates.But can’t market power at least influence the
lag between disturbances in M and responses on the price and wage side? There is some evidence that this may indeed happen in some cases, but so what? It is still not the market power that has
produced the inflation.Now that I have mentioned “evidence,” perhaps I should pay some attention to those of you who prefer something a little more concrete as an answer than warmed-over Mises. I freely admit that I have undertaken no rigorous research of my own on the question under discussion. What I have done is to read the reports from the research of my “betters.” Not too surprisingly, what I find there tends to confirm my original presuppositions.For the single best summary of research findings (including his own) I suggest that you turn to a monograph by Steven Lustgarten of City University of New York, published by that most useful organization, the American Enterprise Institute. The title is
Industrial Concentration and Inflation, and it includes a foreword by Yale Brozen of the University of Chicago, research director of the American Enterprise Institute (and incidentally the man who first turned my own eyes in the direction of market economics).Brozen summarizes the findings in his foreword as follows:

It is frequently argued that industries in which a few firms produce most of the output charge higher prices than they would if the large, component firms were broken into several smaller ones (as was done, for example, with the old Standard Oil Company and the American Tobacco Company early in the century). Whether or not the argument is valid, and much evidence to the contrary has appeared, it does not follow that inflation is a consequence of a highly concentrated industrial structure. Assuming, for the sake of argument, that concentrated industries charge higher prices, we should suffer
rising prices only if industrial concentration were rising. But data for the U.S. economy show average market concentration levels to be fairly stable. That being the case, no connection should be expected between industrial concentration and inflation.

Professor Lustgarten examines the movement of prices of manufacturing industries. He seeks to determine whether prices in the most concentrated industries increase more rapidly than those in the less concentrated industries. He finds that the price behavior of the highly concentrated industries has not been a source of inflation in the United States. According to his data, the prices of these defamed industries have not only
not been a source of inflation, but have risen more slowly than those in the atomistic industries. They have, in fact, been a moderating factor in inflation.
*59

Lustgarten’s own summary runs as follows:

Both theoretical and empirical evidence relating industrial concentration to inflation have been examined. The theoretical arguments were that concentration promotes inflation because it allows sellers to maintain prices when demand declines, to pass on inflationary wage increases, and to avoid competitive pressures to reduce costs. These arguments were found to be inconsistent with the evidence, which showed that prices and unit labor costs have increased more slowly in concentrated industries than in other industries.
*60

Admittedly, what Lustgarten and others have done is largely to show that there seems in fact to be no relationship between industrial
concentration and inflation—and this is not equivalent to proving that there is no relationship between
market power and inflation. Their findings may only suggest that there is no real relationship between concentration ratios and the real exercise of market power—a thesis I believe to be almost certainly valid.
*61As a matter of fact, it is my firm conviction that neither concentration ratios nor market shares nor profitability nor any of the usual criteria of imperfectly competitive markets are of any significance to economic performance. To put it another way, I believe that the only meaningful definition of monopoly is that of a position in a market maintained by the use or threat of the use of force. Most commonly, the kind of use of force I have in mind is technically legal, i.e., it comes directly from governmentally enforced barriers to entry or to free market pricing as in plumbing or banking or doctoring or what have you. But it is sometimes in the form of a permissive attitude on the part of those charged with maintaining the peace towards the use of violence by private groups, such as dairy farmers or automobile workers or carpenters.I intend to return for final comment on this topic in the next section. At the moment I wish to deal with the question of whether or not the exercise of this kind of
real market power might not be related to inflation. To the disappointment of many of you, I suspect, I must reply that it is my firm belief that not only can Gulf Oil and General Motors not produce inflation but neither can it be “manufactured” in the regulatory offices, the tariff commissions, the city halls, or the courts of the land. Again actions taken (or not taken) there can, like the rattlesnake, introduce a poison into the economic system, but the poison is not that of general inflation.Here, in part at least, I must disagree with a man whose work I hold in highest esteem, Professor Murray Weidenbaum. Here are his words:

As the American public is learning to its dismay, there are many ways in which government actions can cause or worsen inflation. Large budget deficits and excessively easy monetary policy are usually cited as the two major culprits, and quite properly. Yet, there is a third, less obvious—and hence more insidious—way in which government can worsen the already severe inflationary pressures affecting the American economy.

That third way is for the government to require actions in the private sector which increase the costs of production and hence raise the prices of the products and services which are sold to the public…. Literally, the federal government is continually mandating more inflation via the regulations it promulgates. These actions of course are validated by an accommodating monetary policy.

In theory, the monetary authorities could offset much of the inflationary effects of regulation by attempting to maintain a lower rate of monetary growth. In practice, however, public policy makers, insofar as they see the options clearly, tend to prefer the higher rate of inflation to the additional monetary restraint and the resulting decreases in employment and real output.
*62

Weidenbaum notes that the actions he describes require the validating influence of a more rapid rate of increase in the quantity of money to produce their inflationary effects, an admission usually made as well by those who argue that union action does indeed lead to inflation. But here again I would object; if there are no more dollars floating around, the primary effect of government regulation (whether wise or unwise) will be to divert those dollars from one channel to another, with price increases in some areas and price decreases in others, rather than to produce general inflation.

Can Inflation Be Cured by Making the Economy More Competitive?

The heavy emphasis I put upon this point seems to me to be necessary and appropriate. While it is true that the Weidenbaum-type argument may strengthen the case for a long-overdue dismantling of many parts of the regulatory apparatus (a consummation devoutly to be wished), the general argument linking market power to inflation is also being used by such men as Senators Hart and Bayh to propose structural changes in American business that would bring in turn a sharp reduction in the economic well-being of the masses of the people.As a matter of fact we have been saved from this fate over the years, under the existing legislation, because of a largely tacit recognition by the political leadership of the nation that antitrust makes for great rhetoric but lousy economics. I am absolutely serious when I say to you that I believe the antitrust laws to be in direct opposition to both the spirit and the practice of capitalism. The very criteria by which a businessman measures his success in serving his stockholders and his customers—increasing share of the market, industry leadership, superiority in product and processes over rivals, above-average profitability—are often precisely the same criteria used by the antitrust division of the attorney general’s office as evidence of noncompetitive markets. Or, to put it another way, how can we label as “unjust” a position in the market that has been achieved over time through a series of peaceful, non-fraudulent exchanges with willing partners?It is my firm conviction that Schumpeter was absolutely right when he argued that “the power to exploit at pleasure a given pattern of demand … can under the conditions of intact capitalism hardly persist for a period long enough to matter … unless buttressed by public authority.”
*63It is my belief that competition inheres in the very nature of man and the exchange economy; in the words of Adam Smith, “All systems of preference or of restraint, therefore, being thus completely taken away, the obvious and simple system of natural liberty establishes itself of its own accord.”
*64 Competition does not need to be created or protected or restored; all that government need do to see that competition prevails is not to get in its way.My position here is very similar to that taken by Joseph Schumpeter (and by Mises as well), but I was not brought here to discuss with you the various views on the meaning and nature of competition and monopoly. My assignment was to discuss the question of whether or no the problem of inflation was significantly related to the exercise of market power in the economy.To summarize, I have argued that market structure and performance are
not significantly related to the problem of inflation. It follows from this that inflation cannot be reduced or eliminated by actions taken to make the economy more competitive. Moreover, I have insisted that for the nation to turn its policy eyes in that direction would be for it to divert attention from the only area where it must look if it is in fact to bring inflation under control—and, in the process, to be as likely to produce harm as good in the market structures of the economy. Finally I have identified that “only area” where a solution to the problem of inflation is to be found as that of the money supply.This leaves unresolved all of the really important questions! What is the objective to be sought in the making of monetary policy? No increase in M, however defined? a steady rate of increase? is the proper dial to be watched M
1 or M
2 or M
3? Should all such attempts to create a controlled paper currency be abandoned and replaced by the gold standard? If so, which of the many forms of the gold standard? or should some other commodity standard be put in place?These are the topics with which other speakers are concerning themselves, and they are not a part of my assignment. However, in closing, I cannot resist offering two comments:(1)  Turning the control of the money supply over to government, under any conditions, is like turning the liquor store over to an alcoholic; and(2)  I do not believe that any expert or group of experts can possibly devise a monetary system as effective as the one that would spontaneously emerge in a society in which the government played no more and no less of a role with reference to money than I would have it play in all of economic life: maintain law and order, enforce contracts, and stand ready to assist the plaintiff in cases of fraud. In money as elsewhere, I prefer the rule of the market to the rule of men.

58.
Washington Post, July 28, 1971.

59.
Steven Lustgarten,
Industrial Concentration and Inflation (Washington, D.C.: American Enterprise Institute, 1975), p. 1.

60.
Ibid., p. 36.

61.
Here again Brozen is a useful source; see his “Concentration and Profits: Does Concentration Matter?” in Brozen,
The Competitive Economy (1975).

62.
Murray Weidenbaum,
Government Mandated Price Increases: A Neglected Aspect of Inflation (Washington, D.C.: American Enterprise Institute, 1975), p. 3.

63.
Joseph A. Schumpeter,
Capitalism, Socialism, and Democracy, 3rd ed. (New York: Harper & Row, 1962), p. 99.

64.
Adam Smith,
The Wealth of Nations (New York: Modern Library, 1937), p. 651.

Part VII