In the same chapter of Friedrich Hayek’s Law, Legislation, and Liberty that I discussed two days ago, Hayek has some excellent discussion of the benefits of competition and on the optimal size of firms.
The benefits of competition
Competition, if not prevented, tends to bring about a state of affairs in which: first, everything will be produced which somebody knows how to produce and which he can sell profitably at a price at which buyers will prefer it to the available alternatives; second, everything that is being produced is produced by persons who can do so at least as cheaply as anybody else who is not producing it; and third that everything will be sold at prices lower than, or at least, as low as, those at which it could be sold by someone who in fact does not do so. (p. 74)
I stated in our Liberty Fund colloquium that this was a beautiful, succinct statement of the benefits of competition. Fellow participant David Friedman pointed out that the first one is not quite true. He noted that the argument against monopoly is that it underproduces even though more could be sold at a profit (just a lower profit.) I immediately agreed with David. Still, the second clause of the first point is spot on, as are the second and third points.
It’s possible that Hayek could avoid David Friedman’s criticism by pointing out that he uses the word “tends.” Also, in the paragraph that follows, Hayek writes that this state of affairs “is approached remarkably closely in all fields where competition is not prevented by government or where governments do not tolerate such prevention by private persons or organizations.” So Hayek admits that it’s close, not necessarily all the way.
Hayek also points out that only a market can bring about this situation.
On the optimal size of firms
The most effective size of the individual firm is as much one of the unknowns to be discovered by the market process as the prices, quantities or qualities of the goods to be produced and sold. (p.78)
Hayek goes on to explain that the optimal size will depend on technology and economic conditions, both of which are “ever-changing.”
Hayek then lays out how size is often an antidote to the power of size, writing:
It may well be that, say, in the electrical industry of one country, no other corporation has the strength or the staying power to ‘take on’ an established giant intent upon defending its de facto monopoly of some of the products. But as the development of the great automobile or chemical concerns in the USA shows, they have no compunction about encroaching on such fields in which the backing of large resources is essential to make the prospects of entry promising. Size has thus become the most effective antidote to the power of size. (p. 79)
READER COMMENTS
David Seltzer
Apr 28 2023 at 6:45pm
Reading this, does one infer productive efficiency determines optimal size of a firm given a state of technology? All four years of undergrad, 1967 -1970, I worked summers at US Steel in Gary Indiana. AKA Gary Works. I labored in the open hearths. A standard furnace could take a charge of iron, say 300 tons, and convert it into steel in approximately 8 hours. By 1970, I was in B School but now worked in QC part time. By then, Basic Oxygen Furnaces replaced the old hearths. The new technology could convert scrap iron to steel in about 30 minutes. This new technology reduced plant capital costs and increased labor productivity. The size of the US Steel plant remained the same.
blowing oxygen. It reduced capital cost of the plants and smelting time, and increased labor
David Seltzer
Apr 28 2023 at 6:49pm
Reading this, does one infer productive efficiency determines optimal size of a firm given a state of technology? All four years of undergrad, 1967 -1970, I worked summers at US Steel in Gary Indiana. AKA Gary Works. I labored in the open hearths. A standard furnace could take a charge of iron, say 300 tons, and convert it into steel in approximately 8 hours. By 1970, I was in B School but now worked in QC part time. By then, Basic Oxygen Furnaces replaced the old hearths. The new technology could convert scrap iron to steel in about 30 minutes. This new technology reduced plant capital costs and increased labor productivity. The size of the US Steel plant remained the same.
David Seltzer
Apr 28 2023 at 7:09pm
I suspect optimal size is determined by the state of technology. Until 1970, US Steel used open hearth furnaces to manufacture steel. A standard furnace could take a 300 ton charge of iron and scrap and convert it to steel in approximately 8 hours. Basic Oxygen Furnaces, introduced around 1970, converted scrap iron into steel in under an hour. Capital costs were reduced and production efficiency increased.
David Seltzer
Apr 28 2023 at 7:11pm
Apologies for the redundant comments. I was editing the first when I sent it by mistake.
Monte
Apr 28 2023 at 11:51pm
Ronald Coase, in his many debates with Hayek during the 1930s, suggested a very large firm (ie. one considered “too big to fail”) is, in effect, a microcosm of central planning, or in his words, “a centrally planned economy in miniature.” This idea has seems to have merit:
In order to mitigate these shocks, we’ve witnessed a substantial growth of the welfare state and increased regulation of the economy, both of which Hayek was adamantly opposed to and argued against in The Road to Serfdom. And yet, we seem to score well on measures of democracy, civil liberties, and innovativeness (World Bank 2017). Even more compelling is the fact that European social democracies seem to do slightly better by these measures than the U.S. and the U.K.
So how do we respond to this indictment of free markets?:
Richard W Fulmer
Apr 29 2023 at 8:53am
I don’t believe that either the Great Society welfare programs or the steadily increasing reach of the regulatory state were responses to “shocks” caused by corporate size.
When LBJ’s welfare programs were enacted (1964-1965), the poverty rate was at about 15% – down from 80% in 1800 and from over 55% in 1900. So, during the all the years in which U.S. corporations were growing both in size and in number, poverty was steadily falling.
And increased corporate size is more likely a response to increased regulation than the reverse. Large companies are better equipped than are their smaller rivals to handle the growing regulatory burdens placed on them by local, state, and federal governments. In fact, big corporations have often supported regulations, in part, because they serve as a barrier to market entry.
David Seltzer
Apr 29 2023 at 11:44am
“In fact, big corporations have often supported regulations, in part, because they serve as a barrier to market entry.” Indeed! Regulatory capture and rent -seeking firms fear competition.
Monte
May 4 2023 at 11:56am
I’m not no sure. A classic example of the regulatory state’s growth in response to an economic shock caused by corporate size was the bailout of Wall Street and other financial institutions deemed “too big to fail” during the global financial crisis of 2007-2008. The federal government ushered in EESA and TARP along with a bevy of regulations under Dodd-Frank. Outside of the financial sector, other entities deemed “too big to fail” during the financial crisis requiring government intervention included GM, Chrysler, and AIG.
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