Hayek on Benefits of Competition and the Optimal Size of Firms
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)