Profit for Progress
By Bryan Caplan
In economics textbooks, monopolies are socially dysfunctional because they raise price above marginal cost. This implies deadweight loss – consumers’ pain is not producers’ gain. Picture a matinee at a movie theater. The marginal cost of admitting one more viewer is practically zero, but the price is still, say, $10 a seat. If someone values attendance at $9, charging him $10 destroys $9 of consumer’s surplus without yielding a penny of profit.
Economics textbooks also routinely claim that antitrust laws exist to mitigate this harm. What’s strange, then, is that antitrust laws almost never simply punish firms for charging prices above marginal cost! Yes, antitrust authorities try to change market conditions to make high prices less likely; forbidding mergers in highly concentrated industries is a typical approach. But if Amazon, with all its monopoly power, doubled every one of its prices today, antitrust authorities probably wouldn’t lift a finger.
What justifies this inaction? If you pressed informed economists on this point, they’d probably say two things.
First, many firms – especially firms in concentrated industries – have high fixed costs. Given this cost structure, pushing prices down to marginal cost wouldn’t hand consumers a pile of cheap products. Instead, it would disastrously drive every business into bankruptcy.
Second, the textbook model totally ignores what economists call dynamic efficiency. Sure, raising price above marginal cost implies deadweight costs today… but it also yields a monopoly profit. The opportunity to earn these monopoly profits gives entrepreneurs a powerful incentive to create and improve businesses. And that, of course, is how progress happens. Everyone – including everyone who pays monopoly prices – should smile to read the words “If you come up with a great new business idea, you’ll get rich” emblazoned above the gates of the world of business.
Both of these arguments are solid. The first implies that antitrust authorities should definitely leave firms alone unless they’re earning supernormal profits. The second implies that antitrust authorities should at least consider leaving firms alone even if they are earning supernormal profits.
Yet on reflection, neither argument justifies the status quo. The challenge: If it’s bad to use antitrust to directly force prices down to marginal cost, why isn’t it bad to use antitrust to indirectly force prices down to marginal cost?
Suppose, for example, that HBO and Netflix want to merge. Antitrust authorities plausibly argue that this horizontal merger will substantially raise the prices consumers pay for premium entertainment. They’re probably right, but the story doesn’t end there. The knowledge that successful firms can legally merge increases the incentive to create successful firms. Not just successful firms in the entertainment industries. All firms. If you take dynamic efficiency seriously, you should at least be open to the possibility that the net economic effect is positive – the naive textbook monopoly model notwithstanding.
The same goes for monopsony as well. If your business is awesome, you’ll be able to pay your workers less than their marginal product. However, this in turn amplifies the incentive to make awesome businesses. Every worker should want to live in a world where this incentive is supercharged.
Once you buy this argument, you’ll see most other “suspect” business practices in a favorable new light. What’s so bad, for example, if employers add a non-compete clause to their employees’ contracts? There may be some static inefficiency, but it’s nice to live in a world where entrepreneurs know they can profit as they please if they make their firm great.
Further point: Dynamic efficiency may take – and last – a long time. The current success of Jeff Bezos isn’t merely incentivizing his fellow 54-year-olds to make great businesses. Word of his fabulous fortune is already inspiring our business-savvy kindergarteners. Verily, as Maximus says in Gladiator, “Brothers, what we do in life, echoes in eternity.” The way your culture feels about business matters. It’s not crazy to think that the monopoly profits Rockefeller earned in the 19th century continue to fuel the ambition of the aspiring Rockefellers of the 21st century. Nor is it crazy to think that the antitrust case against Rockefeller continues to numb American entrepreneurship. “If you build something great, the government just might decide to smash it” is a demotivating whisper.
So should we learn to love monopoly? Not exactly. Business excellence is one route to monopoly power. The other, however, is government favoritism, which stifles static and dynamic efficiency alike. Is this really a big deal? Absolutely. Government routinely and deliberately crushes free competition, most egregiously with immigration restrictions, housing regulation, and occupational licensing. If you really want to fight socially dysfunctional monopoly, don’t urge government to tame monopoly. Instead, urge government to create less monopoly. We have a massive monopoly problem. But government is not a solution to our problem; government is the problem.