Tuesday, March 07, 2006

Monopoly Power

On 3/4/06, Travis links to an article written by Allan Greenspan in the 1960’s to assert that monopolistic behavior does not exist. Travis misreads Greenspan if he thinks the article disproves the notion of a monopoly. Greenspan states:

Therefore, the existence of a free capital market does not guarantee that a monopolist who enjoys high profits will necessarily and immediately find himself confronted by competition. What it does guarantee is that a monopolist whose high profits are caused by high prices, rather than low costs, will soon meet competition originated by the capital market.

Monopolistic behavior exists. Greenspan’s point is that if a monopolist holds his prices too high for too long he risks allowing a competitor to profitably enter his market. In the presence of free capital markets, monopolies, like glory, are fleeting. Here is where I actually have an issue with Greenspan’s article.

Greenspan uses the nineteenth century western railroad industry as an example of how flawed government policy aided in creating monopolies, which other flawed government policies tried to eradicate. However, Greenspan’s analysis hinges on “the existence of free capital markets.” However one of the notable characteristics US economy of the nineteenth century was the lack of liquidity in the capital markets. Without free capital markets, competitors would not be able to generate capital to challenge firms charging monopoly rents. In fact of the reasons that many people wanted to move to a silver standard was to increase liquidity so that competition could emerge in the railroad industry. The nineteenth century railroad industry is a poor example because the mechanisms that Greenspan advocates to regulate monopolies did function well at the time.

In addition, while there may be some truth to the fact that Standard Oil gained important efficiencies by being an integrated monopoly oil supplier, Standard Oil is also a poor example of a good monopoly because of the well documented cases of corruption and thuggery that protected it’s monopoly status.

Nonetheless, I did like the thesis of Greenspan’s piece in that it illustrates that monopoly power can be regulated by the threat of competition posed by the capital markets funding new market entrants. However, this regulation can only be viewed as a kind of delayed regulation in that it takes time for other firms to enter monopoly markets and become competitive. Unfortunately, this type of regulation cannot remove the dead weight loss caused by monopoly.

So are we ready to dispense with the Justice Department’s regulation of monopolies? Certainly our capital markets are extremely liquid and persistently low long-term interest rates ensure that firms should have no trouble finding capital for new investments. In fact, one of the bigger concerns about today’s economy is the lack of new investment ideas. But my concern is, why does monopoly power still exist? In this case, why is every song on iTunes $0.99? Are there structural issues in the music industry that allow monopolies to exist there without the threat of emerging competition? I will be interested to see the follow-up to this investigation.

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