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January 2002; Volume 20, Number 1

Understanding Barriers to Entry

by George Reisman

 

With the Microsoft antitrust suit near a final settlement, it is a good time to take an entirely new direction in antitrust. That new direction ought to be its complete elimination. Its underlying concepts in economics and political philosophy need to be thoroughly discredited, and the legislation on which antitrust rests in practice needs to be repealed.

An essential start must be to understand how badly flawed are the concepts of freedom of entry, monopoly, and competition that underlie the theory and practice of antitrust. 

In her essay "Man’s Rights," Ayn Rand critiqued the prevailing concepts of freedom of speech and press. Freedom of speech and press, she said, does not mean that one has the right to say anything one likes, anywhere, at any time, and that censorship exists when this alleged right is denied. There are no rights entailing the use of others’ property against their will. 

On this basis, Rand argues, there are no rights to houses, automobiles, jobs, education, or medical care. There is only the right to take the actions necessary to earn such things and to purchase them from willing sellers.

Similarly, we must not equate the freedom of entry with the mere ability to enter an industry, and conclude that to the extent people are unable to enter an industry for any reason (such as the lack of the necessary capital) the freedom of entry is violated. Thus, for example, if it takes a minimum investment of, say, a billion dollars, to have any hope of competing in the automobile industry, it does not follow at all that the automobile industry lacks freedom of entry or that my freedom of entry as an individual is violated or infringed in any way because I personally cannot raise the necessary billion. 

My freedom of entry is no more violated by the fact that I don’t possess and cannot raise the necessary capital than my freedom of speech or press is violated because I don’t own a television station or newspaper and cannot gain the support of one.

Under what circumstances would freedom of entry be violated? It would be violated if I did possess or could raise the necessary capital, and, of course, met the other requirements of being able to compete, such as having assembled the necessary management and workers with the necessary skills, technological and otherwise, and then was forcibly prevented from entering the industry by the government. 

That would be the counterpart of censorship. It could also be properly described as monopoly. For I would be confronted with a market, or part of a market, that was closed to me by the essential element of the initiation of physical force by the government—a market from which I was forcibly excluded and that, in consequence, was made the monopoly of others. That is how that enforcement of antitrust laws routinely serves to violate the freedom of entry, properly understood, and thereby promote monopoly properly understood.

Now violations of the freedom of entry and the concomitant establishment of monopoly are routine consequences of the antitrust laws. Again and again, they forcibly exclude from markets precisely those firms that in their absence would be in them, namely, the firms that do possess the necessary capital and meet all the other requirements for competing.

Every antitrust decision to prohibit a merger or to force a divestiture is a decision to forcibly exclude from a market or part of a market a firm that would otherwise be in that market. It is a decision that violates the freedom of entry and/or the freedom of competition of that firm and monopolizes the market against it. 

That same mentality, however, does not see any violation of the freedom of entry if General Motors is prohibited by a government agency from entering the segment of the automobile market presently served by another automobile company. Yet such prohibition is the meaning of routine government decisions to prohibit mergers or acquisitions, and would almost surely take place if General Motors were to attempt to merge with any other major automobile manufacturer.

A proper understanding of the concept of monopoly implies that monopoly need not exist merely because there is just one seller, and may exist when there are many thousands of sellers. Alcoa before World War II was the only producer of aluminum ingot in the United States. However, it achieved and maintained that position by means of its competitive efficiency, in the face of the legal freedom of entry of all other producers, i.e., by achieving and maintaining lower costs of production than potential competitors and by selling at lower prices than its potential competitors required to achieve profitability.

By the same token, there may be many thousands of producers protected by a tariff, say, that gives a monopoly of the domestic market to domestic producers. Indeed, monopoly can exist in circumstances in which many thousands of inefficient small producers are protected from the competition of the very small number of producers who would ultimately replace them, indeed from the competition of perhaps just the one producer who would replace them all.

If there were thousands of small aluminum producers protected against the competition of Alcoa, that would be the case. They would be the monopolists, not Alcoa. Monopoly does not depend on the number of producers. It should be understood as a market or part of a market that is reserved to the exclusive possession of one or more producers by means of the initiation of physical force by the government, or with the sanction of the government.

Enactment of the government’s failed plan to break Microsoft into two separate companies, one confined to operating systems, and the other to application software, would constitute the monopolization of one or the other of these two branches of software production against Bill Gates, who would be forcibly excluded from the production of the one or the other.

A quick word on high capital requirements: So far from representing any kind of barrier to competition, they are the result of competition. They are the result of the fact that to compete, one must match competitors’ low prices, and that to be able to be profitable at those low prices, one must have low costs of production. High capital investment is typically required to achieve those low costs of production.

By the same token, high capital requirements could be eliminated, and thus the ideal of the supporters of antitrust achieved, if the prices of products were high enough to cover the high costs of production accompanying small capital investments. If, for example, automobiles were produced one at a time, by hand, in barn-like structures, as they were at the beginning of the twentieth century, we might have thousands of small automobile companies, and everyone with a few million dollars would be able to enter the automobile industry.

That would make the supporters of antitrust happy, because in their deluded world it would represent an approximation of pure competition. In the real world, however, it would represent the absence of the competition that has so greatly improved the automobile industry.

As for competition, support for antitrust rests on a concept of competition so confused that it abandons all reference to the actual phenomenon of competition. Indeed, it finds the actual phenomenon of competition—which, of course, is a species of rivalry—to be antithetical to its concept of competition.

Under capitalism, the quest for high profits leads to continuous innovations in the form of improved products and more efficient methods of production. Again and again, competition eliminates the premium rates of profit and serves to pass the entire benefit of the innovations on to the consumers, who buy progressively better products at progressively lower real prices. Premium rates of profit continue to be earned only by virtue of the introduction of still further innovations.

Over the course of the twentieth century, this process of innovation and competition served to lower real prices probably on the order of well over 90 percent. The magnitude can be inferred from the fact that in 1900 the average worker worked approximately sixty hours a week and obtained the average standard of living of 1900. In the year 2000, the average worker worked approximately forty hours a week and obtained the at least ten-times-higher average standard of living of 2000. 

Thus, for two-thirds the work, the average worker received ten times the goods and services, which implies a fall in real prices to 6 2/3 percent of their initial level, i.e., by 93 1/3 percent. This incredible real-world price competition is ignored by contemporary, "microeconomic" theory and the supporters of antitrust. Their concept of price competition is the equality of price and marginal cost, which big business does not achieve. And because it does not, it is denounced for lacking price competition. 

The equality of price and marginal cost is an absurd standard. Think of the empty seats you often see in movie theaters, at athletic events, or on airplanes, buses, or trains. Ask yourself what is the marginal cost of admitting or carrying one more customer in such cases. Obviously it’s zero or close to zero. The effect of price having to equal marginal cost in such cases would simply be to prevent the existence of the industry, unless, of course, the government were to nationalize or otherwise subsidize it while it charged a price equal to marginal cost.

In the case of almost all other industries, such as steel or automobiles, marginal cost is constant over long stretches of output. The effect of having to charge a price equal to marginal cost in such circumstances would be to prevent the coverage of fixed costs. The result would be smaller industries to the point of ensuring prices high enough to cover full costs often enough to stop further decline in the amount of capital invested. 

The resulting situation would be one of repeated bottlenecks in the economic system owing to lack of fixed capacity. That too would hardly serve to justify price equal to marginal cost as any kind of rational standard for economic activity.

Antitrust’s concept of competition, derives from a Platonic dreamworld in which competition comes to stand for the conditions—mainly the existence of an enormous number of individually insignificant sellers of a perfectly interchangeable, homogeneous good—required for profit-seeking businessmen voluntarily to drive price to equality with marginal cost.

Such an equality for its part can be held to be desirable only from a thoroughly collectivist perspective that distorts the nature of private property and of prices no less than that of competition. Such are the intellectual foundations of antitrust— disgraceful to the point of being laughable. 

* * * * * 

George Reisman, adjunct scholar of the Mises Institute, teaches economics at Pepperdine University (greisman@pepperdine.edu). He is the author of Capitalism: A Treatise on Economics (Ottawa, Ill.: Jameson Books, 1996) and is the translator of Ludwig von Mises’s Epistemological Problems of Economics (New York: D. Van Nostrand, 1960). His website is http://www.capitalism.net. He delivered a version of this article at the Mises Institute’s Austrian Scholars Conference, 2001.

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