Institutions Matter, Even for Monopolies

Noah Smith has a rather interesting new article at Bloomberg detailing new research and proposals on regulating monopolies. I have written on the dangers of knee-jerk regulation as a solution to various market failures and others have written on the dangers of the perfectly competitive model to measure market failure. However, there is a different flaw I want to discuss with Smith’s article:

The big question Smith needs to ask is this: what are the institutional arrangements that allow for the monopoly (granting that the effects discussed, lower wages and higher prices, are due to the monopoly) to arise and persist? Monopolies are not necessarily a permanent fixture in industries; they always face competition (think of once “dominant” firms that are now on the garbage bin of history: Sears, Blockbuster, Myspace, etc). Monopolies theoretically arise under only a handful of situations and are constantly feeling the pressure of competition. Why is it some of these firms can now effectively ignore competition and suppress wages?

Smith blames lax anti-trust regulation and implicitly blames low minimum wages and unions. (The irony, of course, of using these last two options to “solve” monopoly issues is that both minimum wage and unions are themselves means of building monopoly power). However, the issue may (and, I’d wager, likely is) not one of lax regulation but rather excessive regulation. Regulation, by its nature, restricts competition. Granted, some restrictions may be desirable (eg, prohibition on using violence to conduct business), but that does not change the fact that regulations are designed to restrict competition and this provides some level of monopoly power to firms. So, what are these institutional arrangements? What legislation is in place? Occupational licensing? Tariffs? Environmental Regulations? All these things raise the fixed costs of suppliers, and when fixed costs rise, and subsequently barriers of entry imposes, one should not be surprised when monopolies arise.

By not considering the institutional framework in which economic activity takes place, Smith is mistaking symptoms for causes. Regulation, even if we ignore the public choice, law & econ, and behavioral economics concerns laid out in my linked article, would at best be treating these symptoms rather than the causes of monopolies. Indeed, ignoring institutional arrangements may lead to regulatory action that worsens, rather than helps, the problem.

Whenever some “market failure” is supposed, the first question in any analysts mind should be “why did this outcome happen?” That is the line of inquiry for the economist, for the lawyer, for the scientist. We assume too much by ignoring that all important question.

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