Basic Economics

by Sowell, Thomas

  The inefficiencies created by regulation were indicated not only by such savings after federal deregulation, but also by the difference between the costs of interstate shipments and the costs of intrastate shipments, where strict state regulation continued after federal regulation was cut back. For example, shipping blue jeans within the state of Texas from El Paso to Dallas cost about 40 percent more than shipping the same jeans internationally from Taiwan to Dallas.{246}

  Gross inefficiencies under regulation were not peculiar to the Interstate Commerce Commission. The same was true of the Civil Aeronautics Board, which kept out potentially competitive airlines and kept the prices of air fares in the United States high enough to ensure the survival of existing airlines, rather than force them to face the competition of other airlines that could carry passengers cheaper or with better service. Once the CAB was abolished, airline fares came down, some airlines went bankrupt, but new airlines arose and in the end there were far more passengers being carried than at any time under the constraints of regulation. Savings to airline passengers ran into the billions of dollars.{247}

  These were not just zero-sum changes, with airlines losing what passengers gained. The country as a whole benefitted from deregulation, for the industry became more efficient. Just as there were fewer trucks driving around empty after trucking deregulation, so airplanes began to fly with a higher percentage of their seats filled with passengers after airline deregulation, and passengers usually had more choices of carriers on a given route than before. Much the same thing happened after European airlines were deregulated in 1997, as competition from new discount airlines like Ryanair forced British Airways, Air France and Lufthansa to lower their fares.{248}

  In these and other industries, the original rationale for regulation was to keep prices from rising excessively but, over the years, this turned into regulatory restrictions against letting prices fall to a level that would threaten the survival of existing firms. Political crusades are based on plausible rationales but, even when those rationales are sincerely believed and honestly applied, their actual consequences may be completely different from their initial goals. People make mistakes in all fields of human endeavor but, when major mistakes are made in a competitive economy, those who were mistaken can be forced from the marketplace by the losses that follow. In politics, however, those regulatory agencies often continue to survive, after the initial rationale for their existence is gone, by doing things that were never contemplated when their bureaucracies and their powers were created

  ANTI-TRUST LAWS

  With anti-trust laws, as with regulatory commissions, a sharp distinction must be made between their original rationales and what they actually do. The basic rationale for anti-trust laws is to prevent monopoly and other non-competitive conditions which allow prices to rise above where they would be in a free and competitive marketplace. In practice, most of the famous anti-trust cases in the United States have involved some business that charged lower prices than its competitors. Often it has been complaints from these competitors which caused the government to act.

  Competition versus Competitors

  The basis of many government prosecutions under the anti-trust laws is that some company’s actions threaten competition. However, the most important thing about competition is that it is a condition in the marketplace. This condition cannot be measured by the number of competitors existing in a given industry at a given time, though politicians, lawyers and assorted others have confused the existence of competition with the number of surviving competitors. But competition as a condition is precisely what eliminates many competitors.

  Obviously, if it eliminates all competitors, then the surviving firm would be a monopoly, at least until new competitors arise, and could in the interim charge far higher prices than in a competitive market. But that is extremely rare. However, the specter of monopoly is often used to justify government policies of intervention where there is no serious danger of a monopoly. For example, back when the A & P grocery chain was the largest retail chain in the world, more than four-fifths of all the groceries in the United States were sold by other grocery stores. Yet the Justice Department brought an anti-trust action against A & P, using the company’s low prices, and the methods by which it achieved those low prices, as evidence of “unfair” competition against rival grocers and rival grocery chains.

  Throughout the history of anti-trust prosecutions, there has been an unresolved confusion between what is detrimental to competition and what is detrimental to competitors. In the midst of this confusion, the question of what is beneficial to the consumer has often been lost sight of.

  What has often also been lost sight of is the question of the efficiency of the economy as a whole, which is another way of looking at the benefits to the consuming public. For example, fewer scarce resources are used when products are bought and sold in carload lots, as large chain stores are often able to do, than when the shipments are sold and delivered in much smaller individual quantities to numerous smaller stores. Both delivery costs and selling costs are less per unit of product when the product is bought and sold in large enough amounts to fill a railroad boxcar. The same principle applies when a huge truck delivers a vast amount of merchandise to a Wal-Mart Supercenter, as compared to delivering the same total amount of merchandise to numerous smaller stores scattered over a wider area.

  Production costs are also lower when the producer receives a large enough order to be able to schedule production far ahead, instead of finding it necessary to pay overtime to fill many small and unexpected orders that happen to arrive at the same time.

  Unpredictable orders also increase the likelihood of slow periods when there is not enough work to keep all the workers employed. Workers who have to be laid off at such times may find other jobs, and not all of them may return when the first employer has more orders to fill, thus making it necessary for that employer to hire new workers, which entails training costs and lower productivity until the new workers gain enough experience to reach peak efficiency. Moreover, employers unable to offer steady employment may find recruiting workers to be more difficult, unless they offer higher pay to offset the uncertainties of the job.

  In all these ways, production costs are higher when there are unpredictable orders than when a large purchaser, such as a major department store chain, can contract for a large amount of the supplier’s output over a considerable span of time, enabling cost savings to be made in production, part of which go to the chain in lower prices as well as to the producer as lower production costs that leave more profit. Yet this process has long been represented as big chain stores using their “power” to “force” suppliers to sell to them for less. For example, a report in the San Francisco Chronicle said:

  For decades, big-box retailers such as Target and Wal-Mart Stores have used their extraordinary size to squeeze lower prices from suppliers, which have a vested interest in keeping them happy.{249}

  But what is represented as a “squeeze” on suppliers for the sole benefit of a retail chain with “power” is in fact a reduction in the use of scarce resources, benefitting the economy by freeing some of those resources for use elsewhere. Moreover, despite the use of the word “power,” chain stores have no ability to reduce the options otherwise available to the producers. A producer of towels or toothpaste has innumerable alternative buyers and was under no compulsion to sell to A & P in the past or to Target or Wal-Mart today. Only if the economies of scale make it profitable to supply a large buyer with towels or toothpaste (or other products) will the supplier find it advantageous to cut the price below what would otherwise be charged. All economic transactions involve mutual accommodation and each transactor has to make the deal a net benefit to the other transactor, in order to have a deal at all.

  Despite economies of scale, the government has repeatedly taken anti-trust action against various companies that gave quantity discounts that the authorities did not like or understand. There was, for example
, a well-known anti-trust action against the Morton Salt Company in the 1940s for giving discounts to buyers who bought carload lots of their product. Businesses that bought less than a carload lot of salt were charged $1.60 a case, those who bought carload lots were charged $1.50 a case, and those who bought 50,000 cases or more in a year’s time were charged $1.35. Because there were relatively few companies that could afford to buy so much salt and many more that could not, “the competitive opportunities of certain merchants were injured,” according to the Supreme Court, which upheld the Federal Trade Commission’s actions against Morton Salt.{250}

  The government likewise took action against the Standard Oil Company in the 1950s for allowing discounts to those dealers who bought oil by the tank car.{251} The Borden Company was similarly brought into court in the 1960s for having charged less for milk to big chain stores than to smaller grocers.{252} In all these cases, the key point was that such price differences were considered “discriminatory” and “unfair” to those competing firms unable to make such large purchases.

  While the sellers were allowed to defend themselves in court by referring to cost differences in selling to different classes of buyers, the apparently simple concept of “cost” is by no means simple when argued over by rival lawyers, accountants and economists. Where neither side could prove anything conclusively about the costs— which was common— the accused lost the case. In a fundamental departure from the centuries-old traditions of Anglo-American law, the government need only make a superficial or prima facie case, based on gross numbers, to shift the burden of proof to the accused. This same principle and procedure were to reappear, years later, in employment discrimination cases under the civil rights laws. As with anti-trust cases, these employment discrimination cases likewise produced many consent decrees and large out-of-court settlements by companies well aware of the virtual impossibility of proving their innocence, regardless of what the facts might be.

  The emphasis on protecting competitors, in the name of protecting competition, takes many forms and has appeared in other countries besides the United States. A European anti-trust case against Microsoft was based on the idea that Microsoft had a duty to accommodate competitors who might want to attach their software products to the Microsoft operating system. Moreover, the rationale of the European decision was defended in a New York Times editorial:

  Microsoft’s resounding defeat in a European antitrust case establishes welcome principles that should be adopted in the United States as guideposts for the future development of the information economy.

  The court agreed with European regulators that Microsoft had abused its operating system monopoly by incorporating its Media Player, which plays music and films, into Windows. That shut out rivals, like RealPlayer. The decision sets a sound precedent that companies may not leverage their dominance in one market (the operating system) to extend it into new ones (the player).

  The court also agreed that Microsoft should provide rival software companies the information they need to make their products work with Microsoft’s server software.{253}

  The New York Times editorial seemed surprised that others saw the principle involved in this anti-trust decision as “a mortal blow against capitalism itself.”{254} But when free competition in the marketplace is replaced by third-party intervention to force companies to facilitate their competitors’ efforts, it is hard to see that as fostering competition, as distinguished from protecting competitors.

  The confusion between the two things is long standing. Back when Kodachrome was the leading color film in the world, it was also what was aptly called “the most complicated film there is to process.”{255} Since Eastman Kodak had a huge stake in maintaining the reputation of Kodachrome, it sought to protect that reputation by processing all Kodachrome itself, so it sold the processing and the film together, rather than risk having other processors turn out substandard results that could be seen by consumers as deficiencies of the film. Yet an anti-trust lawsuit forced Kodak to sell the processing and the film separately, in order not to foreclose that market to other film processors. The fact that all other Kodak films were sold without processing included might suggest that Kodak was not out to foreclose the processing market but to protect the quality and reputation of one particular film that was especially difficult to process. Yet the focus on protecting competitors prevailed in the courts.

  “Control” of the Market

  The rarity of genuine monopolies in the American economy has led to much legalistic creativity, in order to define various companies as monopolistic or as potential or “incipient” monopolies. How far this could go was illustrated when the Supreme Court in 1962 broke up a merger between two shoe companies that would have given the new combined company less than 7 percent of the shoe sales in the United States.{256} The court likewise in 1966 broke up a merger of two local supermarket chains which, put together, sold less than 8 percent of the groceries in the Los Angeles area.{257} Similarly arbitrary categorizations of businesses as “monopolies” were imposed in India under the Monopolies and Restrictive Trade Practices Act of 1969, where any enterprises with assets in excess of a given amount (about $27 million) were declared to be monopolies and restricted from expanding their business.{258}

  A standard practice in American courts and in the literature on anti-trust laws is to describe the percentage of sales made by a given company as the share of the market which it “controls.” By this standard, such now defunct companies as Pan American Airways “controlled” a substantial share of their respective markets, when in fact the passage of time showed that they controlled nothing, or else they would never have allowed themselves to be forced out of business. The severe shrinkage in size of such former giants as A & P likewise suggests that the rhetoric of “control” bears little relationship to reality. But such rhetoric remains effective in courts of law and in the court of public opinion.

  Even in the rare case where a genuine monopoly exists on its own— that is, has not been created or sustained by government policy— the consequences in practice have tended to be much less dire than in theory. During the decades when the Aluminum Company of America (Alcoa) was the only producer of virgin ingot aluminum in the United States, its annual profit rate on its investment was about 10 percent after taxes. Moreover, the price of aluminum went down over the years to a fraction of what it had been before Alcoa was formed. Yet Alcoa was prosecuted under the anti-trust laws and convicted.{259}

  Why were aluminum prices going down under a monopoly, when in theory they should have been going up? Despite its “control” of the market for aluminum, Alcoa was well aware that it could not jack up prices at will, without risking the substitution of other materials— steel, tin, wood, plastics— for aluminum by many users. Technological progress lowered the costs of producing all these materials and economic competition forced the competing firms to lower their prices accordingly.

  This raises a question which applies far beyond the aluminum industry. Percentages of the market “controlled” by this or that company ignore the role of substitutes that may be officially classified as products of other industries, but which can nevertheless be used as substitutes by many buyers, if the price of the monopolized product rises significantly. Whether in a monopolized or a competitive market, a technologically very different product may serve as a substitute, as television did when it replaced many newspapers as sources of information and entertainment or when “smart phones” that could take pictures provided devastating competition for the simple, inexpensive cameras that had long been profitable for Eastman Kodak. Phones and cameras would be classified as being in separate industries when calculating what percentage of the market was “controlled” by Kodak, but the economic reality said otherwise.

  In Spain, when high-speed trains began operating between Madrid and Seville, the division of passenger traffic between rail and air travel went from 33 percent rail and 67 percent air to 82 percent rail and 18 percent air.{260} Clearly ma
ny people treated air and rail traffic as substitute ways of traveling between these two cities. No matter how high a percentage of the air traffic between Madrid and Seville might be carried (“controlled”) by one airline, and no matter how high a percentage of the rail traffic might be carried by one railroad, each would still face the competition of all air lines and all rail lines operating between these cities.

  Similarly, in earlier years, ocean liners carried a million passengers across the Atlantic in 1954 while planes carried 600,000. But, eleven years later, the ocean liners were carrying just 650,000 passengers while planes now carried four million.{261} The fact that these were technologically very different things did not mean that they could not serve as economic substitutes. In twenty-first century Latin America, airlines have even competed successfully with buses. According to the Wall Street Journal:

  The new low-cost carriers in Brazil, Mexico and Colombia are largely avoiding competition with incumbent full-service airlines. Instead, they are stimulating new traffic by adding cheap, no-frills flights to secondary cities that, for many residents, had long required day-long bus rides.

  Largely as a result, the number of airline passengers in these countries has surged. The newfound mobility has opened up the flow of commerce and drastically cut travel times in areas with poor roads, virtually no rail service and stretches of harsh terrain.{262}

  One low-cost airline offers flights into Mexico City for “about half the price of the 14-hour overnight bus ride.”{263} In Brazil and Colombia it is much the same story. In both these countries, new low-cost airlines have reduced bus travel somewhat and greatly increased air travel, as the total number of people traveling has grown. Planes and buses are obviously very different technologically, but they can serve the same purpose and compete against each other in the marketplace— a crucial fact overlooked by those who compile data on how large a share of the market some company “controls.”