Friedrich Hayek on Industrial Organization, Competition, and Monopoly

From David Henderson.

"One of the treats of the recent Liberty Fund colloquium on the Austrian and Chicago schools of thought was getting to read or reread various excerpts from Friedrich Hayek’s work. In a chapter titled “Government Policy and the Market” from his 1982 book Law, Legislation, and Liberty, Volume 3, Hayek nicely puts perfect competition in perspective  and lays out the incredible benefits of real-world, as opposed to “perfect,” competition.

On the problem with perfect competition as a normative standard:

From basing the argument for the market on this special case of ‘perfect’ competition it is, however, not far to the realization that it is an exceptional case approached in only a few instances, and that, in consequence, if the case for competition rested on what it achieves under these special conditions, the case for it as a general principle would be very weak indeed. The setting of a wholly unrealistic, over-high standard of what competition should achieve thus often leads to an erroneously low estimate of what in fact it does achieve. (p. 66)

Hayek goes on to lay this out more.

Two comments:

First, I occasionally run into people who took economics as undergraduates, and even some how minored or majored in economics, who believe that because the market is not perfectly competitive, it has failed and that the door is wide open for government to intervene and improve things.

Second, one reason I like Shark Tank is that the sharks generally appreciate markets as they are. They will often ask those who pitch their firms and products what their margins are. The margin they have in mind often seems to be the difference between average variable cost and price and sometimes seems to be the difference between average total cost and price. If someone answered, for the latter case, that the margin is zero (which would be the case for perfect competition) all 5 sharks would say, almost in unison, “I’m out.”

On temporary monopoly as an incentive to innovate:

The inducement to improve the manner of production will often consist in the fact that whoever does so first will thereby gain a temporary profit. Many of the improvements of production are due to each striving for profits even though he knows that they will only be temporary and last only so long as he leads. (p. 70)

When I was teaching this point to my students and we were studying efficiency of perfect competition versus efficiency of real-world competition, I would ask them to imagine 2 buttons, one of which they could push. The first button would yield a world in which no one would make above-normal profits, even for a short time. The second button would yield a world in which such profits would be allowed. Which one would they push if they cared about long-run well-being? Most of them got that they should push the second button because pushing the first would reduce the incentive to innovate, thus reducing innovation, so that most innovations would come about randomly rather than due to focused effort.

The injustice of requiring a monopolist to produce to where the price equals marginal cost:

Quite apart from the practical difficulty of ascertaining whether such a de facto monopolist does extend his production to the point at which prices will only just cover marginal costs, it is by no means clear that to require him to do so could be reconciled with the general principles of just conduct on which the market order rests. So far as his monopoly is a result of his superior skill or of the possession of some factor of production uniquely suitable for the product in question, this would hardly be equitable. At least so long as we allow persons possessing special skills or unique objects not to use them at all, it would be paradoxical that as soon as they use them for commercial purposes, they should be required to use them to the greatest possible extent. We have no more justification for prescribing how intensively anyone must use his skill or his possessions than we have for prohibiting him from using his skill for solving crossword puzzles or his capital for acquiring a collection of postage stamps. (pp. 71-72)

Later, Hayek gives what he thinks is the clinching reductio ad absurdum:

There exists no more an argument in justice, or a moral case, against such a monopolist making a monopoly profit than there is against anyone who decides that he will work no more than he finds worth his while. (p. 72)

I would agree with Hayek that this is a slam-dunk reductio ad absurdum. But two authors have recently taken that absurd conclusion and run with it. In their 2018 book, Radical Markets: Uprooting Capitalism and Democracy for a Just Society, Eric A. Posner and E. Glen Weyl warm to a related proposal. Here’s what I wrote in my 2018 review of their book in Regulation:

Toward the end of the book, they even toy with having people pay taxes on their human capital. They give an example of a surgeon who announces that she would perform gallbladder surgery for $2,000 and pay a tax accordingly. She would be obligated to provide that surgery to anyone willing to pay $2,000. So if the surgeon was thinking of retiring, forget it. The only satisfactory solution for her would be to estimate the value of her services at a number that really would make her indifferent between working and retiring.

The authors are aware that they’re treading on sensitive ground here, writing, “A COST [common ownership self-assessed tax] on human capital might be perceived as a kind of slavery.” Might be? They claim that such a perception is incorrect, but the reasoning behind their claim is weak.

They implicitly admit that their proposal is coercive when they write that it would be a mistake “to think that the current system is not coercive.” How is the current system coercive? Here’s how: “Those with fewer marketable skills are given a stark choice: undergo harsh labor conditions for low pay, starve, or submit to the many indignities of life on welfare.” In short, to Posner and Weyl, being relatively poor is akin to being coerced. I would bet that a newly freed slave in 1865, though almost certainly poor, would understand the difference between poverty and coercion better than Posner and Weyl seem to.

I’ll have more to say on Hayek on these issues soon."