Monopolies and Cartels: Where Do They Come From?

It’s actually nearly impossible for an “abusive” monopoly to exist in a free market, except maybe for a brief moment. Most people are afraid of the possibility, but there is nothing to be afraid of in the free market. Here’s why. Let’s imagine a case where a company, for whatever reason, was the only one selling a product. Our fear is that they will use this market leverage to then raise prices exorbitantly since there are no competitors to keep them in check and no one else consumers could buy from. But, this could not last in a free market. If the company drastically raised prices, then that would send a signal to other businesses, entrepreneurs, or others to enter the market and start selling that product also. Imagine a bunch of people being angry that they have to pay high prices to a monopoly for some product. This would obviously be a huge incentive for OTHERS to then start making and selling the product at a lower price and then undercut the monopoly. Entry to the marketplace is the key to preventing and/or quickly ending “abusive” monopolies or cartels. However, if a monopoly keeps its prices very low to benefit and please consumers, it may maintain its monopoly, but that’s perfectly fine since they aren’t “abusing” the monopoly status. (I put quotations around “abusive” because, technically, a free market company that decides to dramatically raise prices on its products is not unfairly “abusive”, as the products are their property, not yours, and you aren’t entitled to their stuff. They can do anything they want with their stuff as long as they aren’t violating others’ rights).

Now, if we do see an “abusive” monopoly, that’s a sign that there is not a free market. Most people think that the government protects the people from monopolies, but the historical truth is that governments usually create or sustain monopolies and cartelization, either explicitly or indirectly in many ways.

One way is through subsidization (handing out tax money to unfairly advantage certain enterprises). But another common way is to create barriers to entry in certain markets in order to protect existing industries from startup competitors. This is sometimes done through corrupt mechanisms, where politicians do favors for already established businesses that they have close ties with by writing regulations in a way that benefit them. But, often, this process is not done through corrupt mechanisms, but through good intentions by regulators and politicians who simply don’t understand economics. They may do this by making a bunch of very complex and expensive regulations, which may be easier for an already wealthy company to pay and comply with, but difficult for small startup companies who have little initial capital. Or, the industry can be so complicated that the politicians simply don’t know how to write the regulation, so they actually ask the regulated company to write the regulations for their industry. The regulated company would then obviously write subtle requirements that benefit themselves over potential or existing competitors. And, sometimes, a government will explicitly outlaw competitors; this happens with some utilities, and a recent example in the pharmaceutical industry is when the FDA granted Turing Pharmaceuticals a monopoly on the drug Daraprim (this was not a patent issue, the drug was many decades old). Tariffs are another way that governments can protect domestic businesses from foreign competition.

The government also creates licensing and certification requirements where it mandates that the only people/companies who can do business are ones who have licenses, and usually the licenses are limited in number or very difficult to get. Essentially, many people have to get a permission slip from the government to make a living. According to the Institute for Justice, only 5% of workers had to have licenses in 1950, but that number has grown to roughly 33% by 2012. Even for low income jobs (not doctors, engineers, etc.), licensing requirements have expanded greatly to new occupations to include education or training, passing tests, paying fees, and more. Some states require such licenses for interior decorators, massage therapists, shampooers, funeral attendants, manicurists, travel guides, locksmiths, animal trainers, and cosmetologists. On average, licensing requirements for low and moderate income occupations include $209 in fees, pass an exam, and 9 months in school, and the associated tuition. And, that’s just average, some states require interior decorators to complete 6 years of training. The worker could have spent this time working and earning money instead of paying money and seeking permission to work from the state. These licensing and certification requirements restrict the ability for individual people and potential businesses from accessing a market, which reduces future competition and protects already established businesses. This may not produce single monopolies, but it restricts competition to a smaller number of companies, and maybe a cartel.

An old example of govt-created cartels are guilds in the Middle Ages. Local govts or centralized monarchs granted special legal powers to guilds (which are precursors to modern day unions) that allowed guilds to create extremely detailed and strange rules and regulations about how a product could be made and who is allowed to enter the industry. Local or regal govts would then enforce these rules. Not surprisingly, those privileged workers already within the guild made sure that only they could produce and sell certain products so that they didn’t face any competition from outside producers.

Government-created monopolies or cartels then have the power to raise prices (or maintain high prices) because they know that they have no or little competition. The government stifles innovation and competition and raises the cost of living, which hurts everyone, including the poor. Besides raising costs, the government decreases opportunity. In particular, the barriers to entry prevent poor and middle-income people from easily getting a job or starting new small businesses to make a living.

As a side note, some hippie activists mistakenly point to the classic, infamous East India Company as an example of the excesses of free market capitalism. This is absurd, as the East India Company was explicitly granted a monopoly and special government-like powers and protections by the British monarch. Some modern examples of government-created protections are 1. When rideshare companies like Uber want to provide pick-up services, the existing taxi industry got the government to pass laws banning the new competitors in some places, 2. When doctors and hospitals use government to outlaw nurses and other less-specialized health care providers from offering cheap health care for simple illnesses that don’t require specialized care, 3. Public schools, and 4. some states have required that you can only become an interior decorator if you get an expensive and time consuming interior decorating license. This is obviously to protect the existing established interior decorators from further competition.

George Smith’s essay (here) contains several interesting historical examples of government-created monopolies and cartels. Here’s an excerpt: “when tailors in seventeenth-century France began to weave a new kind of cloth button into their garments, they were vigorously opposed by the button-makers guild, whose members branded this innovation a threat to the handicraft industry. The French government then imposed fines for the production, sale, or use of unauthorized buttons. When guild officials called for stronger enforcement, they were authorized to search houses and arrest any perpetrator who was enjoying an illegal button in the privacy of his own home.”

You may be thinking to yourself, “But, what about those evil monopolies in the earlier industrial times that the government helped save us from?” In 1890, the Sherman Act (antitrust law) made monopolies illegal. I don’t favor this law. Regardless, consider the classic historical examples of supposedly big scary monopolies that the government prosecuted to break them up using antitrust laws. But, these companies were not “abusive” and often times not even monopolies at all. So, the government’s claims against them were baseless. Here are two major landmark case examples: Standard Oil and Alcoa.

1. Standard Oil Co. (remember old Rockefeller), 1870-1911: (regardless of what you think about oil in general and the environment, this is a different topic. We are just talking about monopolization right now). This oil company grew rapidly into a large oil producer. They pioneered integration techniques to make production efficient so that they could sell oil cheaply and outperform their competitors, so they eventually dominated the sale of oil. During the “progressive era”, a big company was seen as a bad company, so politicians made sure to prosecute Standard Oil in 1911 for being a monopoly under the Sherman Act. Putting aside the fact that there’s nothing morally wrong with being a monopoly in the free market, the government’s claims of monopoly were factually incorrect. By 1911, Standard Oil’s market share was actually decreasing from 88% in 1880s to 64% in 1911, and still declining because its competitors were growing. And, about 147 other oil companies were competing with Standard Oil at the time, including Gulf, Texaco, and Shell. So, if our definition of a monopoly is a single supplier (100% market share), Standard Oil obviously doesn’t fit the definition, not even close. Also, if it was a monopoly, then we might expect it to dramatically raise prices. But, kerosene (Standard’s main product) prices were always falling from 80 cents/gal in the 1860s to 6 cents/gal in 1906 when the government sued them, and when kerosene was the cheapest it had ever been at the time. It benefitted consumers by having such low prices. No monopoly, abusive or not, ever existed. But, the government still found them guilty because big successful companies were politically unpopular in the “progressive era”, the same time when socialism and communism were on the rise.

2. Alcoa: Alcoa produces aluminum. They eventually dominated aluminum production to the point where they literally, admittedly, were a monopoly on the production of aluminum. This sounds scary, but wait. In 1945, they were prosecuted for being a monopoly. The case was considered ridiculous by the lower court and Alcoa wasn’t found guilty at first because Alcoa was only a monopoly because they were so efficient, but the federal government appealed. Later, the federal judge himself admitted that the reason why Alcoa had a monopoly was because they were extremely efficient, could always outcompete competitors and offer lower prices to consumers, and were extremely fast in responding to consumer preferences and new markets. Every time a new aluminum demand arose, Alcoa was there to quickly supply that demand before any competitor would. And, Alcoa’s aluminum prices were always falling. They were so efficient and good, that no new business even wanted to risk starting up and competing against them because they knew they would lose. The judge admitted all of this, as if he was praising the company. But, they were still found guilty simply because they were a monopoly, and monopolies are illegal. Of course, the very reason why they were a monopoly is because they were so good at selling very cheap aluminum, which benefits consumers, not harms them. They did not “abuse” their monopoly status. If they did “abuse” that status by raising prices dramatically, then they would lose their monopoly since other companies would then enter the market to undercut Alcoa. This threat of free market competition kept them selling cheaply.

We do not need the government to protect us from monopolies. The free market works very well in real life, not just theoretically in economics. Our only fear should be monopolies and cartels sustained by the government.

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