Category: Regulation

The Price Helix in Inframarginal Perspective

Post author By Ramsi Woodcock
Post date May 11, 2023

Is the current inflation caused by corporate greed?

The answer is very likely yes.

But is it caused by monopoly?

The answer is very likely no.

The difference between these two answers tells us a great deal about why progressives should take an inframarginalist approach to political economy rather than an antimonopoly approach.

That is, it tells us why focusing on who gets the surplus generated by production is more helpful for progressives than obsessing about market concentration.

To see why the present inflation is likely about greed but not monopoly, we need to spend some time thinking about the concept of inflation, and, in particular, distinguishing between the inflationary spiral itself and the triggers of that spiral.

The Inflationary Spiral

As Olivier Blanchard pointed out a few months ago, inflation itself is a spiral, or a tug of war, bred of a conflict over the distribution of wealth.

In inframarginalist terms, it is a conflict over the distribution of surplus.

When a firm produces a good at a cost of $3 and sells it to a consumer who is willing to pay at most $7 for it, production generates a surplus of $4. The price the consumer pays divides that surplus between buyer and seller. If the price is $6, for example, then the seller gets $3 of the surplus (which we call “profit” in the economic sense) and the buyer gets $1 of the surplus.

The price suppliers charge the firm divides the firm’s share of surplus (i.e., divides the firm’s profit) between suppliers and the firm. If a supplier raises its price by $1, then the firm’s costs increase from $3 to $4, and its profits fall from $3 to $2. By raising its price, the supplier has redistributed one dollar of surplus from the firm to itself.

In an inflation, suppliers and the firm battle over the division of profits—they fight over price—but the battle gets out of hand because the battle isn’t just between one firm and its suppliers but between many firms and many suppliers. As a result, price increases by suppliers feed back into the willingness of consumers to pay the firm for its products, and that enables the firm to increase its own prices and profit levels in response to changes in supply prices.

Indeed, the economy is a great feedback loop. Rarely do a particular firm’s suppliers find themselves buying all of their own inputs from supply chains leading back to that firm. Firms sell to other firms’ suppliers and other firms sell to their suppliers.

But when we consider a large enough cross section of firms, it is the case that those firms ultimately sell to their own suppliers as a group. The economy is a tangled web, and although individual strands rarely loop back on themselves, the web as a whole does loop back.

As we learned in Econ 101, the economy is a great feedback loop. Choose a proper cross section of firms and you will find that if you follow the chain long enough, the firms actually indirectly supply themselves. Note that workers are one kind of supplier.

Consider that $1 supplier price increase again. The firm might not be happy to lose $1 of profit. In order to make up for the loss of that dollar to suppliers, the firm might, in response, raise the price it charges to consumers. That would allow the firm to appropriate an additional dollar from consumers as a substitute for the dollar of profit that the firm lost to the supplier price increase. The firm might therefore raise price from $6 to $7, reducing consumers’ surplus from $1 to $0 (recall that the maximum consumers were willing to pay for the firm’s output was $7).

If the supply price increase is limited to this one market, and this one firm responds by increasing its own price, then the analysis ends here. Consumers will be made worse off; suppliers will be made better off; and the firm’s fortunes will remain unchanged.

But if many suppliers have increased their prices, and many firms have responded by increasing their own, then the firms’ price increase will feed back through the tangled web of supply chains that is the economy—back to the suppliers from which the firms buy.

Suppliers will find that the price of the inputs they need to buy to create the products that they supply to firms has increased. In our example, after the firm increases price from $6 to $7, the firm’s suppliers will now find that their own costs have increased by $1. The consumers who purchased goods from the firm for $7 instead of $6 will have increased the prices they in turn charge for the goods and services that they supply to others. And those others will in turn have increased their prices, and the price increase will have propagated through the tangled, looping web until it at last reached the firm’s own suppliers, who will experience it as an increase in the price of the inputs they purchase to make the things that they supply to the firm. Their input costs will increase by $1. (In reality, the a $1 increase in a supply price is unlikely to feed back into a $1 increase in costs, but a one-for-one feedback loop will do for a simple numerical example such as this.)

The $1 in extra input costs that the firm’s suppliers now incur will eat up the extra dollar of surplus they appropriated via their initial supply price increase. The extra dollar they charged to the firm will have turned out to be an extra dollar charged to themselves.

If suppliers want to preserve the extra dollar of surplus that they initially gained from the supply price increase, they will need to raise the supply price they charge to the firm again by another dollar. So suppliers raise price by an extra dollar. That price increase in turn redistributes to suppliers the additional dollar of surplus that the firm had appropriated from consumers by raising the firm’s price to $7 from $6. The firm now pays a supply price of $5 (the initial supply price was $3 and suppliers have now twice raised price by a $1) and once again takes only $2 of the surplus.

If the firm wishes again to make up for this reduction in profits, the firm must again raise its own price to consumers. But isn’t that impossible, because price is already $7 and the maximum that consumers are willing to pay is $7?

The answer is no. The willingness of consumers to pay has now risen from $7 to $8. Why? Because when consumers passed the firm’s original price increase of $1 on to suppliers, they effectively generated an additional dollar of income for themselves when they responded by raising the prices they charged to others. That additional dollar of income made it possible for them to pay an additional dollar for the firm’s product. Their willingness to pay went up.

(Note that consumers here can be individual persons, for whom the good is an input into their production of labor services. Or they can be other firms that produce other goods or services that eventually serve as inputs into the production of the supplies that the firm needs to make its own good. So when I say that consumers responded to the firm’s price increase by raising the prices they charge to others, I mean that they either demanded higher wages (in the case of consumers who are workers) or charged higher prices for the goods or services that they produce (in the case of “consumers” that themselves are firms).)

The firm therefore has leeway to raise price to $8 and the firm will do that if it wishes to restore its erstwhile profit level of $3. So altogether we have seen that an initial price increase of $1 by suppliers triggered a $1 price increase by the firm, which then triggered a subsequent $1 price increase by suppliers, which then triggered a subsequent $1 price increase by the firm. This cycle of price increases can continue for a long time.

That is the inflationary spiral.

In other words, the lines in Blanchard’s struggle over the distribution of surplus are drawn as follows.

On one side, you have a firm’s suppliers seeking to obtain a greater share of the surplus generated by the firm.

On the other side, you have the firm itself seeking to obtain a greater share of the surplus that it generates.

Firms and their suppliers can’t both obtain a greater share of the surplus. Suppliers raise prices, reducing firms’ share of the surplus. Firms then raise prices, seeking to recoup what they have lost.

As a result, the higher prices that firms charge eventually raise the costs of the firms’ suppliers, reducing their share of the surplus and leading them again to raise the prices they charge to firms. Firms respond by raising their prices again, and so prices rise and rise.

The Triggers of That Spiral

Ideas

Inflation spirals when suppliers and firms disagree over the proper division of the surplus. If there were no disagreement, the spiral would not get under way. Suppliers would raise prices to the point at which they would achieve the agreed surplus and firms would not respond, because they would be in agreement with suppliers that the resulting distribution of surplus is fair.

If the firm in our example were satisfied with $2 of profit, the firm would not respond to the supplier’s initial $1 price increase by raising its own prices by a dollar. The firm would eat the loss. And if all firms were to respond in this manner, then inflation would not ensue.

But, by the same token, because the heart of the spiral is a disagreement regarding what a fair distribution of surplus should be, an inflationary spiral can, in principle, develop at any time. And it can develop for what an economist might be surprised to discover are purely intellectual—indeed, even ideological—reasons.

If some cross section of America’s businessmen were to wake up one morning feeling that they are not getting a fair share of the surplus, and if they were to raise prices accordingly, and if their suppliers were to be unwilling to accept the smaller share of the surplus allocated to them by those higher prices, and if their suppliers were therefore to raise prices themselves, then we would be off to the inflation races.

This rarely happens, however, because the feedback loop only appears in the aggregate. Many minds would need to change at the same time. So if one supplier were to wake up and want more, that is not likely to lead to an inflationary spiral.

Indeed, if the supplier operates in a competitive market, the supplier might not even be able to raise prices, as competitors would simply take the supplier’s market share and the supplier would not be able to sell at all at higher prices. But if many suppliers were to wake up and want more, inflation would follow—if firms decide to contest this change by raising prices themselves.

Note that the distinction I have been drawing between a firm and its suppliers is arbitrary, because an economy is a feedback loop. At whatever level of a supply chain one wishes to focus—at whatever point along the loop—the focal point contains the firms of interest and the firms and workers that sell to them are the firms’ suppliers.

Given that mass shifts in views regarding the proper distribution of wealth are not common, and that the current inflation does not seem to be driven by one, we need to look for this inflation’s causes elsewhere.

Structure

Inflation that isn’t triggered by an ideological shift must be triggered by a structural change in the economy—a change that is broad enough in effect to cause many firms to raise their prices at the same time. Something must have happened to markets that gave one side of the conflict—suppliers or firms—the opportunity to take a larger share of the surplus, and the other side must have fought back by raising prices itself, leading to a tug of war.

Here is where the conflict between inframarginalism and antimonopolism comes into play.

The Antimonopoly Story: Crises Desensitized Consumers to Price Increases

Antimonopolists want to say that monopolies triggered the present inflation by using their monopoly power to raise prices.

If we imagine that the firm in our example is a monopoly, then antimonopolists want to argue that in 2021, when the present inflation started, this firm took the initiative to raise price from $6 to $7. Assuming that many other monopolies raised their prices as well, a feedback loop would have followed. Consumers would have passed the cost of the price increase on through the supply chain to the monopolists’ suppliers, which would in turn have raised prices by a $1, and then the monopolies would have responded by raising prices again by a dollar in order to hang on to the gains from their initial price increase. Consumers would have been able to pay that additional dollar because of the extra income they generated from passing on the original price increase. The inflationary spiral that appears to still be running today would have followed.

But this argument falls victim to the venerable question: why now? Antimonopolists themselves have argued that markets have been growing more concentrated for decades. They date the commencement of the trend toward concentration to the importation of Chicago School thinking into antitrust during the Carter and Reagan Administrations. If markets have been concentrating for decades, why would firms have waited until 2021 to raise prices and trigger an inflation?

Antimonopolists’ answer has been to argue that firms could not exploit market concentration to raise prices until the pandemic and the Ukraine war created the circumstances that would allow them to do so. To understand their argument, a trip through the mainstream economic account of the present inflation is required.

Mainstream economists argue that the present inflation was triggered by two structural factors: first, supply chain disruption triggered by the pandemic and the Ukraine war, which caused supply to fall below demand; second, pandemic stimulus checks, which caused demand to exceed supply.

According to the mainstream account, the first factor drove up firms’ costs, leading them to raise prices. The second factor enabled firms to raise prices even further. This fed back into further increases in costs for suppliers, and thence to further increases in prices by firms, leading to an inflationary spiral.

Antimonopolists accept that supply chain snarls and stimulus-driven demand increases provided the initial inflationary impetus. But they insist that this alone was not enough to get the spiral going. They argue that all that this did was to create the psychological prerequisites for an inflationary spiral.

At this point, they argue, market concentration stepped in to create the inflation. Specifically, they argue that once consumers had experienced an initial increase in prices due to the pandemic and later the Ukraine war, they became psychologically primed to attribute price increases to forces majeures of this kind. Antimonopolists argue that this created an opportunity for big firms tacitly to collude to raise prices further.

Market concentration matters here because tacit collusion is possible only when the number of players in a market is small. But according to antimonopolists, concentration alone was not sufficient for tacit collusion to take place until consumers were primed by crises to accept higher prices.

Big firms could tacitly collude to raise prices because consumers, believing that price increases were an inevitable result of the global crises, were willing to pay those higher prices. Consumers would not recoil in righteous indignation, punishing firms by buying less, but instead would continue to buy at the higher prices.

In economic terms, consumer willingness to pay increased by more than the extra money they received from stimulus checks justified. That extra demand created an opportunity for firms tacitly to collude to increase prices.

The Inframarginalist Story: Firms Rationed with Price

The antimonopoly account of inflation doesn’t actually withstand scrutiny on its own terms. But I will get to that later.

What’s important to notice now is that the argument is more complex and overdetermined than it needs to be when it comes to making a progressive, moral case against business behavior during this inflation.

Progressives seem to think that they need to tell a story about market concentration, collusion, or monopoly, in order to blame firms for the present inflation.

They don’t.

All the elements they need to make a moral case are right there in the mainstream account. No collusion or monopolization is required.

That’s because when supply chains snarled and demand surged, firms had a choice. They could have responded by rationing their inventories based on a rule of first-come-first-served or some other principle of distributive justice.

Instead, they chose to ration with price.

That is, when supply chains snarled and stimulus checks caused demand to outstrip supply, firms could have kept their prices where they were and just let their goods to sell out. That amounts to rationing based on a rule of first-come-first-served. Instead, they chose to raise prices.

In the short run—which is all that matters when it comes to getting an inflationary spiral started—raising prices doesn’t increase supply. It takes time to ramp up output, especially when ports are clogged or sanctions against Russia foreclose sources of supply.

But raising prices does ration output to those who can afford to pay the highest prices, which usually means the rich. It also has the rather nice attribute, from the perspective of firms, of increasing profits. In the short run, the inventory that firms have on hand has been acquired at low, pre-crisis costs. Every additional dollar that firms charge for that inventory is profit. It is a redistribution of surplus from consumers to firms.

It therefore follows directly from the mainstream economic account of the current inflation that the root cause of the inflation was corporate greed—specifically, the choice of businesses to ration with price instead of based on some other metric.

Graphically

In partial equilibrium terms, we have something like this. We start with a competitive market for the firm’s product.

Then there’s a supply disruption or a demand surge that restricts output in relation to demand. Graphically, the supply curve kinks upward rather steeply. The firm then has the option to charge a low price at which the good sells out or to charge a high price that rations access to those with the highest willingness to pay. The high price also generates extra profit.

If the firm chooses the ration price, buyers pass the price increase along through the tangled loop of supply chains that is the economy. Buyers’ ability to pass the increase along effectively increases their willingness to pay for the good, so the demand line rises. The passing-along of the price increase travels through that tangled loop until it increases sellers’ costs, which is reflected in an increase in the supply line. This increase in the supply line reduces firm profits at the current price (the area below the original “greedy, inflationary price” and the higher supply line). The firm moves to restore those profits by increases its price in turn. We are off to the inflationary races thanks to the firm’s initial decision to ration with price instead of letting goods sell out in response to the shortfall of supply relative to demand.

There Is No Efficiency Justification for Rationing with Price

Economists used to argue that rationing with price is necessary, notwithstanding its ugly distributive effects, because it is efficient. Keeping prices low and letting goods sell out forces people to wait on interminable lines, wasting time that could be spent doing more productive things.

As I’ve argued elsewhere, in the information age that’s no longer true. It takes the time required to open up a webpage to reserve a place on line—or to know whether a good has sold out.

Economists also argue that non-price rationing leads to wasteful attempts to subvert the rationing system. People invest in bots, for example, designed to subvert digital lines. But, as I’ve also argued elsewhere, that argument is an example of the Nirvana fallacy. It ignores that people already waste lots of resources attempting to subvert the price system. People expend great effort on wasteful attempts to acquire the money they need in order to be able to pay the prices that firms use to ration access to their products. Theft and corruption are examples.

Indeed, the vast infrastructure of the criminal law and its administration, as it relates to financial crimes, is a monument to the waste associated with operating a price system.

Economists also sometimes argue that rationing with price allocates goods to those who value them the most. But few really believe that. Economists have known for a long time that willingness to pay is a poor proxy for utility because the rich are often willing to pay more than others for things that they value less than others do. As I’ve argued elsewhere, it’s unclear that place in line is a less accurate proxy for value than willingness to pay.

All of which is to say that a firm’s decision to ration with price is not necessarily efficient.

But, as we have seen, it is profitable.

And indeed a firm’s decision to ration with price is inefficient to the extent that it can trigger an inflationary spiral. The reason inflation is inefficient is that it makes it difficult for buyers to plan; prices start to change so fast that they don’t know what their money will buy tomorrow. That shuts down economic activity.

The Greed of Firms Both Small and Large Will Trigger Inflation in Response to Supply or Demand Shocks

It’s important to understand that monopoly or even market concentration is not required to tell a story about greedy price-rationing.

Whether a firm is a monopoly, or a big player in a concentrated market characterized by tacit collusion, or a bit player in a highly competitive market, the firm will have the option to raise price in response to supply or demand shocks—so long as the shocks cause industry demand to exceed industry supply in the short run.

To see why this is true in competitive markets having lots of small sellers, consider what happens when industry supply falls below industry demand.

Some group of buyers won’t be able to find sellers who are willing to sell to them. That’s what it means for demand to exceed supply. We can imagine these buyers going from seller to seller begging for access to goods. Each seller, no matter how large or how small, will face a choice: the seller can either say “sorry, I’ve already promised by stock to someone else.” Or the seller can say “I’ll redirect my stock to you if you pay me a more than the other guy.”

That is, every seller, no matter how big or small, faces the choice whether to ration based on a rule of first-come-first-served (or some other basis apart from price), or to ration with price. When prices rise in competitive markets in response to supply or demand shocks, that’s because each tiny market participant is choosing to ration with price.

Each is choosing to exploit the crisis to make an extra buck.

What is true of competitive markets is true of concentrated markets as well. Supply and demand shocks can drive up the profit maximizing price in the market, but the big firms that have the preexisting power to charge such prices don’t actually have to adjust their prices upward in response. They can continue to charge their legacy, pre-crisis prices.

When they choose instead to raise prices, they are exploiting the crisis to make an extra buck.

The progressive case that corporate greed lies at the heart of the present inflation does not, therefore, require an antimonopoly story. All it requires is the basic recognition that, when firms raise prices in the short run in response to supply or demand shocks, they are engaged in one thing only—exploiting a crisis to redistribute wealth to themselves, and thereby triggering an inflation that could make everyone worse off.

Why This Is an Inframarginalist Story

The inframargin is the category of market transactions in which surplus is generated and distributed. In a competitive market, the marginal buyer and seller place the same value on the good and so their exchange generates no surplus.

The greedy price-rationing story is an inframarginalist story because it emerges from a laser focus on the way prices distribute surplus in markets.

When the inframarginalist sees prices rising, the inframarginalist asks whether the price increases are necessary to cover costs. If not, then the price increases are redistributing surplus—and posing the question whether that redistribution is desirable.

It’s thanks to this process of thought that the inframarginalist perceives that short run price increases during a crisis are not driven by costs. Output adjustments, even costly ones, take time, and until they have been undertaken, firms are selling their legacy, low-cost inventory.

It follows that short-run price increases are elective. They are effectively a policy decision on the part of firms to take advantage of a shortage to redistribute surplus to themselves.

Antimonopolists miss all of this because they spend their time looking for market concentration. For them, redistribution is an afterthought—the stylized consequence of monopolization or collusion.

Implications for Inframarginalism in Relation to Antimonopolism

As I suggested above, the inframarginalist story is a better story for progressives to tell than the antimonopoly story because it is simpler and broader. All you need is evidence that demand exceeds supply. You don’t need market concentration and you don’t need claims about the psychology of consumers or the social behavior of firms.

To be sure, the inframarginalist story does require claims regarding the efficiency of price increases during a crisis that are not needed to make the antimonopoly case. But the notion that willingness to pay is not a particularly good proxy for value, or that in the digital age we don’t spend much time waiting on physical lines anymore, are hardly controversial. Claims regarding consumer psychology and firms’ capacity for tacit collusion are.

The inframarginalist story is also a better story because it represents a more fundamental critique of the economic system. It points to a structural flaw in markets as such, rather than to a market imperfection.

The inframarginalist story basically says: in a crisis, prices in every market—perfect or imperfect, competitive or monopolized, concentrated or unconcentrated—are going to rise even though efficiency does not require that they do, so long as firms remain greedy, profit-seeking entities. There’s nothing that can be done to restructure markets in ways that will prevent this from happening. The only solutions are government regulation of price, taxation of profits, or a reorientation of executives’ legal duty of care away from profit maximization.

The antimonopoly story says: during a crisis, prices are going to rise primarily in concentrated markets, and the solution is to deconcentrate them. There’s no problem with markets as such, and, as a result, greed is for the most part good—it leads to competition in markets and ultimately to efficient outcomes. The problem we face today is merely a problem of market imperfection. If we solve it, then government can go away.

Progressives’ current romance with antimonopolism in the inflation context has been particularly painful to watch because it has lately swept in a scholar who really knows better, and caused her to shoot herself in the foot. Isabella Weber made a splash last year arguing that that the Biden Administration should consider price controls as a solution to the present inflation.

But then last winter she released a paper arguing that tacit collusion explains the inflation. Although I suspect that Weber continues to support price controls as an inflation remedy, the implication of her paper is that price controls may not be the solution after all. Instead, an economy-wide campaign of deconcentration might do the trick.

The inframarginalist account of the present inflation provides stronger support for price controls because it applies regardless of the level of concentration in markets.

The Antimonopoly Account Is Also Incoherent

As I suggested above, the antimonopoly story is not just too complex and too narrow, it also does not withstand scrutiny on its own terms.

That’s because consumer desensitization to price increases will drive up prices in all markets, regardless of the level of competition and regardless whether firms in concentrated markets are tacitly colluding or not. Concentration and tacit collusion therefore aren’t actually required for the story that antimonopolists wish to tell.

If consumers become desensitized to price increases, prices will rise in competitive, unconcentrated markets. Imagine a perfectly competitive market consisting of numerous small sellers. If consumers become desensitized to price increases because pandemics and wars suggest to them that increases are inevitable, then firms that once could not sell to consumers in the market, because their costs, and hence the minimum prices they were willing to charge, were too high, will now be able to sell to consumers in the market. Other firms in the market that have lower costs will observe this and will raise their prices to match those of the high-cost firm. For if consumers can now afford to pay that firm’s prices, they can now afford to pay that price to any firm. As a result, the market price will increase.

The analysis does not change for markets that are concentrated but also competitive. The increase in demand will bring a higher-cost competitive fringe in the market, and the higher prices that fringe needs to charge in order to enter the market will enable all firms in the market to increase their prices.

Prices will also rise in concentrated markets in which firms are already engaged in tacit collusion, so long as the increase in demand also increases the profit-maximizing industry price. Perceiving that demand has increased, big firms will collude further to raise their prices. But they won’t do this because the increase in demand facilitates collusion, but rather because they are already colluding to charge the profit-maximizing price and the profit-maximizing price has increased.

It is possible that firms in concentrated markets might find it easier to initiate tacit collusion when consumers expect price increases. If each firm knows that the others expect consumer demand to rise, creating opportunities to increase prices, each firm may be more confident that a price increase will be matched by other firms.

But against a backdrop in which firms would raise prices in both concentrated and unconcentrated markets and whether they have been colluding or not, it is not clear what any additional price increases due to greater ease of collusion contribute to the inflation story. For the story to work, antimonopolists would need to show that price increases absent the additional collusion would have been insufficient to trigger the inflation. This antimonopolists have not begun to do. Without it, consumer desensitization tells an inflation story without the need for concentration or collusion.

Indeed, consumer desensitization to price increases is a demand story and not a concentration story. And as a demand story, it just puts us back at the basic structural fact of this inflation, which is that it was triggered by an excess of demand over supply that firms big and small chose voluntarily to exploit.

Weber and her coauthor seem to have been led to think otherwise by listening to a bunch of earnings calls in which representatives of firms in concentrated markets suggested that they were raising prices because they were confident that competitors would not try to undercut them.

But to the extent that executives can be assumed to understand what they are doing—which is not a foregone conclusion by any means—all this shows is that, when firms engaged in tacit collusion encounter demand increases, they raise prices. It does not establish that they started tacitly colluding for the first time due to the demand increases. And it does not establish that firms in unconcentrated markets encountering the same demand increases are not raising prices as well.

The antimonopoly argument turns out to be based on a snapshot of how big firms in concentrated markets behave. But if you only look at behavior in those markets you are not going to be able to perceive whether their performance is unique to them or not.

* * *

Progressives want to tell a story about greed and inflation. To tell it with the greatest possible generality and power, they should ditch the antimonopoly blinders.

Inframarginalism Regulation Tax

Congestion Pricing Is Class Warfare. Here’s a Better Idea

Post author By Ramsi Woodcock
Post date May 9, 2023

Plans are afoot to charge drivers to enter Manhattan. But we need a fairer way to reduce traffic.

[I published this opinion piece in the ill-fated OZY in 2019. As the OZY website appears to be gone, and with it this piece, I’m reposting it here.]

March 31, 2019

By Ramsi Woodcock

Henry Ford’s dream was to democratize transportation by selling cars so cheaply that every American could own one. His shareholders sued him for it, but Ford eventually succeeded, and we owe today’s driver-friendly America in part to Ford’s insistence that the automobile be a mass-market item. While climate change has taught us that the car was the wrong route to transport democracy, it has done nothing to undermine the principle that there should be no class divide in American transportation.

But one of the most progressive states in the union, New York, is about to write such a class divide into law, in the form of congestion pricing for access to Manhattan. If the plan goes forward, drivers will be charged more than $10 to enter the island, and other major U.S. cities may follow the Big Apple’s lead.

Congestion pricing taxes car commuters. Advocates, including New York Gov. Andrew Cuomo, public transport groups and even a once reluctant Mayor Bill de Blasio, argue that the tax would reduce rush-hour traffic and raise billions of dollars to invest in improving the city’s decrepit subways, which in turn would increase subway ridership, further reducing traffic.

Congestion pricing isn’t really reserving the city’s streets for those who need them most; it’s reserving them for the rich.

All that is true, but congestion pricing does something else: It puts the burden of decongesting the city entirely on the backs of poor and middle-class drivers, by politely but effectively making it impossible for some to drive into the city because they simply can’t afford the tax.

If there were no other way to reduce traffic, then, of course, New York should ask the poor and the middle class to shoulder this burden. But my research shows that there are other ways to reduce traffic that won’t write a class divide into law.

The Limits of the Price System

The premise of congestion pricing is that the best way to prevent overuse of an important resource is by charging for access to it. Those who value the resource more, the theory goes, will be willing to pay more for it, and so those who actually end up paying the price and using the resource will be those who value it the most. Those who decide not to pay—and therefore shoulder the burden of eliminating overuse of the resource—will be those who needed the resource the least.

In reality, however, willingness to pay is an imperfect indicator of need. A dollar, after all, is worth much less to a rich person than to a poor or middle-class person. So congestion pricing isn’t really reserving the city’s streets for those who need them most; it’s reserving them for the rich.

Ration with Tech, Not Price

But there is a way to reduce traffic in Manhattan without excluding the middle class or the poor: allocate access based on the rule of first come, first served. Instead of charging for access, simply close the island (or the parts of the island that are the focus of the current plan) once it has filled up.

First come, first served, like congestion pricing, strives to grant access based on need—the more you want to enter the city, the earlier you will line up—but unlike congestion pricing, it would be far harder for the rich to use their wealth to short-circuit the sorting mechanism. Sure, the wealthy could pay people to line up in their place, but New York could ban the practice, whereas under congestion pricing the city could never prohibit the rich from buying access when they don’t really need it.

First come, first served evokes visions of lines of vehicles stretching off into the distance along the approaches to the city, and 10 years ago that would have been true. But the internet has taken the effort out of waiting by allowing us to join virtual lines from the comfort of home, which means the first-come, first-served model is now a viable alternative to the price system.

Imagine that instead of congestion pricing, city leaders were to create a city access app. The app would know your location and how long it would take you to drive into the city, and therefore could inform you before you depart whether you will be granted entrance. Even better, the app could measure your need to drive, allowing those who live far from public transport to drive during rush hour but requiring those with public transport options to use them during busy periods. Either way, no physical line would be necessary.

Sure, it’s a bit more cumbersome than just driving into the city and having the tax deducted automatically from your bank account. But that’s only for those lucky enough to be able to afford congestion pricing. For those who would be priced out of the city, and thus their jobs, by congestion pricing, an app-based first-come-first-served approach would be a big improvement.

Some have suggested that New York’s congestion pricing plan should include an exemption for the poor, but any proposal to make the plan truly affordable is doomed to failure, because if everyone can still afford to drive into the city under the plan, then the plan won’t stop congestion. The proposal to exempt the poor should be seen for what it is: an attempt to obscure congestion pricing’s classist reality, at the expense of the middle
class, which would not be exempt.

Tax Incomes, Not Drivers

First-come-first-served might be a more democratic way of rationing access to the city’s streets, but what about all the tax revenue congestion pricing will generate to fund the subways? First-come-first-served can’t generate that revenue, because it keeps city access free. Nor should it.

Economists have long argued that the best way to soak the rich is directly — through taxes on high incomes and capital gains, like the state’s Millionaire’s Tax and a proposed exaction on second homes — not by taxing behaviors. Behaviors, such as commuting, often cut across class lines, and you end up taxing the rest along with the rich.

America has a long tradition of preferring market-based solutions to public problems, which is what congestion pricing represents, but America also has a longstanding hatred of class privilege — epitomized by Ford’s desire to put a car in every garage. That may explain why a still-class-bound London, and authoritarian Singapore, have embraced congestion pricing, but American cities have not.

And shouldn’t.

Ramsi Woodcock is a law professor at the University of Kentucky.

Antitrust Regulation

Monopoly Is Constitutive of the Division of Labor

Post author By Ramsi Woodcock
Post date May 7, 2023

We say that direct democracy is not practicable because we don’t all have time to vote on every matter of government. Therefore, we delegate to elected representatives. That delegation concentrates power in the hands of the representatives. But we don’t worry too much about that because we regulate our representatives’ behavior. If they do wrong, we throw the bums out of office. It follows that as between individuals we do not condemn all concentrations of power as a general matter, but instead permit those concentrations that we believe will be good for the community, and regulate them to make sure that they are in fact good for the community.

Antitrust does the same thing with respect to business firms.

Antitrust permits concentrations of economic power when their owners wield it for the benefit of society. Antitrust condemns concentrations of economic power otherwise. Antitrust lets the phone monopoly persist for so long as it provides cutting edge service.

The view that all monopoly is non licet is tantamount to the view that no one should ever have more power in any domain than any other person. That, of course, is incompatible with the administration of anything so large as a society, in which the division of labor, and hence the concentration of power in the hands of particular people or organizations in particular domains, is essential. What prevents such concentrations from leading to abuse is oversight and regulation—not deconcentration.

The concept of the virtuous monopoly is inherent in the concept of the division of labor. To oppose monopoly per se is to oppose the division of labor.

Inframarginalism Monopolization Regulation

Confusing Scarcity with Monopoly: 1803 Edition

Post author By Ramsi Woodcock
Post date March 24, 2023

Proposed regulations would read New York’s law against price gouging to police gouging by small firms less strictly than gouging by big firms. I’ve argued that this confuses scarcity with monopoly.

Price gouging is the exploitation of natural scarcity to charge higher prices. Monopoly is the creation of artificial scarcity in order to charge higher prices. Big firms have the power to create artificial scarcity. But all firms can equally take advantage of natural scarcity to rip the public off. So there’s no good reason to apply a more lenient price gouging standard to small firms.

It turns out that New York Attorney General Letitia James is not the first person to get the distinction between natural and artificial scarcity wrong.

Hapsburg Austria did too.

According to a book by David J. Gerber, an 1803 statute invalidated cartel agreements “to prevent merchants from profiting from shortages caused by the Napoleonic wars, particularly in necessities such as food” (p. 53).

The law’s authors don’t seem to have reflected that the point of a cartel is to agree on output reductions and thereby to create an artificial shortage. If the Napoleonic wars have created the shortage for you, then you don’t need to form a cartel to create one.

You just raise prices.

An anti-cartel law is therefore not going to be effective at keeping prices down in wartime. Or anytime prices are driven up by natural scarcity.

It is an amazing but true fact that antimonopoly policy won’t solve every economic problem. But it does seem to have the notable property of enabling us to remake every economic mistake.

Inframarginalism Monopolization Regulation

The Counterproductive Antimonopolism in New York’s Proposed Price Gouging Rules

Post author By Ramsi Woodcock
Post date March 17, 2023

In the modern age, we have trouble taking ideas seriously. We prefer to think in terms of dumb mechanism. We need oil for energy. It is in limited supply. Therefore we fight over it. Therefore we have conflict in the Middle East, which has a lot of oil. We apply this sort of economic logic to everything.

The view that ideas determine social behavior seems, by contrast, wishy washy. Does anyone need an idea in the way he needs energy and hence oil to live? Why would two groups that are otherwise well fed and well clothed fight over a figment of the mind?

To the extent that we credit ideas with power, we do so only by seeing them as snare and delusion—weapons in our quest for physical resources. Ideas are spin. They are the Viceroy butterfly’s colors, which mimic those of the bitter-tasting Monarch, warding off predators. Ideas are psyops, nothing more.

The ancients didn’t have this problem. Ideas, for them, were quite obviously everything, which is why people got worked up about religious dogma, as when the greens and the blues came to blows over the question whether Jesus was mostly human or mostly god. (We still do occasionally get violent over religion today, but we see that as a shame and a throwback.)

As I have argued before, the irony of our modern disdain for the power of ideas is that one of our greatest modern inventions—the computer—is an object lesson in the importance of ideas relative to physical mechanisms. No one questions the importance of software. No one questions its influence over the behavior of our machines.

And yet we are somehow certain that our own software—ideas—is mere epiphenomenon.

Antimonopolism as Mere Idea

So it is that when I point out to progressives that antimonopolism is bad for the movement because it leads, ultimately, to a vindication of the justice of the free market, I am told not to worry because antimonopolism is just good progressive psyops. Yes, I am told, free markets are themselves engines of inequality, but being an antimonopolist isn’t the same thing as being a free marketer.

Instead, I am told, antimonopolism is a way of affirming that business interests are the enemy. It’s a way of marshaling support for government intervention. And that is all. Once progressives have ridden a wave of antimonopoly sentiment into power, I am told, they will be free to achieve progressive goals however they want, and that may or may not include more markets and more competition.

This view of antimonopoly as psyops has been most on display in progressive calls to use antitrust to fight inflation. So far as I know, a century of progressive economics had never taken the position that inflation is caused by monopolization or that antitrust might be a useful remedy.

Keynes, for example, thought inflation’s flip side—deflation—had little to do with market structure. He thought Roosevelt’s first New Deal, which was about using cartelization of markets to fight deflation, was a mistake. He invented macroeconomics because microeconomics—tinkering with market structure—was a dead end. It stands to reason that, if he thought deflation wasn’t a problem of market structure, he didn’t think inflation was either.

Progressive economists no doubt understand that the link between inflation and monopolization is tenuous at best. And yet here, for example, was Paul Krugman writing a year ago when this debate was flaring:

Give Biden and his people a break on their antitrust crusade. It won’t do any harm. It won’t get in the way of the big stuff, which is mostly outside Biden’s control in any case. At worst, administration officials will be using inflation as an excuse to do things they should be doing in any case. And they might even have a marginal impact on inflation itself.
Paul Krugman, Why Are Progressives Hating on Antitrust?, N.Y. Times (Jan. 18, 2022).

In other words, arguing that inflation is an antitrust problem is good psyops, allowing progressives to leverage concern about inflation to achieve an unrelated agenda.

Well, there are costs to this kind of instrumental use of ideas—costs that arise because, at the end of the day, ideas aren’t just weapons for striking the other side. They are the software that governs the behavior of those who harbor them. If you hold onto ideas when they’re no good, you are going to do the wrong thing.

When you run bad software, the computer does bad things.

The New York Price Gouging Regulations

The peril of harboring bad ideas is reflected in the rather peculiar interpretation of New York’s new price gouging law proposed by New York Attorney General Letitia James.

The law itself is a good one. It prohibits “unconscionably excessive” pricing during any “abnormal disruption” of a market for a good or service that is “vital and necessary for the . . . welfare of consumers”.

The language is capacious enough to allow New York to institute generalized price controls to reign in supply-chain-driven inflation, including today’s inflation. After all, a supply chain disruption is an “abnormal” disruption. And all goods are, by definition, necessary to the “welfare of consumers.”

But only if the Attorney General interprets the law that way. And here is where the power of bad ideas rears its head.

As the Attorney General acknowledges, half a dozen states—including such conservative climes as Georgia, Mississippi, and Louisiana—consider any increase in the price of covered necessities during a time of emergency to be presumptive price gouging. The price of gas can go up by a penny or ten dollars—either way, the burden is on the seller to prove that it is not price gouging.

The New York Attorney General decided, however, to take a different tack. Instead of applying the presumption to any amount of price increase by any firm, the Attorney General decided to apply it only to any amount of price increase by firms having either a 30% market share or competing in a market with five or fewer “significant competitors.” In all other cases, only a price increase in excess of 10% will trigger the presumption of price gouging.

That’s right, New York’s price gouging presumption is actually going to be narrower than Mississippi’s, because it only applies to big firms.

What gives?

Answer: bad software.

Whether they genuinely believe in antimonopolism, or think it is mere psyops, progressives have antimonopolism on the brain. Every economic problem appears to them to be a problem of monopoly. And every solution appears to them again to be a solution to a monopoly problem.

They do not see a statute that prohibits the charging of high prices as an opportunity to redistribute wealth in areas of economic life that antimonopoly policy cannot touch. Instead, they see it as an invitation to extend antimonopoly ideology into new areas.

In their minds, making such a connection actually broadens the statute, by tying it to what they are sure is the root cause of all economic injustice.

Except it isn’t. And they end up narrowing the statute instead.

So they take a statute that could be interpreted presumptively to ban all above-cost pricing attributable to supply chain disruption and use it instead presumptively to ban only above-cost pricing by big firms.

Price Gouging Is about Scarcity, Not Monopoly (and Yes, Those Are Two Different Things)

The pity of using a market concentration requirement to limit a great price gouging law is that price gouging really has zilch do to with monopoly.

Price gouging is, instead, about scarcity. Or one might say that monopoly is about artificial scarcity whereas price gouging is about the exploitation of natural scarcity.

We fear the monopolist because, in the absence of competition, the monopolist can restrict output and raise price without losing market share.

By contrast, we hate price gouging because it involves taking advantage of an involuntary restriction in supply.

When demand for food spikes before a hurricane, the public knows that supermarkets don’t have the inventory to meet demand. But the public also knows that the supermarkets originally expected to sell the inventory that they do have at normal prices. Those eggs were already on the shelves before the impending hurricane was announced. When the supermarkets raise prices, it is therefore obvious to the public that the surcharge is pure profit. That’s what makes the public mad and gives rise to price gouging laws. The manufacturing of a voluntary shortage plays no role here. No one thinks the supermarket is holding back eggs—or choosing not to order more.

Monopoly is famine while grain rots in silos. Price gouging is your neighbor demanding your house in exchange for a slice of bread—after lightning striking the silos.

That’s why price gouging statutes kick into gear only during an emergency—or, as in the case of New York’s law, during a period of “abnormal disruption” of markets. A monopolist’s decision voluntarily to restrict output and jack up prices is plenty evil, but one thing it isn’t is the sort of supply chain disruption that triggers a price gouging statute.

Confusing Scarcity with Monopoly

So what is a market concentration requirement doing in regulations implementing a price gouging statute?

The Attorney General relies on a passage in the price gouging law that identifies “an exercise of unfair leverage” as a factor in determining whether a firms has engaged in price gouging. But the phrase “unfair leverage” could just as easily refer to (natural) scarcity power as it could to monopoly power.

The Attorney General’s comments shed more light on her rationale. They explain that “firms in concentrated markets pose a special risk of price gouging because they can use their pricing power in conjunction with an abnormal market disruption to unfairly raise prices.”

This seems to articulate a category mistake. She has confused scarcity power with monopoly power.

The pricing power upon which price gouging is based is scarcity power. It is the power that arises because an act of god has eliminated part of the supply that would otherwise exist in the market. The pricing power enjoyed by “firms in concentrated markets” is not (natural) scarcity power. It’s monopoly power (artificial scarcity)—the power voluntarily to restrict supply.

A firm in a concentrated market can use its monopoly power whenever it wants, including during an “abnormal market disruption.” But whenever the firm chooses to use it, the firm isn’t using (natural) scarcity power to raise prices. It’s using monopoly power to raise prices.

If, thanks to the abnormal market disruption, the firm is able to raise prices higher than the firm otherwise might, then that extra increment is price gouging due to (natural) scarcity power. But any price increase that the firm would be able to bring about without the aid of the market disruption is due to an artificial restriction in supply and remains an exercise of monopoly power.

So it makes little sense to say that firms with monopoly power pose a “special risk” during periods of market disruption because they can use their monopoly power “in conjunction” with their scarcity power to raise prices. Firms with monopoly power pose the same risk that all firms pose during periods of disruption: the risk that they will use the additional power conferred on them by disruption-triggered scarcity further to raise prices.

If we worry that (natural) scarcity is going to tempt a monopolist to raise prices we should be equally worried that it will tempt a non-monopolist to raise prices: (natural) scarcity gives both firms the exact same kind of power—the power to exploit scarcity to raise prices.

Non-Monopoly Price Gougers Probably Do More Harm

Indeed, one would expect that the harm that a firm that lacks monopoly power can do by exploiting scarcity would generally be greater than the harm that a monopolist can do by exploiting (natural) scarcity because, before the disruption, the monopolist will already have artificially restricted output to try to raise prices to the most profitable extent.

If a monopolist has already artificially restricted supply to the most profitable extent, any additional involuntary restriction caused by the disruption may be unprofitable for the monopolist and the monopolist may, therefore, choose not to exploit it by raising prices further.

As some have long suggested, the first increase in price above costs is always the most harmful to consumers, precisely because when price equals cost, output is at a maximum and consumers reap the greatest benefit from production. They therefore have the most to lose. Subsequent price increases play out over progressively lower sales volumes, inflicting smaller and smaller amounts of harm.

But what kind of firms are induced by an abnormal market disruption to make a first increase in price above costs?

Answer: non-monopolists.

Firms in hypercompetitive markets start out with prices at or near costs before an abnormal market disruption gives them power to price gouge.

Monopolists facing abnormal disruptions have already raised their prices above costs long ago, when they first acquired their monopoly position. To the extent that they increase prices due to a market disruption, that will be far from the first increase in their prices above costs.

Disruptions Operate at the Level of Markets, Not Individual Firms, So Price Gouging Is Not Worse In Concentrated Markets

The Attorney General seems to think that because a monopolist has a large market share relative to a non-monopolist, any price increase by the monopolist will tend to cause more harm because it will apply to a higher volume of sales. She writes that large firms “have an outsized role in price setting.”

This is the sort of mistake that comes from thinking in terms of firms instead of markets.

A market disruption does not enable price gouging by striking a single firm. If a single firm’s output is restricted but no restriction is placed on the market as a whole, other firms in the market will bring more inventory to market to offset the loss of the firm’s output and no firm will have the opportunity to raise prices.

Instead, a market disruption enables price gouging by striking the entire market. If the output of the market as a whole is restricted, then restrictions on the output of some firms won’t be made up by increased sales by other firms. As a result—and this is key—all firms in the market, and not just the firms that have suffered a restriction in output, will be able to raise prices.

That’s because the higher prices are a rationing mechanism: they allocate the restricted market supply to the consumers who have the highest willingness to pay for it.

If any firm in the market doesn’t raise prices, consumers will all try to buy from that one firm. But because there isn’t enough supply in the market to satisfy them all, that one firm won’t have enough to satisfy them all either. The firm will sell the same volume as the firm would have sold at the higher prices. But the firm will earn less profit. So the firm will prefer to just charge the higher prices.

That’s why only market-level disruptions enable price gouging.

What this means is that a supply disruption that is concentrated in a large firm doesn’t affect more consumers than a supply disruption that hits smaller firms instead. Regardless where the disruption is felt, all prices, charged by all firms in the market, rise—so long, that is, as the disruption is a market-level event in the sense that other participants in the market are unable instantaneously to make up for the reduction in the firm’s supply.

And, as I pointed out above, in markets with large numbers of small, hypercompetitive firms, those price increases are likely to be more harmful precisely because prices are likely to start out lower than in concentrated markets.

One must, therefore, scratch one’s head at the Attorney General’s further observation that “the profit maximizing choice for a smaller competitor in an industry with [a larger] seller will often be to match the larger company’s price,” as if that establishes that price gouging is more severe in markets that have larger competitors.

When industry supply is restricted, the profit maximizing choice for a smaller competitor will be to raise price to match smaller competitors’ price increases, as well. All firms, regardless of size, will find it profit-maximizing to raise price in order to ration the industry’s limited output.

The point of a rule against price gouging is to prevent the market from using high prices to ration access to goods in short supply. The rule effectively requires the market to ration based on the principle of first-come-first-served instead.

Price gouging enforcers target only a small subset of firms in any given market for enforcement. But the goal of the a rule against price gouging is not, ultimately, to regulate the conduct of individual firms but rather to get the market price down to cost. Enforcement against individual firms is meant to have a deterrent effect on the pricing behavior of all firms in the market.

While targeting the biggest firms for enforcement might send a stronger warning to the market than targeting a smaller firm, prosecutors do not need a regulation making it easier to bring cases against big firms in order to pursue such a strategy. Indeed, such a regulation makes it harder for them to bring cases in markets in which there are no big firms.

Does Plenty Really Make Firms More Likely to Collude?

The Attorney General’s theory seems to be that market disruptions enhance monopoly power, enabling a monopoly to leverage scarcity to increase prices in response to a market disruption to a greater extent than could a non-monopolist.

The Attorney General seems to have in mind that market disruptions facilitate collusion. “[I]t may be easier for big actors to coordinate price hikes during an inflationary period, even without direct communication,” she writes.

One would, of course, expect that firms in concentrated markets that are prone to tacit collusion would be able to raise prices after a market disruption. The disruption by definition reduces the amount of output in the industry in the short term, as discussed above.

That allows the firms in the market to raise prices. But such price increases are due to the increased scarcity of output, not to the collusion.

In order for the collusion to be responsible for the price increase, output would have to fall further. The firms would need to engage in collusion that enables them voluntarily to restrict supply above and beyond both the involuntary restrictions created by the market disruption and any voluntary restrictions that the firms were capable of impose absent the disruption.

Presumably the argument is that the impetus to raise prices independently that is created by the supply disruption puts firms in the frame of mind required for them further to restrict supply and raise prices in tacit collusion with other firms.

That’s a pretty slim psychological reed upon which to hang a theory of harm. And one can easily imagine alternative psychologies.

Plenty tends to make us self-involved and egomaniacal. Hardship, if not too great, makes us generous and cooperative. It would seem to follow that the profit opportunities created by a market disruption should undermine cooperation between firms, rather than promote it.

I don’t know if this story is any more likely to be true than the one that the Attorney General seems to favor. The point is that psychological arguments of this sort do not provide a strong basis for carving out special treatment for large firms under a price gouging rule.

More Confusion of Scarcity with Monopoly

The only other argument the Attorney General makes for special treatment reprises the Attorney General’s confusion of scarcity and monopoly power.

The Attorney General argues that

the risk of firms taking advantage of an abnormal disruption may be greater where certain market characteristics reduce the likelihood of new entry—for example, where supply chains are disrupted or key inputs are scarce or where high concentration makes investment less attractive in a particular market. . . . Incumbents are insulated from the credible threat of new competition to discipline prices during abnormal market disruptions.

The Attorney General seems not to understand what a “disruption” is. It is, well, a disruption. Supply is destroyed. Or, equivalently, it is insufficient to meet a surging demand. By definition, there can be no entry. If there were entry by other firms into the market, then supply would not be insufficient anymore!

It follows that the extent to which before the disruption the market is already protected against entry due to the deterrent effect created by high concentration is irrelevant.

If such a deterrent existed before the disruption, and firms took advantage of it, then output would already have been artificially restricted in advance of the disruption. The disruption may destroy additional supply, and firms may raise prices in response, but that destruction won’t be due to market concentration but instead to the disruption.

To be sure, if the market were less concentrated and there were no concommitant entry deterrent, then prices in the market would be lower over the period of the disruption. And, moreover, the extent of the price increase created by the disruption might be different—either greater or lesser depending on the shape of the demand curve.

But that increase would still be attributable to scarcity and not to monopoly. And the ability of firms to enter the market to eliminate the scarcity would be controlled by the nature of the disruption and not any deterrent power wielded by incumbent firms.

The disruption destroys production that already existed notwithstanding the incumbents’ monopoly power. It follows that this output could not otherwise have been precluded through incumbent firms’ deterrent power—otherwise it would not have been there to be destroyed by the disruption.

Anyway, Small Amounts of Harm Are Small Amounts of Harm, Whether the Perpetrator Could Do More Harm or Not

But suppose the Attorney General were right that monopolists cause more harm through price gouging. Would it make sense to treat any price increase by a monopolist as presumptively unlawful but only increases by non-monopolists in excess of 10% as presumptively unlawful?

Of course not.

That’s like saying that it should be battery if a semi bends your fender but it should not be battery if a Prius bends your fender.

Harm is harm whether it’s inflicted by someone who could have done you a lot more harm or by someone who could only have done you a little more harm. A 5% increase in price above cost is a harm to consumers, whether that 5% markup is charged by a firm that could have, under some circumstances, charged you $100 more or only a dollar more.

A Lesson in the Perils of Antimonopolism

Antimonopoly framing may appeal to progressives because they are pushing back against two generations of market fetishism in economics. The framing lets progressives assert that markets aren’t free without having to go to the trouble of rejecting markets in the abstract.

That might feel like a powerful move.

First, it’s true: there’s a lot of monopolization in the economy.

Second, it means progressives don’t need to get into theoretical battles about the virtue of markets in the abstract.

But because antimonopolism sidesteps the theoretical problem of the market, it’s a compromise, not a power play. And a bad play at that.

In order to score points on means antimonopolists concede ends. To curry support for government intervention in business they concede that the end of intervention should be (truly) free markets.

But progressives have known for more than a century that the free market is the problem, not just in practice but in its abstract, idealized form. There’s no guarantee that really, truly, perfectly competitive markets will distribute wealth fairly. Instead, they arbitrarily distribute wealth to those who happen to own relatively productive resources or who happen to place a relatively high value on what they consume.

As David Ricardo pointed out, if you happen to own land having relatively good soil, you will earn a profit, because the price of agricultural produce needs to be high enough to cover the higher cost of tilling less fertile land. Your costs—including any reward needed to induce you to make your land more fertile—are lower, so you will generate revenues in excess of costs. That excess isn’t necessary to keep you in the market or to fertilize your soil. It’s a pure distribution of wealth based on the arbitrary fact that someone else in the market doesn’t have costs as low as your own.

Indeed, as Thomas Piketty has pointed out, the source of the explosion of inequality in recent decades has nothing to do with “market imperfection[s]” like monopolization. It has to do with markets.

There’s no way to divorce the gains progressives make on the means from the losses they suffer on the ends. If you succeed at convincing Americans that every market is monopolized, then Americans’ response is going to be: deconcentrate markets.

It’s not going to be to use every means available, including tax and transfer and price regulation, to redistribute wealth.

But, more importantly in the context of the New York price gouging law, the habit of proving market concentration in order to appease conservative priors regarding the benefits of markets can take on a life of its own.

It makes progressives forget that market concentration is far from the only source of inequality. And they end up casting aside or hamstringing policies aimed at those other sources.

That’s what may have happened here.

Antitrust Monopolization Regulation Tax

Wealth and Happiness

Post author By Ramsi Woodcock
Post date January 14, 2023

In a new paper, Glick, Lozada, and Bush have done both antimonopolism and the antitrust academy a service by making the first real attempt to put the movement in direct conversation with contemporary antitrust method.

GLB have a simple message: welfare economics long ago stopped using willingness to pay to measure consumer welfare, and antitrust should too.

What is more, welfare economics today pursues an eclectic set of approaches to measuring welfare. Some of them suggest that the dispersal of economic power and the availability of small businesses can make people happy.

It follows, argue GLB, that it is entirely consistent with contemporary welfare economics to take these things into account in evaluating mergers or prosecuting monopolies.

The Social Welfare Function

GLB start with the problem that welfare economists faced at the beginning of the 20th century: how to compare the value that different people—say a producer and a consumer—obtain from a transaction in the absence of some universal measure of value.

If the producer gets a profit of $2 and the consumer pays $5 for a bag of apples, did the transaction confer the same amount of value on the two? Are $2 worth the same to the producer as a-bag-of-apples-for-$5 is worth to the consumer?

If there were some universal measure of happiness—denominated in, say, “utils”—then we could answer that question.

We would look up the consumer’s change in pleasure associated with swapping $5 for apples and compare it to the producer’s change in pleasure associated with making a $2 profit. If the former were 50 utils and the latter 30 utils, then we could say that the transaction did not confer the same benefit on both parties.

Pareto

Economists eventually decided that they would not be able to find a universal metric of happiness. But they hoped that they might be able to glean some information about happiness from the behavior of economic actors.

The first approach that they hit upon was the pareto criterion. It said: the only bad transactions are those into which the parties do not enter voluntarily, because those must make at least one party worse off (the party who would not voluntarily enter into the transaction).

Any transaction the parties do enter into voluntarily is, in contrast, good, because they wouldn’t be willing to enter into it unless the transaction made neither worse off.

It followed that voluntary transactions could be treated as welfare improving—or at least not welfare reducing. The parties were signalling, through their willingness to enter into them, that the transactions were at least not undesirable.

If the producer and consumer voluntarily transact in apples at $5, then welfare could be said not to have been reduced and indeed potentially to have increased. That was the pareto criterion.

It helped welfare economics a bit. But it also failed to answer an important question: what about people who are affected by a transaction but who are not entering into it themselves?

If, for example, two producers merge, and, as a result of the merger, they are able to charge a higher price, consumers are affected. But consumers have no choice over whether the merger takes place.

The pareto criterion tells us that the merger does not make the merging parties worse off. But it tells us nothing about whether the merger makes consumers worse off.

Some way of comparing the costs of the transaction to consumers with the benefits to the merging producers is needed, but the pareto criterion cannot provide it.

Willingness to Pay and Potential Pareto

The solution proposed by some economists in the early 20th century was to use willingness to pay as a measure of happiness.

The idea was that if a consumer would be willing to pay $10 for an apple, then that would be a measure of the pleasure the consumer would get from consuming the apple. By noting that a person should be willing to pay cash for cash on a dollar-for-dollar basis, one could proceed to do with dollars what economists had originally hoped to do with utils.

To return to our example of an apple purchased for $5, if the consumer were in fact willing to pay $10 for the apple, then the value to the consumer of the transaction would be the $10 the consumer would be willing to pay less the $5 price that the consumer actually paid for it.

And the value of the transaction to the producer would be the producer’s $2 profit. It would then follow that the consumer did better than the producer in the transaction because the consumer generated a “surplus” of $5 whereas the producer generated a profit (“producer’s surplus”) of only $2.

This willingness-to-pay approach made it possible to evaluate a merger of producers.

If producers were to merge and drive the price up to $7, then the producers (who, if their costs are as before, would now make a $4 profit) would end up better off than the consumers (who would now enjoy a surplus of $10 less $7, or $3). The merger would reduce the welfare of the consumer by $3.

If antitrust were to adhere to a consumer welfare standard—the rule that mergers that reduce consumer surplus are to be rejected—then this merger would fail the test and be rejected.

As GLB note, the willingness to pay concept made it possible to consider tradeoffs as well.

The merger might, for example, also reduce the costs of production of the merged firms from $3 to $0.50, thereby increasing the merging firms’ profits on the transaction from $4 to $6.50.

If one were to view the goal of the antitrust laws as the maximization of total welfare—meaning the maximization of the combined surplus of producers and consumers, however that surplus may be distributed between them—this cost reduction would justify the merger. It would expand the sum of producer and consumer surplus from $7 ($2 for the producers and $5 for the consumer) to $9.50 ($6.50 for the producers and $3 for the consumer).

Moreover, the merger might even be said to satisfy the consumer welfare standard if one were to adhere to the peculiar sophistry that any increase in total welfare should count as an increase in consumer welfare because the increase in total welfare could be redistributed to consumers.

Because the merged producers could be forced to pay the $2.50 increase in total welfare to the consumer, leaving the consumer with $5.50, which is more than the $5 he would have without the merger, the deal could, according to this peculiar sophistry, be classified as consumer welfare enhancing.

At least in potential. And if such a transfer were made, then the consumer and the producers alike would welcome the deal (the producers would be left with $4, which is more than the $3 in profit earned without the deal). Hence GLB refer to this as the “potential pareto criterion”. It is also called the Kaldor-Hicks efficiency criterion.

Wealth Effects

Economists should have, and, indeed, did, realize from the start that willingness to pay was a doomed approach because a person’s willingness to pay changes with his budget.

Between People

Two people who would be willing to pay the same amount for an apple if they had the same wealth would likely be willing to pay vastly different amounts if one were poor and the other rich. The rich person might be willing to pay much more for the apple than would a cash-strapped poor person.

One can avoid this problem by supposing that the poor man is willing to pay less for an apple because he in fact would derive less pleasure from it. He might have to deny his child meat in order to be able to afford the apple, and that might ruin his meal.

But viewing actual pleasure as perfectly consonant with willingness to pay amounts to shoehorning subjective feelings into budget constraints.

It is just as likely that the poor man who did make such a substitution would feel a great deal of guilty pleasure. His rational faculties might enable him to forego that pleasure and give his child meat. But that does not mean that his pleasure centers would not be the worse for it. They would be.

If wealth effects matter, however, then one cannot compare producer and consumer surpluses—or indeed the surpluses generated by any two people.

One cannot say, for example, that a merger that decreases cost by $2.50 is on net a good thing if it results in a price increase of only $2 because $2.50 is more than $2, so the total amount of pleasure generated by the economy has gone up. For if the producers are rich but the consumer poor, then the $2 cost to the consumer might inflict more pain on him than the $2.50 increase in profits for the producers.

Redistribution of those $2.50 in benefits to the consumer is now required for efficiency and not just to achieve distributive justice. If efficiency is about increasing the total amount of happiness generated by the economy, and those $2.50 make the consumer happier than the producers, then efficiency requires that the $2.50 go to the consumer.

If the only implication of wealth effects were that redistribution from rich to poor is required for efficiency, then wealth effects would not be particularly problematic for progressives.

But very often a policy change not only creates a benefit and raises a price, as in our merger example, but also inflicts an economic cost in the sense of precluding some production—or aspect thereof—that consumers value.

The merger might, for example, not only reduce apple production costs by $2.50 but also lead to slightly less tasty apples. Perhaps the merger saves on costs by enabling the sale of an orchard that produced particularly tasty apples but was also relatively costly to maintain.

If the consumer’s maximum willingness to pay falls by $2 because the apple is less tasty, then the willingness to pay measure suggests that the merger should go ahead. The benefits in terms of a reduction in costs of $2.50 exceed the costs in terms of a reduction in the value of the apple to consumers of $2. There is a net gain of $0.50.

To be sure, if the price again rises to $7 as a result of the merger, consumers find themselves even worse off than before. Their surplus falls to $1 (a maximum willingness to pay of $8 less a price of $7).

But the merging producers can, at least in theory, make up for this by transferring $2 to the consumer to offset the price increase and by transferring at least $2 of the cost reduction they enjoy as well, ensuring that the consumer ends up with at least the $5.00 in surplus the consumer would have enjoyed without the deal.

And the producers, who initially enjoyed an increase in profits of $5.50 ($2.50 in cost reductions plus $2.00 from the increase in price) end up better off so long as they do not pay more than $5.50 to the consumer.

So all parties can, in theory, end up better off.

That’s because the benefits created by the merger exceed the costs by $0.50. Once one uses transfers to correct for the resulting price increase and to compensate the consumer for his loss, which is smaller than the producers’ gains, there is necessarily some net gain left over that producers and consumer can divide up, leaving them all better off.

The potential pareto criterion is satisfied and, if the transfers are actually made, so is the consumer welfare standard.

If wealth effects matter, however, then one cannot reliably compare the $2.50 benefit in terms of production cost savings to the $2 loss associated with the reduced tastiness of the apple. If the consumer is poor, then the consumer may place a dollar value on the reduction in tastiness of the apple that is far below the actual loss of pleasure the consumer would suffer in consuming a less tasty apple.

If there were utils and we could compare the value of the production cost savings to the producers to the reduction in the consumer’s happiness associated with the less tasty apple, we might find that the producers’ gain is 100 utils and the consumer’s loss is 1000 utils, resulting in a net reduction in happiness due to the merger.

Wealth effects prevent the consumer from registering his dissatisfaction in terms of willingness to pay, however, and so the merger appears to offer a net gain when in fact it does not.

It follows that the producers will never be able fully to compensate the consumer for the loss without incurring a loss themselves, and so according to the potential pareto criterion the merger should be blocked.

If we nevertheless treat willingness to pay as a measure of welfare, however, the deal will appear to be welfare increasing and the deal will go through, reducing overall happiness.

Wealth effects cause willingness to pay to lead to bad policymaking.

Within People

Wealth effects also undermine the commensurability of values with respect to the same person.

To see why, let’s go back to the example in which the merger raises prices but doesn’t reduce the tastiness of apples.

If unwinding the merger would reduce the price of an apple from $7 to $5, it is clear that the consumer becomes $2 richer. He saves $2, which he can now spend on other things.

In order for willingness to pay to be a useful proxy for welfare, one would, then, like to be able to say that the consumer is made just as well off by the price reduction as he would have been had he been given $2 in cash in lieu of the price increase.

But if willingness to pay depends on wealth, we cannot say that a $2 cash payment would leave the consumer in the same position as the consumer would be had price fallen by $2.

If a consumer cares more for apples the richer that he is, then the consumer will prefer a $2 cut in the price of apples to a $2 cash payment. Given his stronger preference for apples, the consumer might want to plow the $2 savings on apples into buying more apples, and that money would buy more apples at the lower apple price than would a $2 cash payment used to purchase more apples at the higher price.

It follows that the consumer would require a cash payment in excess of $2 in order to be made as happy as he would be if the price of apples were reduced by $2.

Similarly, we might ask whether taxing away $2 from the consumer when prices are low would leave the consumer just as happy as the consumer would be were he to experience a $2 price increase.

Again the answer would be “no.”

When the price of apples increases, it is clear that the consumer becomes poorer; his wealth buys him less. If the consumer’s taste for apples decreases with poverty, however, then the consumer will prefer a $2 increase in the price of apples to having $2 of cash taxed away from him.

Because he prefers other things to apples as he becomes poorer, the consumer will place a higher value on cash, which he can use to buy things other than apples, than he places on the price of apples.

But if a tax of $2 makes him less happy than he would be under an increase in the price of apples of $2, then a tax of less than $2 is equivalent, from his perspective, to an increase in the price of apples of $2.

So, overall, we have the peculiar result that a $2 price reduction is equivalent to a cash payment of more than $2 but a $2 price increase is equivalent to a cash reduction of less than $2.

Commensurability would, of course, require that all these things be equal.

And so we see that wealth effects not only prevent us from saying that a $2 gain to the producers creates the same amount of pleasure as a $2 gain to a consumer, but also that a $2 gain to the consumer via a price reduction creates the same amount of pleasure as a $2 cash payment. And the same can be said of losses.

GLB don’t acknowledge that between- and within-person incommensurability both stem from the same problem of wealth effects. But they do a good job of discussing both.

They also spend considerable time refuting the arguments of mainstream economists that within-person incommensurability is small and can be ignored.

But even if it were small, and indeed, even if wealth effects were not a problem for commensurability between persons either, willingness to pay would remain a highly problematic measure of value.

There is no basis for supposing that, just because two people having the same wealth level are willing to pay the same amount for a particular good, they will get the same level of pleasure from it.

Indeed, it is possible that two people who place the same relative values on all goods, and so are willing to pay the exact same amount for each good, might experience very different levels of pleasure from consuming them.

One person might take almost no pleasure from any good. Another might be sent into fits of ecstasy by the smallest purchase.

So long as the relative pleasure conferred by each good vis a vis the other goods is the same for both people, each will be willing to pay the same amount for each good. They will divide their budgets between goods in exactly the same way despite deriving very different levels of pleasure from them.

The Return to the Social Welfare Function

As GLB relate, welfare economists responded to these limitations by giving up on what might be called the overall “revealed value” approach to measuring welfare embodied in the pareto criterion and potential pareto (i.e., willingness-to-pay-based) criterion.

These criteria took a common revealed value approach because they both tried to read value from the actions of economic agents.

Whether a transaction satisfied the pareto criterion could be determined by checking to see whether the parties entered into it voluntarily. If they did, then it followed that neither party was made worse off.

And if a consumer purchased an apple at $10 but not at $11, one could infer that the maximum the consumer was willing to pay for apples was $10 and use that number to determine by how much the consumer could be compensated, pursuant to the potential pareto criterion, for the loss of an apple.

Under both approaches, economic agents were assumed to reveal the pleasure they take in goods via their actions, enabling economists to identify changes in welfare associated with various policies without needing direct access to the pleasure centers in consumers’ brains in order to make those determinations.

With the demise of willingness to pay, welfare economists would no longer try to find a way to read the pleasure and pain of consumers through their economic behavior.

Instead, they would return to the direct approach that they had abandoned more than fifty years before; they would try to measure happiness directly.

They took a variety of approaches to this problem. They would ask people if they are happy or not in various situations; they would study health indicators such as longevity, freedom from disease, and so on, in various situations; they would consult psychologists and neurologists.

Based on the results of these inquiries, they would identify the material circumstances most likely to be conducive to happiness and recommend economic policies (such as antitrust cases) that produce those circumstances.

Medical inquiry might determine, for example, that spinach is good for consumers. Welfare economists would then respond by ranking policy choices that lead to more spinach consumption higher than those that lead to less.

This was a departure from the willingness to pay approach, according to which welfare economists would have given spinach consumption the ranking implied by the dollar value that consumers revealed themselves to be willing to pay for spinach relative to what they would pay for other things.

Now other branches of science, and not revealed preference, determined the ranking.

This takes us up to the present state of welfare economics.

And for GLB, this completes the argument for taking political power and small businesses into account in doing antitrust.

According to GLB, one can no longer argue that, because consumers are manifestly willing to pay high prices charged by dominant firms, consumers like big firms and like the influence they have over politics.

Consumers’ willingness to pay is no reliable measure of the pleasure they get from buying the products of politically influential, small-business-destroying monopolists.

Instead, as already mentioned, GLB point to studies that suggest that consumers are happier in democratic environments free of concentrations of economic power. And that consumers are happier when they have access to small businesses.

It follows, argue GLB, that it is perfectly reasonable, per current practice in welfare economics, to argue that mergers that increase consumer surplus in the willingness-to-pay sense nevertheless make consumers unhappy, and should therefore be targeted for antitrust enforcement.

The Willingness to Pay Measure Is about Choice, Not Happiness

GLB’s paper presents a powerful rejoinder to any antitruster who might have been under the misapprehension that willingness to pay is a good measure of happiness. There are surely some out there.

But I suspect that the paper will not win too many converts, because what attracts people to willingness to pay is not that it is a good measure of happiness, but instead that it is the best way of doing justice to consumer choice that we have.

Welfare economics embodies a tension felt throughout the modern human rights project regarding who decides what happiness means.

Do we study human beings as if they were complex robots, figure out what makes these machines happiest, and impose those conditions on them? Or do we let the machines decide what makes them happiest?

GLB tell the story of welfare economics as if the field has always been interested only in the first option: to figure out what makes people happy and then impose those conditions upon their economic lives.

Under this assumption, GLB’s conclusion follows immediately from the arc of welfare economics. Willingness to pay is not a good measure. Others must be found.

But, as GLB acknowledge, economists have known almost from the inception of the willingness to pay approach in the 1940s that it was unsound. Why hasn’t the field moved on?

GLB chalk it up to “zombie economics.”

The real reason is that many people want to preserve a space in which consumers can vote for what they want through their purchase decisions.

That is, these people don’t view economics as a descriptive science but rather as a democratic project. It is the project of empowering consumers to vote on the character and magnitude of production through their purchase decisions.

The willingness to pay measure is ultimately built upon such a foundation, because willingness to pay is measured by observing the prices at which consumers do and do not buy.

The measure is highly imperfect, even incoherent, but it is the only way economics knows to recommend policy changes that account for the votes consumers have cast in markets. It honors their choices.

Happiness surveys, public health information, and the like are based on consumer input, but they are not based on purchase decisions—they are not based on circumstances in which consumers are forced to put their money where their mouths are.

Of course, the question whether consumers should take direction from experts regarding what to buy, or make those choices themselves, has already been resolved in favor of consumer choice.

Neither GLB nor anyone else will be able to impose purchases on consumers unless consumers vote to elect political leaders who take the GLB approach.

If antitrust enforcers decide to follow GLB’s paper, but consumers don’t like it, consumers can always vote political leaders into office who will sack those enforcers or give them new legislative commands to follow.

The premise of the economic project of enabling consumers to vote through their purchase decisions is, however, that the electoral process is defective.

The assumption is that, at least with respect to industrial production, consumers are better able to choose by voting through purchase decisions than by voting for elected representatives to direct production.

That is the subject of public choice theory. It is the view that, at least with respect to some matters, markets are more democratic than democracy.

People who hold this view won’t be swayed by GLB. In their view, markets are most likely to maximize happiness if they are structured to read it in consumers’ purchase decisions, not if they are structured by consumers’ elected representatives to achieve happiness according to any other measure.

Ultimately, the battle in antitrust over the consumer welfare standard, is, like all battles over regulation, a battle over the legitimacy of the electoral process.

And yet progressives have spent remarkably little time contesting the public choice view of the electoral process and government regulation as inherently vulnerable to capture.

I suspect that is in part because many progressives share the public choice intuition.

Indeed, distrust of government seems to be one of the major reasons for which some progressives have focused in recent years on strengthening antitrust instead of pursuing the projects that earlier generations of progressives thought were more likely to be effective, such as price regulation and taxation.

Even an antitrust that imposes an external standard of happiness on markets instead of trying to read a standard from consumer purchase decisions pays a certain amount of respect to those purchase decisions. It is oriented toward preserving markets and empowering consumer choice within them.

In contrast, taxation and price regulation are relatively indifferent to those goals. They represent a pure privileging of choice via the electoral process over choice via markets.

And to many people from both left and right operating in an essentially anti-statist culture, that’s scary.

The irony, then, may be that the worldview required to overturn the consumer welfare standard in antitrust is undermined by progressives’ own attraction to antitrust as a vehicle for progressive change.

Regulation

Second Thoughts about Government as the Origin of Property

Post author By Ramsi Woodcock
Post date September 8, 2022

It has been a common progressive move for more than a century to argue that property rights are not sacrosanct because the government creates them. Government creates them and government can take them away. I heard this in seminars in law school. And I recall Elizabeth Warren making this argument on the campaign trail in 2020. And Morris Cohen said it in 1927.

But I do not understand why this argument has so much appeal to progressives, because it does nothing more than assert a contrary position to that taken by libertarians. It does not prove anything in favor of government intervention.

The question, after all, is how the government should use its power. Should the government use it to protect and expand property rights? Or should the government use it to dissolve and restrict property rights?

The libertarian asserts that the government should protect property rights because these are in some sense prior or fundamental.

And the progressive, in arguing that the government giveth and so can taketh away, asserts no more than that government action—regulation—is in some sense prior or fundamental.

There is no more substance than that to the government-giveth argument.

It resolves nothing, just as libertarians’ assertion that property rights are prior and fundamental resolves nothing. It merely asserts the opposite of what the libertarians assert.

The fact that government is needed to enforce property rights does not in itself imply that government need not enforce them. It does not imply that property rights are not in some sense prior or fundamental. It may well be that property rights guaranteed by government are prior and fundamental in relation to all things. And that government elimination of property rights is posterior. I do not personally believe this to be so, but I do not see why the fact that government is needed to guarantee property rights implies that property rights need not be fully and absolutely guaranteed.

And that is before we even get to social contractarian arguments that claim that government is no more than a mutual defense pact between prior possessors of things that come to be called property under the terms of the social contract.

Moreover, as a historical matter, it is not clear to me which side has the better of the argument. On the one hand, government enforcement does reduce outside interference with one’s possessions, and one cannot speak of property in the legal sense without assuming the existence of a legal authority committed at least in principle to recording and enforcing such rights.

On the other hand, it is the case that people living in places that have no central government possess things and enjoy them quietly for long periods of time, so long as they are individually powerful enough or in sufficient harmony with their neighbors to protect their possession of the things.

The only thing that progressives’ assertion that the government giveth really does is to demonstrate to progressives that there is an alternative to the view that property is fundamental—namely, that government regulation is fundamental.

But it does not answer the question how much to protect property and it does not even establish that the libertarian view is necessarily wrong.

Regulation

Democracy as the Heart of Debates about Regulation

Post author By Ramsi Woodcock
Post date August 2, 2022

There is a tendency among free marketers to say: “if markets are bringing it about, it is necessary.” And the big insight on the left for at least the past fifty years has been to say: “ah, but the market is shaped by the law, so if we pass a law preventing it from happening, then markets won’t bring it about after all.”

So, in the context of the influx of American digital nomads to Mexico City, and the opposition to gentrification they have aroused, the free marketer says: “locals are getting rich selling to the Americans, and the Americans clearly believe they are getting something of value, so this is natural; it’s going to happen; if you try to stop it you might as well try to use your pinky to dam the Nile.” And the left winger replies: “the only reason the Americans can move here is that Mexico permits them to stay for six months without a visa. Change the rule, and this goes away. Mexico has a choice.”

The free marketer seems to espouse market naturalism: society is self-organizing and policymakers have little choice regarding outcomes. The most they can do is create a temporary disequilibrium—a dam that will break. By his reply, the left winger restores the policymaker’s freedom to decide social outcomes.

Both the free marketer and the left winger miss the point.

The proper argument for free markets is not that market outcomes are natural. The left winger has the better of the debate on that score: the state does in fact come first, then the market. That is why free marketers fear Communism. Because the state really can shut down the market—and, by extension, use a lighter touch to shape the social outcomes to which the market leads.

A proper free market argument accepts that policymakers can channel or override market outcomes but the argument holds that policymakers shouldn’t do that, because the people speak clearest through markets. That is, the only really coherent argument for free markets is that markets are more democratic than the electoral process. When people buy and sell, they vote, and the free market position is that un- or lightly-regulated markets process those votes in a way that is more faithful to the preferences of the voters than are the institutions of representative democracy that process the votes that people cast in electing the policymakers who would otherwise regulate market outcomes.

So, the argument would go, while activists might not like the fact that Americans are moving to Mexico City, the fact that Mexicans themselves are willing to rent them places to live and sell them tacos is the clearest possible indicator that Mexicans want the Americans to come.

The left winger’s response that the state comes first is not a good rejoinder to this proper form of the free market argument. For the free marketer can argue that the state ought to embrace the system that most faithfully reflects the will of the people, and that markets, in his view, are that system. The only way for the left winger to strike back is to argue that the electoral process, through which people can choose to alter market outcomes, does an even better job of reflecting the will of the people.

That might be true—and I tend to think that it is. But unlike the question whether the law is prior to the market and can influence market outcomes, the answer is easier to contest, as several generations of public choice theorists have done.

In the market, one’s ability to speak is mediated by wealth—more money and more ownership means more votes. But even were it possible to keep money out of politics—and if not, then elections are mediated by money, too—elections would still be prone to distortion by small, highly-organized interest groups. Many voters don’t show up to the polls, and their representatives don’t always do what they want even when they do.

Indeed, it is difficult even to compare outcomes under these approaches because they represent, in effect, different social welfare functions. Are the sale decisions of landlords and street food vendors a more accurate expression of the abstraction that is the “will of the people” than the decisions of representatives elected by the subset of the population that showed up to vote in the last election?

The debate over regulation of markets is really a debate over norms—and specifically democratic legitimacy—not market naturalism.

It won’t be resolved until both sides start acting that way.

Meta Regulation

The Other Conflict of Interest and the Root of Inequality

Post author By Ramsi Woodcock
Post date May 19, 2022

It is common in the study of corporate governance to worry about the conflict of interest between shareholders and managers. Managers are supposed to run the firm to maximize shareholder value, but because they run the firm on a day-to-day basis, not the shareholders, they have plenty of opportunity to enrich themselves are shareholder expense. Others worry that the power of shareholders and managers over firm governance enables them to cheat creditors, workers, and sometimes even suppliers.

But there is another interest that no one ever talks about, and which is even less able to defend itself than are shareholders against managers, or creditors, workers, or suppliers against shareholders and managers.

That is the firm itself.

The firm is not its shareholders. It is not its managers. It is not its workers, creditors, or suppliers.

It is a fiction in the sense that a firm always is a fiction, a thing that exists only because shareholders, managers, workers, creditors, suppliers, and the government act like it exists. It has no flesh and no blood. It cannot be found anywhere; or, rather, it is located wherever the law says that it is located rather than where the laws of physics place it.

But it has a name: the name of the business.

It can open bank accounts.

It can own property.

It can sue.

It even has a right not to be deprived of life, liberty, or property without due process of law.

The firm exists in the way that the mime’s wall exists. There is nothing there, but his hand stops as if it were there.

Just so, the corporation exists because we speak as if it exists. Because we find all of our legal institutions bending around its form as if there were something there to bend them.

And yet, despite all the care that we take to act as if there really were an independent, living, breathing thing that is the firm, when it comes time to count up conflicts of interest, we never talk about the conflict between the interests of shareholders, managers, workers, creditors, and suppliers—and the firm itself.

We recognize that there must be such a conflict, and we even have an entire body of law—agency law—devoted to protecting the firm itself against managers and employees who put their interests before the firm’s. We say that managers and employees have duties of loyalty and care to the firm.

And yet we seem hardly able to take such duties seriously, or, at any rate, fully to appreciate that they are owed to the firm—to the mystery, to the fiction, to the hollowness beneath the mime’s hand.

We say that the board of directors owes a duty to the firm, but we think that the duty is really owed to the firm’s shareholders, or to its workers, or to whatever set of actual, living, breathing persons are ultimately harmed by the cupidity of the firm’s agents.

We comply with the fiction that managers and employees owe their duties to the firm by describing the shareholders who sue careless or disloyal managers as filing a “derivative” lawsuit on behalf of the firm. The shareholders have no direct claim against the wrongdoers, we say, because the wrong was done to the firm and not directly to the shareholders.

And we comply further by asking that any recovery be paid first to the firm as compensation for harm to the firm and only thence to shareholders.

But we experience this part of the fiction of the corporate person as unnecessary. Nothing would be lost were shareholders to be permitted to sue managers directly.

We are wrong to do that.

If we were actually to take conflicts with the firm seriously, we would come to a very troubling thought indeed: that the mute, defenseless fiction that is the firm is surely the worst victim of self-interested behavior of all.

Conflicts run deepest not between shareholders and managers, or even between managers and workers, but between all of these groups and the firm, because of all of these groups only the firm lacks a physical presence and hence even the slightest semblance of autonomy. The firm exists entirely in the unseen world behind the world, and speaks only through the very groups—the shareholders, managers, workers, and so on—from which the firm needs protection.

And the firm does need protection because the firm’s interests are necessarily always in conflict with those of shareholders, managers, workers, and all the other counterparties of the firm.

Because the firm never dies. It alone is in business for the long term and the long term interest is almost always in conflict with the short term interests of mere mortals.

Imagine that a firm generates a billion dollars in net income and that maximizing the long-term—as in over the course of the next two centuries—profits of the firm can be achieved only by investing that billion in clean energy technology.

It is easy to imagine that no flesh and blood humans associated with the firm might be interested in actually investing the money. The shareholders might want it paid out as dividends (they want to party). The managers might want it paid out in executive compensation (they want to party). The workers might want it paid out in retirement benefits (they want to party). The creditors want their debts paid. The suppliers want higher contract prices.

The the profit-maximizing firm—yes, the firm, that metaphysical life force, that abstract interest—would want the money invested and, if all the assumptions of general equilibrium theory hold, the fact that the profit-maximizing firm would want the money invested implies that investing it is necessary for the efficient operation of the economy. It is required to maximize economic growth and otherwise to launch society forward to the greatest extent possible.

But the firm with not invest the money. Because the flesh and blood humans who control what the firm does, who are agents to the firm’s fiction, mimes to its hollowness, don’t want that to happen. The door might want to be opened, but the mime will shut it.

The money will be spent instead on shareholders, managers, workers, creditors or suppliers, and both the firm and the economy will be smaller for it in the long run.

What’s more—and this is important—legal duties will have been breached by this failure to invest. Management will have violated the duty of care, which requires managers to operate the firm with a view to maximizing the firm’s long-term profits.[1]

But no one will sue.

Shareholders will not bring a derivative suit on behalf of the corporation—they wanted to be paid.

Competition will not force the firm’s agents to behave—lest competitors take the firm’s market share and put the agents out of their jobs—because the consequences of a failure to invest for the long term manifest in the long term.

One can only imagine how much bigger the economy would be, and how much more successful the firms in it, if the conflict of interest between the firm itself and its agents were not to exist. Or if there were some way of protecting firms against it.

Imagine all the investments that have not been made throughout history because those in control of firms preferred consumption to saving.

One gets the barest hint of how bad the problem must be in the hysterical objection of business elites to mid-20th-century price regulation in industries such as telecommunications, air transport, and energy distribution. Or the hysterical objection of business elites today to attempts to limit the scope of patent grants in order to prevent windfall gains from intellectual property.

The government, businessmen argue, systematically sets prices—or, in the intellectual property context, rewards—too low, because it fails to take into account all of the investment that must be made in the future of a business.

Firms must invest in research and development.

They must insure against risk.

And so, businessmen argue, what looks like profit really is not profit, but rather a cost of long-term survival and flourishing of the firm.

Ah, but if that is the case, if we cannot trust rate regulators adequately to determine how much must be spent for a firm to flourish, why should we be able to trust shareholders or managers to do that either?

It is not, after all, in their interest to carry out that analysis faithfully, for they can never have an outlook quite as long as the firm’s.

If we think that rate regulation was bad for American business in the mid-20th century, or that stinginess with the patent grant is a big problem for the dynamism of the American economy, we must—must, must—wonder just how bad the totally unaccountable dominance of flesh and blood over fiction, of the agents over their dumb master, must be for American business.

How much less is invested than optimally should be?

This, it seems to me, explains much—not just about a structural inefficiency in the economy but also about the structural maldistribution of wealth.

Why is it that the captains of industry are so rich? Is it just that they control scarce resources? Or that they have some monopoly power? Those are, to be sure, causes.

But I wonder whether the most important is not, quite simply, that they underinvest—and keep the difference for themselves.

When I was in high school, I ran an assassin game with a classmate. I ordered some very cheap waterguns direct from China. We asked every student to pay $30 to participate in the game. We gave each student a cheap water gun and the winner $200 as reward.

There were perhaps thirty participants, which made the game very profitable.

I was so embarrassed about this windfall that I let my surprised coventurer keep all of the profits, which he used to take a trip to Europe.

I was afraid to profit and he rejoiced in it. But the point is that both of us thought of the windfall as profit.

But was it? Neither he nor I thought for minute about the interests of the business.

Perhaps the best thing for our assassin business would have been for us to invest that money in the following year’s game. We could have increased the reward, attracting more participants. We could have ordered better guns. We could have organized a joint game with another school. Whatever.

But while these were the interests of the business, they were not our interests. The business was mute; and so we ignored it.

One sees this also, I think, in how homeowners treat their houses. It is very often the case that a person will buy a house that he would not be willing to rent because the rent would be too high.

Perhaps the house is very large, or there is a shortage of rental units in the area. Whatever the case, when a person owns and lives in a house that he would not be willing to pay to rent, he is putting his own interests as a customer and indeed shareholder (i.e., owner) of the space-selling business that is his home before the interests of the business itself.

His home could generate greater profits by being rented out and indeed those profits could be invested to improve the home or expand the business to include other properties, making the business and the economy better off.

But none of this happens because the flesh and blood person who controls the business would rather forego (read: consume) the profits that could otherwise be generated by renting to others—and which would lead to long-run profits—in order to enjoy the pleasure of living in a big house, or in the right neighborhood, or what have you, right now.

Once you understand the problem, you see it everywhere.

The owner of my car repair shop was kind enough to give me a lift in his personal, very expensive vehicle while I was getting my oil changed. What portion of the purchase price of that car should he have reinvested in his business? We will never know.

Indeed, one wonders what proportion of all the executive compensation, all the share buybacks, and all the dividends paid out to owners over the past few decades—payouts that turned an L-shaped postwar inequality curve into the U-shape of Piketty fame—should optimally have been reinvested in the firms themselves.

That is, one wonders whether, if the fiction that is the firm were real and could defend itself, captains of industry would be no richer than the rest of us, and the economy a whole lot larger.

One might think that the solution is for the state to step in to protect business fictions against their flesh and blood agents.

And perhaps that is right. We need regulation not just to protect consumers against grasping firms, or shareholders against grasping managers, but to protect firms—those helpless fictions—and indeed the economy entire, against all of the grasping human agents that constitute the sum total of a firm’s human capital.

But it might just as easily be right to say that unregulated firms produce more even after taking into account how much less they produce than they might thanks to the cupidity of their agents and the helplessness of the firm.

Regardless, we must see firms as almost always victims of their human controllers. And the wealth of those controllers as almost always funded in part not just by rents—revenues in excess of costs—but by theft in the form of underinvestment in their businesses.

It might well be that, in an optimally efficient world, every businessman would eat one meal a day and darn his own socks, for that is the real minimum that a businessman would accept in exchange for doing business.

And the profits that remain are best reinvested by firms in their own futures.

Notes

[1] Yes, the duty of care is subject to the business judgment rule, which means that courts defer to the judgment of managers regarding what actions will maximize profits, and so, in practice, even were shareholders to sue, it would be very difficult for them to win such a case. But the business judgment rule is meant only to give managers the benefit of the doubt. It does not make legal actions that are known in advance to fail to maximize profits. Indeed, in a world in which there were never any doubt regarding what course of action would maximize profits, the business judgment rule would count for nothing and a manager’s failure to take the known profit-maximizing course of action would give rise to immediate liability.

Antitrust Inframarginalism Monopolization Regulation

Competition Trumps Information

Post author By Ramsi Woodcock
Post date November 18, 2021

Scholarly interest in personalized pricing is growing, and with it confusion about what, exactly, empowers a firm to personalize prices to its customers. You might think that the key is information. So long as you know enough about your customers, you can tailor prices to each. That is, however, incorrect.

No matter how much you happen to know about your customers—indeed, even were you to have a god’s total information awareness regarding each of them—you would not be able to charge personalized prices if you were to operate in a perfectly competitive market. Competition trumps information.

That is because in a perfectly competitive market there are always other sellers available who are willing to charge a price just sufficient to make the marginal buyer in the market willing to stay in the market and make a purchase. If there weren’t, then there would be a chance that the marginal buyer would not be able to find a price that he is willing to pay, and so would not buy, and then the market would no longer be perfectly competitive. For the perfectly competitive market is one in which competition leads to a price at which the marginal buyer and seller are willing to transact.

And so any attempt you may make to personalize a higher price to your inframarginal customers—the ones who are in principle willing to pay a higher price than the marginal buyer—will be met with scorn. Your customers will find those other sellers offering prices keyed to the willingness to pay of the marginal buyer and will purchase from those sellers instead at that marginal-buyer-tailored price.

Thanks to this effect, all buyers will transact at the same, marginal-buyer-tailored price, and so we can conclude that in a perfectly competitive market, price will always be uniform—and uniformly equal to the price at which the marginal buyer and seller transact. (More here.)

It follows that while information is a necessary condition for the personalizing of prices, it is not a sufficient condition.

You also need a departure from perfect competition, which is to say, you need: monopoly. Or at least a hint thereof.

I have argued that personalized pricing is one way to break the iron link between redistribution and inefficiency. When you personalize prices, you can personalize one price to the marginal buyer, ensuring that he stays in the market and the market is efficient, and whatever other prices you wish (within limits) to inframarginal buyers, enabling the redistribution of wealth. But it is important to remember that information on buyers is not alone enough to make this possible. The seller must be a monopolist, too.

Thus the use of personalized pricing as a tool of social justice directly conflicts with the mindless “big is bad” rhetoric that one finds today in certain corners of the progressive movement.

To redistribute wealth at the market level you need to start with big.

And then discipline big’s pricing behavior.