Category: Regulation

Categories
Antitrust Monopolization Regulation

Boeing Shows Us Why Prices Are Too Important for Private Enterprise to Decide Alone

The sad tale of Boeing’s pricing of essential safety features for the 737 MAX 8 as product options is an object lesson in why pricing should always be a public-private project.

Many firms engage in price discrimination: charging different prices for the same product. The ideal way to do that is to generate reliable information on the willingness of each customer to pay, and then to charge higher prices to those willing to pay more and lower prices to those willing to pay less. But often firms can’t just discriminate in prices directly, either because discriminatory pricing would be politically sensitive, or because firms just don’t know how much buyers are willing to pay. So firms discriminate indirectly, by splitting the product into a base model and then selling optional additions.

By pricing the additions far above the actual incremental cost of adding the addition onto the product, the firm can seduce buyers into bringing price discrimination upon themselves. The buyer who is relatively price insensitive — and therefore has a high willingness to pay — will load up on options, and end up paying a far higher total price for the product than will the price-sensitive buyers, who will go with the base model. If this sounds like the business model of the car industry, that’s because car makers — particularly GM — pioneered this form of covert price discrimination in the mid-20th century.

Is covert price discrimination of this kind good for the economy? If a firm’s overhead is so high that the firm would not be able to cover costs, including overhead costs, at a competitive uniform price, then the answer may be yes. But if not, then price discrimination represents a pure redistribution of wealth from consumers to firms, by allowing firms to raise prices higher than necessary, to those consumers who happen to be willing to pay more.

Boeing’s decision to charge pilots extra to be able to read data from a key sensor used by an anti-stall system in the 737 MAX 8 is a classic example of covert price discrimination. The cost of enabling pilots to read data off the sensor was apprently near zero, but Boeing charged airlines thousands of dollars for that option in order to coax airlines with a higher willingness to pay to pay more for a 737 MAX 8. Predictably, budget airlines, like Lion Air, whose 737 MAX 8 crashed on takeoff, possibly because pilots could not read data off of the sensor, and therefore did not know that the plane’s anti-stall system was malfunctioning, did not choose that option.

If America had a general price regulator — an administrative agency responsible for approving the prices charged by large American businesses, including Boeing — then that regulator would be able to tell us today whether Boeing really needed to price discriminate in order to cover overhead, and therefore whether the high price Boeing charged for that safety option really was justified by its costs. Or whether Boeing’s price discrimination amounted to the charging of above-cost prices — prices that redistribute wealth from consumers to firms, not because the extra wealth is required to make the firm ready, willing, and able to produce, not because the extra wealth is necessary to give investors a reasonable return on their investment, but simply because Boeing, as a member of a two-firm global airplane production duopoly (along with Airbus), had the market power to raise price. And because Boeing thought it had more of a right to airline profits — and ultimately to the hard-earned cash of consumers — than do the airlines that buy planes from Boeing and the consumers that fly on them. If it turns out that the safety option was priced higher to extract monopoly profits from consumers, rather than to cover overhead, then we have in Boeing an example of how market power can inflict not just harm on the pocketbook, but actually take lives.

The existence of a general price regulator would have allowed us to pass judgment on Boeing, because what price regulators do is to extract information from big businesses about their costs, including overhead, and based on that to determine whether these firms need to engage in price discrimination to survive, and if so, how much price discrimination is required to cover costs. Regulators then approve price discrimination — called “demand-based pricing” in regulator-speak — if it is needed to cover costs, and reject it where it amounts to no more than an exercise of monopoly power.

Because we have no price regulation of airline production, we simply have no way of telling for sure what Boeing was doing when it decided to charge more for the safety option.

Indeed, the advantage of having a rate regulatory agency goes deeper than just ensuring that firms deploy price discrimination only when it is absolutely necessary to cover costs. Rate regulators have a long history of using their power to approve prices to insist that firms structure their covert price discrimination in a way that is maximally beneficial to consumers. That includes insisting that when firms break their products into base models and sets of options, they do so with a view to safety. Indeed, one of the great benefits of rate regulation is government say over what constitutes an acceptable product. When the airlines were regulated by the Civil Aeronautics Board, for example, the regulator insisted that the airlines maximize the number of direct flights they offer, with the result that today’s layover hell was largely unknown to mid-century fliers.

Boeing has an incentive to make safety features optional, because high willingness-to-pay airlines are more likely to cough up for safety options. But the extra profits that go to Boeing from being able to price discriminate against wealthy airlines come at the cost of delivery of unsafe planes to budget carriers. A rate regulator might well have insisted that that Boeing’s definition of a base aircraft model include far more safety features than it does today.

Of course, the Federal Aviation Administration, which has authority over flight safety, could have mandated that airlines purchase the optional safety features, but chose not to do so. But a rate regulator would have added an additional regulatory safety net, making it possible to stop dangerous pricing at the source — when the prices are chosen — rather than when airlines make decisions about which options to buy, as the FAA would have done.

Given that aircraft manufacturing prices are not regulated today, is our only option to throw up our hands in despair? No. We can still at least get to the bottom of the question whether Boeing priced that option as an exercise of monopoly power, or out of a need to cover costs, through the unlikely vehicle of the antitrust laws. I have argued that the Sherman Act should be read to provide a right of action to any buyer to sue for a judicial determination whether a firm is charging above-cost, and therefore unnecessarily high, prices.

Now would be the perfect time for the world’s airlines to bring that antitrust case.

Categories
Antitrust Deliberate acts against interest Monopolization Regulation

Amazon, MFNs, and Second-Best Antitrust

Antitrust advocates are hailing Amazon’s decision to stop requiring third-party sellers to offer products on Amazon at the lowest prices they charge for their products anywhere. But the decision is decidedly second-best: consumers would be much better off were government to regulate Amazon’s fees, and allow the platform to keep those “most-favored-nation” (MFN) rules.

The elimination of MFNs, argue antitrust experts, will promote competition between Amazon and other ecommerce platforms, by allowing third-party sellers to pass on savings to consumers from doing business on lower-fee platforms. If Barnes & Noble, for example, charges a bookseller less to sell books on the Barnes & Noble website, the bookseller will now be free to charge a lower price for its books on the Barnes & Noble website than the seller charges for the same books on Amazon. That in turn will drive business to the Barnes & Noble website, giving Barnes & Noble a reward for lowering its fees and innovating in cost reduction.

That would be the right way to think about MFNs, if the choice were only between laissez faire and antitrust. But there is in fact a third option, which strictly dominates both of the others. Namely, to regulate Amazon’s fees. If Amazon were required to obtain federal government approval of the fees it charges third-party sellers for use of its platform, then regulators could insist on low fees, and even force Amazon to innovate in cost reduction by mandating fees that are below current costs (preventing Amazon from turning a profit unless it innovates). That would unleash all of the benefits that greater competition between platforms promises to provide.

But it would also preserve advantages that platform competition simply cannot offer. Consumers, after all, like knowing that the price they get on Amazon is the best price available anywhere for the product. Anyone who has wasted hours on one travel website after another trying to find the best airfare knows how much time and effort is required to get the best price when such guarantees do not exist.

Indeed, through MFNs, Amazon effectively leveraged its size to impose a law of one price for consumer products across the internet, and that had huge consumer benefits. Amazon is so big that virtually all products of any interest to consumers are sold through its website. By imposing MFNs, Amazon ensured that consumers wouldn’t need to engage in wasteful and time-consuming searches for the best internet prices when they went to buy online. By going to Amazon, consumers could be sure to find any product available on the internet at the best possible price. Amazon used its size to make life easy for consumers, by turning the internet into a one-stop shop.

We must think of Amazon’s MFNs as accomplishing something that we might ideally want a government regulator to accomplish: making it impossible for anyone, anywhere on the internet, to get ripped off by being charged a higher price for a product than a price available for the same product somewhere else. The MFNs, in other words, were an internet-wide guarantee against price discrimination, that nemesis of all consumer welfare.

While the MFNs did prevent third-party sellers from passing the gains from buying on cheaper platforms on to consumers, the MFNs’ elimination of price discrimination was also valuable to consumers. To give but one example, consider that price discriminating firms frequently use search costs to distinguish between high and low willingness to pay buyers: they offer lower prices only to those who signal their inability to pay more by engaging in wasteful searches for better prices. The poor must clip coupons to get lower prices — or waste time searching for better prices on seller websites or obscure platforms — whereas the rich sail through checkout lines. The MFNs spared consumers such indignities.

Their demise undermines the public benefit of one internet price that Amazon was able to provide to consumers thanks to the firm’s size. And that’s why government regulation of Amazon’s fees is better than either laissez faire or the antitrust solution of simply eliminating the MFNs.

A fee-regulated Amazon would be unable to take advantage of the MFNs to charge higher fees, or to fail to continue to invest in innovations that would reduce the cost of providing platform services, thus the concerns about MFNs that antitrust and competition policy are intended to address would also be addressed by fee regulation. But fee regulation would not require elimination of the MFNs, and would therefore preserve the huge benefits to consumers that come from the guarantee of always being able to find the lowest internet price in one place: Amazon.

Thus fee regulation would realize all of the benefits of competition, while inflicting none of the costs on consumers. As in so many areas, we must therefore understand the antitrust victory here to be only relative at best. Society might be better off as a result of the demise of Amazon’s MFNs, but only if the gains to consumers in the form of more platform competition happen to outweigh the losses to consumers from the demise of the guarantee of one internet price and the associated return of price discrimination. But even if society is rendered better off by the demise of the MFNs, it certainly is not rendered as much better off as it would be were policymakers simply to step in to regulate Amazon’s fees and allow MFNs, and the Internet of one price, to prevail.

Antitrust is a decidedly second-best policy here.

Categories
Antitrust Monopolization Regulation

The Original Progressive View of Antitrust

Much of the popular discussion of the trust question has proceeded upon the assumption that trusts are the result of some sort of immoral conduct which should be made illegal. But the same facts which led to the grant of exclusive franchises (legal monopolies) in the case of local public utilities, have led also to a belief that many of the monopolies which have grown without formal legal grant may likewise be beneficial if subjected to proper public control. The courts in this country, as well as many economists who specialize on “trusts,” have long since come to the conclusion that the anti-trust laws, even if desirable, do not in all cases furnish a sufficient solution of the monopoly problem, and that accordingly governmental price-fixing may be a desirable supplement. But neither the courts nor the teachers of “trusts” seem fully to realize that the determination of a “fair price” is not a search for some objective fact, but that it involves the adoption of a policy; and that the policy cannot be adopted intelligently without a drastic revision of accepted economic theory as well as the accepted theory of private ownership; and that the officials charged with the formation of the policy must perforce resort to some theory as to the proper distribution of income and as to the channels into which industry should flow.

Robert Lee Hale, Economic Theory and the Statesman, in The Trend of Economics 189, 193 (Rexford Guy Tugwell, ed., 1924).

Commentators regard the [Alcoa] case as one of the most powerful statements in antitrust jurisprudence for the robust efforts to constrain dominant firms. Discussions of the case often place [eminent progressive jurist] Learned Hand at the center of attention and ascribe to Hand the views espoused in the court’s decision. Hand believed otherwise. He disliked the antitrust laws from his earliest days in public life. In a representative statement of his views, Hand wrote to a friend in 1914:

“I do not agree by any means that the Sherman Act is of value or that the progressive party should take its position against monopoly. . . . I have always suspected that there are monopolies possible which depend for their maintenance wholly upon economic efficiency and which it would be an economic blunder to destroy.”

. . .

In a separate memorandum [in the Alcoa case], Learned Hand noted: “There are two possible ways of dealing with [monopolies]: to regulate, or to forbid, them. Since we have no way of regulating them [because regulatory legislation has not been put into place], we forbid them. I don’t think much of that way, but I didn’t set it up; and now the ordinary run of our fellow-citizens — some, even of the ‘rugged individualists’ — regard the Sherman Act as the palladium of their liberties.”

Andrew I. Gavil et al., Antitrust Law in Perspective 475, 477 (3d ed. 2017).
Categories
Antitrust Regulation

Back to Atomic Laissez Faire

Lest we forget that deregulation was a project of the left, not just the right, here is Marxist legal historian Morton Horwitz in 1984:

Almost nothing in the antitrust debates supports what would soon become Theodore Roosevelt’s new conservative distinction between “good trusts” and “bad.” Roosevelt was operating under a newly emerging view that corporate concentration could be justified by economic efficiency-increasing returns to scale. Only corporations that achieved dominance through illicit means-financial manipulation or unfair competition-were “bad” trusts. By contrast, the old conservatives who passed the Sherman Act did not believe that the neoclassical economic law of diminishing returns had been repealed. [B]igness was per se bad. From their perspective, large-scale economic concentration was inherently illicit because, according to economic laws, there was no way corporations could legitimately achieve overwhelming economic dominance. Almost nothing in the Sherman Act debates suggests that economic concentration could be justified on efficiency grounds. That was for a later day.

. . .

The regulatory state, originally conceived as a means of checking corporate power, has gradually become discredited. In most cases deregulation now means that corporate power will simply be left unchecked. The original Progressive conception of the state as the means to our salvation must be fundamentally reconsidered. Without the sort of decentralized institutions that the old conservatives (and Progressives like Brandeis) supported, we seem destined to fluctuate between deregulation and its somewhat less overtly rapacious and more noble sounding sibling, regulation. Deregulation generally means unrestrained corporate control. Regulation frequently means more subtle, more disguised, and often more effective forms of corporate control.

Morton J. Horwitz, Progressive Legal Historiography, 63 Or. L. Rev. 679, 686 (1984).

Curiously, Horwitz’s position is today fast becoming the mainstream, bipartisan position on markets. Thus, to borrow Horwitz’s schema, we have come full circle, from the old conservative vision of antitrust-defended, laissez-faire markets of atomized sellers, to the new conservative/Progressive consensus on the importance of size, to the triumph of the Progressive accommodation with size in the form of New Deal rate regulation, to the triumph of the new conservative accommodation with size in the form of deregulation and Chicago School antitrust, to today’s gathering return to the old conservative rejection of size and embrace of an antitrust-defended atomized laissez faire. Ah me.

Categories
Regulation

Begging Markets

In a world in which there were no government, firms would be forced by competition to do things that are bad for the world, that even the firms themselves realize are bad and do not really want to do, and our only hope for salvation would be that firms choose not to do those things, to suffer the punishment of the markets, to martyr themselves for society.

But of course there is a government, and government can put an end to whatever it wants. We do not need to rely on the good graces of the business world.

If you forget this — forget that there is a government — because you have worshiped so long at the altar of the free market, then you find yourself insisting on absurd things. Such as that CEOs ought, out of the goodness of their hearts, and with all the incentives pulling to the contrary, to start making socially just decisions:

Automating work is a choice, of course, one made harder by the demands of shareholders, but it is still a choice. And even if some degree of unemployment caused by automation is inevitable, these executives can choose how the gains from automation and A.I. are distributed, and whether to give the excess profits they reap as a result to workers, or hoard it for themselves and their shareholders.

Live by the market, despair by the market.

Categories
Antitrust Regulation

Flying 20/20

Frank Lorenzo, head of Texas International Airlines:

[I]f the Aviation Act of 1975[, which deregulated the airlines,] goes into effect, we will, over a period of years, end up with a couple of very large airlines. There will be many small airlines that will start up here and there, but they will never amount to a very significant amount of the transportation market. The smaller certificated airlines like Texas International[, which was acquired in 1982 by Continental Airlines, which itself merged with United in 2010,] will shortly become history. The operating and financial advantages will go to the large carriers with substantial resources, and to very small carriers that temporarily have lower labor costs, primarily because they are non-unionized.

Quoted in Richard H.K. Vietor, Contrived Competition: Regulation and Deregulation in America 54 (1994).

In 1978, when Congress deregulated the airline industry, there were 10 airlines that provided scheduled national and international service, and those 10 accounted for 90 percent of the domestic marketplace. Today, [in 2016,] there are four major airlines and a few smaller ones providing comparable service, and the four major airlines provide 80 percent of U.S. domestic flights.

Paula W. Render, The Airlines Industry, Concentration and Allegations of Collusion, Competition Policy International (June 14, 2016).
Categories
Antitrust Regulation

Slouching toward Reregulation

There is one solution to the monopoly problem that is conspicuously absent from Noah Smith’s account of monopoly power debates at this year’s ASSA.

Smith rightly concludes that breaking up big firms is not a perfect solution to the monopoly problem. (He thinks, incorrectly, in my view, that breakup is too hard; the real reason not to break up big firms is that they are often more efficient than small ones.) And he rightly gives a list of alternatives to breaking big firms up, including unions, minimum wage laws, putting workers on corporate boards, and imposing tougher labor standards on large firms than small. But he doesn’t seem to see where all of these alternatives point.

Where do minimum wage laws and applying tougher labor standards to large firms point?

To rate regulation, of course. To that approach to governing the market that once — in the decades following World War Two — stretched from securities brokerage to railroads to telephones to airlines.

In a regulated industry, a government administrative agency dictates prices and performance standards to the privately-owned firms that compete in the market. Applying tougher labor standards to firms with monopoly power, a proposal that Smith attributes to Nick Hanauer, is a shade of the old rate regulation, which was often imposed on monopolized industries, such as telephone service, to restrain the power of large firms.

Minimum wage laws are themselves a form of blunt price regulation, blunt because they are imposed on a one-off basis by legislatures instead of by expert administrative agencies with authority to revise the prices dynamically in response to changing circumstances. And both unionization and putting workers on corporate boards are even blunter forms of rate regulation, in that they hope that by increasing the bargaining power of workers, workers will succeed at negotiating the higher wages and better working conditions that a regulator would be empowered to impose by fiat.

True, most of Smith’s proposals are aimed at softening the consequences of labor market monopsony, whereas rate regulation was generally aimed at softening the consequences of consumer market monopoly. But there’s no reason why the Department of Labor couldn’t apply the tenets of rate regulation to labor markets.

Rate regulation is the most developed form of intervention in markets, one that encompasses all the other forms, but also goes beyond them, so it’s the natural choice for achieving just market-level distributions of wealth where unregulated markets fail to do so. A rate regulator can unionize an industry if the regulator wishes, just as the ICC effectively cartelized long-haul railroads to stabilize their prices: the regulator simply insists on approving only a wage tariff that is uniform for all workers, effectively forcing workers to bargain collectively with their employers. But a rate regulator can do more than that, regulating market entry to strike a balance between job security and competitiveness, insisting that workers offer certain bundles of skills, and even imposing workplace safety and benefits standards.

Once we start to believe that markets are failing, and that just breaking up big firms won’t achieve distributively fair market outcomes, as economists seem to be concluding, the door is open to market intervention, and at that point it makes sense to use the best tool for the job. The one-off ad hockery of minimum wages won’t do. Nor will strengthening unions — if you make them strong enough to really succeed, you make them strong enough to oppress investors and consumers. What you need is a politically accountable agency empowered to make markets work for all market participants.

That’s what rate regulation was, and could be again. Let’s stride to it, not slouch.

Categories
Annals of American Decline Regulation World

Markets and American Decline

Operating from headquarters in a hilltop villa in the capital city, protected by government soldiers, a businessman with strong ties to his own government back home, a belief in his own manifest destiny, a desire to go down in history as a bringer of industrial development, and deep experience in completing hydropower and mining projects, submits a bid to the country’s leaders to build them a new oil refinery. The bid is backed by a loan guarantee from one of his country’s largest banks, provided as part of an initiative by his country’s government to win the friendship of other nations by providing development support.

Lacking an office in the country in which the refinery is to be built, a former mid-level government official with no experience building anything tries to cobble together a bid of her own from shared office space in her own country. She finds an investor — not at home but in a third country — gets an expression of interest from some executives from a firm in her own country with refinery construction experience, and places a bid in which she promises to secure the rest of the funding for the project by selling shares in the venture on capital markets. When ministers visit her country as part of consideration of her bid, they are shocked to be shown around shared office space, and insist that she line up a more secure source of financing. She begs her government to sign on, but the most she gets is a letter from a government lender saying that it would considering lending a fraction of the project cost.

Once upon a time, this would have been a tale about American power. The first person would be a TR, say, supremely confident about his place in history, carrying out a Marshall Plan (if you will forgive the anachronism) reflecting the ambition of the U.S. government to use aid to secure the allegiance of the world. The second person would be some luckless underfunded competitor operating out of a backward country with a weak state lacking the vision to promote its businesses and interests abroad.

But of course the first person in this story is Chinese and the second is American. As the article in today’s Times strongly suggests, the American won the bidding only because Uganda’s leader hopes to encourage American competition, and thereby to improve the terms he gets from the Chinese in the future. Indeed, the American project may well fall apart, as GE — the firm with expertise in refinery building that had shown interest in the bid — has started to exit that line of business.

How did we get here? The answer is our decades-long obsession with market magic. There has been much talk in some circles about the “fissured workplace,” the converting of many jobs into “independent contractor” positions that allow employers to treat their employees as temp staff with no job security and few benefits. Firms no longer have employees, but instead simply tap contractor markets, buying labor hours when they are needed and not when they are not, much the way you make a run to the supermarket for lemons when you need them and not when you don’t, instead of tending your own lemon tree.

Well, more than just labor markets have fissured. Everything has fissured, as our obsession with markets has spread to every corner of the economy since the 1970s. Just look at how the American bid for the refinery came about. Not at the instigation of our government, despite its recognition that China’s dominance in African business is putting us at a great strategic disadvantage, but because a mid-level foreign policy official, thrown out of work by the exit of the Obama Administration, saw a market opportunity. She then went into a set of different markets in order to try to cobble together a bid. She rented shared office space, tapping the fissured commercial real estate market, in which businesses no longer own their own space, let alone build their own custom spaces, as they once did. She also had no funding of her own, but promised to tap the fissured funding markets by selling shares in the project. And she had no experience building refineries, so she also promised to tap the fissured project market, potentially by bringing GE into the project. Markets, market, markets.

All these markets are supposed to make our economy and nation stronger, by ensuring that everything is allocated to the people who need the things the most. Workers can be repurposed via the market from one job to another at a moment’s notice, office space can be saved for the most important projects, cash can flow to the most important projects, and so on.

But what market excess really does is expose our economy and nation, to risk. The trouble with markets is that they are risky. At the end of the day the Ugandans got a bid that was worth little more than the paper it was written on. It was in effect a commitment from an amateur to use acceptance of the bid by the Ugandans to convince investors to invest, refinery builders to build, and so on. What the Chinese offered, by contrast, was a government-backed commitment to fund construction of the refinery by an experienced firm. The parts of the Chinese offer were so well integrated — so unfissured — that the Chinese even insisted on importing 60% of the labor and materials from China to complete the project. That’s right, the Chinese would bring in their own laborers to complete the work.

No wonder the American bid was at a severe disadvantage. If you were taking bids to have your floors redone, would you go with the man off the street with no experience, no operations, and no money — even if he offered the lower price — or the experienced flooring operation that’s ready to get to work as soon as you sign on the dotted line?

When you do business with integrated operations, instead of markets, you carry less risk, because integration reduces risk. It makes sure that the money is there, the expertise is there, the workers are there. You may still bear the risk of non-completion, but that risk is lower. And when the state gets behind its businesses in these deals, as the Chinese government has via its Belt and Road initiative, risk is reduced further. The Chinese drive a hard bargain, using the infrastructure they build to secure repayment of the loans, but they can do that because they have something credible to sell.

If the story of a businessperson trying to get along in an international deal — one that forwards the President’s own policy of going head to head with China — without government support, without expertise, without financing, without even an office, sounds the story of a failed state, that’s because a fissured economy — an economy in which everything, at every level in the supply chain, has been turned into a market — is a failed state. It’s a country that can have no vision or unity of purpose because its government is paralyzed by the need to respect market boundaries, unable to direct the economy according to any vision, and in which every individual and private firm is paralyzed too, at the mercy of markets in everything that they do. Therein lies the state of nature.

Of course it was not always this way. Until market dogma took over the country in the 1970s, American industry looked a lot more like Chinese industry does today. Long-term commitment to workers and suppliers was the norm. Indeed, in America’s many regulated industries, the government required firms to provide packages of services, instead of fissuring the services into the a la carte menus that have proliferated today. The government promoted international development as a strategic goal, most famously in the Marshall Plan.

And, perhaps most importantly, America had a taste for greatness. It would not have thought that “the threat posed by the Belt and Road Initiative to American interests is debatable.”

Categories
Antitrust Regulation

Competition as Tax Policy

Once upon a time, Chicago to New York was a cheap rail fare, whereas the much shorter trip from Chicago to Peoria was expensive, because in a dense rail network there were lots of ways to get from Chicago to New York, and therefore lots of competition on that route, whereas there were only a few ways to get from Chicago to Peoria, and therefore much less competition. The big city people who rode Chicago to New York had more money than the small city people who rode Peoria to Chicago, but the big city people paid lower fares, because the big city people benefited from competition.

Competition gave the big city folk alternatives, and that strengthened their bargaining power vis a vis the railroads. The lack of competition denied the small city folk alternatives, and that reduced their bargaining power vis a vis the railroads. But the changing of alternatives is taxation.

Suppose instead that rail competition were somehow equal in both markets, but the government were to tax small city riders by a certain amount and redistribute that amount of money to the big city riders. The tax would effectively drive up the fare paid by the small city riders and drive down the fare paid by the big city riders, achieving the same result as did the unequal levels of competition on the big and small city routes. Inequality in competition is tantamount to inequality in pricing, which is tantamount to tax and transfer.

Put another way, the presence of competition on the big city route and absence on the small city route caused the railroads to collect a large share of their revenues from small city riders. Small city riders subsidized big city riders, in a sense. The railroad acted as a kind of taxing authority, redistributing from small city riders to big city riders, but the railroad’s tax policy was determined by the competitive environment, not the railroad itself, by the presence of competition on the big city route and the absence of competition on the small city route.

Flip the competitive configuration — make the small city route less competitive than the big city route (perhaps by allowing cartelization of service providers on the big city route) — and now the big city riders will contribute a larger share of the railroad’s revenues. Now the big city riders might be said to pay the subsidy and the railroad to be taxing the big city riders for the benefit of the small city riders.

Depending on how antitrust divides up markets and goes about promoting competition in them — as I discuss briefly in another post — the competitive terrain created by antitrust represents a tax system and a specific set of distributive results.

From this perspective, if your goal is to redistribute wealth, you want more competition in some markets — the ones inhabited by the poor — and less competition in other markets — the ones inhabited by the rich. That’s just the kind of policy that progressives advocate: antitrust for big firms, cartelization for workers and small businesses.

Note that this is not an argument about the ability of competition to force a particular distribution of surplus within a market, between buyers and sellers. This is about the ability of antitrust to alter relative outcomes in different markets by altering relative levels of competition. This is about how antitrust makes price discrimination possible, and how that price discrimination redistributes, even when the different prices charged are charged by different firms in different markets.

Categories
Regulation

Hotelling on the Blessings of Bigness and Taxes

How very different were the efficiency gods of 1938! How I long to sacrifice intellectual property to those gods, as once were slain private bridges and railroads on their art deco altars.

The idea that all will be for the best if only competition exists is a heritage from the economic theory of Adam Smith, built up at a time when agriculture was still the dominant economic activity. The typical agricultural situation is one of rising marginal costs. Free competition, of the type that has usually existed in agriculture, leads to sales at marginal cost, if we now abstract the effects of weather and other uncertainty, which are irrelevant to our problem. Since we have seen that sales at marginal cost are a condition of maximum general welfare, this situation is a satisfactory one so far as it goes. But the free competition associated with agriculture, or with unorganized labor, is not characteristic of enterprises such as railroads, electric-power plants, bridges, and heavy industry. It is true that a toll bridge may be in competition with other bridges and ferries; but it is a very different kind of competition, more in the nature of duopoly. To rely on such competition for the efficient conduct of an economic system is to use a theorem without observing that its premises do not apply. Free competition among toll-bridge owners, of the kind necessary to make the conclusion applicable, would require that each bridge be parallelled by an infinite number of others immediately adjacent to it, all the owners being permanently engaged in cutthroat competition. If the marginal cost of letting a vehicle go over a bridge is neglected, it is clear that under such conditions the tolls would quickly drop to zero and the owners would retire in disgust to allow anyone who pleased to cross free.

The efficient way to operate a bridge — and the same applies to a railroad or factory, if we neglect the small cost of an additional unit of product or of transportation — is to make it free to the public, so long at least as the use of it does not increase to a state of overcrowding. A free bridge costs no more to construct than a toll bridge, and costs less to operate; but society, which must pay the cost in some way or other, gets far more benefit from the bridge if it is free, since in this case it will be more used. Charging a toll, however small, causes some people to waste time and money in going around by longer but cheaper ways, and prevents others from crossing. The higher the toll, the greater is the damage done in this way; to a first approximation, for small tolls, the damage is proportional to the square of the toll rate, as Dupuit showed. There is no such damage if the bridge is paid for by income, inheritance, and land taxes, or for example by a tax on the real estate benefited, with exemption of new improvements from taxation, so as not to interfere with the use of the land. The distribution of wealth among members of the community is affected by the mode of payment adopted for the bridge, but not the total wealth, except that it is diminished by bridge tolls and other similar forms of excise. This is such plain common sense that toll bridges have now largely disappeared from civilized communities. But New York City’s bridge and tunnels across the Hudson are still operated on a toll basis, because of the pressure of real estate interests anxious to shift the tax burden to wayfarers, and the possibility of collection considerable sums from persons who do not vote in the city.

Harold Hotelling, The General Welfare in Relation to Problems of Taxation and of Railway and Utility Rates, 6 Econometrica 260-61 (1938).