Why free markets don’t foster competition


My favorite class in high school was my 11th grade American Studies. Sadly no longer offered in a world of AP courses and teach-to-the-test education, this was a combination of American history and and American literature. I never had much interest in history until I took this class, but the teacher had such a contagious enthusiasm for American history that it was hard not to get swept up in it. And it fostered an interest in history that has never left me.

As time has passed, I’ve realized that the course contained a fair amount of subversiveness that eluded me at the time, but nevertheless had a profound impact on me.

Case in point, a class exercise that I remember vividly, even now, that taught me about free markets and competition.

How to make an offer that can’t be refused

We were talking about the rise of big business in the 19th century, and specifically the development of the railroads. The teacher turned the discussion into an exercise. We divided the class into groups, with each group representing a railroad company and the teacher representing a decision maker. Each of the companies wanted to build their railroad, but needed the assent of the decision maker. The exercise was that we needed to convince him to go with our company.

In fact, none of the groups came up with a winning plan. Instead, the teacher stepped us through the one deal that couldn’t be refused, and indeed, wasn’t refused back in the day: “You should have all banded together and created one single railroad company, so that you would be my only option. Then I wouldn’t have a choice.”

And indeed, that happened. Standard Oil, U.S. Steel, and Bell Telephone, all had their markets cornered. There was nothing preventing these large companies from buying up all the other competitors, creating a single colossus. It’s not hard to see that if there is only one railroad company, the leverage that company holds is strong. They can raise prices, cut service, and in general keep the consumers on the hook. Good for the railroad company, but bad for everyone else.

An uneven competition

One could argue that with no restrictions on business that any other company is free to start up and challenge the entrenched power. Technically, this may be true, but in practice this doesn’t happen. The upstart can be bought and assimilated, or muscled out of the space by the sheer force of the monopoly.

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There’s also the “network effect” (everyone is on Facebook because everyone is on Facebook, despite the contraindications of doing so).

We’ve seen from history that in a free market, monopolies naturally develop, which eliminates competition and raises costs. Monopolies can’t be easily broken (if at all) by the free market. They need something external.

Healthy competition is good

I think we can agree that competition is a good thing. There is an incentive to work harder, be more creative, and push yourself to achieve greater things.

And I say that effective competition is fostered by an external referee. Not unlike sports, a referee ensures that the rules of the game are clearly stated and enforced. Imagine how quickly a sports game would break down if all the players knew that they could get away with breaking rules without fear of reprisal?

But in fact, that is what we often see around us now. Sometimes if seems like our system is run by a referee with a blindfold and one hand tied.

For example, US Airways and American Airlines are planning to merge. This will leave four major US airlines instead of five. How will having fewer options lead to greater competition? How will we benefit? I’m still waiting for an answer on that.

If we did not have an environmental referee, then companies would be free to pollute and destroy our living environment, all in the name of job growth and profit. And yet, when regulations are weak or non-existent, companies can easily run roughshod over them, with only punitive penalties.

Remember that the next time that someone says that we need less regulation in business. Personally, I’ll take a safe, fair, livable planet and shave a few points off of our companies’ earnings. I think we can handle that. Referees are important. If people disagree, blow the whistle.

What do you think? Is competition overrated? Does the analogy of referee and regulator hold? I’d love to hear your thoughts.

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