How Can the Government Spur Competition?

Thursday, July 15, 2021
Image credit: 
istock

Recently the Wall Street Journal stated that President Biden’s July 9 executive order on competition is a “sweeping proposal to spur competition.” That raises an important question: how can a government spur competition? Economics has a lot to say about that question. The major way, which goes back to Adam Smith, is to get rid of barriers that government itself uses to block or limit competition. While the Biden executive order does mention one government barrier to competition, occupational licensing, it is vague about what should be done on that issue and passes on getting rid of most of the extensive government barriers to competition. Unfortunately, much of the order’s focus is on the danger of market concentration. It might surprise Biden and many in his administration to know that economists extensively debated the issue of market concentration in the 1960s and 1970s and that the bottom line is that market concentration is not a good measure of the presence or absence of competition.

Seen from this perspective, the Biden administration’s latest proposals are a grab bag: some, fortunately, might increase competition, some would decrease competition, and some would dictate outcomes rather than letting the competitive process emerge.

A Glimmer of Hope on Occupational Licensing

The most promising parts of the executive order are the statements about occupational licensing. The order states, “[W]hile many occupational licenses are critical to increasing wages for workers and especially workers of color, some overly restrictive occupational licensing requirements can impede workers’ ability to find jobs and to move between states.” To his credit, President Biden, like President Obama before him, recognizes that requiring people in various occupations to get licenses limits competition by imposing barriers to new entrants. In the United States today, there are more than eight hundred occupations in which potential workers need some kind of government permission if they want to work legally. Here’s what I pointed out in “Occupational Licensing Is a Bad Idea,” (Defining Ideas, April 2, 2019):

(T)he percent of workers who must have licenses to practice their occupations grew dramatically between the early 1950s and 2000. In the early 1950s, according to labor economists Morris Kleiner, a professor at the University of Minnesota’s Humphrey School of Public Affairs, and Alan Krueger, who, before his recent death, was a professor at Princeton, “less than 5 percent of the US work force was in occupations covered by licensing laws at the state level.” By 2000, they found, that number had risen to at least 20 percent.

Unfortunately, Biden seems to want one of the bad consequences of licensing. Notice his sentence that I quoted above. Biden is right that “many occupational licenses are critical to increasing wages for workers” and that’s the problem. Licensing, like any restriction on entry into a business, makes that industry’s prices higher than otherwise. Licensing plumbers, for example, makes plumbers’ wages higher than if they weren’t licensed. The case against licensing is that ending licensing would increase competition, thereby bringing down prices and wages earned by people in licensed occupations. Of course, it would also help people on the outside get into those occupations and increase their wages. But that’s an effect of reducing licensing, not of keeping it. Biden claims that licensing increases wages “for workers of color,” but it is licensing, not the absence of licensing, that disproportionately hurts workers of color—by keeping them out. Biden’s troublesome statement makes one wonder how serious he is about increasing competition in licensed occupations.

Is Market Concentration a Threat to Competition?

Much of the executive order is based on the assumption that a concentrated market, one in which a few firms sell a large percent of the industry’s output, is less competitive than an unconcentrated market. This view, sometimes known as the Market Concentration Doctrine (MCD), was the dominant view in economics in the 1950s and 1960s. Consider the first statement of the order: “A fair, open, and competitive marketplace has long been a cornerstone of the American economy, while excessive market concentration threatens basic economic liberties, democratic accountability, and the welfare of workers, farmers, small businesses, startups, and consumers.” One could quibble by pointing out that the order targets only “excessive” market concentration, but a fair reading of the long order would lead an unbiased observer to conclude that the Biden administration is hostile to market concentration. Indeed, the order uses the words “concentration” or “overconcentration” ten times.

But does increased concentration in markets reduce competition? That would depend on how the concentration came about. Imagine a market in which there is only one company because the government allows only one company. We don’t need a lot of imagination. That was the situation with cable television for decades. Virtually every local government in the United States allowed only one cable TV company in its area. So those cable TV companies had a monopoly, and their monopoly would have continued even longer if satellite TV had not come along.

But now imagine an industry in which the government has not prevented competition but there is only one company. Those cases are harder to imagine. If they came about, it would likely be because the company came up with a new product and potential competitors had not yet geared up to compete. That situation would likely not last long. Any misstep by the existing company, whether it be allowing costs to rise, pricing too high, or failing to meet new demand, would likely cause one or more new competitors to enter. If the situation did last long, it would likely be because the company was acting as if it faced competition. But then why would we care? We would still get the benefits of competition. And if the government were to penalize such companies, it would reduce the incentive to compete.

One influential person who thought that successful companies should be hobbled was famous federal judge Learned Hand. One of the low points of US antitrust law was his decision and reasoning in United States v. Aluminum Co. of America (1945). In deciding against Alcoa, Hand stated:

We need charge it with no moral derelictions after 1912; we may assume that all it claims for itself is true. The only question is whether it falls within the exception established in favor of those who do not seek, but cannot avoid, the control of a market. It seems to us that that question scarcely survives its statement. It was not inevitable that it should always anticipate increases in the demand for ingot and be prepared to supply them. Nothing compelled it to keep doubling and redoubling its capacity before others entered the field. It insists that it never excluded competitors; but we can think of no more effective exclusion than progressively to embrace each new opportunity as it opened, and to face every newcomer with new capacity already geared into a great organization, having the advantage of experience, trade connections, and the elite of personnel.

In short, because Alcoa acted like a competitor and thereby succeeded in forestalling competition, it was guilty. Some people are never satisfied. But we shouldn’t let Judge Hand’s muddled reasoning distort our perceptions. Even if there’s one dominant firm in the market, we can have vigorous competition as long as government doesn’t prevent competition.

The dominant view among economists until the late 1960s was that market concentration led to higher prices by making it easier for firms to collude, either explicitly or implicitly. But in the 1960s, University of Chicago economist Harold Demsetz noted that General Motors seemed to be the only one of the Big Three auto companies (the two others were Ford and Chrysler) that was making high profits. It was also the biggest. He speculated that large economies of scale and good management led GM to be the most successful firm and that the high profits in the auto industry, due mainly to GM, had nothing to do with any kind of collusion. Later research by Sam Peltzman at the University of Chicago confirmed Demsetz’s point. While Peltzman did find a positive relationship between concentration and price, the relationship between higher concentration and lower average cost (due presumably to economies of scale) was far stronger.

The Anti-Amazon Wrath of Khan

One person present at Biden’s signing of the executive order was Lina Khan, Biden’s new appointee as chair of the Federal Trade Commission. Not surprisingly, the FTC is featured prominently in the order and, whatever her role in writing it, Khan will have a role in implementing it. Khan made her reputation in January 2017 when, as a law student, she wrote “Amazon’s Antitrust Paradox,” a long article in the Yale Law Journal. In that article, Khan showed herself to be Learned Hand’s twenty-first-century embodiment. In page after page Khan discussed Amazon’s efforts that have brought prices down to consumers and had not, Khan admitted, resulted in fat profit margins for Amazon. She claimed in her article that Amazon’s P/E ratio was 900. It was much lower at the time of publication but, of course, there are lags between when the article is finished and when it is published. The closest I could find to 900 in the previous two years was 720 in September 2015. Let’s go with that.

Khan’s reasoning is a little different from Hand’s. She argues, quite reasonably, that the stock traded at such a large multiple of current earnings because investors expected much higher earnings in the future. And, she feared, Amazon would get those earnings by setting much higher prices. In short, Khan feared that Amazon was engaging in predatory pricing—pricing low to knock out competitors and then setting prices high after they’re gone. But as of July 12, 2021, Amazon’s P/E ratio had come much closer to earth at 70.72. That’s still high, but not ridiculous. If Khan’s fears are valid, then we should see Amazon pricing not just higher than before, but higher than its competitors were pricing before Amazon competed them out of the game. We don’t.

The closest Khan comes to making her case is her example of Amazon setting up Amazon Mom, discounting prices to compete with Quidsi on items like diapers, buying Quidsi, and then reducing the discounts. She approvingly quotes journalist Laura Owen’s statement that “The Amazon Mom program has become much less generous than it was when it was introduced in 2010.” But that doesn’t make her case: reduced discounts are still discounts and “less generous” is still somewhat generous. In short, prices at the end of the process were still lower than before Amazon entered.

In her article, Khan emphasized the idea that competition is a process. Unfortunately, she isn’t willing to let the competitive process play out. Nor is President Biden. The most telling example is the executive order’s discussion of airline baggage fees. Biden calls for the secretary of transportation to “not later than 45 days after the date of this order, publish for notice and comment a proposed rule requiring airlines to refund baggage fees when a passenger’s luggage is substantially delayed.” But how does he know what the right strategy is for consumers? If, when passengers’ luggage is substantially delayed, the airline must refund the fee, then airlines will likely set baggage fees higher than they do now. How does the federal government know that that’s optimal? Only the competitive process will tell us.

A Lost Opportunity

One of the main failings in the Biden executive order is of omission. It largely missed out on the surest way to get more competition: quit making it illegal. There are so many targets of opportunity for deregulating to allow more competition. One of the most egregious is the Jones Act. In “How the Jones Act Harms America” (Defining Ideas, October 7, 2019), I noted that the Jones Act hampers competition by imposing a four-part test for cargo to be shipped by water between two US ports. The ships must be (1) US-owned, (2) crewed by Americans, (3) registered in the United States, and (4) built in the United States. That keeps prices high for shipping between any two US ports. An April 2019 study by the Organization for Economic Cooperation and Development found that the new competition spurred by ending the Jones Act would increase total output of the US economy by $40 billion to $135 billion annually. That’s nothing to sneeze at.

Conclusion

The federal government can do many things that would reliably spur competition. All of them involve deregulating to allow competition. Although the Biden administration has made some noises in this direction, the big failing of the recent executive order and, I fear, of Lina Khan’s tenure at the Federal Trade Commission, will be the push to limit market concentration even when companies have achieved it the old-fashioned way: by earning it.