quested a rebate in exchange for his business, a firm (usually a railroad) could comply or deny as it saw fit. According to classical economics, which had a profound influence on the nineteenth century, competition would keep the economy in balance.
But while many theories of the classical economists—such as their description of the working of a free economy—were valid, their concept of competition was ambiguous and led to confusion in the minds of their followers. It was understood to mean that competition consists merely of producing and selling the maximum possible, like a robot, passively accepting the market price as a law of nature, never making any attempt to influence the conditions of the market.
The businessmen of the latter half of the nineeenth century, however, aggressively attempted to affect the conditions of their markets by advertising, varying production rates,. and bargaining on price with suppliers and customers.
Many observers assumed that these activities were incompatible with the classical theory. They concluded that competition was no longer working effectively. In the sense in which they understood competition, it had never worked or existed, except possibly in some isolated agricultural markets. But in a meaningful sense of the word, competition did, and does, exist—in the nineteenth century as well as today.
“Competition” is an active, not a passive, noun. It applies to the entire sphere of economic activity, not merely to production, but also to trade; it implies the necessity of taking action to affect the conditions of the market in one’s own favor.
The error of the nineteenth-century observers was that they restricted a wide abstraction—competition—to a narrow set of particulars, to the “passive” competition projected by their own interpretation of classical economics. As a result, they concluded that the alleged “failure” of this fictitious “passive competition” negated the entire theoretical structure of classical economics, including the demonstration of the fact that laissez-faire is the most efficient and productive of all possible economic systems. They concluded that a free market, by its nature, leads to its own destruction—and they came to the grotesque contradiction of attempting to preserve the freedom of the market by government controls, i.e., to preserve the benefits of laissez-faire by abrogating it.
The crucial question which they failed to ask is whether “active” competition does inevitably lead to the establishment of coercive monopolies, as they supposed—or whether a
laissez-faire economy of “active” competition has a built-in regulator that protects and preserves it. That is the question which we must now examine.
A “coercive monopoly” is a business concern that can set its prices and production policies independent of the market, with immunity from competition, from the law of supply and demand. An economy dominated by such monopolies would be rigid and stagnant.
The necessary precondition of a coercive monopoly is closed entry—the barring of all competing producers from a given field. This can be accomplished only by an act of government intervention, in the form of special regulations, subsidies, or franchises. Without government assistance, it is impossible for a would-be monopolist to set and maintain his prices and production policies independent of the rest of the economy. For if he attempted to set his prices and production at a level that would yield profits to new entrants significantly above those available in other fields, competitors would be sure to invade his industry.
The ultimate regulator of competition in a free economy is the capital market. So long as capital is free to flow, it will tend to seek those areas which offer the maximum rate of return.
The potential investor of capital does not merely consider the actual rate of return earned by companies within a specific industry. His decision concerning where to invest depends on what he himself could earn in that particular line. The existing profit rates within an industry are calculated in terms of existing costs. He has to consider the fact that a new entrant might not be able to achieve at once as low a cost structure as that of experienced producers.
Therefore, the existence of a free capital market does not guarantee that a monopolist who enjoys high profits will necessarily and immediately find himself confronted by competition. What it does guarantee is that a monopolist whose high profits are caused by high prices, rather than low costs, will soon meet competition originated by the capital market.
The capital market acts as a regulator of prices, not necessarily of profits. It leaves an individual producer free to earn as much as he can by lowering his costs and by increasing his efficiency relative to others. Thus, it constitutes the mechanism that generates greater incentives to increased productivity and leads, as a consequence, to a rising standard of living.
The history of the Aluminum Company of America prior
to World War II illustrates the process. Envisaging its self-interest and long-term profitability in terms of a growing market, ALCOA kept the price of primary aluminum at a level compatible with the maximum expansion of its market. At such a price level, however, profits were forthcoming only by means of tremendous efforts to step up efficiency and productivity.
ALCOA was a monopoly—the only producer of primary aluminum—but it was not a coercive monopoly, i.e., it could not set its price and production policies independent of the competitive world. In fact, only because the company stressed cost-cutting and efficiency, rather than raising prices, was it able to maintain its position as sole producer of primary aluminum for so long. Had ALCOA attempted to increase its profits by raising prices, it soon would have found itself competing with new entrants in the primary aluminum business.
In analyzing the competitive processes of a laissez-faire economy, one must recognize that capital outlays (investments in new plant and equipment either by existing producers or new entrants) are not determined solely by current profits. An investment is made or not made depending upon the estimated discounted present worth of expected future profits. Consequently, the issue of whether or not a new competitor will enter a hitherto monopolistic industry, is determined by his expected future returns.
The present worth of the discounted expected future profits of a given industry is represented by the market price of the common stock of the companies in that industry.2 If the price of a particular company’s stock (or an average for a particular industry) rises, the move implies a higher present worth for expected future earnings.
Statistical evidence demonstrates the correlation between stock prices and capital outlays, not only for industry as a whole, but also within major industry groups.* Moreover, the time between the fluctuations of stock prices and the corresponding fluctuations of capital expenditures is rather short, a fact which implies that the process of relating new capital investments to profit expectations is relatively fast. If
•Alan Greenspan, “Stock Prices and Capital Evaluation.” Paper delivered before a joint session of the American Statistical Association and the American Finance Association on December 27, 1959.
8 For a detailed analysis of this correlation, see Alan Greenspan, “Business Investment Decisions and Full Employment Models,” American Statistical Association, 1961 Proceedings of the Business and Economic Statistics Section.
such a correlation works as well as it does, considering today’s governmental impediments to the free movement of capital, one must conclude that in a completely free market the process would be much more efficient.
The churning of a nation’s capital, in a fully free economy, would be continuously pushing capital into profitable areas— and this would effectively control the competitive price and production policies of business firms, making a coercive monopoly impossible to maintain. It is only in a so-called mixed economy that a coercive monopoly can flourish, protected from the discipline of the capital markets by franchises, subsidies, and special privileges from governmental regulators.
To sum up: The entire structure of antitrust statutes in this country is a jumble of economic irrationality and ignorance. It is the product: (a) of a gross misinterpretation of history, and (b) of rather naive, and certainly unrealistic, economic theories.
As a last resort, some people argue that at least the antitrust laws haven’t done any harm. They assert that even though the competitive process itself inhibits coercive monopolies, there is no harm in making doubly sure by declaring certain economic actions to be illegal.
But the very existence of those undefinable statutes and contradictory case law inhibits businessmen from undertaking what would otherwise be sound productive ventures. No one will ever know what new products, processes, machines, and cost-saving mergers failed to come into existence, killed by the Sherman Act before they were born. No one can ever compute the price that all of us have paid for that Act which, by inducing less effective use of capital, has kept our standard of living lower than would otherwise have been possible.
No speculation, however, is required to assess the injustice and the damage to the careers, reputations, and lives of business executives jailed under the antitrust laws.
Those who allege that the purpose of the antitrust laws is to protect competition, enterprise, and efficiency, need to be reminded of the following quotation from Judge Learned Hand’s indictment of ALCOA’S so-called monopolistic practices.