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The report of the Competition Commission to outline a new Competition Law to replace the old monopolies and merger legislation is shortly to be published. But before the government rushes to embrace its recommendations a more fundamental question needs to be asked, namely is there any need for any competition law?
To the layman, as well, unfortunately, for many economists the answer is an obvious 'yes', but as my UCLA colleague Harold Demsetz has cogently argued this view is based on many misconceptions and needs to be rejected. The confusion is best seen by recognising as historians of economic thought from Schumpeter to Blaug have noted that, there has been a subtle shift from the notion of 'free competition' of the classics- from Adam Smith to Marshall- to that of 'perfect competition' of modern general equilibrium theorists. The rot started with Cournot and his delineation of the theoretical limiting case of pure monopoly, with the marginalists outlining the other limiting case of perfect competition. But these are purely theoretical benchmarks; actual business behaviour does not correspond to either extreme. As Schumpeter put it in his History of Economic Analysis: "instead of considering the[se] hybrid cases [of actual business behaviour] as deviations from, or adulterations of, the fundamental ones we may also look upon the hybrids as fundamental and pure monopoly and pure [perfect] competition as limiting cases in which the content of actual business behaviour has been refined away"(p.975)
While most people will be able to see the notion of perfect competition with all producers as price-takers facing perfectly elastic sales curves for their outputs, as clearly Utopian- a theoretical curiousom, many, including for instance Jawaharlal Nehru and other Third World leaders, find the view propounded by socialist thinkers like R.H.Tawney that, a market economy will inevitably be dominated by monopolies, plausible.
Not least because there is almost an atavastic fear of Big Business. It was this populist feeling which was mobilised in the passage of the Sherman Anti-trust act in the US at the turn of the last century, and which has cast a long shadow subsequently on even market economies. But is this view right?
Demsetz has cogently argued (see his The Organization of Economic Activity, vol.1) that there are two beliefs about monopoly. The first goes back to Adam Smith who argued that a monopoly can only arise because of government action which prevents potential rivals from competing- as was the effect of India's past industrial licensing regime and import controls.
The second is a purely theoretical construct which assumes that monopoly power exists without explaining how monopoly power is exercised and maintained. The presumption that market concentration will lead to monopoly profits following the work of Bains, has been thoroughly discredited by more recent empirical work, which also acquits the usual culprits- economies of scale, indivisibilites of capital and advertising- as sources of barriers to entry which could allow monopoly power to be exercised. Moreover, the recent theory of 'contestable markets' propounded by Baumol and associates shows that, even with scale economies limiting the number of firms that can service a particular market, as long as potential rivals can contest the 'monopoly', even a single eventual incumbent's pricing and output need not diverge from the competitive outcome. The only rents such a 'monopolist' can acquire are the sunk costs of firm-specific assets essential for production. So monopolies in the real world must- as Smith maintained- ultimately depend upon government support. In the absence of such public protection, even in industries where only one firm survives there is no presumption that its behaviour will be monopolistic. Hence the very notions of 'dominant position' and even more so 'its abuse' so beloved of competition and anti-trust lawyers are meaningless.
Similarly, the theoretical benchmark of perfect competition, which is usually used to justify 'competition' and anti-trust laws, besides being Utopian is also misleading about the nature of competition in a real world economy. Efficient economic performance does not only depend upon the imitative competition emphasised by perfect competition, where a large number of firms produce and supply identical goods. It also depends upon the innovative competition, particularly of the creatively destructive type, emphasised by Schumpeter. Most innovations are like a race in which the 'winner takes all'. The existence of patents and other devices to prevent imitative competition allows the winners in innovative competition to secure a big payoff for their innovative effort. Thus in a dynamic market economy there will be many dimensions of competition- some as with the imitative competition of perfect competition requiring a large number of firms in an industry, others as in innovative competition perhaps only one. Given the incommensurability of these different dimensions of competition, in an efficient dynamic economy there can be no single measure of competitiveness such as market concentration to judge its efficiency.
Nor will 'rate of return' or 'price cap' regulations so beloved of the anti-trust industry ensure competition at large. For, if besides imitative, there is also innovative competition, actual competition will always have some elements of a contest in which some economic agents win and others lose. It would be inappropriate to judge the intensity of competition of such a contest by the ex post rate of return to the winner. This would be like judging the rate of return to investment in a lottery by the returns only of the winners, forgetting the wagers lost by the losers. So if a proper rate of return for the innovative elements of competition were to be calculated it would have to include the costs of all those who competed to become incumbents and lost. But such a meaningful rate of return will be impossible to calculate in practice.
Given, these powerful arguments against any anti-trust or 'competition' laws, why do most advanced economies nevertheless have them? The answer is the example of the dominant economy- the US. But its Sherman Act was the result of populism, and its economic rationale as I have tried to show is in shreds. Its continuance and attraction for other governments shows the final danger in going down this route. As a large amount of research in the US has shown (see G.Stigler:Chicago Studies in Political Economy) regulatory agencies are inevitably captured by the companies being regulated, so that such regulations instead of promoting competition create government mediated barriers to entry which nurture monopolies. Combined with the self-interest of the anti-trust lawyers and industrial organisation academics then called in to service this state 'industry', there is a powerful coalition of rent-seeking interests which will prevent its demise. As India is only gradually escaping from the rent-seeking society created by Nehruvian planning it will be a disaster if it merely exchanges it for one based on regulation.
Our conclusions can be brief. Adam Smith was right. To ensure effective competition the government needs only to get rid of regulations on business both big and small. The best pro competition and anti- monopoly policy for a developing country like India is free trade. By totally rejecting the rent-seeking recommendations of the Competition commission- dominated by lawyers and bureaucrats-for any competition law, the government will not only strike a blow for the dynamic efficiency of the Indian economy but also blaze a global trail - much as Lady Thatcher did with privatization- based on sound economic principles.
* This article is based on Chp.5 of the author's Unfinished Business, Oxford University Press, New Delhi.