The Ambiguity of Competition

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In our view, the best explanation for the continuing confusion about the degree of monopoly in the economy is due to what we call the “ambiguity of competition.” This refers to the opposite ways in which the concept of competition is employed in economics and in more colloquial language, including the language of business itself. It is best explained by Milton Friedman, in his conservative classic Capitalism and Freedom, first published in 1962, Friedman writes:

Competition has two very different meanings. In ordinary discourse, competition means personal rivalry, with one individual seeking to outdo his known competitor. In the economic world, competition means almost the opposite. There is no personal rivalry in the competitive market place. There is no personal higgling. The wheat farmer in a free market does not feel himself in personal rivalry with, or threatened by, his neighbor, who is, in fact, his competitor. No one participant can determine the terms on which other participants shall have access to goods or jobs. All take prices as given by the market and no individual can by himself have more than a negligible influence on price though all participants together determine the price by the combined effect of their separate actions.22

Competition, in other words, exists when, because of the large number and small size of firms, the typical business unit has no significant control over price, output, investment, which are all given by the market—and when each firm stands in a non-rivalrous relation to its competitors. An individual firm is powerless to intervene in ways that change the basic competitive forces it or another firm faces. The fate of each business is thus largely determined by market forces beyond its control. Such assumptions are given a very restrictive and determinate form in neoclassical economic notions of perfect and pure competition, but the general view of competition in this respect is common to all economics. This is the principal meaning of competition in economics.

Yet, as Friedman emphasizes, the above economic definition of competition conflicts directly with the way in which the concept of competition is used more generally and in business analyses to refer to rivalry, particularly between oligopolistic firms. Competition in the business sense of rivalry, he says, is “the opposite” of the meaning of competition in economics associated with the anonymity of one’s competitors.

The same problem arises exactly the other way around with respect to what is taken to be the inverse of competition: monopoly. As Friedman states: “Monopoly exists when a specific individual or enterprise has sufficient control over a particular product or service to determine significantly the terms on which other individuals shall have access to it. In some ways, monopoly comes closer to the ordinary concept of competition since it does involve personal rivalry” (italics added).23 In economic terms, he is telling us, monopoly can be said to exist when firms have “significant” monopoly power, able to affect price, output, investment, and other factors in markets in which they operate, and thus achieve monopolistic returns. Such firms are more likely to be in rivalrous oligopolistic relations with other firms. Hence, monopoly, ironically, “comes closer,” as Friedman stressed, to the “ordinary concept of competition.”

The ambiguity of competition evident in Friedman’s definitions of competition and monopoly illuminates the fact that today’s giant corporations are closer to the monopoly side of the equation. Most of the examples of competition and competitive strategy that dominate economic news are in fact rivalrous struggles between quasi-monopolies (or oligopolies) for greater monopoly power. Hence, to the extent to which we speak of competition today, it is more likely to be oligopolistic rivalry, i.e., battles between monopoly-capitalist firms. Or to underline the irony, the greater the amount of discussion of cutthroat competition in media and business circles and among politicians and pundits, the greater the level of monopoly power in the economy.

What we are calling “the ambiguity of competition” was first raised as an issue in the 1920s by Joseph Schumpeter, who was concerned early on with the effect of the emergence of the giant, monopolistic corporation on his own theory of an economy driven by innovative entrepreneurs. The rise of big business in the developed capitalist economies in the early twentieth century led to a large number of attempts to explain the shift from competitive to what was variously called, trustified, concentrated, or monopoly capitalism. Marxist and radical theorists played the most prominent part in this, building on Marx’s analysis of the concentration and centralization of capital. The two thinkers who were to go the furthest in attempting to construct a distinct theory of monopoly-based capitalism in the early twentieth century were the radical American economist Thorstein Veblen in The Theory of Business Enterprise (1904) and the Austrian Marxist Rudolf Hilferding in his Finance Capital (1910). In his Imperialism, The Highest Stage of Capitalism Lenin depicted imperialism in its “briefest possible definition,” as “the monopoly stage of capitalism.”24 The Sherman Antitrust Act was passed in the United States in 1890 in an attempt to control the rise of cartels and monopolies. No one at the time doubted that capitalism had entered a new phase of economic concentration, for better or for worse.

In 1928 Schumpeter addressed these issues and the threat they represented to the whole theoretical framework of neoclassical economics in an article entitled “The Instability of Capitalism.” “The nineteenth century,” he argued, could be called “the time of competitive, and what has so far followed, the time of increasingly ‘trustified,’ or otherwise ‘organized,’ ‘regulated,’ or ‘managed,’ capitalism.” For Schumpeter, conditions of dual monopoly or “multiple monopoly” (the term “oligopoly” had not yet been introduced) were much “more important practically” than either perfect competition or the assumption of a single monopoly, and of more general importance “in a theoretic sense.” The notion of pure competition was, in fact, “very much in the nature of a crutch” for orthodox economics, and due to overreliance on it, the undermining of economic orthodoxy was “a rather serious one.” Trustified capitalism raised the ambiguity of competition directly: “Such things as bluffing, the use of non-economic force, a will to force the other party to their knees, have much more scope in the case of two-sided monopoly—just as cut-throat methods have in the case of limited competition—than in a state of perfect competition.”

Schumpeter’s own solution to this in “The Instability of Capitalism” (and much later in his 1942 Capitalism, Socialism, and Democracy) was to introduce the concept of “corespective pricing.” This meant that the giant firms in a condition of “multiple monopoly” (or oligopoly) acted as corespectors, determining their actions in relation to those of others, deliberately seeking to restrict their rivalry, particularly in relation to price, by various forms of collusion, in order to maximize group advantage.25 Yet there was no hiding the fact that such a solution constituted a serious “breach” in the wall of economics, introducing a notion of the basic economic unit that was foreign to the entire corpus of received economics in both its classical and neoclassical phases.26

This breach in the established doctrine was only to widen in subsequent decades. In mainstream economics the theory of imperfect competition introduced almost simultaneously by Joan Robinson and Edward Chamberlin in the 1930s, dealt not only (or even mainly) with oligopoly but rather emphasized the influence of monopolistic factors of all kinds in firms at every level, particularly in the form of product differentiation.27 It was found that monopoly elements were much more pervasive in the economy than the orthodox neoclassical analysis of perfect competition allowed. Sweezy developed the most influential theory of oligopolistic pricing, known as the “kinked-demand curve” analysis in 1939. He argued that there was a “kink” in the demand curve at the existing price such that oligopolistic firms would find themselves facing competitive price warfare, and hence would experience no gain in market share if they sought to lower prices, which would then only squeeze profits.28 These contributions to imperfect competition theory constituted an important qualification to conventional economics. Yet they were largely excluded from the core analytical framework of orthodox economics, which continued to rest on the unrealistic and increasingly preposterous assumptions of perfect competition, with its infinitely large numbers of buyers and sellers. Hence, small firms, able to enter and exit freely from industries, enjoyed perfect information, and produced homogeneous products.29

The essential challenge facing neoclassical economics, in the face of the rise of the giant, monopolistic or oligopolistic firm, was either to hold on to its economic model of perfect competition, on which its overall theory of general equilibrium rested, and therefore forgo any possibility of a realistic assessment of the economy—or to abandon these make-believe models in favor of greater realism. The decision at which neoclassical theorists generally arrived—reinforced over and over throughout the twentieth century and into the twenty-first century—was to retain the perfect competition model, despite its inapplicability to real world conditions. The reasons for this were best stated by John Hicks in his Value and Capital(1939):

If we assume that the typical firm (at least in industries where the economies of large scale are important) has some influence over the price at which it sells…[it] is therefore to some extent a monopolist…. Yet it has to be recognized that a general abandonment of the assumption of perfect competition, a universal adoption of the assumption of monopoly, must have very destructive consequences for economic theory. Under monopoly the stability conditions become indeterminate; and the basis on which economic laws can be constructed is therefore shorn away….
It is, I believe, only possible to save anything from this wreck—and it must be remembered that the threatened wreckage is the greater part of [neoclassical] general equilibrium theory—if we can assume that the markets confronting most of the firms with which we shall be dealing do not differ very greatly from perfectly competitive markets…. Then the laws of an economic system working under perfect competition will not be appreciably varied in a system which contains widespread elements of monopoly. At least, this get-away seems well worth trying. We must be aware, however, that we are taking a dangerous step, and probably limiting to a serious extent the problems with which our subsequent analysis will be fitted to deal. Personally, however, I doubt if most of the problems we shall have to exclude for this reason are capable of much useful analysis by the methods of economic theory.30

The choice economists faced was thus a stark one: dealing seriously with the problem of monopoly as a growing factor in the modern economy and thus undermining neoclassical theory, or denying the essential reality of monopoly and thereby preserving the theory—even at the risk of taking the “dangerous step” of “limiting to a serious extent the problems” with which any future economics would be “fitted to deal.” Establishment economic theorists have generally chosen the latter course—but with devastating consequences in terms of their ability to understand and explain the real world.31

In the United States in the 1930s, the issues of economic concentration and monopoly took on greater significance in the context of the Great Depression, with frequent claims that administrative prices imposed by monopolistic firms and restraints on production and investment had contributed to economic stagnation. The result was a large number of studies and investigations in the period, including Adolf A. Berle and Gardiner C. Means’s seminal The Modern Corporation and Private Property (1932) on concentration and the managerial revolution, and Arthur Robert Burns’s forgotten classic, The Decline of Competition (1936), addressing the effective banning of price competition in oligopolistic industries. These studies were followed by hearings on economic concentration conducted by the Roosevelt administration’s Temporary National Economic Committee, which, between 1938 and 1941, produced forty-five volumes and some thirty-three thousand pages focusing, in particular, on the monopoly problem.32 After the Second World War, additional investigations were conducted by the Federal Trade Commission and the Department of Commerce. In the words of President Roosevelt in 1938, the United States was experiencing a “concentration of private power without equal in history,” while the “disappearance of price competition” was “one of the primary causes of our present [economic] difficulties.”33

In his 1942 Capitalism, Socialism, and Democracy, Schumpeter famously responded to these New Deal criticisms of monopoly by trying to combine realism with a defense of “monopolistic practices,” viewed as logically consistent with competition in its most important form: “the perennial gale of creative destruction,” or what Marx had called the “constant revolutionizing of production.” Schumpeter argued that what mattered most were the waves of innovation that revolutionized “the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.” Yet such creative destruction, he recognized, also led to consolidation of capitals.

Pointing to oligopolistic industries, such as U.S. automobile production, he contended that “from a fierce life and death struggle three concerns emerged that by now account for over 80 per cent of total sales.” In this “edited competition,” firms clearly enjoyed a degree of monopoly power, behaving “among themselves…in a way which should be called corespective rather than competitive.” Nevertheless, such oligopolistic firms remained under “competitive pressure” from the outside in the sense that failure to continue to innovate could lead to a weakening of the barriers to entry, protecting them from potential competitors. It was precisely innovation or creative destruction that made the barriers surrounding the giant monopolistic firms vulnerable to new competitors. Indeed, if there were a fault in the giant corporation for Schumpeter, it lay not in “trustified capitalism” per se, but rather in the weakening of the entrepreneurial function that this often brought about.34

But it was John Kenneth Galbraith who best voiced the public sentiment with respect to monopoly and competition in the post-Second World War United States. Galbraith led the heterodox liberal assault on the conventional view in three influential, iconoclastic works:American Capitalism (1952); The Affluent Society (1958); and The New Industrial State (1967). Significantly, he launched his critique in American Capitalism with the concept of the ambiguity of competition. In neoclassical economics, the very rigor of the concept of competition was the Achilles heel of the entire analysis. This was best explained, he argued, by quoting Friedrich Hayek, who had insisted: “The price system will fulfill [its] function only if competition prevails, that is, if the individual producer has to adapt himself to price changes and cannot control them.” It was this definition of competition, as used by economists, Galbraith contended, that led him to comment:

There is an endless amount of misunderstanding between businessmen and economists. After spending the day contemplating the sales force, advertising agency, engineers, and research men of his rivals the businessman is likely to go home feeling considerably harassed by competition. Yet if it happens that he has measurable control over his prices he obviously falls short of being competitive in the foregoing sense. No one should be surprised if he feels some annoyance toward scholars who appropriate words in common English usage and, for their own purposes, give them what seems to be an inordinately restricted meaning.35

Galbraith argued that the typical industry in the United States was now highly concentrated economically, dominated by a handful of “very, very big corporations.” As long as the firms in the economy could be viewed in “bipolar classification” as consisting of either perfect competitors (small and numerous, with no price control) or monopolists (single sellers—a phenomenon practically nonexistent), the ideal competitive model worked well enough. But once oligopoly or “crypto-monopoly” was recognized as the typical case, all of this changed. “To assume that oligopoly was general in the economy was to assume that power akin to that of a monopolist was exercised in many, perhaps even a majority of markets.” Prices were no longer an impersonal force, and power and rivalry could no longer be excluded from economic analysis. “Not only does oligopoly lead away from the world of competition…but it leads toward the world of monopoly.”36

The reality-based view of monopoly had considerable currency in the postwar decades, even in economics departments, as Keynesians and liberals enjoyed prominence. Harvard economist Sumner Slichter, a free market advocate, lamented that “the belief that competition is dying is probably accepted by a majority of economists.”37 How much influence it had over government antitrust policies is another matter, but it is striking that a leading scholar and critic of monopolistic markets, John M. Blair, served as the chief economist for the Senate’s Subcommittee on Anti-Trust and Monopoly from 1957 to 1970. Blair was somewhat disappointed with the government’s inability to arrest monopoly power during these years, but in retrospect it seems like a period of robust public interest activism, compared with the abject abandonment of antitrust enforcement that began in the 1980s.38