Remember Adam Smith? I recently did, oddly enough, bouncing along in the cab of a beer truck, the gravel-throated hum of its diesel engine drowning out all other noise (but not so much the thoughts in my head). I recalled Mr. Smith because very little I had thus far seen of the beer distributing company with which I had taken a job seemed rational. But irrationality and inefficiency is never rewarded in the marketplace. So how did they do it? How had they managed to survive in business for over a half-century? It occurred to me that the superficial irrationalities and inefficiencies must belie a deeper competitive rationale than Mr. Smith described in his economic magnum opus comprising the intellectual beginnings of academic economics, The Wealth of Nations.
Mr. Smith published his book in the “watershed year of 1776” as the Wall Street Journal describes it, explaining, in the “About Us” section of the Journal’s opinion page, that defense of the book’s free market principles comprise a part of its reason for being (along with defending Thomas Jefferson’s Declaration of Independence, the simultaneity of publication of the two documents apparently the factor rendering the year a watershed).
Smith reasoned (some might say rationalized) his way to the conclusion that things previously considered bad—like greed and selfishness—could be magically transformed into virtue by the operation of free markets. For Smith, the baker did not bake his bread out of his altruistic impulse to provide bread for the community, but from his own selfish and greedy desires, common to all living creatures, to survive and propagate so far as he was able, yet his selfishness and greed ultimately accrued to the community’s benefit, as the community was supplied with bread baked as efficiently and skillfully as possible. (How exactly the impulse to survive and propagate—the most basic and necessary of all human impulses– came to be viewed as selfish and greedy, i.e., evil, is a story for another day. Suffice to say, it is doubtful our caveman ancestors felt as moderns do about our fundamental biological imperatives, so perhaps it has something to do with the rise of sedentary agriculture).
Smith’s theory is all well and good, so far as it goes, provided the assumptions upon which it is implicitly founded prove valid. Two premises are necessary for Smith’s theory to work in practice: that there exists a competitive, functioning market in which the baker might trade his wares with some expectation of being equitably treated, and that there exist defensible property rights. The latter assumption depends on the ability to defend property interests, which, in a civilized state, depends on there being a governmental entity with a monopoly on the use of force. In most instances in the modern era, this premise is satisfied, and particularly was in Smith’s eighteenth century England.
But the first assumption, that of a competitive market in which the capitalist might trade his wares, is rarely, if ever, a valid assumption to make. And why not? Why can’t a competitive, functioning market be assumed? It is not because the baking of bread naturally trends to monopoly, such as might be said of communications platforms like, e.g., telephone lines, where there is a continually declining or flat unit cost curve—it costs nearly nothing extra to add a customer to an existing phone line, but baking another loaf of bread costs about the same as the first loaf. Baking bread is not a natural monopoly (it might be added that the cost curve for wired telephones is not applicable to cellular phones, where bandwidth gets gobbled up by ever more powerful phones, and thus gets ever more expensive and scarce the more customers are added). Markets that trend to monopoly are often supplied by government (e.g., defense, roads, etc.), and are not the markets of which Smith was musing.
No, Smith’s virtuous capitalist depended for his virtue on the market being characterized as what neo-classical economists call “perfect competition”, meaning there were no officially-sanctioned barriers to entry; there were very few impediments to information gathering for market participants; no market participant enjoyed special favor with the authorities providing the market’s infrastructure; the market’s participants were price-takers, i.e., they had no individual power to determine prices to be paid for their wares, and a corollary, the market was supplied, or potentially supplied, by a multitude of participants. Smith’s baker was virtuous because he had no choice but provide his bread at the lowest possible price if he wished to sell bread. The baker’s forced virtue (Kant would argue there was nothing at all virtuous about the baker’s behavior, as he engaged in it to receive a benefit, but that also, is another story) would benefit the community served by the market, as it enjoyed the lowest possible cost for its bread.
But here’s the problem. Even if markets start out more or less perfectly competitive, every competitor within the market is ceaselessly striving to make them less so. And what better way is there to alleviate the harshness of competition than by soliciting the government to leverage its monopoly on the use of force to quell competitor’s urges? The government could be tasked with raising barriers to entry (e.g., requiring onerous licensing regimes). It could impede the flow or usefulness of information (e.g., granting patents for processes used by existing firms). It could impose a minimum price level, eliminating the strategy most commonly used by upstarts to jar non-competitive firms from their market share. The point is, as soon as Adam Smith’s virtuous capitalist gets the chance, he will try to eliminate his competition, but not necessarily through more efficient operations (which would make him even more virtuous in Smith’s eyes), instead through manipulating government policies to his advantage. The whole of capitalist economic organization depends on a strong government capable of protecting property rights; it takes little imagination to see that capitalists who seek to protect their markets from upstarts (or from the most efficient of their lot) will instinctively seek to deploy their profits to influence the government to divert the power at its disposal for protecting property rights to the task of protecting the capitalist from competitors, both extant and possible. As soon as he is able, Smith’s virtuous capitalist becomes selfish and greedy again, enlisting the aid of the very government which provided the infrastructure he exploited for his initial sanctification. And governments, perfectly capable of understanding from where their ability to extract revenues (taxes) arise ( the profits generated by capitalists), more often than not greedily collude and aid them in their quest to quell competition.
Taking Adam Smith’s ideas to their logical conclusion, in practice if not in theory, a principle of economic regulation resolves to simply this—government sanctioned economic regulations ostensibly intended to protect the public instead operate to protect from competition the businesses purportedly regulated. And this principle points to an even deeper premise—government regulation of economic activity generally accomplishes the exact opposite of its stated intent. Thus a licensing regime for barbers does not protect the public from bad barbers; instead, it protects, if perhaps only moderately and weakly, barbers, bad and otherwise, from the public. A bad barber who is nonetheless licensed has the capacity to remain in business, afflicting the public with bad haircuts a bit longer than the market might otherwise allow when licensing rules create a barrier to entry. Barber licensing laws exist to protect the barbers from competition, not the public from bad haircuts.
More nefarious than barber licensing laws is the sweeping governmental mandate to meddle in markets embodied in the Sherman Antitrust Act and its progeny. The government, by defining “markets” as narrowly or expansively as it pleases, can exact tribute from market participants so unfortunate to be very good at what they do, and usually at the behest of weaker competitors, ostensibly to protect the consumers in the market, but in actual practice, to protect weaker competitors within the market, or strong competitors from without. So it was that the Justice Department initiated a case against IBM in 1969, claiming that IBM had monopolized the market for mainframe computers (when mainframes were the only computers going). The Justice Department (an Orwellian name for a government agency if ever there were one) finally dropped the suit, after many millions of dollars and countless hours spent defending and prosecuting it, in 1982, when the advent of the personal computer made continued prosecution outright ridiculous, even for a government agency like the Justice Department.
Which brings us to the Justice Department’s recent objections to the merger of In Bev and Modelo, the largest brewery in Mexico. Relying on the cockeyed economic theorizing of its lawyers and no actual evidence, the Justice Department claimed that the merger would impair competition in the American beer market. But the combined company would only hold about forty percent of the total market share for beer. While a forty percent share would make it the single biggest brewery in the American market, In Bev, recently merged with Anheuser Busch, already holds the largest market share. Sixty percent of the market, however, is still held by others, not least Miller Coors, still a reasonably close second in market share. And market share is not a static thing. What would be the expected response of Miller Coors to an In Bev price increase of a monopolistic character? Unless Miller Coors is run by imbeciles, if it wished to maximize profits it would hold its prices stable while expanding output to capture market share from In Bev. The cure for high prices is high prices. The cure for monopoly power, though doubtful it would exist with In Bev even after the merger, is its attempted exercise. I found the Justice Department’s objections laughable.
There are protected monopolies in the beer industry, but not at the brewery level, and they exist without objection from the Justice Department. In several of the various states, beer manufacturers must hire local distributors if they wish to sell in the state, and must provide them with exclusive territories for distribution. The Clayton Act, legislation passed in 1914 to clarify the Sherman Act, and denote specific practices as anti-competitive, prohibits exclusive dealing arrangements. The state laws mandating exclusive distribution contracts if a brewery is to sell beer in the state contravenes the plain language of the Clayton Act, and the claimed spirit of federal antitrust law. The state beer distribution schemes very obviously have the potential of increasing prices to the ultimate consumer, as retailers have no choice, if they wish to sell a certain brewery’s products, from where they buy their beer, no matter the price. The beer distributors have effectively and completely contravened Smith’s capitalist model for state-sanctioned agency. The result is not quite socialistic, but is close. It is perhaps best described as crony capitalism, endemic to developed world democracies these days, and a favorite of both Republican and Democratic parties.
It initially seemed quite queer to me to find that one of the two brothers who owned and managed the beer distributor where I recently took a job spent most of his time in Montgomery, lobbying the state legislature. I was further mystified at how the company managed to stay in business, as inefficient and wasteful were its operations, readily apparent to even the most novice of observers. It all made sense when I discovered the company’s “customers” have no choice, if they want to sell Miller Coors products, but to buy them from the company. The waste and inefficiencies and misplaced priorities so clearly evident with the company’s operations could be directly attributable to the company’s state-sanctioned monopoly. No consumer was benefiting by dint of one of Adam Smith’s capitalists acting selfishly. The capitalists were acting selfishly indeed, but their energies were directed not at delivering a superior product or service to a competitive market. Instead, they directed their energies at protecting from competition the market in which they operated by keeping close tabs on their legislative delegation. Their selfishness and greed did not, as Adam Smith surmised would be the case, inure to the benefit of the consuming public. It inured to the benefit of politicians, and the capitalist’s own pockets, but without the necessity of producing a superior product or service. Distributing beer efficiently and effectively is only a secondary, or even tertiary, concern. Of paramount importance is protecting the state-sanctioned monopoly they and other distributors like them had managed to finagle through political machinations.
The lesson here is that Adam Smith’s principle of virtuous greed, though correct in theory, more often than not fails in practice. The very machinery required of the state for creating and defending property rights, rights critical to the capitalist who wishes to trade his goods and services in the marketplace, is too often co-opted for the protection of the capitalist from market competition. The reality fosters a certain stability to capitalism—there is less destruction, creative and otherwise, when the state protects market participants from competition—perhaps counterbalancing somewhat capitalism’s inherent instability as observed by Marx. But stability quickly yields to sclerosis, a characterization applicable to all the developed world economic systems, and to some measure of the markets in the developing world as well.
So say a toast for Adam Smith the next time you tip a frosty one. And try to forget that a bit of what you paid for the beer went to line some politician’s pocket. It’s not Mr. Smith’s fault, except that he gave cover to capitalist pretensions of virtue.