Monday, March 19, 2012

On the Need for Regulation of Oligopoly and Oligopsony

 A modern economy relies on a robust distribution of assets. This distribution of assets is necessary for its distribution of income.  It has a certain ‘shape,’ and the distributed income from these assets is necessary for it to maintain that shape.  Where ownership and control of these assets is narrow, the income from these assets goes to a small portion of the economy, depleting the rest of the economy of the income it needs to maintain itself  Even where there is redistribution, there is loss of efficiency.  While this is recognized with government redistribution, which is why large private interests often oppose it, it also happens with private redistribution, which tends to shortchange vital services which are not easy to extract profit from.   The privately powerful also have other interests in opposing or co-opting government authority, since government is, besides other private interests, the only counter-weight to their own unbridled power.  And this power will not always act in the public interest. Indeed, there is no reason, once it attains a certain magnitude, to imagine that it would act in the public interest, and instead that it would see the public as a source of rent extraction and exploitation.   

Our point is that while regulation may be a matter of justice, it is as importantly a matter of economic stability and efficiency.

There is clearly a need for regulation in monopoly. It is in the interests of the monopolist to produce less and charge more for what is produced, reaping an extra normal profit.  Extra normal profit translates into extra normal growth.  This results in an increase in the share of the economy going to the monopolist.  When the monopoly is small, this is incidental to the economy.  Where large, in proportion to the economy, however, it is insupportable in the long term.   

Just as in monopoly and monopsony, we see a need for regulation in oligopoly and oligopsony, and their combination oligonomy.  (When referring to all or any of them, we’ll use term oligopy, and similarly oligopist.)   The point is that rational behavior for the oligopist is not the best outcome for society. The oligopolist will produce less, and charge higher prices, than at competitive equilibrium.  The oligopsonist will pay less, and buy less, than at competitive equilibrium. Both will reap extra normal profits. The continuing transfer of wealth to the oligopist leads to accumulation and concentration of wealth and power, and a depletion of the wealth from the rest of society, while at the same time shorting the economy of goods and services it otherwise desires and even needs.

But this is not even in the long range interest of the oligopist.  For the oligopist, his market must grow at a rate equal to his own.  But by collecting extra normal profits from his market, his market cannot grow at that rate. His market grows, if at all, at a slower rate, and this rate limits the rate at which the oligopist himself can grow.

An oligopsony reduces the revenue available to producers facing that oligopsony.  Producers cannot sell as much, nor can they get the best prices for what they do sell.  They are thus discouraged from production.  Fewer enter the market.  Production is less reinvested in, becomes undercapitalized, and tends towards obsolete methods. 

When the oligopsony is in labor markets, (and the destruction of labor union power has essentially resulted in such an oligopsony,) it has these effects on the investment in human capital.  There is greater unemployment, greater underemployment, and less investment in education, as the labor force becomes undercapitalized, and tends towards obsolescence.

An oligopoly, where it is a supplier of factors for other producers, (and even finished goods may be regarded as factors for labor,) has the same effect. Because the producer forced to buy his factors from an oligopolist must pay more for those factors than he would if he could buy his goods in a more competitive market.  His product must either be more expensive, sell for more and at reduced quantity, or, if priced the same, sell at reduced profit.  His revenue is reduced.  His ability to capitalize his business is reduced.  Production is less reinvested in, becomes undercapitalized, and tends towards obsolete methods.   

The oligopist, because of his power, finds himself in a situation where he must sacrifice the long range good of society, and thus his own long term interests, for the short run interests of his oligopy.   Putting it the other way, if he were to seek to better serve his society, he must put his firm at disadvantage. The only other option is to cooperate with his fellow oligopists in producing, or buying. to competitive equilibrium,  in price and quantity. But this would entail sacrificing their extra normal profits, and worse, losing market share in the event any of the other oligopists defected, and ceased to cooperate.  (Of course, they could always cooperate to enhance their extra normal profits, to society’s detriment.) The preservation of his society is simply not seen in his best interests. This is a situation he would not be in with more perfect competition, when his interests would be more closely aligned with that of the economy at large.  

And it is a situation of composition.  Where oligopy is a relatively small portion of the economy, the economy can endure the distortions brought about by the abnormal profits of the oligopy.  The rent collected is not so exorbitant that it cannot be compensated for, at least to some degree, by the other operations of the economy.

 It is worse when oligopy is pervasive. Suppose the economy consists, somewhat evenly divided, of oligopy and its market. Then the oligopist is in a quandary.   What can he do with his extra normal profits?  It is pointless to invest in the oligopy’s market, which, limited in profit from facing the oligopy, is restricted in growth.   And it is pointless to invest further in the oligopy, which, because its market is restricted in growth, itself is restricted in growth.   Since there is no profitable investment in the real economy, he seeks to invest in the financial economy.  But the financial economy is also limited by the real economy.  Financial assets must eventually be redeemed for real assets, but since the growth in real assets is arrested by the extra normal profits of oligopy, there is no growth in the real assets for any growth in the financial assets to be redeemed for.  The result is a surplus of money for investment, with no real profitable opportunity.

This is the important point.  Unregulated oligopy, with its extra normal profits, when it becomes extensive, arrests the growth of the entire economy.  Indeed, the situation is actually worse, because by continuing to purge the rest of the economy of its normal income, it can cause the rest of the economy’s revenue to be less than its expenses.  Thus, the remainder of the economy, the oligopist’s market, may actually be forced into contraction.  But this is bad for the oligopist as well. For an oligopolist, it will shift the demand curve left and/or down, thus reducing the optimum quantity, or the price, or both, depending.  In any case, the revenue will be reduced.

With a straight demand curve, shifting it left, down, or left and down, are all equivalent.  With a kinked, or curved, demand curve, these each result in different diagrams, so we have to figure what factors will reduce the price, but not the quantity demanded, and which will reduce the quantity demanded, but not the price, and which both.  We must follow the kink, since that is where the price and quantity will become fixed at. 

If money were taken out of the market for food, say, a good with a relatively inelastic demand, the quantity demanded would probably not change, but the price would decline. The demand curve would shift downward, and pa would decline.   In the food market it would be price deflationary.  In the more elastic market for luxury goods, the quantity demanded would probably change, but maybe not so much the price. qa would shift to the left, but pa would not change so much.  For goods or services in intermediate elasticity, the demand curve would probably shift down and to the left, and both pa and qa would change.   

(And similarly for increases in the demand curve.  The demand curve would shift up for inelastic, right for elastic, or both, depending on the price elasticity of the good or service demanded.)

In analyzing the situation, reducing the economy to just an oligopy and the rest of the economy, the situation then reduces to the producer-consumer problem, with the oligopist in the position of the producer. But of course, the oligopist attains his advantage, and his extra normal profits, not by doing more, but by doing less, and charging more, and paying less.  Rather than contributing his ‘fair share’ for the economy, of ‘pulling his weight,’ he slacks off, and uses oligopistic power to demand more money for what he does contribute, and to pay less for what others contribute.  That is, compared to the rest of the economy, he becomes a net consumer, the consumer of the purchases of his extra normal profits.   So really, it is more accurately described as the strong sector vs. weak sector economy, with the strong sector extracting its rents from the weak sector. See:

We see here, with oligopy, Adam Smith's invisible hand, rather than acting to the benefit of society, acts to its detriment.

So now that we have established the need, the issue becomes what techniques can most efficiently counter the redistributionist tendencies of oligopy.

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