Tuesday, June 26, 2012

Regulating Oligopoly and Oligopsony

Regulating Oligopoly and Oligopsony

Having concluded there was a need to regulate oligopoly and oligopsony, ( http://anamecon.blogspot.com/2012/03/on-need-for-regulation-of-oligopoly-and.html ) we discuss some ways how it might be done. Other suggestions are welcome.

The problem is the oligopolist produces less than the competitive equilibrium, and at a higher price, while the oligopsonist buys less than the competitive equilibrium, and at a lower price.
In dealing with oligopy we wish to decide which oligopies are most damaging.  Those in elastic markets, for instance, would be naturally limited in their ability to extract rents, while those in inelastic markets would have greater opportunity, and given the situation, inclination, to do so.  Similarly, the costs of entry to a market would also set limits on how much extra normal profit could be collected. Low entry costs would limit the extra normal profits to low levels, since higher profits would encourage the entry of other firms into the market.

With damaging oligopy, one way is simply to tax the results. A problem here is getting the receipts back to the damaged parties.  Another problem with this solution is that it would not affect the oligopist’s equilibrium, to produce at higher prices and lower quantity produced than at competitive equilibrium for oligopoly, and to buy at lower prices paid for and a lower quantity than at competitive equilibrium for oligopsony. That is, it would not eliminate bottlenecks in an economy. As may be, this approach would be to tax extra normal profits at a punitive rate, say, 90% of profits over 6% (allowing for a 3% inflation rate.)  The point is, by the time oligopy is manifest, the market is relatively fixed in proportion to the economy as a whole. Yet because of the price scheme of the oligopy, the market is defective in size to the economy, and the rent collected goes into the bank, ie taken out of the economy at large, or goes into buying up assets in the economy at large, increasing the proportion of ownership of the oligop, at the expense of the other members of the economy.  So one would wish to force the oligopy to grow to proportion of and at the growth rate of the economy as a whole.  (This is a mature market problem, not a growing market one.  It is not a problem of a company expanding into an open market, such as Apple, with its product innovations.  Extra normal profits here can still be a problem to an economy, and lead to alterations in the distribution of wealth and power.  But the reinvestment of extra normal profits in plant is also necessary to expand production to meet the demand a smaller company cannot reasonably fulfill.) 

What is desired is that normal profits are allowed to be reinvested in the oligopy, while extra normal profits are returned to the economy at large.  In oligopoly, one might gear the tax to be scaled at 6% on profit per unit produced, (with a 3% nominal rate of inflation, and a 3% rate of growth.). This would be effectively a progressive VAT, or value added tax, on the ologopoly.  This would incentivize the oligopolist to produce to competitive equilibrium, since the maximum profit would then be proportional to quantity produced. (Actually this by itself wouldn’t quite work, as the oligopolist would just be encouraged to internalize costs, so as to reduce his ‘profit’ to the 6%.)   

Another is to institute price floors in the case of oligopsony, or price ceilings in the case of oligopoly, at what one would hope to be nearer the equilibrium price for a perfectly competitive market. One example of price floors, with oligopsonies, is with minimum wage laws.

A problem here seems to be that one loses the use of price signals, although this is actually not a problem with oligopy, since the quantity traded is no longer responsive to prices anyhow.  Or more correctly, the price becomes fixed, and unresponsive over a large variation of economic conditions. In any case, over a large variation, price and quantity do not respond to the demands of the economy. While these price levels could just be legislated, probably a more efficient method would be a competitive buyer, in the case of oligopsony, or a competitive producer, in the case of oligopoly.  In the case of oligopoly, another option might be to subsidize production.  This option, subsidizing production, would fail, however, in all cases but the mildest kinks, that is, where there were numerous competitors in the oligopoly, (or hardly like an oligopoly at all.)  This is because, with a severe kink, the vertical part of the Marginal Cost MC curve extends through the price axis, or at least very close, and thus all or most of the cost of production would have to be subsidized in order to encourage an increase in quantity produced.  Otherwise, the quantity for profit maximization would not change. This would still be useful, in cases like health care, where the goal was universal coverage.  See: http://anamecon.blogspot.com/2010/03/real-problem-with-health-care-in-us.html

Similarly, just buying up large quantities from the oligopoly would be very expensive, since you would be buying at the oligopolist’s price, and providing him his extra normal profit, as is in fact the current US government policy with respect to the health care industry.  Policy should be to force the oligopolist to sell at a price nearer the equilibrium price.  Again, the situation with health care is different, since if you want universal coverage, you want to drive the oligopolist’s price to near zero, and to do so must effectively subsidize the entire production.  That is, make health care a public good. 

In the case of oligopsony, by competitive, we mean a buyer who buys sufficient goods to drive the price up to what it would be under competitive equilibrium.  This buyer would constitute a regulator.  And what would the signals be, that this regulator would look for?  He would seek a normal profit for suppliers. (This assumes that for firms facing the oligopsony, there is no barrier to entry.  If there were such a barrier, we would expect the situation to evolve into one of oligopoly facing oligopsony. Does such a market exist at a competitive equilibrium?  It would seem to depend on the relative elasticities of the supply and demand.)

One way this might be shown would be an equilibrium in firms entering and leaving the market.  This shows how the quantity of suppliers might also be regulated. By increasing the price and quantity bought, firms would be encouraged to enter the market.  By reducing the price and quantity bought, firms would be encouraged to exit the market.

The idea of government being a last resort buyer of labor suggests an alternative to minimum wage laws.  The government would enter the labor market and act as a monopsonist, and bid up wages until the unemployment rate was down to desired levels.  Private industries would have to pay this rate also, or lose employees to the government.

The situation would seem to be more difficult with oligopoly.  The problem with the government producing to competitive equilibrium is that governments are notorious for producing inferior products.  Another problem, as in agriculture and education, is what the government actually does.  That is the government subsidizes production into the face of oligopsonies.   This results in producing a surplus of goods into a buyers market, driving down the prices.  (Indeed, the prices have been driven down so low, in the case of education, that buyers, the institutions of higher education, must be paid to accept most of the production of public education. The prices are negative.  This is an alternative way of looking at the distribution of pricings and cost burdens in education.  On the other end, businesses refuse to pay the universities for the production of the universities, their graduates.  They do not send clear signals as to what they want, except in a few career specific employment and unemployment rates. 

One way to rein in oligopoly is to promote the production of substitute goods.  The development and subsidy of alternative energy sources, for instance, would moderate the action of oil and coal oligopolists, which is one of the reasons they oppose alternative energy sources so fiercely.
As another alternative, the government could employ the aggressive use of anti-trust legislation, to prevent the formation of oligopoly. Probably a figure of providing 20% of the market would constitute a member of an oligopoly.  Thus, keeping firms below that size would prevent the kink from becoming too pronounced.  A problem arises, when the oligopoly faces oligopsony, or monopsony, as in retail supermarket chains, with their limited shelf space.   By hindering one, one encourages the other, and oligopsony can be as socially destructive as oligopoly.   

Another possible solution is to separate the functions of the oligopy, making one part into a quasi-utility, and eliminating costs of entry to the other function.  Thus, for instance, (as was done with British rail) providers of cable TVcould be separated into parts, one which merely operated and maintained the cable, and the other which provided the content, paying the operators of the cable a fee.  The operator would be a regulated monopoly, and the content providers would be competitive, the costs of entry, one of the prerequisites for oligopoly, minimized.  The same could be done with cell phones, the towers being regulated, and selling their bandwidth, which they would seek to maximize, for a fee.

Health care in the US is an instance of oligopoly. Actually it is an instance of several different oligopolies.  One is medical equipment supply.  Another is pharmaceutical supply.  Locally hospitals form oligopolies.  (Hospitals are an obvious choice for regulated utility.)  Finally, a limited supply of doctors and other medical personnel creates an effective oligopoly to health care consumers.   Production of health care is restricted, driving up prices. Buying from the oligopoly will not change this, and indeed can be expected to further drive up prices. 

For industries requiring a high level of maintenance of resources, such as farming, further regulation might be required of producers, to prevent depletion of assets in efforts to temporarily acquire extra normal profits.  Progressive taxation would be helpful here, since it increases the present value of future returns, rather than exploitation of the resource for immediate returns.

Wednesday, June 13, 2012

Milton Friedman: "The Social Responsibility of Business is to Increase its Profits," is Wrong

Milton Friedman, "The Social Responsibility of Business is to Increase its Profits," is wrong.

In his famous article, “The Social Responsibility of Business is to Increase its Profits,” (originally published in the New York Times Magazine September 13, 1970, see eg:http://www.colorado.edu/studentgroups/libertarians/issues/friedman-soc-resp-business.html) Milton Friedman quotes himself from his book Capitalism and Freedom:

"there is one and only one social responsibility of business–to use it(s) resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”

This is his concluding line in an article dedicated to denigrating the idea of “social responsibility” in businesses, and in particular by corporate executives. For a corporate executive to act in a “socially responsible” manner, Dr. Friedman posits that “it must mean that he (the corporate executive) is to act in some way that is not in the interest of his employers.”  That is, any act, (not geared to maximizing profits,) in excess of the minimum required by law and custom is not in the interests of his employers. 

His conclusion is at least na├»ve.  Clearly, a business can increase its profits if  “it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud."  How much easier, though, to maximize its profit by externalizing all costs, by capturing and corrupting government, and altering the rules of the game to its convenience?  How much easier to profit by eliminating free and open competition, and legalizing deception and fraud? 

Dr. Friedman criticizes the 'socially responsible' postures taken by executives in and prior to 1970.  He further condemns socially responsible behavior by smearing it with the ‘socialist’ paint brush:   ”This is the basic reason why the doctrine of "social responsibility" involves the acceptance of the socialist view that political mechanisms, not market mechanisms, are the appropriate way to determine the allocation of scarce re­sources to alternative uses.”  Here Dr. Friedman makes no compromise. He essentially claims that market mechanisms are the only way to determine the allocation of scarce resources, denying any limitation to or failure of markets, or any use for political mechanisms of allocation.  But pollution control, and work place safety, are political allocations of resources, and ones which would be opposed by market mechanisms.  The failure of the market in the US to provide universal health care is another case in point, assuming universal healthcare is desired by a majority of the people.  

Milton Friedman's claim that the sole social responsibility of business is to increase its profits, places businesses into an adversarial relation to society.  That is, businesses become the enemies, the exploiters, of the society of which they are a part.  The logical conclusion of Dr. Friedman’s statement is that it is not a part of the social responsibility of business to behave in a socially responsible manner.  His implication, although I don’t think he realized this, is indeed quite the opposite, that a business should behave in a socially irresponsible, and even socially destructive, manner, if this increases its profit. This position is schizophrenic.  It is as if the hand was encouraged to act against the interests of the body of which it was a part.

There are ways of increasing a business’ profits which are damaging to the society of which it is a part. Indeed, it is a tendency of business to seek to externalize all costs. Thus, to pollute, to ignore worker safety regulations, to engage in mis-representation if not fraud, etc. If the business is in competition, and these things are permitted, it must do them, since its competitors, similarly situated, will also do these things.  Its competitors, if allowed to externalize costs by polluting, will do so, and so it must also.  Its competitors, if allowed to externalize costs by skimping on worker safety, will do so, and so it must do so also.  Further, business will seek subsidies by the government, and taxes by the government on its competition.

The conclusion of Dr. Friedman’s position implies the necessity that the corporate executive act without conscience.  This is necessary, since any operation of conscience within the confines of the executive’s office would be contrary to the profit maximization principle under which the executive, as an employee of the owners, is obliged to operate.  Indeed, profit maximization obligates the corporate executive to pollute and otherwise externalize all costs, so far as practically permitted, and to undertake the corruption of the regulating bodies, that is the corruption of government. 

But where is the root of his error?  Consider this quote from the article: “Society is a collection of individuals and of the various groups they voluntarily form.”  Society is hardly a mere collection.  It is dynamic, and its dynamic is non-linear. Society is not merely the collection of individuals, or even the mere collection of their actions.   The effect of everybody doing a thing, is quite different from the effect of just one or a few persons doing that thing.  Society is more than the sum of its parts. A business is more than the sum of its parts.  And the actions of businesses, and the other parts of society, combine in non-linear, and synergistic ways. There are returns of scale, and greater returns on the scale of integration of an entire society.  A business unconcerned with these interactions does society, and itself, disservice.  Dr. Friedman’s conception serves to atomize and divide, and reduce those social returns to scale, impoverishing society.  This is what we have seen, in the triumph of his error, and the rise of those who subscribe to it.

Consider instead a purely operational, and self-interested, definition of conscience: seeking to do that which is ultimately best for one’s self:  Seeking the larger good, with the expectation that one’s own welfare will be improved if that larger good is enhanced.  We do assume that the executive is interested indeed in maximizing the profits of his company. Then a goal of the business executive is the optimization of his society, (and by optimizing we can here mean purely maximizing the economy's growth rate,) since in an optimum society, his corporation itself is optimized, and in the long run, its profits maximized.  Thus, the executive with conscience will seek to participate in, and encourage the development of, a well regulated market, one which will enhance the value of his business to society, since in such a market growth is optimized for all businesses.  Therefore, rather than corrupting the regulators, he will seek regulation which maximizes the efficiency of resource allocation. Rather than competing in a race to the bottom, he will seek effective regulation that will encourage all businesses to good behavior. The business man of conscience, therefore, will speak out against corruption, and the capture of government by other businesses. As this will be in his own long term best interest.

The corporate executive’s duty to his employers is not uncritical obedience to the principle of short term profit maximization. Long term maximization requires the long term survivability of the society of which it is a part. 

Neither do the owners enjoy all incidents of property.  Ownership of property in any society is not an absolute.  It entails duties.  Society, and its government, retain the most important incidents of property, and this implies the obligation of the owners to ”socially responsible” behavior.   All individuals in society, by voluntary agreement, undertake this. 

While it is beneficial for each business to pursue its narrow interests, even to act in an unethical manner, (which Dr. Friedman in the larger sense implies is OK as long as it is within ‘the ‘rules of the game,’) it is bad for each business if all businesses act so.  Where all businesses sacrifice the larger good, sacrifice their ‘responsibility to society,’ for their narrower interests, all are poorer, and all lose. Where all businesses sacrifice the larger good, the larger good contracts.   

Even the winners lose. Therefore, it is in the interests of each business, to see that other businesses act in an ethical manner.  Thus, that the business exists in a well regulated market, and not a corrupt, environment.

We take Dr. Friedman to his logical conclusion, and that business indeed exists in an adversarial relationship to society, that its ultimate interests are contrary to the interests of society.  Then there is no intrinsic restriction to its activities in that society:  There is no limit on the things it can, or should, do, to gain profit. So business should seek to capture government,  and seek to ‘free’ itself from the constraints of regulation, and mitigate or corrupt that regulation.  Then when business captures government, and corrupts regulation, it must be that the government also acts contrary to the interests of society.  Therefore, it is in the interests of society, that the separation of business and state remain inviolate.  The Supreme Court’s decision Citizens United, therefore, must be considered inimical to society, at the least a terrible mistake, and those who support it, and profit by it, society’s enemies.

Clearly, it is in the interests of failing executives, and failing businesses, to corrupt government, and to legitimize deception and fraud.  Failing at production, they seek success through corruption.  Instead it is in the interests of successful executives and businesses to seek a well-regulated environment, and good government.

Society is captured by men who do not believe that the larger good is to their benefit, and therefore seek their own narrower self-interests, to the destruction of the larger good, and ultimately their own.

That our government is captured by executives and businesses, many of which would otherwise fail, that is to say, are not producers in any real economic sense, and so could not compete in a free and open market, bodes ill.   

Executives and corporations have taken Dr. Friedman's statement to heart.  His prescriptions have, so far as they have been carried out, done untold damage to the economy.