Without Market Imperfections There Would Be No Market Process – And No Economic Progress

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Among the errors frequently made by people who see real and relevant market power as being widespread is a failure to appreciate at least two features of reality in a market economy:

(1) the largeness of the number of margins in reality on which people who are in exchange relationships with each other can adjust. (For example, the higher rent asked by the landlord might be accepted by tenants if and only if the landlord improves the apartment-building’s security against thieves; both landlord and tenants might be made better off by this new arrangement.)

(2) the intensity and ubiquity of competitive forces. If higher-than-normal profits are being earned today by some market incumbents, existing or newly created rivals have strong incentives to devise ways to capture for themselves some of those profits by offering better deals to those people off of whom the higher-than-normal profits are currently being earned. The people off of whom the higher-than-normal profits are currently being earned need not themselves take the initiative to improve the market in their favor.

The initiative to improve the market can be – and I’m quite confident is typically – taken not by the people off of whom existing firms are today earning higher-than-normal profits but, rather, by existing and potential rivals of those firms. Workers who are today paid less than the value of their marginal products need not ever know this fact and, indeed, many or most of them might also be stuck in narrow geographic locales (e.g., the City of Fairfax, Virginia). No matter: other firms in the region – whether existing or newly formed – have incentives created by the excessively low pay itself to hire these workers away from their current employers by making known to these workers the existence of, and by offering to these workers, better employment deals. Ditto with prices and product qualities in output markets. The initiative to improve the market comes mostly from profit-seeking entrepreneurs rather than from consumers and workers.

So unless an incumbent firm enjoys a special privilege against competition granted by government (or by some other force-wielding outfit), that incumbent firm enjoys nothing that is reasonably called “market power.” Careful students of economic history have no trouble seeing this reality, as nearly all of the firms in the past that were Exhibit “A”s of market power – firms such as Standard Oil, Swift’s meatpacking firm, American Tobacco, U.S. Steel, A&P, Alcoa, IBM, and Microsoft – never possessed the power to make consumers or workers worse off over time. Yes, each of these firms had (or has) the power to harm consumers and their workers today because adjustments by consumers and responses by existing and potential rivals take time. But the history of these firms shows that, as long as they got no special privileges from government, they acted as though they were under constant threats of being out-competed. These firms therefore constantly improved their products and expanded their product offerings, improved the efficiency of their operations, and lowered prices to consumers. And none of these firms, as far as I’m aware, ever had any difficulties expanding their workforces, which is a pretty good sign that these firms did not generally underpay their workers.

The term “market power” is one of the most unfortunate ever devised and deployed by economists. It is a static concept, Conclusions that it exists are almost always drawn from the practice of taking a snapshot of the market or industry situation today (that is, at a given point in time) and then inferring from nothing more than this snapshot that this situation will last into the indefinite future. Yet because at any given time some firms and industries are waxing while others as waning, some firms and industries at any given time will have “market power” as economists unhelpfully define that concept. Fortunately, the business people actually participating in the market process ‘see’ what the typical economist does not – namely, that the market process isn’t a snapshot but, rather, a motion picture. Today’s situation gives rise to tomorrow’s corrective responses – a reality that causes most business people today to act today as if they do not possess the “market power” today that the economic textbooks say that they possess today.

It is precisely today’s market ‘failures’ that spark and guide tomorrow’s market corrections. Talk to successful market entrepreneurs (as I frequently do). Among the many valuable insights that you’ll hear when you talk with them is that each one ‘saw’ or ‘sensed’ or ‘noticed’ some flaw in the market that he or she had the vision, guts, and determination to attempt to correct. (Yes, they did so in order to profit personally from doing so. So what? That motivation in private-property markets works spectacularly well.) I can recall not a single entrepreneur who I’ve met who said anything close to “Well, I saw lots of people making money doing X so I set up shop to do exactly X too!” Instead, what I always hear is something akin to “Well, I saw that X was being done in Y way, but I realized that X could be better done in Z way.” Or “Well, I saw that Y was being used to do X, but I realized that Y could also be used to do Z.” Or “I realized that no one was doing W, so I did W.”

Put differently, every successful entrepreneur who I know (and I do know plenty of them, I’m proud to boast) saw a market imperfection and acted to correct that imperfection. Entrepreneurs actively search for – or are unusually alert to – opportunities to hire and to purchase currently underpaid workers and other inputs; entrepreneurs actively search for – or are unusually alert to – opportunities to sell in competition against overpriced products; entrepreneurs actively search for – or are usually alert to – opportunities to produce and offer for sale goods and services that have never before been offered to consumers but which consumers might prefer to some of the goods and services that consumers are purchasing today; entrepreneurs actively search for – or are unusually alert to – opportunities to produce existing goods and services in new and lower-cost ways.

In short, entrepreneurs actively search for – or are unusually alert to – opportunities to correct what academic economists and government bureaucrats call “market imperfections. The uncreative response of the latter group of people is to grab the hammer of government power and to bang the imperfection into better shape (as judged by these academics and bureaucrats, without much direct feedback from consumers and input suppliers); the creative response of the former group is to risk their own funds and efforts in ways that will correct the imperfection without any use of force.

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