How does one respond to the idea that government needs to regulate monopolies? More specifically, in a free, capitalist economy, is there any time when government would intervene “for the consumer’s good”?

Unfortunately the free market has been tarred with a bad reputation as a facilitator of centralized power in the form of business monopolies. But much of the attack on free markets comes from a failure to comprehend just what a monopoly is, what constitutes “market share,” and what powerful forces free markets bring to bear in disciplining even the largest of firms when it attempts to abuse its position.

In Adam Smith’s day, monopoly referred to a firm that enjoyed some government grant ofexclusive privilege (e.g. the Navigation Acts of 1651 or the Tea Act of 1773)–the use of the power of government on behalf of one or more special, private interests, to hobble or preclude competition. One step further in this direction, of course, is an actual government monopoly itself whereby government says, “We will do this work and will forcibly shut down anyone who tries to compete with us,” as it does in first class mail delivery. Send a letter in the United States and you must use the government post office but send a package and you get to choose between lots of private alternatives. (It shouldn’t surprise anyone that the government monopoly loses money even as it pays no taxes or dividends and outlaws direct competition, whereas the private providers of other classes of mail actually make money and pay both taxes and dividends to shareholders.)

Government can forbid competition directly, or it can indirectly accomplish some degree of the same thing (intentionally or otherwise) by burdensome taxation and regulation. Taxes and regulations usually hit newcomer or smaller businesses harder than the older, bigger, or politically well-connected firms; the effect is, to some extent, to limit competition and thereby confer a degree of monopoly privilege on the existing or larger firms. Many people today are candidates to start a business, perhaps in competition with large existing companies, but they do not do so because the tax and regulatory barriers discourage them from the start.

When governments, by one method and to one degree or another, limit competition by the various means described above, the result is a coercive monopoly for those producers who benefit from the limitation of competition. This is the kind of monopoly to be concerned about because it breeds a situation where a company (or the government itself) can get away with abuse that would doom a company in a truly competitive, consumer-responsive market.

The other kind of “monopoly” some of us occasionally refer to is known as an “efficiency” monopoly. It is simply a situation where a company gets a high market share not because of any government grant of exclusive privilege, subsidy, special tax treatment, or the like, but because it simply does the best job. If such a firm ever became sloppy and complacent, it would be as if it publicly displayed a sign reading “COMPETITORS WANTED,” and that’s precisely what it would get.

A free market system provides powerful restraints against any company abusing its customers or its competitors. (It even whittles away at coercive government monopolies: by my communicating with you via e-mail or fax, I am undermining the Postal Service’s legal monopoly on first-class mail.) In a free market, the following constitute some of the ways an abusive firm is disciplined:

Free entry–the fact that another entity (a newcomer or an existing firm that may not even currently be in the same business) will find it attractive to enter a market in which consumers are unhappy with the current major supplier.

Competition of substitutes–the fact that for most goods, there is some reasonable substitute. Breakfast cereal is a good example.

Foreign competition–the fact that simply opening the borders to free trade is enough to imperil the monopoly position of almost any domestic producer. Once, many considered that Detroit would dominate the automobile industry with its powerful market share forever, but Japan found a way into the market, and slowly chipped away at the American automakers’ hold on consumers worldwide.

Competition of ALL goods for the consumer’s dollar–the fact that if I don’t like the air fares charged by the airlines, for example, I may take that disposable income and buy the washer and dryer I’ve been thinking about. In that case, United Airlines competes directly against Maytag.

I would be remiss if I did not also mention the simple matter of the “price” mechanism. Should any firm or firms establish a dominant market share of any industry, let’s say, airlines–for instance–any rise in price and profits acts as an instantaneous signal that alerts other aviation entrepreneurs to an opportunity for profit.

Of course, a tricky problem is always the question of what constitutes “market share.” I have a 100% monopoly on lectures by Lawrence Reed, but I hardly have a monopoly over “lectures on economics.”

A few years ago, the Federal Trade Commission tried to convict five ready-to-eat cereal manufacturers of what it called a “shared monopoly,” because those five firms sold 80% of the “ready-to-eat” cereal in the U.S. The trouble was, those five firms not only competed against themselves, but they also competed against anything anybody eats for breakfast! (So don’t lose any sleep over a vicious, price-gouging cereal monopoly). The point is, depending on how you define market share, you can make almost anybody look like a monopolist if you think monopoly has something to do with market share alone.

Sometimes people become concerned with how large a share of a particular market a firm has, without considering the dynamics of competition over time. But that’s a little like stopping a horse race in the middle because one horse is ahead. The race isn’t over yet and in a free market, it never is.

One accusation often made is that “monopolistic” firms use “predatory pricing” as a weapon in suffocating competition–as a “barrier to entry”–so as to maintain its preferred status. As I explain in this article, that is a highly unlikely proposition.

The bottom line is that “monopoly” in free market is a very slippery concept and competition is far more dynamic and effective over time than most attempts to regulate.