Monday, December 10, 2012

Are monopolies back? Part 1

This is the first of a 3 part series on monopolies. I am dividing the post into 3 parts just to keep it the posts shorter and more blog friendly.
In a recent NY Times article by the always enlightening Paul Krugman, Mr. Krugman makes the case that a return of the Gilded Are robber barons is partially to blame for the slow recovery in America. To be fair, Mr. Krugman does not do his own research but instead cites an article from The Washington Monthly written by two fellows of the New America Foundation. In this article, the authors Mr. Lynn and Mr. Longman use historical and present day anecdotal evidence to argue that increased corporate consolidation is holding back the emergence of new small businesses, which they claim are the primary drivers of job growth.

But is the U.S. really going back to the days of Rockefeller, Carnegie, and Morgan? And even if we are, is that really so terrible?

Part 1: Debunking the robber baron myth

First, just to set the historical record straight, a little data on the two classic historical "monopolies" Mr. Lynn and Mr. Longman refer to in their article, Standard Oil and Alcoa.

Standard oil was incorporated in 1870 in Ohio by John D. Rockefeller, his brother, and a few other investors. By 1890 they controlled 88% of the refined oil flows in the U.S. That sure sounds monopolistic huh? But what actually happened to the price of refined oil? In the graph below (source) you can see that the price went from $0.26 in 1870 to about $.06 cents in 1898. That hardly seems like the pricing trend of a monopolist. (Click graph to expand)

The ideas of knowledge specialization, trade secrets, and increasing returns to scale, criticized by Mr. Lynn and Mr. Longman in their article as "corporatism", are the reasons Standard Oil was able to lower the price of refined oil so dramatically. Since when is creating a product that people want for less money harmful to consumers or the public in general? Yet many people today still believe that John D. Rockefeller was an unscrupulous businessman driven by greed and the love of money, his only goal in life being to screw over the oil consuming public.

In reality Mr. Rockefeller was exceptionally hard working and thrifty. His donations to medical research were instrumental in the eradication of yellow fever and hookworm. He founded the University of Chicago and Rockefeller University and as a devout Northern Baptist supported many church based institutions. Though I am certain he had his faults, he was hardly the snake that many people know him as.

If you want to learn more about Standard Oil I suggest this unbiased article by Lawrence Reed in the The Freeman.

Like Standard Oil, Alcoa has become synonymous with the evil monopoly. In 1938 the Justice Department under FDR sued Alcoa, demanding that the company be broken up. Four years later the case was tossed out and two years after that, in 1944, the U.S. Supreme Court referred the case back to the U.S. Court of Appeals for the Second Circuit. Ultimately the case was referred back to District Court which rule against divestiture in 1950, though they did place Alcoa under watch for 5 years.

What was Alcoa's crime? Well in the words of judge Learned Hand, the Second Circuit Court of Appeals judge who presided over the case, they were just too good. From his case opinion:

“It was not inevitable that it should always anticipate increases in the demand for ingot and be prepared to supply them. Nothing compelled it to keep doubling and redoubling its capacity before others entered the field. It insists that it never excluded competitors; but we can think of no more effective exclusion than progressively to embrace each new opportunity as it opened, and to face every new-comer with new capacity already geared into a great organization, having the advantage of experience, trade connections and the elite of personnel.”

So Alcoa just reacted before everyone else, had more experience, better logistics, and better workers. That was their crime. Meanwhile, what was happening to the price of aluminum ingot during Alcoa's reign of terror? As you can see in the graph below, not much (source).

Alcoa became the only legal supplier of aluminum ingot in 1903 and remained the only one while there patents were in force. The price was $0.33/pound that year, down from $0.60/pound in 1895. As seen in the graph, there was a large spike due to the increased demand of WW1 but other than that the price stays relatively constant between $0.15 and $0.30 cents through 1970. The Alcoa "monopoly" was ended in 1955.

So even if Alcoa was a monopoly, it does not appear that they charged consumers classic monopoly prices.

It seems as if both scholars and journalists spend an immense amount of time worrying about natural monopolies even though history shows they never really exist (this is in contrast to government sanctioned monopolies which do exist and are the ones that we should be worried about). In my next post I will discuss why natural monopolies are not as common as we think they are and why they are unlikely to become so regardless of any antitrust laws on the books.

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