Competition Orthodox Economic Thought Holds

Competition

Orthodox economic thought holds that competition is inherently better than monopoly in the provision of goods and services. There are a number of reasons why competition is cited as being superior -- improved innovation, price competition, competition for talent, and the use of features and service to deliver superior goods and services to consumers. This paper will show that the benefits of competition, when compared against a public monopoly, are not universal. There are instances where competition is not superior to a monopoly.

Monopolies

Economic orthodoxy holds that monopolies are inferior in many, if not all respects, to a competitive marketplace. This view, however, is based on the idea of the private industry monopoly, and is erroneously ascribed with universality to the public (government) monopoly. Private monopolies are deemed to be inferior because without competition they have no incentive to innovate, no incentive to provide a reasonable level of customer service and they can charge whatever the market will bear for their prices and service. Thus, the price, service and innovation that a monopoly will deliver will be the bare minimum needed to keep demand at a profitable level for goods with higher elasticity. For goods with lower elasticity, price gouging is a more likely outcome of a monopoly condition.

Government monopolies have generally been ascribed the same characteristics are corporate monopolies. This is a false comparison, however, as government monopolies are subject to unique operating conditions. The first of these is the government monopoly is not necessarily operating with a profit motive. This is in stark contrast to a corporate monopoly. A quick analysis of different government monopolies shows a range of motives where income is concerned. Many government health care arms are subsidized by government and provide services with very little revenue component. Others seek to break even, setting prices at the level that allows them to meet public demand without taking excess profits. Others seek to earn profits for the government, feeding their revenues back to the general coffers. Only the last behave as corporations do, engaging in price gouging and abuse of their monopoly position. The others exist for other motives, usually the provision of public goods.

That the two types of monopolies would have different objectives leads to different behaviors in the market. Monopolies not seeking undue profit are therefore able - and in many cases willing -- to offer lower prices than they could offer. Thus, they are not behaving with economic rationality. A firm that does not behave rationally cannot reasonably be compared with the orthodox monopoly, which does behave rationally. Studies comparing government and private insurance companies in Europe have noted that the government insurance companies offer a lower price than do the private ones (Ungern, 1996; Epple, 1996; Felder, 1996)

Beyond price, government monopolies are less likely to innovate than are competitive companies. They have no economic incentive to do so, but they may emulate innovations from elsewhere if they feel that the public will be better served. While the orthodox view holds that monopolies will deliver poorer service levels, there is a tradeoff here that needs to be considered. In a competitive market, firms will seek to deliver the most efficient service level, unless they are making service a point of differentiation. The government monopoly firm need not worry about cost effectiveness and can throw money at service levels, especially if the monopoly is a revenue-generator. Even with efficiency, governments have budgets and the people that run governments are arguably more accountable than corporate leaders, since they must run for election. This implies that at least a reasonable level of efficiency can be expected from government-run corporations. This contrasts with the orthodox mentality, but that mentality is based on the flawed assumption that there is no accountability in government and state-run companies will run into deficit just because they can. Both are hypotheticals, neither is necessarily true.

Competition

The role that competition plays in a market is to lower prices, improve innovation and improve efficiency. Firms in a state of monopolistic competition must do something to differentiate from competitors in order to earn profit, and this drives them into a process of constant improvement. As a result, the logic goes, competition is inherently better. But in the real world, this depends on the particular industry characteristics. The insurance examples in Europe are a good example to use here.

The insurance markets described in those studies are mature, and the products have changed little in decades, the same with the route to market (at least in 1996, when insurance companies could not sell online). Competition in these markets, therefore, is unlikely to be on the basis of product innovation. Service innovation is possible to some degree with the Internet, but there are only so many ways to deliver insurance -- it is a product centuries old and not subject to much innovation. In a market like this, service and price are two methods of gaining competitive advantage. Private insurance firms use proprietary actuarial tables to set rates, and this might be the only way that an insurance firm can gain advantage, since it is nearly impossible to derive sustainable competitive advantage from service. Thus, profit margins are slim and a firm can improve the spread between the table and the consumer price only by increasing volume. This leads to a price war as firms fight for market share. Knowing that price wars are devastating to businesses on already thin margins, the companies in the industry instead begin to spend on marketing. In addition to insurance in Europe we see this in a number of telecommunications markets, and frequently in the global beer market, among other industries. Products and services are not differentiated because the firms in the industry cannot conceive of how to do so, so they spend extravagantly to outmarket each other. Since they all do it, they all pass the same costs onto customers.

What this shows is that for some industries -- and it depends on the specific industry characteristics -- the nature of competition may lead to higher prices rather than lower, particularly if extensive marketing is considered by the industry players to be the main way to improve market share. Government monopolies, of course, have little need for marketing since their audience is already captive. Thus, they can be profitable at lower price levels…and they are not always trying to do anything more than break even.

Impact on Consumers

Orthodox economic theory holds that consumers will see a range of benefits from competition, not just lower prices. This assumption, however, derives from the assumption that firms within an industry will compete on a number of different levels. However, in some industries we know that not to be the case. The result is that competition does not have any marked benefit to consumers. The reason that governments become involved in some industries is because they consider the product or service to be a public good. Generally, public goods are characterized as having benefits beyond simple economic outcomes. Insurance, for example, standardizes the terms of insurance and can improve the quality of coverage because the government is motivated to deliver a high level of coverage, not just a low cost of coverage. Backed by the government's resources, this is entirely possible for a government-run insurance company.