Monopoly as Enemy to Good Management: Adam Smith's View

Introduction: Adam Smith and The Wealth of Nations

"Monopoly…is a great enemy to good management." — Adam Smith, 1776, The Wealth of Nations, Book I, Chapter XI, Part I.

Adam Smith was born in 1723 in Kirkcaldy, Scotland (Falkner, 1997) and dedicated his life to philosophical studies. He was also a pioneer of the economic theories that guide us today, and his ideas were later adopted and developed by several renowned economists, such as David Ricardo (1772–1823) and Karl Marx (1818–1883). "With the Wealth of Nations, Adam Smith installed himself as the fountainhead of contemporary economic thought. Currents of Adam Smith ran through David Ricardo and Karl Marx in the nineteenth century and through Keynes and Friedman in the twentieth." (Henderson, 1999–2002)

In 1776, Smith published his comprehensive work in economics, entitled An Inquiry into the Nature and Causes of the Wealth of Nations — or, in short, The Wealth of Nations. The book "was published to great success and world-wide acclaim. Only five chapters long, the book introduced original concepts such as the division of labour into specialist skills, individual enterprise, a common international currency, and what today is known as a market-led economy" (Falkner, 1997). An important concept the author examines is monopoly, and one of the most valuable quotes from The Wealth of Nations is that "monopoly…is a great enemy to good management" (Smith, 1776).

Defining Monopoly in Economic Theory

Before approaching monopoly as the enemy of good management, one must clearly understand what monopoly is and how it appears in the context of modern economics.

There are numerous definitions of monopoly throughout economic theory, formulated in different ways but generally leading the reader to the same conclusion: monopoly is power — the power of one company to produce as much as it likes, keeping supply generally lower than demand, and then pricing goods to its own benefit. "Monopoly power refers to the degree of practical control that firms have over their prices" (Karier, 1993).

There are no competitors, due either to man-made restrictions or to barriers imposed by the structure of the economy, and consumers have no choice but to purchase from the sole company operating in that particular industry segment. The man-made restrictions that foster a monopolistic economy include legal barriers and patents. Legal barriers to entry consist of specific regulations that prevent other companies from operating in the specified industry or industry segment. Patents are another important cause of monopoly; they grant an inventor the exclusive right to produce and sell their invention — for example, Pfizer is the sole manufacturer of Viagra. Natural barriers to entry refer to two situations: cases where the costs of entering the market are prohibitively high, or cases where only large companies are advantaged by the cost structure of the market (Moffatt, 2008).

Workers in such a segment also have no alternative but to work for the monopolistic organization. "Monopoly is a term used by economists to refer to the situation in which there is a single seller of a product (i.e., a good or service) for which there are no close substitutes" (The Linux Information Project, 2005).

Although monopoly is generally perceived as a negative feature of the market, it has both supporters and critics, and carries both advantages and disadvantages.

Advantages and Disadvantages of Monopoly

Disadvantages of monopoly include high prices and low output on both a short- and long-term basis, since there are no other companies offering the desired product and the monopolist's capacity is generally insufficient to satisfy the entire demand (Schenk, Font of Cyber-economics); a lack of incentives to innovate; high inefficiency; and an uneven distribution of income. The fact that a monopolistic economy has the power to influence income distribution within a country's population illustrates why Adam Smith considered monopoly so significant and discussed it throughout the pages of The Wealth of Nations.

Advantages of monopoly include economies of scale: "A monopoly may produce at a lower cost than a competitive industry. This is due to economies of scale, which a monopoly is able to exploit more than a competitive firm, as the monopoly is the sole provider of that good, whereas in a competitive industry the firms share the total output" (Course Work, 2003). High corporate profits can also support the development of underdeveloped industrial sectors and increase the state budget.

As Smith himself observed: "A monopoly granted either to an individual or to a trading company has the same effect as a secret in trade or manufactures. The monopolists, by keeping the market constantly understocked, by never fully supplying the effectual demand, sell their commodities much above the natural price, and raise their emoluments, whether they consist in wages or profit, greatly above their natural rate. The price of monopoly is upon every occasion the highest which can be got" (Smith, 1776).

Conclusion

The fundamental feature that makes monopoly a threat to good management is its reduction of competition. Competition benefits every business, especially in a world where change occurs on a daily basis and companies must quickly adapt to satisfy shifting needs. Monopoly creates a rigid company, unable to adapt to new requirements, unable to satisfy all customer needs, and prone to delivering underdeveloped products. The manufacturer, or service provider, will not feel the need to constantly develop its product and service offering, thereby reducing the quality of the managerial act.

Management, however, is not only about product innovation; it encompasses all functions within and outside the company. Another way in which monopoly negatively impacts organizational management is through its effect on the workforce. Employees in a monopolistic industry also tend to stagnate — performing the same tasks every day, with no incentives to develop or improve their performance, no additional training, and no meaningful motivation. Over the long term, this will negatively affect the quality of the final product.

Beyond poor research and development and poor human resource policies, monopoly also affects management from the standpoint of resource allocation. Although the primary objective of a monopoly is to increase revenues through high prices and low costs, this is not always achieved. Focused on market strategies to minimize competition and implement high prices for products that fail to satisfy customers, management may neglect the internal costs of producing goods. As Khemani and Shapiro note: "While monopoly may provide the basis for extracting higher prices from customers, the lack of competitive stimulus may raise the costs of producing the goods and services it sells. The lack of incentives or competitive pressures may lead monopolistic firms to neglect minimizing unit costs of production, i.e., to tolerate 'X-inefficiency' (a phrase coined by H. Leibenstein). Included in X-inefficiency are wasteful expenditures such as maintenance of excess capacity, luxurious executive benefits, political lobbying seeking protection and favourable regulations, and litigation" (Khemani and Shapiro, 1993).

In sum, monopoly is the economic state in which a single company produces a specified product or type of products, places it on the market at discretionary prices, and faces no competition. The Wealth of Nations remains a foundational text for understanding why this market structure is so problematic. Monopoly influences management negatively by reducing its incentive toward product development, satisfaction of customer needs, personnel development, and sound resource allocation — confirming Adam Smith's enduring claim that it is, indeed, a great enemy to good management.

Falkner, R., 1997, Biography of Smith, Liberal Democrat History Group. Retrieved February 13, 2008.

Henderson, D.R., 1999–2002, Biography of Adam Smith (1723–90), the Library of Economics and Liberty. Retrieved February 13, 2008.

Karier, T.M., 1993, Beyond Competition: The Economics of Mergers and Monopoly Power, Sharpe M.E. Inc., ISBN: 9781563241277.

Moffatt, M., 2008, What You Need to Know About Monopolies and Monopoly Power, About Economics. Retrieved February 13, 2008.

The Linux Information Project, 2005, Monopoly: A Brief Introduction. Retrieved February 13, 2008.

Course Work, 2003, Advantages and Disadvantages of Monopolies. Retrieved February 13, 2008.

Schenk, R., What is Wrong with Monopoly, Font of Cyber-economics. Retrieved February 13, 2008.

Smith, A., 1776, An Inquiry into the Nature and Causes of the Wealth of Nations, Volume 1. Adamant Media Corporation, republished 2004, ISBN: 9780543947963.

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Khemani, R.S., Shapiro, D.M., 1993, Glossary of Industrial Organisation Economics and Competition Law, commissioned by the Directorate for Financial, Fiscal and Enterprise Affairs, OECD.