2014-11-13

Stuff in Between Monopoly and Competition

It has been a while since I've ranted about an economics article, but there was one by Peter Thiel (cofounder of PayPal and Palantir) in the Wall Street Journal that caught my eye, so it is the subject of this post. In it, he argues that monopolies are not always the bad entities that people make them out to be. In particular, he argues that Google's dominance in the search market has allowed it to expand to other markets such as advertising, robotics, and phones, and in all of those it is far from a dominant market player. He also argues that firms in perfectly competitive markets are too caught up with staying afloat to be able to innovate in any meaningful way, so real innovation can only come from firms with dominant market positions (such that they have money to gamble on such an innovation). Follow the jump to see my reaction to this.



Let's start from the top. He only talks about monopolies that got to their position by being so much better than former competitors that those other firms drop out of the market, and explicitly tries to leave aside discussions of firms that strong-arm other competitors out of the market or get official government protection; he then goes on to claim that the monopolies he cares about are the innovators compared to other firms. But is this necessarily a meaningful restriction? Very few companies can be like Google in becoming monopolies without resorting to any strong-arm tactics or legal protections. In 2000 or 2001, Google adopted (courtesy Wikipedia) its "don't be evil" motto; in 2000, its share of the search engine market was practically negligible compared to Microsoft and Yahoo. By 2002, that market share had jumped (courtesy Distilled) to about 30%. Clearly, the motto wasn't a result of its established monopoly, because it came before the monopoly; it must have been a gamble that ended up working really well. Moreover, even as long ago as 2005, Google has arguably abandoned (courtesy CNBC) its motto, thanks to the numerous violations of its users' privacy along with its occasional petty fights against sites that weren't kind to its leaders. Besides that, almost all the other companies that I can think of, especially those which have stagnated rather than innovated, have been those that have used strong-arm tactics or legal protections to shut out competition. (Also, Apple is where it is at least in part by strong-arming other companies through market or legal means. I won't go into that more than what I have unless you, the reader, want me to do so.)

Next, he discusses how opening a hypothetical British restaurant in Palo Alto may not work, because even if it is the only such restaurant in the area, to some degree it is competing against restaurants of all kinds in the area, so it cannot depend solely on people who would want to only eat at a British restaurant (whether for the food or for some feeling of novelty). Yet he goes on to claim that PayPal became a successful business in Palo Alto because it was the only "email-based payments company" (quoted from the original article) in town. This is an incredibly misleading statement to make, because it suggests that any kind of business in an area is comparable regardless of other market conditions (despite a direct contradiction earlier in the original article that not all businesses can be analyzed in the same away), and because it suggests that PayPal really had no other competition and could be successful just by being the first. In fact, there were plenty of other payment systems in place, including checks, credit cards, wire transfers, et cetera, so PayPal was competing against all of those. This makes it sound a lot more like the hypothetical British restaurant competing against other restaurants in Palo Alto; certainly it was the first in its niche in the market, but it had to offer a lot more than that to actually succeed in the market. To that end, it was probably successful at least in part because because the email-based payment system was well-implemented and well-advertised from the start. If it weren't for those two factors at least (along with many others), PayPal would have been just another failed startup.

It seems like he's getting confused between monopoly and monopolistic competition or oligopoly. In monopolistic competition, several firms sell differentiated goods allowing them to earn short-term profits, but their long-term profits go to zero (unless they continually innovate). In an oligopoly, a few firms sell goods that may or may not compete with one another, and if the firms themselves do compete, they will still earn profits (but less compared to if they acted together as a cartel). It seems like the situation he is actually advocating for is monopolistic competition or oligopoly. I do agree that having some profit (as opposed to none, as is the ideal case for perfect competition even in the short-term) helps companies invest and innovate. However, I see no evidence that true monopolies, which have no or extremely minimal competition, would be incentivized to innovate. Just look at how Internet service providers like Comcast, Time Warner, and AT&T have failed to bring up broadband speeds to compete with the rest of the world, due to their regional monopolies. On that note, I find it laughable when he tries to convince people that the cell phone service market is competitive; if you want an idea of what a really competitive cell phone market looks like (on both the hardware and service sides), take a look at my post on the subject from 4 years ago. I also find it laughable when he compares microeconomic equilibrium to thermodynamic equilibrium, while completely misinterpreting what thermodynamic equilibrium means (along with heat death): it means that while the statistical microstate of a system may dynamically vary, it has to be consistent with the thermodynamic macrostate. More pressingly than that, though, he also seems to misinterpret what equilibrium in perfect competition implies. It does not forbid innovation from taking place. To the contrary, innovation would push the market supply curve to higher quantities for the same price. This is because if a company can offer more value for a given price, customers will flock to it, so for companies to survive, they have to follow suit (or innovate further).

Then the question becomes the following: are there examples of innovation occurring in perfectly competitive markets? Perfectly competitive markets are extremely hard to come by, but I'll give the three best examples I can think of off the top of my head. One is the automobile market. Each year, car makers add more and more features in space, safety, entertainment, and general comfort to their cars, while keeping prices relatively constant. Even market leaders like Toyota and Honda have to follow suit, because their competition is not negligible. Another example is the fish market in Kerala, which I remember studying in 14.03 — Microeconomic Theory & Public Policy. Fishers in Kerala used to sell in pretty much oligopolistic settings, so they could raise prices much higher than competitive rates because their markets were localized, but this also meant that they would waste fish if they caught too much. Then cell phones came around, and sellers could call other sellers in neighboring towns to inquire about and adjust prices. The result was that prices became much more uniform and much lower overall, fishers got more profits and wasted less fish, and those who didn't take up cell phones couldn't compete as well. The third example is just that of how Mozilla Firefox was so innovative when it came onto the scene, while Microsoft Internet Explorer had stagnated; now the browser market is much more competitive, with features being very similar across browsers, yet each browser manages to push out at least one new innovation of its own with each release.

Overall, then, I think it's a bit disingenuous for Peter Thiel to push for more monopolies when what is really desirable is monopolistic competition. Looking at his page on Wikipedia, though, I can see why he would. My thinking is that he generally wants less regulation of monopolies, and is using the lone example of Google as a "benevolent monopoly" to cover for this (by claiming that "benevolent monopolies" are the norm rather than the exception, without having much other proof than this). Well, that won't fly with me, I'm afraid.
I'd love to hear what you think about this too. Feel free to leave comments below.

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