The Monopoly Dilemma

The internet (and information technology) is often portrayed as a great leveler that democratizes power.  This is one of the themes of Thomas Friedman’s bestselling book, The World Is Flat.  It is true that the internet has leveled power in some areas. Wikipedia has a list of disruptive innovations that includes Wikipedia itself which wiped out the profitable encyclopedia industry.  That leveled power because everyone with a computer can access a better product than the best encyclopedia for free and everyone can even make a contribution to it.  Previously, the best encyclopedia had been Encyclopædia Britannica, which cost over $1,000.  But overall the internet has concentrated power, albeit in new hands, because it has increased economies of scale.  Barry Lynn’s recent book, Cornered: The New Monopoly Capitalism and the Economics of Destruction makes this case (p. 53).  There are two reasons.

First, the internet has increased economies of scale. has wiped out numerous physical bookstores because it has greater economies of scale.  The result has been a greater concentration of economic power in book retail.  Fortunately for consumers, Amazon has been operating as a charitable organization and has never cared at all about making any profits, so this has resulted in lower costs for most Americans (and an improvement in the median standard of living), but Amazon’s shareholders are implicitly betting that in the long run, Amazon will be able to use its monopoly power to make some serious profits.  That is the only rational explanation for Amazon’s high share price.  And the information technology revolution that created the internet has produced greater economies of scale in many areas.  Technological innovation has been increasing economies of scale for all of history and it has been one of the drivers of increased inequality for millennia.

Secondly, the internet is helping expand property rights into new realms of society in a way that increases monopoly power and inequality.  All property rights are a kind of monopoly power.  A property right is the ability to exclude everyone else from something.  It is fine for you to have a monopoly over stuff that other people can easily get substitutes for like your underwear, because a monopoly is only profitable if other people really want the thing you have and they have few alternative substitutes that can satisfy their desire for it.  (Evidently, there are few substitutes for Queen Victoria’s underwear which sold for about $15,000).  So all property rights are a kind of monopoly, but only certain kinds of property rights are really lucrative.  And information technology has created really lucrative property rights because of (at least) two different kinds of economies of scale that are particularly common in information technology.

1. Constant or decreasing marginal costs plus fixed costs mean that there is decreasing average total cost for most information technology products.  That is the traditional textbook definition of a natural monopoly: a monopoly that is caused by economies of scale.

2. Network externalities make many information technologies more valuable as more people have them.  For example, one phone is useless if nobody else has a phone.  But if ten people have a phone, it becomes useful to have a phone to be able to call them.  And the more people get phones, the more valuable each phone becomes.

The perverse thing about economies of scale is that they create barriers to entry that give monopoly power to some lucky people who happened to be at the right time and place to get the property rights.  Barriers to entry unfairly prevent later generations from being able to profit (except the lucky few who inherit the property rights). But economies of scale also increase productivity and that is good for society.  Small businesses are ugly because they lack economies of scale and so they have low productivity and impoverish workers.  The problem with large businesses is that they concentrate power and than can corrupt society.  This is the monopoly dilemma.  We want large monopolies to exploit their efficiencies and productivity, but we don’t want them to use their power to exploit us.

Posted in Managerial Micro, Public Finance

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