WEBVTT NOTE Myths and Facts About Big Business 1 00:00:00.000 --> 00:00:05.280 Okay, so today we're talking a little bit about big business in the 19th century. 2 00:00:05.280 --> 00:00:12.400 And what I'm going to do is review some of the items that are actually in that chapter, chapter 8, 3 00:00:12.400 --> 00:00:18.400 and then expand on that and add a little more information that's more purely economic, 4 00:00:18.400 --> 00:00:24.640 that I think makes it easier for us to understand these ideas. 5 00:00:24.640 --> 00:00:32.540 So, as you can see, this is what you might call a revisionist chapter, in the good sense of the word, 6 00:00:32.540 --> 00:00:38.640 because it does challenge the received view on big business in the 19th century. 7 00:00:38.640 --> 00:00:42.340 And I remember when I was in school, I got that received view, 8 00:00:42.340 --> 00:00:49.740 that big businessmen are wicked exploiters, and in order to tame the wicked exploiters, 9 00:00:49.740 --> 00:01:03.740 We need these selfless public sector employees to intervene on our behalf and that is sort of the standard view that you get all the time that politicians are wonderful and they just care about the public good 10 00:01:03.740 --> 00:01:10.740 whereas these private individuals are nothing but greedy SOBs. I don't know if that can say SOBs in the recording. 11 00:01:10.740 --> 00:01:15.740 And so what I want to suggest is that this is rather cartoonish and unhelpful. 12 00:01:15.740 --> 00:01:23.740 I started off by making a distinction that is made by a professor at Hillsdale College named Bert Folsom. 13 00:01:23.740 --> 00:01:30.740 He makes a distinction between what he calls market entrepreneurs and in effect political entrepreneurs. 14 00:01:30.740 --> 00:01:40.740 A market entrepreneur is somebody who reaches his position in terms of wealth and in terms of his position within his industry 15 00:01:40.740 --> 00:01:44.740 by virtue of the contributions he makes to the well-being of the population 16 00:01:44.740 --> 00:01:51.740 by producing some product at a cost that is welcomed by the population 17 00:01:51.740 --> 00:01:54.740 that makes people better off, well then he profits from this. 18 00:01:54.740 --> 00:01:58.740 The political entrepreneur on the other hand is somebody who reaches his position 19 00:01:58.740 --> 00:02:01.740 through some kind of grant of government privilege 20 00:02:01.740 --> 00:02:08.740 either through some subsidy or through some tariff or something that hobbles his competition 21 00:02:08.740 --> 00:02:15.740 Then he reaches his position and so Folsom is trying to argue that that's kind of an artificial kind of entrepreneur. 22 00:02:15.740 --> 00:02:21.740 We're not as impressed by that because anybody can go begging for special privileges from government 23 00:02:21.740 --> 00:02:29.740 but not everybody is clever enough to think of some innovation on his own that is so beneficial to the general population 24 00:02:29.740 --> 00:02:33.740 that people will voluntarily fork over their money rather than be forced to do so 25 00:02:33.740 --> 00:03:03.740 Now Folsom really is the key figure in terms of recent historians on big business, there are some others I cite in my bibliography, but Folsom has this well-known book that came out around 1991 with a very provocative title called The Myth of the Robber Barons, A New Look at the Rise of Big Business in America, and it's been consistently in print since then, and in our day for a non-figurist, it's been in print since then, and in our day for a non-figurist, it's been in print since then. 26 00:03:03.740 --> 00:03:09.740 A fiction book to be in print for 15 years, it's like an incredible classic, it's very, very rare in our day. 27 00:03:09.740 --> 00:03:16.740 So he gives the example that I then elaborate on of the railroads in the 19th century 28 00:03:16.740 --> 00:03:20.740 and some of the corruption that was associated with railroad construction. 29 00:03:20.740 --> 00:03:28.740 And one of the arguments that I put forth there involves the incentive structure that existed 30 00:03:28.740 --> 00:03:32.740 with regard to government assistance of the railroads. 31 00:03:32.740 --> 00:03:34.740 So what kind of incentives did this create? 32 00:03:34.740 --> 00:03:40.740 Because you got two forms of government assistance, if you were a railroad. 33 00:03:40.740 --> 00:03:43.740 It wasn't direct money, you didn't get a direct grant from the government, 34 00:03:43.740 --> 00:03:49.740 but you would either get subsidized loans, low interest loans, or you get free land. 35 00:03:49.740 --> 00:03:55.740 Government had a lot of land to give away, public lands would be given away to the railroad. 36 00:03:55.740 --> 00:03:58.740 So those were the two forms of subsidy. 37 00:03:58.740 --> 00:04:04.740 Low-interest loans are obvious in terms of why the business would want them, but the land may not be so obvious. 38 00:04:04.740 --> 00:04:08.740 And what typically happened was that the railroads would sell most of this land for money. 39 00:04:08.740 --> 00:04:14.740 So it was an indirect grant of money to the railroads. You give them land, they sell the land, they collect and keep the money. 40 00:04:14.740 --> 00:04:25.740 And of course by selling this land to people and helping to populate this land, the railroads are in effect creating a built-in market for themselves. 41 00:04:25.740 --> 00:04:31.740 by, in effect, populating the very place through which this railroad is going to travel. 42 00:04:31.740 --> 00:04:34.740 Will they therefore attract people to that place? 43 00:04:34.740 --> 00:04:42.740 These people are going to need the railroad to be successful in order for themselves to be successful. 44 00:04:42.740 --> 00:04:48.740 Now, this is indirectly a kind of a subsidy, a kind of a financial subsidy, 45 00:04:48.740 --> 00:04:51.740 even though it's not a direct handing over of cash. 46 00:04:51.740 --> 00:05:00.240 On the other hand, the sale of public lands had been one of the major ways that the federal government had raised money, revenue for itself in the 19th century. 47 00:05:00.240 --> 00:05:07.740 And so the more government, the more public land it gives away for free, the less will be available for it to sell for revenue purposes. 48 00:05:07.740 --> 00:05:13.740 And so therefore, taxes would have to be raised to make up the shortfall. So that is of one effectiveness. 49 00:05:13.740 --> 00:05:30.740 Well, so what we saw is that these incentives tend to be perverse because it simply says you lay down this X amount of track, you get X amount in loans and if you lay down track in mountainous terrain or more difficult terrain you get more in terms of loans and more goodies. 50 00:05:30.740 --> 00:05:38.740 Well, this does not give railroad operators the incentive to build straight efficient tracks. 51 00:05:38.740 --> 00:05:43.740 Of course, naturally it gives them the incentive to build curb tracks through mountains, 52 00:05:43.740 --> 00:05:47.740 which no private owner putting up his own capital would dream of doing. 53 00:05:47.740 --> 00:05:51.740 A private owner would want to be ruthlessly efficient 54 00:05:51.740 --> 00:05:56.740 and have the straightest possible most efficient line that he could. 55 00:05:56.740 --> 00:06:01.740 And I've given as an example in the past that I used to live on Long Island in New York 56 00:06:01.740 --> 00:06:07.740 and the Southern State Parkway was pretty much constructed by giving the same incentives to road builders, 57 00:06:07.740 --> 00:06:37.740 The Southern State goes like this, the whole way, the whole way, and by the way, I would take the Southern State back home from LaGuardia Airport for about an hour's drive to my home, and you know, sometimes when you've been flying all day, you're kind of tired, and you'd rather just have that straight, simple drive home, but on the other hand, at least I didn't fall asleep on the way home, because you have to drive like this the whole way. So this is not that uncommon a phenomenon, and it was all over the internet. 58 00:06:37.740 --> 00:06:54.740 And then there is the interesting counter example of James J. Hill and his Great Northern Railroad going from St. Paul to Seattle that he constructed without any government assistance of any kind and he wound up having an extremely efficient road. 59 00:06:54.740 --> 00:07:00.740 He actually turned a profit in 1893, the year that most of the other railroads went bankrupt. 60 00:07:00.740 --> 00:07:04.740 He had lower fares for his road than the others did. 61 00:07:04.740 --> 00:07:34.740 The railroaders did, very prosperous and just super efficient, he didn't have the distortions that the government assistance created in the other roads and he continued to do very well and he had an incentive again to build up the communities alongside his road and he did that through his own funds and he negotiated rights of way with Indian tribes, he didn't just exterminate them all, he negotiated with them as private individuals typically do. 62 00:07:34.740 --> 00:07:39.300 situation, and by the way this is an example of the distinction that Folsom makes because other 63 00:07:39.300 --> 00:07:45.380 railroad operators were getting all these government grants of one kind or another. Hill was not. So 64 00:07:45.380 --> 00:07:49.860 Hill is a market entrepreneur, the others are political entrepreneurs. There's the example of 65 00:07:50.420 --> 00:07:54.660 John D. Rockefeller. Now there are many things we can say, maybe we don't like the Rockefeller 66 00:07:54.660 --> 00:07:59.780 foundation, whatever, that's not what we're talking about. It's worth noting that for whatever else we 67 00:07:59.780 --> 00:08:29.780 As we can say about John D. Rockefeller, he did improve the well-being of Americans, obviously, by making, for example, kerosene much less expensive for people, making it into an affordable illuminant that was a helpful and important substitute for whale oil that had been in widespread use, but that was obviously not very cheap for people, so all of a sudden people could stay up late at night, which for me is wonderful because I pretty much do all my work around three in the morning, 68 00:08:29.780 --> 00:08:35.780 And on the other hand, you don't have to spend a fortune to be able to stay up late at night 69 00:08:35.780 --> 00:08:38.780 because it's cheap now to illuminate your homes. 70 00:08:38.780 --> 00:08:44.780 Rockefeller of course was into oil refinery rather than the actual pumping of the oil out of the ground 71 00:08:44.780 --> 00:08:54.780 and it was his, again, ruthless efficiency in cost cutting, always wanting to cut costs that made it possible for him to prosper. 72 00:08:54.780 --> 00:09:04.780 I even give the example that when he was faced with the waste that's left over from the refining of the crude oil, he developed 300 products out of the waste. 73 00:09:04.780 --> 00:09:07.780 So again, super efficient. 74 00:09:07.780 --> 00:09:16.780 And we'll talk about predatory pricing later, but the allegation against Rockefeller that he engaged in predatory pricing, 75 00:09:16.780 --> 00:09:23.780 and monetary pricing, that is to say that he sold below cost in order to drive all competition from the field 76 00:09:23.780 --> 00:09:29.780 and then raised prices to earn monopoly profits is basically no longer believed by historians. 77 00:09:29.780 --> 00:09:36.780 That has been debunked for about 50 years, mainly with an article by a historian named McGee 78 00:09:36.780 --> 00:09:40.780 who wrote an article in the Journal of Law and Economics in which he investigated this 79 00:09:40.780 --> 00:09:45.780 and read thousands of pages of testimony and court documents and everything 80 00:09:45.780 --> 00:09:48.780 and the conclusion that Rockefeller had simply bought out people. 81 00:09:48.780 --> 00:09:50.780 That was how he dealt with competition. 82 00:09:50.780 --> 00:09:54.780 He purchased them and he apparently purchased them at decent prices. 83 00:09:54.780 --> 00:09:57.780 He didn't just say, I'll buy your refinery for five cents. 84 00:09:57.780 --> 00:10:01.780 He purchased them at decent prices because we know that, for one thing, 85 00:10:01.780 --> 00:10:05.780 because he ended up employing some of these people in his own firm 86 00:10:05.780 --> 00:10:09.780 and if he had taken ruthless advantage of them, it's unlikely he'd want to have them sticking around. 87 00:10:09.780 --> 00:10:12.780 They'd obviously just engage in sabotage. 88 00:10:12.780 --> 00:10:20.780 And we also have the example of at least one guy who sold, made a very nice living selling refineries to Rockefeller, building them up and then selling them. 89 00:10:20.780 --> 00:10:25.780 At least three sold to Rockefeller by one person. 90 00:10:25.780 --> 00:10:37.780 So this is, as I say, this is an important cost-cutting innovation by Rockefeller, his efficient oil refinery, which improved the standard of living of everybody. 91 00:10:37.780 --> 00:10:43.780 So notice that Rockefeller does not just take from some people and give to other people in political fashion. 92 00:10:43.780 --> 00:10:52.780 He increases efficiency such that everybody is wealthier because now I need to expend fewer of my own resources to get what I need. 93 00:10:52.780 --> 00:10:56.780 I now have more resources left over to buy additional things that I couldn't have had before. 94 00:10:56.780 --> 00:10:58.780 That's how wealth is created. 95 00:10:58.780 --> 00:11:03.780 I also make note of Andrew Carnegie who was involved in steel production. 96 00:11:03.780 --> 00:11:33.780 Now it's true that Carnegie did favor steel tariffs, you know everybody involved in steel favored steel tariffs so this is a kind of a blot on his record but nevertheless he was still super efficient and I give the example of the homestead plant in Pennsylvania where with 4,000 men Carnegie could produce several times the amount of steel that the most renowned European facility, the Krupp Steel Works could produce with 15,000. 97 00:11:33.780 --> 00:11:40.780 So an extraordinary testament to his efficiency and again dramatic price reduction over time. 98 00:11:40.780 --> 00:11:47.780 From the 1860s to the 1890s, the price of steel rails goes down from $160 to $17 a ton. 99 00:11:47.780 --> 00:11:52.780 Now it's true that the general price level was also falling in the late 19th century, 100 00:11:52.780 --> 00:11:58.780 but the price of steel was falling much faster than the rest of prices were. 101 00:11:58.780 --> 00:12:12.780 Now I want to go into in some detail this concept of predatory pricing because it has, after years of falling out of fashion in the economics profession, 102 00:12:12.780 --> 00:12:21.780 it has come back into some degree of respectability. So I do want to talk about it and to go on at greater length than is in the text. 103 00:12:21.780 --> 00:12:33.780 Predatory pricing, as I indicated a moment ago, is the practice whereby a dominant firm will simply price its goods below cost for some length of time, 104 00:12:33.780 --> 00:12:40.780 whatever length of time is necessary to drive all its competitors from the field, that's what's predatory about it, 105 00:12:40.780 --> 00:12:46.780 and then with its competitors gone, it will then raise its prices and enjoy monopoly profits. 106 00:12:46.780 --> 00:12:55.780 Now this for a long time was considered to be a real danger and in fact we have economists in the 50s warning that this could happen. 107 00:12:55.780 --> 00:13:03.780 Well then with the passage of time by the 1970s and early 80s certainly this doctrine was really falling out of favor 108 00:13:03.780 --> 00:13:07.780 because for one thing it was very hard to find an actual example of this. 109 00:13:07.780 --> 00:13:15.780 If you look through antitrust cases you can hardly find an actual example of a firm really trying this much less succeeding 110 00:13:15.780 --> 00:13:24.780 So it seemed to be, as one economist has said, rather like sightings of the Loch Ness Monster, finding examples of predatory pricing. 111 00:13:24.780 --> 00:13:34.780 You can find firms lowering their prices, obviously all over the place, but you don't find this pattern whereby their competition disappears and they just raise their prices. 112 00:13:34.780 --> 00:13:43.780 What a number of economists observed is that it's extremely difficult to carry out this strategy. It sounds very simple, it sounds almost plausible. 113 00:13:43.780 --> 00:13:51.780 It's almost plausible that sure, yeah, that businesses do this all the time, but in fact it's very difficult to do this for a number of reasons. 114 00:13:51.780 --> 00:13:55.780 One of them is people tend to stock up on whatever it is you're selling. 115 00:13:55.780 --> 00:14:00.780 If you're going to sell below cost, well, people will just buy huge quantities and keep them in their garage. 116 00:14:00.780 --> 00:14:07.780 And so it's going to take you even longer to recoup your losses because even if you do drive all your competitors out, everybody has all they need. 117 00:14:07.780 --> 00:14:12.380 Okay, so when I used to have to do my own food shopping when I was a bachelor, 118 00:14:12.380 --> 00:14:16.660 see, now my wife and I go together, but I used to go all by myself when I was a bachelor, 119 00:14:16.660 --> 00:14:20.220 and I will never buy Progresso soup for $2.59 a can. 120 00:14:20.220 --> 00:14:23.700 I don't care how much I want it, I am just not paying that. 121 00:14:23.700 --> 00:14:26.660 I'll wait for it to go down to $1.25 or $1 a can, 122 00:14:26.660 --> 00:14:29.940 and then I'll buy whatever the maximum amount is and take that home with me. 123 00:14:29.940 --> 00:14:33.180 So that's naturally what you do, you stock up in those situations. 124 00:14:33.180 --> 00:14:37.580 But beyond that, there's the problem of what do you do about new competitors entering the field? 125 00:14:37.580 --> 00:14:45.480 Sure, I drive these people out of business, but okay, well then some other competitor can buy their physical plant for next to nothing 126 00:14:45.480 --> 00:14:54.180 and then go into business with me with very low cost foundations and once again I have to compete against yet another entrant into the market. 127 00:14:54.180 --> 00:14:58.580 And it turns out that it's basically impossible to drive everybody out consistently. 128 00:14:58.580 --> 00:15:06.480 It's an enormously expensive strategy and it's very difficult to carry out. 129 00:15:06.480 --> 00:15:13.480 Now, I have got some, I devised in one of my books a kind of a thought experiment 130 00:15:13.480 --> 00:15:17.480 about what it would involve to actually engage in predatory pricing. 131 00:15:17.480 --> 00:15:24.480 And I rely on an important book by George Reisman, who in 1996 wrote a book called Capitalism. 132 00:15:24.480 --> 00:15:27.480 It's the size of a phone book. It's the most, it's the biggest book I've ever seen. 133 00:15:27.480 --> 00:15:33.480 It's like a thousand pages. It's this big. And then you open it up and it's two columns. 134 00:15:33.480 --> 00:15:39.480 So, how somebody could write a book like this is completely beyond me, but nevertheless, 135 00:15:39.480 --> 00:15:47.480 Riesman points out that one thing to remember is that a large firm that attempts predatory pricing 136 00:15:47.480 --> 00:15:56.480 during the predatory stage where it's cutting its prices below cost is making losses commensurate with its size. 137 00:15:56.480 --> 00:16:26.480 size. That is to say, suppose I'm a firm and I dominate, I've got 90% of the market in some product, well then I am making losses on my 90% market share. So my competitor, suppose I've got just one competitor for simplicity's sake, and he's got the other 10%. Well okay, so he's making losses on his 10%, but I am losing an absolutely gigantic amount of money with the passage of time. And Riesman says, it is difficult to see 138 00:16:26.480 --> 00:16:31.880 and the advantage constituted by nine times the wealth and nine times the business 139 00:16:31.880 --> 00:16:37.480 if money is lost at a rate that is nine times as great. 140 00:16:37.480 --> 00:16:41.180 Another economist writing in the Journal of Political Economy says this, 141 00:16:41.180 --> 00:16:44.880 price wars are far more expensive than is often realized. 142 00:16:44.880 --> 00:16:49.280 For one thing, it takes quite a long time to drive a rival from the field. 143 00:16:49.280 --> 00:16:53.080 The smaller firms may simply close down and wait and then reopen 144 00:16:53.080 --> 00:16:58.080 The larger firm, in the expectation of recovering its losses, raises its prices. 145 00:16:58.080 --> 00:17:02.080 Even if the large firm succeeds in driving one set of owners into bankruptcy, 146 00:17:02.080 --> 00:17:05.080 the capacity does not thereby disappear from the area. 147 00:17:05.080 --> 00:17:08.080 The small company may now reopen under new management, 148 00:17:08.080 --> 00:17:12.080 with plant bought at knock-down prices and capable as a consequence 149 00:17:12.080 --> 00:17:15.080 of marketing a product at very low cost. 150 00:17:15.080 --> 00:17:18.080 Only when the small plant is worn out or becomes obsolete, 151 00:17:18.080 --> 00:17:21.080 a matter of years, is it out of the picture. 152 00:17:21.080 --> 00:17:26.040 and only then is the large firm in a position to raise its prices to recoup its losses. 153 00:17:26.040 --> 00:17:30.760 After that, the prolonged period over which prices must be kept high 154 00:17:30.760 --> 00:17:33.160 in order that the large business can entirely recover its losses 155 00:17:33.160 --> 00:17:35.880 may simply invite new entrants or new expansion 156 00:17:35.880 --> 00:17:40.520 and start the whole period of unprofitably low prices over again. 157 00:17:40.520 --> 00:17:45.240 Now, there is also a chain store variant of the predatory pricing argument. 158 00:17:45.240 --> 00:17:50.760 So, a lot of times opponents of chain stores think that chain stores are so large 159 00:17:50.760 --> 00:18:05.760 and they have all these resources at their disposal that they'll always win out in competition with smaller stores so they can draw on the profits that they earn in other markets to sustain them while they suffer losses in some local market in order to drive their competitors out. 160 00:18:05.760 --> 00:18:12.760 But again, there is some faulty reasoning here. Again, you have all the difficulties associated with predatory pricing. 161 00:18:12.760 --> 00:18:18.760 But let us suppose we have a nationwide chain of grocery stores called Megamart 162 00:18:18.760 --> 00:18:22.760 and let's suppose Megamart has a thousand stores around the country 163 00:18:22.760 --> 00:18:28.760 and a billion dollars of total capital invested for an average of one million dollars per store. 164 00:18:28.760 --> 00:18:34.760 Now a lot of people seem to believe that Megamart can bring its entire fortune to bear 165 00:18:34.760 --> 00:18:38.760 in order to drive its competitors out of a new market where it seeks to expand 166 00:18:38.760 --> 00:18:42.760 But it would actually be an example of a ludicrously poor business strategy 167 00:18:42.760 --> 00:18:45.760 and economic judgment for Megamart to do so. 168 00:18:45.760 --> 00:18:51.760 Suppose for the sake of argument that in the face of all the theoretical and empirical evidence to the contrary 169 00:18:51.760 --> 00:18:58.760 that we nevertheless conceded the possibility that Megamart could drive all its competitors from the field in a given market 170 00:18:58.760 --> 00:19:05.760 and keep them out forever simply through the implicit threat of crushing any new competitor who should emerge on the scene. 171 00:19:05.760 --> 00:19:12.300 Megamart would indeed enjoy abnormally high profits in that market should it be successful 172 00:19:12.300 --> 00:19:17.640 and the prospect of those premium profits could well entice the company into making this effort. 173 00:19:17.640 --> 00:19:22.840 But as Reisman observes, such a premium profit is surely quite limited, perhaps an additional 174 00:19:22.840 --> 00:19:27.420 hundred thousand per year, perhaps even an additional half million per year, but certainly 175 00:19:27.420 --> 00:19:32.560 nothing remotely approaching the profit that would be required to justify the commitment 176 00:19:32.560 --> 00:19:35.760 of the firm's total financial resources. 177 00:19:35.760 --> 00:19:39.720 So let us suppose that the premium profit that could be reaped by Megamart 178 00:19:39.720 --> 00:19:45.120 after removing all its competitors fell in the middle of those figures of $100,000 and $500,000. 179 00:19:45.120 --> 00:19:49.120 Suppose $300,000 per year they could make in this market 180 00:19:49.120 --> 00:19:52.680 as a premium profit after clearing all their competitors out. 181 00:19:52.680 --> 00:19:57.560 Let's also assume the average rate of profit in the economy is 10%. 182 00:19:57.560 --> 00:20:02.800 That means that Megamark can afford to lose three million dollars in order to seize this market for itself, 183 00:20:02.800 --> 00:20:07.800 because three million dollars is the capitalized value of three hundred thousand dollars per year. 184 00:20:07.800 --> 00:20:13.720 If Megamark devoted any more than three million dollars to the acquisition of this market, it would be a bad investment. 185 00:20:13.720 --> 00:20:19.080 They would earn a lower than average return on their capital, that is, they would earn less than ten percent on this investment. 186 00:20:19.080 --> 00:20:24.440 Despite their billion dollars of capital, even Megamark would find it absurd and self-destructive 187 00:20:24.440 --> 00:20:31.440 to devote anything above $3 million to the capture of this market, since they would earn a better return investing their money elsewhere in the economy. 188 00:20:31.440 --> 00:20:40.440 If they spent $9 million to capture this market, they would earn a profit of only 3.33% instead of the going rate of 10%. 189 00:20:40.440 --> 00:20:42.440 It would make no economic sense. 190 00:20:42.440 --> 00:20:46.440 Now Riesman explains with an example, a similar example of his own. 191 00:20:46.440 --> 00:20:48.440 He says, here's what follows from this. 192 00:20:48.440 --> 00:21:18.440 Ludwig von Mises says everyone contemplating an investment in the grocery business who has an additional $5 million or even just $1 million to put up is on as good a footing as Megamart in attempting to achieve such premium profits for it simply does not pay to invest additional capital beyond these sums in other words the predatory pricing game if it actually could be played in these circumstances would be open to a fairly substantial number of players not just the extremely large very rich firms but everyone who had an additional capital 193 00:21:18.440 --> 00:21:48.440 Now it is true that in some cases of course the larger firm can undersell the smaller firm on the basis of the advantages it enjoys in terms of economies of scale and other benefits but this is not necessarily to be deplored there certainly are advantages that accrue to everyone from business concentration Ludwig von Mises after whom this institute is named 194 00:21:48.440 --> 00:21:58.440 said this, in the pre-capitalistic ages, the difference between rich and poor was the difference between traveling in a coach and four and traveling sometimes without shoes on foot. 195 00:21:58.440 --> 00:22:07.440 Today, in the industrialized parts of the U.S., the difference between rich and poor is the difference between a late model Cadillac and a secondhand Chevrolet. 196 00:22:07.440 --> 00:22:12.440 It is difficult to see how this result could have been achieved without bigness in business. 197 00:22:12.440 --> 00:22:15.440 and Business. 198 00:22:15.440 --> 00:22:21.440 Well on this predatory pricing issue there is yet another example that one might refer to 199 00:22:21.440 --> 00:22:27.440 and it's a historical example that's cited in my book about the chemical manufacturer Herbert Dow 200 00:22:27.440 --> 00:22:32.440 and again I feel compelled to mention this example because I love the cleverness involved here. 201 00:22:32.440 --> 00:22:39.440 If you read in there about Herbert Dow you noted that he was a great, basically a great chemical man 202 00:22:39.440 --> 00:22:46.320 who worked extraordinary hours, sometimes 18-hour days, sleeping overnight in his plant 203 00:22:46.320 --> 00:22:50.120 and he started Dow Chemical Company right around the turn of the century, 204 00:22:50.120 --> 00:22:54.800 into the 19th into the 20th century, and he specialized in particular chemicals 205 00:22:54.800 --> 00:23:00.200 and one in particular he had discovered an inexpensive way to produce bromine 206 00:23:00.200 --> 00:23:07.240 which was used for a variety of purposes, used for film developing and sedation as a dye and so on and so forth. 207 00:23:07.240 --> 00:23:11.240 And so he wanted to sell his product, not only in the United States, but also in Europe. 208 00:23:11.240 --> 00:23:18.240 So he went to sell in Europe, and in Europe they were selling bromine for about 45 cents. 209 00:23:18.240 --> 00:23:24.240 You could get your unit. But 45 cents, he could, Dow could do much better than that. 210 00:23:24.240 --> 00:23:27.240 He was able to sell at 36 cents. 211 00:23:27.240 --> 00:23:34.240 But this was not satisfactory to the German cartel that dominated the chemical market in Europe. 212 00:23:34.240 --> 00:24:04.240 a representative of which visited Dow and reminded him around the early 1900s that no American upstart company is allowed to compete in the bromine market in Europe and that if he continues to do this they will drive him out of business by undercutting him in the United States by dumping excess bromine in the United States at very very low prices he won't be able to compete they'll drive him out so they were threatening to engage in predatory pricing but Dow being a strong-willed man continued to sell his bromine 213 00:24:04.240 --> 00:24:14.240 So the German cartel took their revenge and began selling bromine in the United States at the unheard of price of a mere 27 cents. 214 00:24:14.240 --> 00:24:23.240 So you've got Europe is the price is 45, Dao's is 36 and now all of a sudden this German cartel is selling for 27. 215 00:24:23.240 --> 00:24:31.240 So now Dao has to figure out what to do and what he decides to do is he realizes that the German cartel has to turn a profit in Europe 216 00:24:31.240 --> 00:24:37.240 The German cartel has to turn a profit in Europe in order to sustain the losses it's going to make in the United States. 217 00:24:37.240 --> 00:24:45.240 So he simply, through his purchasing agent, buys up enormous quantities of bromine at 27 cents a pound in the United States 218 00:24:45.240 --> 00:24:52.240 and then goes to Europe and sells it at a slightly higher price, but well under 45. 219 00:24:52.240 --> 00:24:58.240 So the German cartel naturally is wondering how there could be all this demand for bromine in the US. 220 00:24:58.240 --> 00:24:59.240 They couldn't have anticipated it. 221 00:24:59.240 --> 00:25:07.240 So meanwhile, Dow carries on with this sort of underhanded scheme, and the cartel just continues to drop its price down to 15 cents. 222 00:25:07.240 --> 00:25:10.240 We'll show this Herbert Dow. So he just buys all the more of it. 223 00:25:10.240 --> 00:25:20.240 So finally it gets to a point where they're reduced to selling it at the absolutely rock bottom price of 10.5 cents, until finally they just can't keep this up. 224 00:25:20.240 --> 00:25:28.240 And he gets another knock on his door from the cartel, and they say to him, you know, how about we just make a truce here? 225 00:25:28.240 --> 00:25:38.240 And they say, we will have Germany to ourselves, you can have the United States to yourself, but we'll let the rest of the world be open to free competition. How do you like that? And Dow accept them. 226 00:25:38.240 --> 00:25:48.240 So that sort of goes to show that the predatory pricing strategy can seriously backfire, as it did against the competitors of Herbert Dow. 227 00:25:48.240 --> 00:25:58.240 But the final point that I want to make involves where economists stand on this predatory pricing doctrine today. 228 00:25:58.240 --> 00:26:06.240 Because as I noted in my book, typically economists tend to dismiss predatory pricing. 229 00:26:06.240 --> 00:26:10.240 The average person gives it much more credence than the average economist gives it, 230 00:26:10.240 --> 00:26:15.240 and I cite George Stiegler, who's a great Chicago School economist, to the effect that today 231 00:26:15.240 --> 00:26:19.880 it would be embarrassing to encounter this doctrine in professional discourse. 232 00:26:19.880 --> 00:26:27.080 Well, on the other hand, though, it should be noted that in a small number of influential cases, 233 00:26:27.080 --> 00:26:31.560 there are economists who increasingly have brought the doctrine up again. 234 00:26:31.560 --> 00:26:35.560 In some ways, it's parallel to economists' views on foreign aid. 235 00:26:35.560 --> 00:26:39.800 1950, 1960, economists said foreign aid is a wonderful thing. 236 00:26:39.800 --> 00:26:43.640 It's going to bring about the development of the third world, and we all need to do it. 237 00:26:43.640 --> 00:26:53.640 By the 1980s, when everyone could see that foreign aid had been an absolute disaster for the third world, 238 00:26:53.640 --> 00:26:59.640 a disaster for a million reasons that perhaps we'll talk about next term or slightly referred to in my book, 239 00:26:59.640 --> 00:27:04.640 well, all of a sudden economists were all saying, oh yeah, we all knew that foreign aid would be a disaster 240 00:27:04.640 --> 00:27:07.640 because it has all these terrible incentives built in. 241 00:27:07.640 --> 00:27:21.640 But then around the year 1995 and up to today you have economists who say well you know let's not abandon foreign aid altogether if we direct it to good regimes then maybe you'll have a good outcome so it's made a comeback. 242 00:27:21.640 --> 00:27:28.640 Well the same sort of pattern is visible with predatory pricing. In the old days yep this model is absolutely true it could really happen. 243 00:27:28.640 --> 00:27:34.640 Then by the 70s and early 80s everybody was saying oh no we all knew that this can't really happen it's a big fantasy. 244 00:27:34.640 --> 00:27:40.640 But now in recent years there's been this view that, well, maybe in some cases it can be strategically used. 245 00:27:40.640 --> 00:27:45.640 Maybe some firms can use it just to put the fear of God into their competitors, 246 00:27:45.640 --> 00:27:54.640 to be such vigorous cost cutters that it will intimidate other firms into simply refraining from trying to compete with its cost cutting. 247 00:27:54.640 --> 00:27:58.640 So there are some economists who have said that it could possibly still work. 248 00:27:58.640 --> 00:28:18.640 The difficulties with even that view are that it's very hard for a court that's called in to adjudicate an antitrust dispute to distinguish between cost cutting that has a predatory goal in mind and just normal cost cutting that any business does, or I should say price cutting. 249 00:28:18.640 --> 00:28:26.640 How do you know that this firm is cutting its prices in order to drive everybody else out of business but this firm is cutting its prices just to be competitive? 250 00:28:26.640 --> 00:28:30.640 I mean, conceptually, there's no way to distinguish between them. 251 00:28:30.640 --> 00:28:34.640 So there's no non-arbitrary way to adjudicate disputes like that. 252 00:28:34.640 --> 00:28:38.640 And even if you uncover internal memos in some firms saying, 253 00:28:38.640 --> 00:28:40.640 we've got to crush our competitors. 254 00:28:40.640 --> 00:28:42.640 Well, every firm says that about their competitors. 255 00:28:42.640 --> 00:28:46.640 I mean, sometimes there is a certain poetic license that's allowed here 256 00:28:46.640 --> 00:28:48.640 when speaking about competition. 257 00:28:48.640 --> 00:28:50.640 So this is still a problem. 258 00:28:50.640 --> 00:28:55.640 And typically, or at least very, very often in antitrust cases, 259 00:28:55.640 --> 00:28:59.640 The people who bring the anti-trust cases are not consumers. 260 00:28:59.640 --> 00:29:02.640 It's other firms who just are sick of the dominant competitor 261 00:29:02.640 --> 00:29:06.640 and they just want to cripple them using the law, using the long arm of the law. 262 00:29:06.640 --> 00:29:08.640 It's typically not the consumer saying, 263 00:29:08.640 --> 00:29:11.640 Oh, please, please, I'm so tired of having inexpensive goods. 264 00:29:11.640 --> 00:29:12.640 I wish I could pay more. 265 00:29:12.640 --> 00:29:14.640 Well, if you want to pay more, go ahead and pay more. 266 00:29:14.640 --> 00:29:16.640 Go to the competing firm and pay. 267 00:29:16.640 --> 00:29:19.640 But they hardly ever actually bring anti-trust suits themselves. 268 00:29:19.640 --> 00:29:24.640 It's the competitors who just see this as the best way to cripple their efficient competition. 269 00:29:24.640 --> 00:29:32.640 Competition. But beyond this, there is the point, and this is a point that I want to give credit to Professor Don Boudreaux for. 270 00:29:32.640 --> 00:29:40.640 He points out that firms themselves have an incentive to prevent creditory pricing from being successful. 271 00:29:40.640 --> 00:29:51.640 And by that we mean as follows. Any one of us in our capacity as a consumer wants to purchase from a company that is competitive in some way. 272 00:29:51.640 --> 00:29:55.920 in some way. I'm not using this strict Austrian definition of competitive, but in other words, 273 00:29:55.920 --> 00:30:01.520 I mean, when I was living in Cambridge, Massachusetts, and I wanted to go out and buy music, that 274 00:30:01.520 --> 00:30:06.400 was the place to buy music, because they had strawberries there, that was a chain. They 275 00:30:06.400 --> 00:30:09.160 had a, I don't even remember the names of these places anymore, they had a whole bunch 276 00:30:09.160 --> 00:30:14.240 of big major music things right in the area, so you could get super cheap music. And then 277 00:30:14.240 --> 00:30:17.880 now, you know, I go to the mall, and I see the prices they charge for music, and I say, 278 00:30:17.880 --> 00:30:21.040 well, I'm not paying that, because I remember when I was in college, I didn't have to pay 279 00:30:21.040 --> 00:30:26.040 Well, I'm not living in Cambridge anymore, but I still have this view that I should have to pay only those low prices. 280 00:30:26.040 --> 00:30:29.040 Naturally, when I buy music, I want to be in that situation. 281 00:30:29.040 --> 00:30:34.040 I want to be in Cambridge, where I can get low prices because there's all this vigorous competition going on. 282 00:30:34.040 --> 00:30:41.040 That's not difficult to understand, that as buyers we want vigorous competition among the firms that are catering to us. 283 00:30:41.040 --> 00:30:48.040 But at the same time, a supplier also wants its customers to be competitive. 284 00:30:48.040 --> 00:30:52.320 Because suppose you have the example of Coke and Pepsi. 285 00:30:52.320 --> 00:30:56.960 Let's suppose Coke and Pepsi collude and decide that they're going to 286 00:30:56.960 --> 00:31:02.000 enter into a pool with themselves and then just control their prices. 287 00:31:02.000 --> 00:31:05.920 They're going to have the price go up slightly and neither one will undercut the other. 288 00:31:05.920 --> 00:31:10.440 So they're going to have some kind of a price setting scheme going on. 289 00:31:10.440 --> 00:31:15.000 Well, there is somebody other than consumers that has an interest in preventing that from happening 290 00:31:15.000 --> 00:31:20.800 And that would be Archer Daniels Midland, for instance, that produces high fructose corn syrup. 291 00:31:20.800 --> 00:31:27.500 Because, think of it this way, if Coke and Pepsi are vigorously competitive with each other, 292 00:31:27.500 --> 00:31:31.200 we're going to buy more of their stuff, they're going to have lower prices, we're going to buy more of their stuff, 293 00:31:31.200 --> 00:31:35.600 and so in turn, Coke and Pepsi are going to buy more high fructose corn syrup. 294 00:31:35.600 --> 00:31:40.900 But now let's suppose that they set their prices, they have some kind of collusion going on, 295 00:31:40.900 --> 00:31:45.900 They set their prices higher than they would otherwise have done. 296 00:31:45.900 --> 00:31:48.900 Well, we're going to buy less of their product, 297 00:31:48.900 --> 00:31:52.900 and so they're going to need less high fructose corn syrup under that situation. 298 00:31:52.900 --> 00:31:56.900 So, Archer Daniels Midland has no desire to see this happen. 299 00:31:56.900 --> 00:32:00.900 So, therefore, they have an incentive to try to prevent that from happening. 300 00:32:00.900 --> 00:32:04.900 Now, how can they prevent that from happening will hold to the very end. 301 00:32:04.900 --> 00:32:07.900 But another example would be, let's suppose Wal-Mart, 302 00:32:07.900 --> 00:32:13.900 which is the usual villain in these situations, is set to dominate the pharmaceutical market. 303 00:32:13.900 --> 00:32:16.900 And in fact, Walmart has announced, I guess some of you have probably seen the signs, 304 00:32:16.900 --> 00:32:24.900 that they're making 300 generic pharmaceutical products available for $4 for a 30-day dosage. 305 00:32:24.900 --> 00:32:29.900 You know, well, I think most people would welcome that, but other people, 306 00:32:29.900 --> 00:32:32.900 and then Target announced that they would match that price. 307 00:32:32.900 --> 00:32:34.900 Well, there would be some people who might say, 308 00:32:34.900 --> 00:32:40.220 But, what will happen if Wal-Mart drives all its competitors out of business 309 00:32:40.300 --> 00:32:43.860 and then it's the only pharmaceutical outlet, 310 00:32:43.940 --> 00:32:46.420 then it'll just raise those prices again? 311 00:32:46.500 --> 00:32:49.900 Apart from, I think, how implausible that scenario is, 312 00:32:49.980 --> 00:32:53.220 let's consider who has an incentive to prevent that from happening. 313 00:32:53.300 --> 00:32:57.340 In other words, the market itself has an incentive to prevent this outcome, 314 00:32:57.420 --> 00:33:00.340 to prevent an outcome in which Wal-Mart is so dominant 315 00:33:00.340 --> 00:33:04.740 that it can just say, well, you want this drug, then it'll be a zillion dollars. 316 00:33:04.740 --> 00:33:08.980 For one thing, I mean, obviously these pharmaceutical companies 317 00:33:08.980 --> 00:33:11.980 could just simply open their own storefronts as a last resort, 318 00:33:11.980 --> 00:33:16.820 but they probably want to prevent the monopoly from occurring in the first place. 319 00:33:16.820 --> 00:33:20.140 How do they prevent that? If they suspect it may be happening, 320 00:33:20.140 --> 00:33:24.820 if they suspect that Walmart is engaged in some kind of mad attempt 321 00:33:24.820 --> 00:33:28.860 to carry out predatory pricing, well, Merck, 322 00:33:28.860 --> 00:33:32.980 Let's say that pharmaceutical company Merck would not necessarily want to see that 323 00:33:32.980 --> 00:33:38.220 because let's suppose Walmart suddenly starts charging a zillion dollars for all of Merck's products. 324 00:33:38.220 --> 00:33:41.740 All right, well, Merck isn't going to be able to supply as many products as it could before. 325 00:33:41.740 --> 00:33:44.220 It's not going to make the profits it could before. 326 00:33:44.220 --> 00:33:50.260 So one thing that Merck might consider doing to prevent this from happening in the first place would be 327 00:33:50.260 --> 00:33:55.740 to refuse to deal with Walmart, just to distribute all their products through other competing stores, 328 00:33:55.740 --> 00:33:58.020 so as to draw some of Walmart's customers away. 329 00:33:58.020 --> 00:34:06.020 And other firms would have the incentive to do that, to prevent Walmart from building up such an unchallengeable position. 330 00:34:06.020 --> 00:34:19.020 But there is a second possibility, perhaps even more effective, that suppliers themselves, like Merck or like Archer Daniels Midland, would have an incentive to carry out. 331 00:34:19.020 --> 00:34:24.020 And that involves minimum resale price maintenance. 332 00:34:24.020 --> 00:34:29.020 Now, this is unfortunately a strategy that the antitrust laws forbid. 333 00:34:29.020 --> 00:34:33.020 Antitrust laws forbid the use of minimum resale price maintenance, 334 00:34:33.020 --> 00:34:35.020 which I'm going to explain in a minute. 335 00:34:35.020 --> 00:34:40.020 But the point is that what I'm about to show you is a perfectly plausible mechanism 336 00:34:40.020 --> 00:34:45.020 that private firms could use to prevent, if this really is a problem, 337 00:34:45.020 --> 00:34:49.020 if this really isn't just a phantom, to prevent predatory strategies from succeeding, 338 00:34:49.020 --> 00:34:53.020 the private market would have an incentive to do this and could use this mechanism. 339 00:34:53.020 --> 00:35:00.020 they can't use this mechanism because it's made illegal by the very legislation that is supposed to encourage competition. 340 00:35:00.020 --> 00:35:07.020 Minimum resale price maintenance involves contracts between suppliers and retail outlets 341 00:35:07.020 --> 00:35:12.020 whereby a supplier could say to a retail outlet, we're going to supply you with this product 342 00:35:12.020 --> 00:35:16.020 but you have to sell it at at least this price. 343 00:35:16.020 --> 00:35:19.020 And the reason that that could be useful in this sense is that suppose, 344 00:35:19.020 --> 00:35:26.020 Let's say there were people who really believed Walmart was going to become this single producer, single retailer in pharmaceuticals. 345 00:35:26.020 --> 00:35:32.020 Well, Merck could prevent that from happening by saying, you've got to sell our product at at least this price or we don't deal with you. 346 00:35:32.020 --> 00:35:36.020 And then that way they can't undercut people to that great of an extent. 347 00:35:36.020 --> 00:35:44.020 Or conversely, Merck could also use maximum retail price maintenance, which is also prohibited. 348 00:35:44.020 --> 00:35:49.020 The antitrust laws also prohibit a supplier from saying to a retailer, 349 00:35:49.020 --> 00:35:52.020 you can't sell this product for above X amount. 350 00:35:52.020 --> 00:35:57.020 So there's something that clearly and obviously hurts consumers in the antitrust legislation, 351 00:35:57.020 --> 00:36:02.020 that it forbids manufacturers to say to retailers, 352 00:36:02.020 --> 00:36:07.020 you can't raise the price above this certain level. 353 00:36:07.020 --> 00:36:13.020 Maximum resale price maintenance would have the benefit of, let us say, 354 00:36:13.020 --> 00:36:23.020 Let's say, again, let's say that this fantasy scenario comes true and Wal-Mart suddenly becomes this big, staggering, giant, unchallengeable, raising its prices dramatically. 355 00:36:23.020 --> 00:36:33.020 Merck could simply use maximum resale price maintenance and say, well, you cannot sell our product for above X number of dollars. 356 00:36:33.020 --> 00:36:37.020 Of course, again, Merck has an incentive to do this. 357 00:36:37.020 --> 00:36:42.020 If Wal-Mart does sell it above X number of dollars, they will sell fewer than they otherwise would 358 00:36:42.020 --> 00:36:44.020 and Merck's profits will tend to be lower. 359 00:36:44.020 --> 00:36:51.020 So Merck would have the incentive to enforce these terms on any potential giant predator. 360 00:36:51.020 --> 00:36:57.020 But unfortunately, these very mechanisms have been made unavailable to suppliers 361 00:36:57.020 --> 00:37:01.020 and yet it is through these very mechanisms that the market itself could prove to be 362 00:37:01.020 --> 00:37:11.020 to be the best guarantor that such nightmare scenarios, whether they are theoretically possible or not, could never actually occur in reality.