Free markets.



Those three don’t sound like a paradox at all… But I’ll get to them in a moment. First:

A Brief History of how we became Free Market Economists

In the beginning, we were all just farmers. And then we became farmers that farmed for lords and occasionally fought in their battles. And then we invented the steam engine and we became industrial. At which point, Adam Smith and David Ricardo began to talk about the Wealth of Nations and the relative worth of labour.

And industry did well, and the banks did better, and everyone began to get on board with this whole stock-exchange lark. Even the farmers. Until one dark Thursday…

The Great Depression

When the stock markets crashed in 1929, the economic-political world was at a bit of a loss. And very confused:

  1. Some important people thought that the depression was being caused by evil businesses paying low salaries – so they put policies in place to keep wages high. (because nothing keeps a company in business like an expensive labour force…)
  2. These were the days before Milton Friedman (and monetary theory) – so the Federal Reserve thought the real problem was actually the instability of the dollar in relation to gold. They therefore tried to preserve the value of the dollar by increasing interest rates. Which, um, decreased the amount of money in the economy. #NotHelpful

Unsurprisingly (to all of us now) – those two policies meant that the Depression only got worse.

Sidebar: it does make you wonder what future economists might say about our little situation today… I’m sure the Fed and the economists at the time thought they were doing a great job.

Enter: Mr Keynes

John Maynard arrived on the scene with a new general theory about how it all worked – and basically, his proposal was that the government should spend its way out of the depression. Whether it was this that changed things, or the fact that World War II arrived with all the war production demands, is not altogether clear.

But since then, politicians have been generally delighted, because Keynes offered them an economic theory that required them to spend money in order to save their constituents (could it be any more perfect?). So governments spent the next 30 years spending money and being generally applauded. And if employment came at the price of a little inflation – then hey, whatevs. At least people are earning salaries that could adjust…

Exit: Mr Keynes

Then came the 1970s and the oil shocks. Suddenly, inflation was being driven up by outside forces (that evil OPEC), alongside rising unemployment internally (the higher costs caused companies to cut back – because it’s difficult to pass all your costs along to customers). And the inability of governments to do anything Keynesian led to some revisions in economic thought. And then Reagan and Thatcher emerged on the scene with new greengrocer-style ideas about thrift and the independence of the working class.

They gave us Neoliberalism and its free-market economic policies: less regulation, lower tax rates, more free markets – which is where we stand today (in theory).

Free Markets in Theory

The concept of free markets actually extends back to something Adam Smith said about invisible hands. The essential idea: if the market were left to itself, everything would end up in the right place. That is, the market would self-regulate.

Which is wonderful in abstract – in practice, I think that every economic agent has a direct and clear incentive to capture the market. Here’s an example:

  • My mother brings home a box of frosted doughnuts every Monday.
  • I have to share them equally between my brother and myself, meaning that I can only have half the doughnuts.
  • But if I tattle-tale on my brother for doing something wrong (highlighting his flaws!), then maybe my mother will ban him from eating the doughnuts.
  • And then I can have all the doughnuts.
  • And even if she doesn’t let me have his half – I’ve still increased my share of the good stuff relative to his…

You see it all the time in practice: regulators get captured by the players that they’re meant to regulate; Republics end up with Emperors; parish committees somehow end up dominated by a grandmotherly tyrant with a gentle demeanour and a thundering will of iron.

So let me throw in a sporting analogy: if you want fair play, you need an umpire. Otherwise, all the cheating turns it into a free-for-all*.

Conclusion: if you want unregulated markets free of government interference, it turns out that you need a government to make sure that everyone plays by the free market rules. But, you know, that’s the ONLY regulation we’ll allow.

Enter: Antitrust Law

So governments developed competition commissions and antitrust tribunals in order to prevent any one company from getting too big and/or powerful in a particular industry. Which, again, sounds like a reasonably good idea. Until the ref’s power goes to his head. Cue:

The Apple eBooks price-fixing saga…**

The story:

  1. In 2009, Apple was inventing iBooks for the iPad.
  2. At the time, Amazon had 90% of the market for ebook sales – and Amazon’s business model revolved around buying the books from the publishers, and then selling them on to customers (the “wholesale” model).
  3. Amazon was selling the ebooks for up to half the price of what it bought them at (ie. it was making a 50% loss). But it was happy to do that, because it wanted to sell Kindles and thereby (presumably) get a first-mover advantage on the e-reader market (some people might call that MONOPSONISTIC*** BEHAVIOUR).
  4. But the publishing houses were unhappy – because the whole undercutting-their-prices-by-50% was creating pressure on them to lower their own prices.
  5. Meanwhile, Apple wanted in on the ebook market, but didn’t want to make losses either.
  6. So Steve Jobs suggested that Apple let the publishing houses sell their ebooks directly through the iBookstore, at a price that they would set, and Apple would take a commission (the Agency model).
  7. It seems that the publishing houses were already talking about doing something similar themselves – but the iPad provided them with the perfect ready-made platform.
  8. As part of the agreement with Apple, the publishers committed to always offering the best price on the iBookstore (that is – the publishers would have to match any lower price offered by a competing ebook retailer).
  9. And because the publishing houses could now turn round to Amazon and say “Guys – if you don’t match our price on the iBookstore, then we won’t sell to you” – Amazon suddenly started matching the (higher) prices that were being charged by the publishers.

And now, the US government is suing Apple under antitrust law for “anti-competitive price-fixing behaviour”.

To be clear: Amazon, who basically had the monopoly (and monopsony) on ebooks, was using their market power to force publishing houses to lower their prices… Only, their behaviour was okay. But because Apple wanted to come in, break the monopoly, but not make a loss while they did it – they were the bad guys? It’s no wonder that Tim Cook calls the situation “bizarre”.

That said, the publishing houses were the ones originally being sued for being anti-competitive – and they’ve all settled. But if you look at point 7 and point 9 above, that does sound a little like they were colluding. Apple, on the other hand, just sounds like it was negotiating a new model of distribution with its suppliers. And correctly identifying the incentives of the market players…

Do competition commissions realise that “higher prices for customers” don’t necessarily mean “anti-competitive behaviours”? Sometimes, higher prices are just the fundamentals of the situation.

Also – who the government really trying to protect here?

*This is the point where someone usually tells me that my argument is built on “pithy truisms” about human nature. I make no apologies. You can belittle my delivery – but ultimately, you’d still have to demonstrate that the profit motive of free markets doesn’t eventually lead to the “winner” establishing a monopoly. And to their stamping out of anyone attempting to offer an alternative…

**I know. I’m biased. But this story is also ludicrous.

***Monopolies occur when you only have one seller of a product (Amazon definitely had monopoly power at the time). Monopsonies occur when there is only one buyer of the product (Amazon had monopsony over purchases of ebooks from the publishing houses). Both are a bit unfair.