TCS Daily

In Defense of Price Fixing

By Sean Gabb - April 8, 2003 12:00 AM

In February 2003, the Office of Fair Trading in London imposed fines of £17 million on two British retailers, Littlewoods and Argos. These are the biggest fines in the history of British competition law. The offense punished is that the two retailers entered into an agreement not to sell the products of Hasbro, an American toy manufacturer, below certain prices.

The fines were imposed under powers given by the Competition Act 1998. This act consolidates powers given under various laws passed since 1948, and adds further regulations required by the European Union. According to the Office of Fair Trading website, "[t]he main aim of the [Competition] Act is to ensure that UK markets remain competitive, to the benefit of both business and consumers". Breaches of the law can be punished with fines of up to 10 percent of a company's UK turnover, and by private action for damages by any third party affected by the breach.

Though justified in language filled with praise of competition and the efficient working of markets, the fines and the general legal framework within which they were imposed are a violation of market freedom, and are not in the interests of consumers.

They are also, of course, a violation of freedom unamended by any adjective. Subject to respecting the rights of others, people should be free to do as they please with themselves and their property. This means that people should have the right to use their minds and bodies as they please in the usual manners defended by civil libertarians. It also means, however, that they should have the right to buy and sell as they please. The two offending retailers, according to this view, should have the right to set whatever terms of business take their joint or several fancy. If they wish, they should be able to charge 25 different prices throughout the country for the same products, and to discriminate openly between customers. If they want, they should be able to insist that customers pay for goods while stark naked or standing on their heads singing the Chinese national anthem. I see no reason why they should ever do these things, but it ought to be their right to do them if that is what they want.

The standard objection here is that, to quote J.S. Mill, "trade is a social act", and as such ought to be regulated for the protection of third parties. Whole books can be written around this point - and have been. The main answer, though, is that the various schemes of regulation made throughout the developed world are based on a radical misconception of the value and function of markets.

Since the death of socialism, hardly anyone of importance now believes that economic planning will make the world a richer place. If only at the pragmatic level, markets are universally accepted as the most effective means of reconciling the fact of unlimited human wants and scarcity of the means to satisfy them. But, this being so, the standard economics textbooks provide an utterly unrealistic defense of the market. They begin with the claim that markets are efficient, and then define efficiency as it does not and cannot exist. A perfectly efficient market, they agree, is one in which there are many buyers and sellers, in which there are no barriers to entry or exit, in which all products are of the same quality, and in which all players know everything about prices, costs and production methods. The closer a market approaches this ideal, the more efficient it is said to be. The further away it is, the greater the case is said to exist for the government to intervene to bring it closer to the ideal.

But the ideal is false. Real markets are never efficient in this sense. Most are dominated by a few buyers or sellers. Getting into or out of most involves significant and often huge costs. Branding and other marketing tools differentiate even those products that are, considered purely in themselves, identical. As for information, this is never freely available: no business knows what its demand curve really looks like, and hardly any is able to know its marginal costs of output in advance.

Markets should not be analyzed in terms of static equilibrium. Undoubtedly, they have a tendency to productive and allocative efficiency. But changing wants and technology and other facts always ensure that the theoretical point of equilibrium in any market - even could it be known - shifts unpredictably from moment to moment.

The real problem of economics is not to know what equilibrium looks like once it has emerged, but to understand the process by which it is continually approached, and the value of that process. This is the view taken by the Austrian school of economists - von Mises, Hayek, Rothbard, Israel Kirzner, among many others. They see the economic value of markets as a discovery process, in which particles of knowledge dispersed among billions of individuals - knowledge about wants and costs and techniques, knowledge that would otherwise remain dispersed - are brought together into a rational structure of opportunities for exchange. Markets allow people to blunder around, or make intelligent guesses, and every so often to light on some previously unimagined way of making the world a better place.

Now, real market outcomes will not necessarily look anything like a perfectly competitive equilibrium. There may be a single supplier in a market, which may earn very high profits in the short and long term. Or there may be general collusion among suppliers to fix prices. But, so long as there is no use of government force to close the market - as is the case with the British Post Office - this must be taken as an efficient outcome for the time that it endures. If an outcome is not efficient - if there are ways for someone else to come into a market and cut prices or raise quality while still making a profit - any position, no matter how apparently dominant, will crumble.

In the case of the two companies fined last month, they are not the only suppliers of toys in the British market. At the very least, there is the Internet - which allows far greater competition throughout the world than has ever existed before, and which does push all markets closer in potential towards equilibrium. Even otherwise, there are always substitutes for the products covered by the price fixing agreement. If consumers are willing to pay the higher prices, that is because they prefer not to buy substitutes, or because they cannot be bothered to incur the possibly high costs of seeking the same products elsewhere at prices unknowable in advance.

The existence of bodies like the Office of Fair Trading illustrates the problem of what Frederic Bastiat called "what is seen and not seen" in economic policy. What we can see is that certain toys from certain suppliers have been made cheaper than would otherwise have been the case. What we do not see so well is that any regulation of markets impairs the discovery procedure that they embody. Firms may need to seek permission to do things that seem barely worth doing even without the cost of seeking. Or they may need to make disclosures that it is not in their interest to make. Or they may find the whole regulatory framework captured by some big competitor that then effectively closes the market.

We cannot know the opportunity cost of any specific act of regulation. But we can be sure that the cost of a general course of regulation is new products not introduced to the market, or new ways of producing or marketing them. Consumers gain in the short term in ways that all can see. In the longer term, they lose, if in ways that no one at all can see.

A government truly committed to free market policies would repeal the Competition Act and all similar legislation, and shut down all enforcement bodies. Sadly, the standard economic theory taught in most universities has a perverse effect that makes this impossible. Students begin with the notion that markets are more efficient than state allocation. They then see that no actually existing market is efficient in the sense given to them. They end by diagnosing "market failure" and call for regulatory laws that come close to abolishing market efficiency in its only real sense.

One day, this may change, but probably not in our time.

Sean Gabb is Director of Communications for the London-based Libertarian Alliance, and the author of Free Life Commentary. He is also a university lecturer in Economics and Law.

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