Minneapolis Fed – Analysis on Monopoly

The MN Fed has issued a working paper recently concerning monopolies, which is an important topic in my opinion. The themes involved in the paper are relevant to the following topics:

  1. Monopolies and their effect on the economy
  2. How monopolies develop and are protected
  3. How monopolies worsen economic inequality

The board game Monopoly was actually called “The Landlord’s Game” originally. It was invented in 1904 by Elizabeth Magie, a left-wing feminist, to highlight the practices of land grabbing and their consequences. When players didn’t have enough money, they went to the poorhouse. If they landed on a private property, they would be charged with trespassing and sent to jail.

Interestingly, there were actually two different versions of the rules. The first set provided everyone was rewarded immediately and then wealth was created during the game. This is the version of the game which never took off. The second set of rules made players compete against each other to create monopolies and crush their opponents.

The game is meant to highlight the economic dichotomy between supply side and demand side economics, and by extension a capitalist economy vs. socialist economy.

We still haven’t yet defined what a monopoly is, and why it is bad for the economy. Monopolies don’t have a set definition. You can’t say that once a company reaches X dollars in market cap they are a monopoly, or how much bigger they are than competitors. Rather, monopolies are defined by whether they hold certain characteristics(this is a useful link for an introduction to monopolies and their various types), such as:

  • They are able to set product prices due to their dominance in the industry
  • They are able to absorb any competitor
  • They are able to price out of the market any competitor due to economies of scale(being able to sell at lower prices due to the large orders they purchase)
  • They are able to artificially inhibit competitors entry into their market

Let’s take a look at an example: online advertising. As of 2016, Google and Facebook had a combined global marketshare of 67.5%. That is an insane number for two companies, and the entire world. With Amazon’s precipitous rise in recent years, it has likely risen near the levels of Google and Facebook, absorbing companies and businesses along the way.

You may have noticed in the bullet points above that monopolists are able to sell for lower prices due to the fact that they are so large that they can order in bulk and get lower prices from manufacturers. From a consumer standpoint, this should be a big win right? That is a valid question which has a mixed answer. First, we need to delve into market concentration and what that means for producers and consumers.

Market concentration is commonly tracked via the Herfindahl-Herschman Index(mercifully known as HHI). The HHI scale goes between 0 and 10,000; 0 means perfect competition, and 10,000 means that there is only one company in the entire sector( a true monopoly). The U.S. defines any industry index above 2,500 to be “highly concentrated”. In the case of online advertising, at least as of 2016, the HHI was 5,276. That is double what it would take for the U.S. to consider an anti-trust investigation between two merging companies in the U.S. In fact, the U.S. Department of Labor did block a merger in 2017 between Aetna and Humana because it was found that it would increase the HHI to over 5,000 in 75% of countries.

Even if you’ve only carelessly glanced at the news in recent years, you would know the extraordinary price increases the U.S. has seen in basic drugs like insulin and epi-pens.

Monopolies develop like all other successful companies develop. They grow rapidly in an underserved market by innovation, talent, and sometimes cheap third world labor. Pharmaceutical companies are able to generate enormous profits from insulin, because they are so concentrated. As of 2019, only three companies supplied the world with 90% of insulin. This is despite the fact that the inventor of insulin, Frederick Banting, said a doctor should not profit from a medicine which could save lives. His co-inventors sold the patent to the University of Toronto for $1. Thank you Canada for being you, and not a pharmaceutical company which goes directly against the wishes of the drug’s inventor.

Monopolies aren’t necessarily the old-school monolith of industry as decades old stereotypes may portray. They are more subtle and insidious owing to the sophisticated nature of advertising which exists today. A Duopoly seems to be much more prevalent, and dangerous, than a true monopoly of days of yore. As in the case of Google and Facebook, far out performing the rest of the global online advertising market, there exists plenty of examples of “superficial competition” among two or three giants in a given sector.

Economic concentration within an economy is a double edged sword. In the case of Amazon, dominating the delivery market has unparalleled benefits for consumers. There are certainly other delivery services within the U.S.: UPS, USPS, DHL, and FedEx. None of those service providers, however, offer a user initial-point of service. Where the other delivery providers “stay in their lane” by providing delivery services only, Amazon captures the consumer from start to finish. Consumers order a product on Amazon, and then Amazon is responsible for delivering their product. This is a fundamental change in the consumer experience since online shopping became mainstream.

Amazon has captured the the consumer sales to delivery market for a purpose. It costs an enormous amount of money to ship a product to an individual. A smart company like Amazon wouldn’t provide this service for free without something in return. Thus, the consumer demographic info-sale is born. This is the real bread and butter of Amazon. To defray the costs of shipping untold amounts of consumer goods, they sell their data to their real customers, their suppliers.

This fundamentally changes the dynamic between the company which provides value and the workers which supply the labor. Amazon workers, diligently serving the “fullfilment centers” are processing orders at a rate that 1970’s factory workers could only dream about. But they are disconnected from the true value proposition of Amazon, which is to sell market access to suppliers. This is why the labor force at Amazon can never truly have any leverage in sharing the record profits which Jeff Bezos has earned throughout 2020 via stock options.

The actual scenario is that workers are supplying value for a demographic which is not the intended target of profit. Consumers are purchasing Amazon products by the truckload, but Amazon the company doesn’t evaluate success in this sense. Their view is directed toward their market share in retail suppliers. Amazon’s success depends on their ability to encapsulate the retail distributor market for consumer goods, not for their ability to deliver those products or provide an easy interface for consumer sales.

This is directly an example of how a monopoly can be both good and bad for consumers; at least in the present. Let’s draw this out into a few years. Amazon takes on a role of a monopsony, meaning they are the primary buyer of good which are to be sold online. Suppliers, seeking their own best interest, must go through Amazon to sell their products, or fail. What terms will Amazon impress upon this newly developed company? Will this company be recompensed proportionately to the value that the company provides consumers? Likely not. This becomes the central issue.

In a “perfect economy”, a company would be able to sell their product on the open market at the price that consumers are willing to purchase. What is this price? Well, this is a function of production cost and marginal cost, but mostly it is what the market is able to bear. In other words, what people are willing to pay for the product. The trouble begins when it is a product which people “need” and the market has artificially raised the price to sell.

This is the central criticism of monopoly. The consumer has a need to purchase the product, but the supplier of this product has such command of the market that they are able to dictate the price regardless of demand. This runs perfectly counter to the values of a free market and has been a thorn in the side of free market economists since the founding of the U.S.

Market concentration exacerbates the issues presented by monopolistic enterprise. In the case of Amazon, workers are fundamentally unable to share in the growth of the company because the growth they contribute to is not the growth which the company is targeting. For other monopolistic endevours, the end goal of the companies growth is not to develop a base of loyal customers which can grow the company. This would benefit the workers of those companies. No, the goal of those companies is to leverage their market position in order to sell that position to periphery companies.

This changing dynamic has a profound impact on our understanding of what a “monopoly” is. It further challenges what it means to “dominate a market”. For legislators and entrepreneurs alike, there must be an acknowledgement that the paradigm has shifted. The end consumer is no longer directly tied to the primary marketer. There are orders of degrees which separate the producer of goods, from the end consumer. A monopolistic version of this economic construct is dangerous for both a healthy, competitive market, as well as the end consumer. The first step is to acknowledge that the issue exists.

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