Mike Munger recently wrote about the misunderstanding of economic competition that many legislators and regulators seem to hold – the idea that improving competition means ensuring that there are more companies rather than fewer. This misunderstanding stems from what Munger calls a confusion between the textbook definition of “perfect competition” (which Munger calls “common sense”) and actual competition, as it occurs in the world outside the classroom. Munger cites this example:
Senator Elizabeth Warren recently argued that the Biden administration, through the FTC, should block the acquisition of Discover by Capital One. His insight into “perfect competition,” two small firms are better than one medium-sized firm. Yet one only needs to look at the big industry, where Visa, MasterCard, and American Express fully control 98 percent of credit sales, to see the folly of that approach. If the Capital One-Discover marriage is not completed, there will be more competition in the industry, not less. The newly formed entity will have the financial strength, and scale of operations, to force the credit card industry out of its outdated ways.
That got me thinking about other situations where “more firms = more competition = better” fails to hold true. Two big examples struck my mind – banks, and mobile applications.
Let’s start with the first one. Before the Great Recession, Canada had a largely unregulated banking system. From that process, what emerged was a very small number of very large banks operating throughout the country. In the United States, there was a highly regulated banking system that (among other things) turned more towards a “unit banking” system rather than a branch banking system. That is, banks were geographically limited in how far they could expand (operating across state lines was often not an option) and were therefore limited in size. In this process, what emerged was the system of tens of thousands of small banks across the country.
From the perspective “more firms = more competition = better”, it would seem that the United States, with its large number of banks, would be in a better position than Canada, which was “dominated” by only a few very large banks. But in reality, it was the opposite. Because the banks were numerous and small, it also meant that each bank was not very diverse in its assets and was only bound by local economic conditions. Larger, more diversified banks can better absorb economic shocks than smaller, less diversified banks. This is part of the reason why during the Great Depression the highly regulated United States banking system had over 10,000 bank failures and the lightly regulated Canadian banking system had none.
The second example that came to mind was mobile applications. Right now, it’s not uncommon to see a certain amount of handwriting despite the fact that mobile operating systems are a duopoly between Android and iOS. Wouldn’t it be better if there were mobile operating systems in the market, due to the increasing competition? Well, it’s not. If you’re wondering why, as Munger himself would say, the answer is transaction costs.
Let’s consider an extremely good example. Imagine a genie snaps his fingers and tomorrow there are 10,000 mobile apps on the market. Why wouldn’t that be good for the competition? However, one of the most annoying real-world aspects left out of introductory board models is the cost of implementation. If you want to produce and sell an app that simulates a coin flip to help improve the lives of people who can’t make decisions, there’s no way you’re going to program and format that app for 10,000 different OSes. Manufacturing costs are simply too high. It’s the same for every app designer and app developer out there. The more operating systems in the market, the more difficult and expensive it becomes to make your app or program available to everyone in the market. Over the past few decades, there has been a wide variety of applications. Symbian was one. BlackBerry had its own, called (unthinkable) BlackBerryOS. WebOS was another. Windows Mobile had a good run, too. All of this has collapsed, leaving Android and iOS locked against each other. Would it be better if all these idle mobile apps were still around, providing more and better competition? Perhaps so in the mental world of perfect competition. But in the real world, in a world where transaction costs exist, it is not at all clear that this would be the case. Multiple operating systems mean increased transaction costs associated with manufacturing everything we use for those operating systems – which could make the mobile OS market less rather than more productive.
What is the “right” number of applications? I don’t know. Neither do you. The answer cannot be found on a board, chair, or tea leaves. But the best chance we have for an answer is when markets are free enough for players to engage in real global market competition.
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