A reader asks:

In a society of laissez-faire capitalism, what would prevent the formation of powerful monopolies able to gain control over the entire economy?

Nathaniel Branden responds:

One of the worst fallacies in the field of economics—propagated by Karl Marx and accepted by almost everyone today, including many businessmen—is that the development of monopolies is an inescapable and intrinsic result of the operation of a free, unregulated economy. In fact, the exact opposite is true. It is a free market that makes monopolies impossible.

It is imperative that one be clear and specific in one’s understanding of the meaning of “monopoly.” When people speak in an economic or political context, of the dangers and evils of monopoly, what they mean is a coercive monopoly—that is; exclusive control of a given field of production which is closed to and exempt from competition, so that those controlling the field are able to set arbitrary production policies and charge arbitrary prices, independent of the market, immune from the law of supply and demand. Such a monopoly, it is important to note, entails more than the absence of competition; it entails the impossibility of competition. That is a coercive monopoly’s characteristic attribute-and is essential to any condemnation of such a monopoly.

In the whole history of capitalism, no one has been able to establish a coercive monopoly by means of competition on a free market. There is only one way to forbid entry into a given field of production: by law. Every single coercive monopoly that exists or ever has existed—in the United States, in Europe or anywhere else in the world—was created and made possible only by an act of government: by special franchises, licenses, subsidies, by legislative actions which granted special privileges (not obtainable on a free market) to a man or a group of men, and forbade all others to enter that particular field.

A coercive monopoly is not the result of laissez-faire; it can result only from the abrogation of laissez-faire and from the introduction of the opposite principle—the principle of statism.

In this country, a utility company is a coercive monopoly: the government grants it a franchise for an exclusive territory, and no one else is allowed to engage in that service in that territory; a would-be competitor, attempting to sell electric power, would be stopped by law. A telephone company is a coercive monopoly. As recently as World War II, the government ordered the two then existing telegraph companies, Western Union and Postal Telegraph, to merge into one monopoly.

One of the best illustrations of the fact that a coercive monopoly requires the abrogation of the principle of laissez-faire is given by Ayn Rand in her “Notes on the History of American Free Enterprise.” She writes:

“ The Central Pacific—which was built by the ‘Big Four’ of California, on federal subsides—was the railroad which was guilty of all the evils popularly held against railroads. For almost thirty years, the Central Pacific controlled California, held a monopoly and permitted no competitor to enter the state. It charged disastrous rates, changed them every year, and took the entire profit of any California farmer or shipper who had no other railroad to turn to. How was this made possible? It was done through the power of the California legislature. The Big Four controlled the legislature and held the state closed to competitors by legal restrictions—such as, for instance, a legislative act which gave the Big Four exclusive control of the entire coast line of California and forbade any other railroad to enter any port. During these thirty years, many attempts were made by private interests to start competing railroads in California and break the monopoly of the Central Pacific. These attempts were defeated—not by methods of free trade and free competition, but by legislative action.

“ This thirty-year monopoly of the Big Four and the practices in which they engaged are always quoted as an example of the evils of big business and Free Enterprise. Yet the Big Four were not free enterprises; they were not businessmen who had achieved power by means of unregulated trade. They were typical representatives of what is now called ‘a mixed economy.’ They achieved power by legislative interference into business; none of their abuses would have been possible in a free, unregulated economy.”

In the comparatively free days of American capitalism, in the late-nineteenth-early-twentieth century, there were many attempts to “corner the market” on various commodities (such as cotton and wheat, to mention two famous examples)—then close the field to competition and gather huge profits by selling at exorbitant prices. All such attempts failed. The men who tried it were compelled to give up—or go bankrupt. They were defeated, not by legislative action—but by the action of the free market.

The question is often asked: What if a large, rich company kept buying out its smaller competitors or kept forcing them out of business by means of undercutting prices and selling at a loss—would it not be able to gain control of a given field and then start charging high prices and be free to stagnate with no fear of competition? The answer is: No, it would not be able to do it. If a company assumed heavy losses in order to drive out competitors then began to charge high prices to regain what it had lost, this would serve as an incentive for new competitors to enter the field and take advantage of the high profitability, without any losses to recoup. The new competitors would force prices down to the market level. The large company would have either to abandon its attempt to establish monopoly prices—or else go bankrupt fighting off the competitors its own polices would attract.

It is a matter of historical fact that no “price war” has ever succeeded in establishing a monopoly or in maintaining prices above the market level, outside the law of supply and demand. (“Price wars” have, however, acted as spurs to the economic efficiency of competing companies—and have thereby resulted in enormous benefits to the public, in terms of better products at lower prices.)

What is frequently forgotten by people, in considering an issue of this kind, is the crucial role of the capital market in a free economy. As Alan Greenspan observes in his article “Bad History” (Barron’s, February 5, 1962): “If entry [into a given field of production] is not impeded by Government regulations, franchises or subsidies, the ultimate regulator of competition in a free economy is the capital market. So long as capital is free to flow, it will tend to seek those areas of maximum rate of return.” Investors are constantly seeking the most profitable uses of their capital. If, therefore, some field of production is seen to be highly profitable (particularly when the profitability is due to high prices rather than to low costs), businessmen and investors necessarily will be attracted to that field; and, as the supply of the product in question is increased relative to the demand for it, prices fall accordingly. “The capital market” writes Mr. Greenspan, “acts as a regulator of prices, not necessarily of profits. It leaves any individual producer free to earn as much as he can by lowering his costs and by increasing his efficiency relative to others. Thus, it constitutes the mechanism which generates greater incentives to increased productivity, thereby leading to a rising standard of living.”

The free market does not permit inefficiency or stagnation—with economic impunity—in any field of production. Consider, for instance, a well-known incident in the history of the American automobile industry. There was a period when Henry Ford’s Model-T held an enormous part of the automobile market. But when Ford’s company attempted to stagnate and to resist stylistic changes—“You can have any color of the Model-T you want, so long as it’s black”—General Motors, with its more attractively styled Chevrolet, cut into a major segment of Ford’s market. And the Ford Company was compelled to change its policies in order to compete. One will find examples of this principle in the history of virtually every industry.

Now if one considers the only kind of monopoly that can exist under capitalism, a non-coercive monopoly, one will perceive that its prices and production polices are not independent of the wider market in which it operates but are fully bound by the law of supply and demand; that there is no particular reason for or value in retailing the designation of “monopoly” when one uses it in a non-coercive sense; and that there are no rational grounds on which to condemn such “monopolies.”
For instance, if a small town has only one drug store, which is barely able to survive, the owner might be described as enjoying a “monopoly”—except that no one would think of using the term in this context. There is no economic need or market for a second drug store. There is not enough trade to support it. But if that town grew, its one drug store would have no way, no power, to prevent other drug stores from being opened.

It is often though that the field of mining is particularly vulnerable to the establishment of monopolies, since the materials extracted from the earth existed in limited quantity and since, it is believed, some firm might gain control of all the sources of some raw material. Well, observe that International Nickel of Canada produces more than two-thirds of the world’s nickel—yet it does not charge monopoly prices. It prices its product as though it had a great many competitors—and the truth is that it does have a great many competitors. Nickel (in the form of alloy and stainless steels) is competing with aluminum and a variety of other materials. The seldom-recognized principle involved is this: no single product, commodity or material is or can be indispensable to an economy regardless of price. A commodity can be only relatively preferable to other commodities. For example, when the price of bituminous coal rose (which was due to John L. Lewis’ forcing an economically unjustified wage raise), this was instrumental in bringing about a large-scale conversion to the use of oil and gas in many industries. The free market is its own protector.

Now if a company were able to gain and hold a non-coercive monopoly, if it were able to win all the customers in a given field, not by special government-granted privileges, but by sheer productive efficiency—by its ability to keep its costs low and/or to offer a better product than any competitor could—there would be no grounds on which to condemn such a monopoly. On the contrary, the company that achieved it would deserve the highest praise and esteem.

The history of the Aluminum Company of America prior to World War II is a case in point. Seeking constantly to expand its market, Alcoa kept its prices as low as possible; this policy required enormous productive efficiency and cost cutting. Alcoa was the only producer of primary aluminum and, as such, was a monopoly; but it was not a coercive monopoly; nothing prevented other companies from attempting to compete with it, except the fact that they could not match its productive efficiency. The pricing policies of Alcoa were entirely subject to the law of supply and demand: aluminum had to compete with steel, with copper, with cement, and with many other construction materials; and had Alcoa attempted to raise its prices—this would have served as an engraved invitation to competitors toe enter Alcoa’s own field.

No one can morally claim the right to compete in a given field, if he cannot match the productive efficiency of those with whom he hopes to compete. There is no reason why people should buy inferior products at higher prices in order to maintain less efficient companies in business. Under capitalism, any man or company that can surpass competitors is free to do so. It is in this manner that the free market rewards ability and works for the benefit of everyone-except those who seek the undeserved.

A bromide commonly cited in this connection by opponents of capitalism is that of the old corner grocer who is thrown out of business by the big chain store. What is the clear implication of their protest? It is that the people who live in the neighborhood of the old grocer have to continue buying from him, even though a chain store could give them better service at lower prices and thereby let them save money. Thus, both the owners of the chain store and the people in the neighborhood are to be penalized—in order to protect the stagnation of the old grocer. By what right? If that grocer is unable to compete with the chain store, then properly, he has no choice but to move elsewhere or go into another line of business or seek employment from the chain store. Capitalism, by its nature, entails a constant process of motion, of growth, of progress; no one has a vested right to a position if others can do better than he can.

When people denounce the free market as “cruel,” the fact they are decrying is that the market is ruled by a single moral principle: justice. And that is the root of their hatred for capitalism.

There is only one kind of monopoly that man may rightfully condemn—the only kind for which the designation of “monopoly” is economically significant: a coercive monopoly. (Observe that in the non-coercive meaning of the term, every man may be described as a “monopolist”—since he is the exclusive owner of his effort and product. But it is not this that is denounced as evil—except by socialists.)

In the issue of monopolies, as in so many other issues, capitalism is commonly blamed for the evils perpetrated by its destroyers: it is not free trade on a free market that creates coercive monopolies, but government legislation, government action, government controls. If men are concerned about the evils of monopolies, let them identify the actual villain in the picture and the actual cause of the evils: government intervention into the economy. Let them recognize that there is only one way to destroy monopolies: by the separation of State and Economics—that is, by instituting the principle that the government may not abridge the freedom of production and trade.