Repairing Rothbardian Monopoly Theory

Guatemala’s Universidad Francisco Marroquín publishes a series called A Companion to… for notable free-market economists. A few months ago, they asked me to write a chapter for A Companion to Murray Rothbard, forthcoming next year. I’ve just finished my draft on “Repairing Rothbardian Monopoly Theory.” Here’s the intro, plus a few choice passages.

1. Rothbard’s Rejectionism

After leading with the theory of perfect competition, economics textbooks standardly add a “corrective” chapter on the evils of monopoly. While they occasionally mention government-created monopoly, the focus is almost always on the harm of free-market monopoly, and the necessity of antitrust laws to combat such monopoly. A free-market monopoly is a business that manages to control a whole industry, and uses its control to slash output and raise prices. Later textbook chapters move on to markets with varying degrees of “monopoly power” – and broadly conclude that as monopoly power goes up, market performance goes down. The moral: Free markets are only optimal in an extreme polar case. The further the real world strays from that case, the more suboptimal they become – and the more regulation improves the free-market outcome.

Murray Rothbard rejects this picture, using three different sets of arguments. (Rothbard 2009) First, he maintains that textbook monopoly theory is literal nonsense. On the free market, there is no coherent way to distinguish a monopoly price from a competitive price. Second, he argues that the size and number of firms is an optimal response to economies of scale and consumer demand. When economies of scale are low and consumer demand is high, you optimally get a lot of small firms; when economies of scale are high and consumer demand is low, you optimally get a few large firms. Finally, Rothbard maintains that when firms have tried to gain free-market monopolies via collusion or predation, economic history shows that they reliably failed. The best check on free-market monopoly is the free market itself. (Rothbard 1986a, 1986b, 1986c, 1986d)

In this essay, I critically assess Rothbard’s critique of the textbook account. His first and most fundamental argument – that textbook monopoly theory is literal nonsense – is not only false. It contradicts his third argument. How can history “show” that market forces prevent free-market monopoly if free-market monopoly is impossible by definition? His second and third arguments, however, are very strong. Free competition works far better than “perfect” competition. Market structure is indeed a functional response to costs and demand. The main way firms gain and maintain monopolies on the free market is by doing an exceptionally good job of controlling costs and pleasing consumers. When they try to gain and maintain monopoly by the alternate path of collusion and predation, they rarely succeed for long. So while Rothbard’s most original contribution to monopoly theory is wrong, bordering on crackpottish, his pro-market, anti-government vision is fundamentally sound and wise.

2. The “Illusion” of Monopoly Price

But it is Rothbard’s critique that is utterly fallacious. Horizontal demand curves are not only logically possible; we commonly observe them. Have you ever managed to sell additional hours of your time without cutting your price? Then you have personally experienced horizontal labor demand.

More fundamentally, even if horizontal demand were impossible, it is still perfectly coherent to claim that monopoly power decreases as demand gets closer to horizontal. Rothbard specifically denies this:

We cannot compare or classify the curves on the basis of degrees of elasticity… once the case of pure competition is rejected. For praxeology cannot establish quantitative laws, only qualitative ones. (Rothbard 2009: 722)

But “Markets work better as demand gets closer to horizontal” is a qualitative law! And the impossibility point would be irrelevant even if it were true. No human being has ever crafted a perfect sphere, yet many products become more useful as they get closer to spherical. Similarly, even if no demand curves are perfectly horizontal, one can coherently claim that markets work better as demand gets closer to horizontal.

4. Some Economic History of Monopoly and Competition

Crucially, it only makes sense to say “monopolies collapsed on the free market” if it is meaningful to speak about monopoly on the free market. In these lectures on American economic history, Rothbard at least temporarily forgets his misguided a priori theory that free-market monopoly is “illusory” by definition. This in turn enables him to review the facts and conclude “Monopoly on the free market is fragile” instead of “Monopoly on the free market is a contradiction in terms” – as well as “Firms get and stay big on the free market by keeping prices low and output high” rather than “Whatever firms on the free market do is by definition ideal.”

The key question is simply: Can we trust Rothbard’s economic history? While economic analysis of the period is surprisingly sparse, the existing literature strongly confirms his overall story. The broad reviews of large samples of industries during the Gilded Age agree that so-called “monopolies” increased production and cut prices much more than the rest of the U.S. economy. (DiLorenzo 1985; DeLorme et al. 1997) Mergers-to-monopoly (a) sometimes managed to raise prices in the short run, but they reliably failed to do so in the long run; (b) quickly attracted large-scale new entry; and (c) very rarely earned supernormal profits. (Dewing 1914, 1921; Lamoreaux 1985) Unlike Rothbard, mainstream researchers acknowledge a few exceptions to these rules, but there is still a strong consensus on the rules.