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Economic Competition Is Not a Tort; Its Costs are Internalized By the Market Process

Here’s a note to frequent EconLog commenter Thomas Lee Hutcheson:

Mr. Hutcheson:

In response to David Henderson’s EconLog post highlighting the benefits to consumers of competition that disrupts long-standing patterns of local commerce, you comment:

I do not see how your example which is perfect for showing the benefits of localized disruption, says anything about the costs. The community may benefit from the new Walmart outside of town, but the fate of all the small businesses “in town” can be sad.

The costs of this creative destruction are obvious; they pretty much define the limits of what, in such cases, everyone – other than a competent economist – sees. Given the context of this discussion, David hardly needs to point out that the creation of new products or new forms of enterprise displace older products and older forms of enterprise.

What’s not obvious is that the benefits of this competition exceed the costs. We know that these benefits exceed the costs precisely because the small businesses in town choose to shutter their doors when new competitors arise. If the costs to these small businesses of shutting down were greater than the benefits enjoyed by those who take advantage of the new competitors, the owners of the small businesses would – to escape the cost of shutting down – cut their prices to attract enough customers to remain in operation.

But whenever a business that is confronted with new competition refuses to cut its prices sufficiently to remain in that particular line of operation, the reason is that that business’s owner has better options than to continue to operate earning only the lower ‘profits’ that are possible in face of the new competition.

Therefore, rather than join the economically untutored public in focusing on the “sad” result of businesses being creatively destroyed by new competition, excellent economists such as David Henderson survey the whole picture. Doing so requires emphasis of the benefits of this competition – benefits that, again, exceed the costs but that are largely overlooked by most policy pundits.

Among the many important ‘unseen’ realities made visible by the economic way of thinking is the fact that firms and workers who are displaced by competition ultimately choose to be displaced. They do so by refusing to accept the lower incomes that would prevent them from being displaced. That this choice is often unpleasant is undoubtedly true. Yet when we take into account the whole range of relevant actions and decisions that fuel the competitive market process we see that – contrary to what many people suppose – the market does not ignore or even discount the costs of competition. These costs are fully internalized.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030