Suppose that Smith began selling yo-yos to the public at a price of $10 each five years ago. You, as is your right, purchased a few of these toys from him. Two years ago, Jones, who has the same rights as do Smith and you, also began to make yo-yos and offer them for sale to the same public served by Smith. To get more sales, Jones charged only $9 for each of his yo-yos. To keep his loss of customers to a minimum, Smith responded to Jones’s entry into the yo-yo industry by lowering the price of his yo-yos to $9.
Let’s pause to admire the beauty and beneficence of economic competition. Here, Jones was enticed into the yo-yo industry by what were handsome – economists call them “above normal” – profits earned by Smith. The very existence of such profits proves that the value that consumers would get from having more yo-yos is greater than is the value of the other goods and services that consumers must sacrifice in order that these additional yo-yos be produced. And these profits also are what enticed Jones to produce these additional yo-yos – which, in turn, enticed Smith to lower the price of his yo-yos.
The freedom of producers to enter markets and of buyers to say “no” or “yes” to offers as they please drives suppliers to transfer to consumers the bulk of the gains from trade. Suppliers keep as ‘profit’ just enough money to stay in business, while competition obliges suppliers to share most of the fruits of entrepreneurial innovation, risk-taking, and effort with consumers. Nobel-laureate economist William Nordhaus found that “only a minuscule fraction of the social returns from technological advances over the 1948-2001 period was captured by producers, indicating that most of the benefits of technological change are passed on to consumers rather than captured by producers.”
Once someone grasps the basic logic of economic competition, it’s almost impossible not to marvel and rejoice at its sheer wondrousness. Nearly a half-century after I first grasped this logic, I still marvel and rejoice at it. But be warned: One must be careful not to be blinded by the simple version of competition as conveyed here.
To see what I warn against, suppose that today Smith and Jones solemnly and sincerely promise each other that neither will sell any yo-yo at a price lower than $9.50. That is, suppose that Smith and Jones collude to raise the price of yo-yos. In the United States, as in much of the rest of the world, such collusion is regarded as a criminal offense. Smith and Jones can be arrested and, if tried and convicted, fined and even imprisoned. Naked collusion among economic competitors is as unambiguous a violation of antitrust statutes as they come, and every competent ECON 101 student can show how the gains to the colluders are exceeded by the losses that the colluders ‘impose’ on consumers.
But return to the questions asked at the start of this essay. If Smith and Jones each has the right not to produce and sell yo-yos at all – that is, if neither Smith nor Jones commits a wrong if he or she produces yams or yogurt or nothing at all instead of yo-yos – why is it such a dastardly moral infraction as to be declared a criminal act if Smith and Jones take the more modest step of agreeing to produce, not none, but only some yo-yos, albeit a smaller quantity than would be produced without collusion?
Odd, that. After all, if Smith and Jones were both simply to exercise their right to quit the yo-yo industry, they would cause the supply of yo-yos to fall by more than they do by colluding to keep the price of yo-yos higher than it would be absent their collusion. Yo-yo consumers would be harmed far more by the former action (quitting the industry) than by the latter action (colluding). The former action would reduce availability of yo-yos more, and thus cause the price of yo-yos to rise higher, than would the latter action. Yet we demonize and criminalize collusion while thinking nothing of simply quitting or even not entering a particular industry.
We here witness a troubling conflict of two different principles that are both widely accepted in today’s liberal market-oriented societies. On one hand, it’s perfectly acceptable to quit a particular productive activity or not to embark upon that activity in the first place; on the other hand, it’s perfectly unacceptable to collude to restrict output or (what is the same thing) to collude to raise prices.
One possible resolution of this conflict is to insist that, however real and splendid are the material benefits of economic competition, no individual is morally obliged to work to improve the economic well-being of strangers or to cause the market to operate in the way that in economics textbooks is described as “competitive.” In liberal society individuals aren’t tools for maximizing the performance of the economy. So the conflict should be resolved in favor of allowing collusion even though this resolution diminishes the marvelousness of markets. Individual rights trump economic efficiency.
Another, very different possible resolution is to aver that, while no one is obliged to enter any productive field, once someone voluntarily does so he or she thereby implicitly agrees – for as long as he or she stays in that line of business – to perform that activity in ways that maximally benefit consumers. Economic efficiency trumps individual rights.
This latter resolution is the one that most people in modern, liberal societies have settled upon. But only a little thought is necessary to reveal that it makes no good sense.
If entering an industry as a producer thereby obliges someone to act in ways that promote maximum economic efficiency, that person should also then be morally and legally prohibited from quitting the industry for as long as his or her firm is profitable. Further, that person must be morally and legally prohibited from operating at a scale deemed too small, or at a speed deemed too slow, to achieve maximum efficiency. Yet we see nothing wrong or criminal with Smith entering and then quitting the yo-yo industry. Nor do we see anything wrong or criminal with Smith building and operating a smaller rather than larger yo-yo factory, or equipping that factory with slower rather than faster machines. It follows, I believe, that we should lose our aversion to collusion.