Industrial organization Jerome Ellig

Industrial organization sports a curious mélange of theory and empirical work, and the Austrian contribution to the field is no exception. Discussing the Austrian contribution is made more difficult by the fact that prominent scholars not normally identified with the Austrian school have developed and applied important Austrian insights. Relevant authors include a number of familiar figures, such as Dominick Armentano, Friedrich Hayek, Israel Kirzner, Ludwig von Mises, Murray Rothbard and Joseph Schumpeter, but a list of contributors to 'Austrian' industrial organization would be seriously incomplete without a second group of names, many of which are associated with the Chicago school. They include, among others, Robert Bork, Harold Demsetz and Frank Knight.

As in many other fields, the Austrian perspective on industrial organization hinges on the concept of uncertainty. Uncertainty, in this context, is 'Knightian' uncertainty: a situation in which not all possible future states of the world can be identified, and not all can be assigned probabilities (Knight, 1971). Uncertainty makes a perfectly competitive equilibrium unattainable, because a fundamental assumption of general competitive analysis is that traders possess all the relevant information they need about opportunities, constraints, technologies and so on. The basic question for industrial organization is thus why various business institutions arise in response to uncertainty.

In addition, most Austrians would endorse the stronger statement that uncertainty makes the perfectly competitive model irrelevant as a welfare ideal. The genuine economic challenge, in this view, is not the optimal allocation of known means to achieve given ends, but the discovery and commercialization of new technologies and products (Hayek, 1978). In terminology popularized by Bork (1978), Austrian industrial organization emphasizes productive efficiency, almost to the exclusion of allocative efficiency (High. 1984-5).

Competition mid entrcpreneurship

Because products, technologies, equilibrium prices and other data are not given and known, re«I world markets can best be characterized as a rough-and-tumble competition to luul all of these things out. Prices convey a great deal of information. 1 mi be* ausc observed prices are not general equilibrium prices, other forms ol « omuumicatlon and organization are also necessary to hnlii.Miliil oi Htiri(:t)Uon J-l^

pi ornate efficiency. Thus, for Austrians, '(lie market' iloi s not mean iln l»t rlectly competitive model composed of atomistii. 111111/ li ii|idi • lionpi . Instead, it comprises a complex web of interactions iluil im lud« < n Iniion ships ranging from spot market transactions to integrated hi 11c Iln mihik«1 Includes both competition and cooperation; hence the Hun is pmi ol ilu market, not an 'island of planning in a sea of market?«' (lompan ( In iiiim

I ike economic theorists before the 1920s, Austrians view competition m a llvalrous process in which entrepreneurs strive to outperform eai It othei (I )|Lorenzo and High, 1988). It is essentially a race wilh many finish lines I lie really crucial form of competition is not the addition of another producei ul lei ing the same product to drive price closer to marginal cost, but rather the pioducer who enters the market with an entirely lower set of cost curves, or a I.i.ind new demand curve. In short, the Austrian view of competition bears a ■ lose resemblance to the innovative competition in the evolutionary models i»l Nelson and Winter (1982). Schumpeter (1942, p. 84) stated the distinction tliost eloquently:

In capitalist reality as distinguished from the textbook picture, it is not thai kind of competition which counts [competition producing known products within known constraints] but the competition from the new commodity, the new technology, the new source of supply, the new type of organization competition which commands a decisive cost or quality advantage and which strikes not nl llir margins of the profits and the outputs of existing firms but at their Inundation* and llieir very lives.

Within this swirl of creative destruction, the entrepreneurs who most ellct lively exercise the qualities of alertness and judgment reap profits Kii/nei 1197 1985) argues that pure entrepreneurship is costless, but the prospect ol piolil nevertheless 'switches on' entrepreneurial alertness. (The carrying out ol entrepreneurial plans, of course, involves resource costs.) In his view, Iheielore, entrepreneurial profit is truly a residual. However, it is not merely the amount of profit that motivates entrepreneurs, but also the 'open-endedness' nl the situation, the prospect of inestimable profit opportunities. As a result, it is impossible to ascertain the amount of return that is adequate to elicit a given level of entrepreneurial activity. Therefore not even persistently high piolits can be taken as a sign of monopoly.

Itiirriers to entry

I lie above proposition holds even in the presence of barriers to entry Neo 1 lassical economics defines barriers to entry as sunk costs - investments thai • innot be recovered if the firm leaves the industry. But if heterogeneity ami 1 ontinuous improvement are the hallmarks of competition, then truly • II«»

live competition actually creates barriers to entry (see Demsetz, 1982; High and Gable, 1992). An entrepreneur who tries a new path, introduces a new technology or offers a new product shoulders substantial sunk costs: if the entrepreneur's judgement proves wrong and he must abandon his project, he incurs a capital loss. The more difficult to imitate is the innovation, the less elastic is the entrepreneur's demand curve; hence, entrepreneurial competition conveys monopoly power, in the traditional neoclassical sense of ability to influence price. Nevertheless, the resulting 'monopoly profits' are not a sign of inefficiency, but a prize that induced the innovation in the first place.

In their informal stories of competition, economics textbooks generally recognize a role for short-run entrepreneurial profits. In similar fashion, Austrian authors frequently speak as if entrepreneurial profits are always short-lived. However, nothing in the logic of the Austrian approach precludes long-lived entrepreneurial profits, depending on the nature of the specific entrepreneurial activity. For example, consider the case in which a profitable natural monopoly arises on the free market, perhaps as the result of very large economies of scale combined with sunk costs. A consistent Austrian account would have to recognize the monopoly's profits as entrepreneurial profits. In the case of a natural monopoly, these profits may be large and quite long-lasting. They provide a significant incentive for entrepreneurs to discover low-cost technologies, implement them quickly and invent new technologies to circumvent the old natural monopolies.

This process of entry barrier creation may appear to jeopardize economic efficiency and, in fact, dynamic competition may often sacrifice short-run allocative efficiency. However, in the Austrian view, competition does not create its principal benefits by beating prices down to marginal costs. Rather, competition for profits forces down costs, and prices eventually follow. Competition for profits also generates value for consumers by spurring entrepreneurs to create new products and services.

Firm conduct

This realization helps explain the Austrian tolerance for a wide variety of seemingly monopolistic practices. Austrians would essentially endorse the Chicago school analysis of vertical business relationships; vertical restraints and vertical integration both serve as powerful tools to promote productive efficiency I ikewisc, Austrians would draw similar conclusions in their analysis of market concentration; for Austrians, as for Chicago economists, large market shares and high concentration are the endogenous results of effi-ciency-enhaiK ii>k entrepreneurship, not exogenous conditions that signify inefficiency. (Compare Hoik, 1978; Armentano, 1982.)

IhUuNIiIiiI inUiinl. iillfin

VVIiul is monopoly?

Wlum ¡1 comes to identifying monopoly, two distinct Autumn a|>| I

apparent. In general, Austrians look for monopoly whnevei theie mo Imiiii ><< lit exercising entrepreneurship. Government restrictions on miiy mnl mi market activity generally, certainly qualify under this definition Wheih. i ,i Inm can gain monopoly purely through private market activity m a mallet ol some debate.

Kirzner (1973) and Mises (1966, pp. 357-79) argue llial monopolies may occasionally arise in the free market if someone owns the entire supply ol m resource essential for producing a product. A person who owned all ol the mange trees (and orange seeds!) in the world would thus be a monopolist, because he controls an essential resource for making orange juice This person is in a position to block other entrepreneurs who may have belter technologies for producing or marketing orange juice, because there exists only one source of oranges.

Others, such as Armentano (1982), O'Driscoll and Rizzo (1985), Rothbard 11977) and High (1985), would question whether even this rare example

0 .illy constitutes a monopoly. In their view, an economically meaningful

1 oneept of monopoly cannot be defined without reference to legal and ethical principles. As a result, O'Driscoll and Rizzo propose that the term 'mo nopoly' be restricted to situations in which a producer has a government enforced property right to a market or market share. For Ibis group ol si hoi iiis, the general implication should be clear: only government inn be llir source of monopoly power.

Whither efficiency?

It would be a mistake to regard this attitude towards anliliust and lepulnioi \ policy as ideology overtaking analysis. Rather, the policy differences he lween Austrians and other economists reflect fundamentally different hehels about the nature and importance of the two different types of economli elliciency. Austrian economists often subscribe to the empirical genernli/n lion that the most significant increases in human welfare occur because ol productive efficiency: the introduction of new products and techniques. The siructure-conduct-performance' school of industrial organization tends to emphasize the importance of allocative efficiency, which is derived from the perfectly competitive norm and requires that prices equal marginal costs In Ibis schema, the Chicago school occupies a middle ground, for Chicago si holars sometimes stress allocative efficiency, sometimes productive fill i lency. As a result, Austrians find much to agree with in the Chicago school. Inn also much to criticize.

24H The Uigur companion to Austrian economics See also:

Chapter 26: The boundaries of the firm; Chapter 55: Industrial organization and the Austrian school; Chapter 57: Mergers and the market for corporate control

Bibliography

Armentano, Dominick (1982), Antitrust and Monopoly: Anatomy of a Policy Failure, New York: John Wiley.

Bork, Robert H. (1978), The Antitrust Paradox, New York: Basic Books.

Cheung, Steven N.S. (1983), 'The Contractual Nature of the Firm', Journal of Law and Economics, 26, (1), April, 1-21.

Demsetz, Harold (1982), 'Barriers to Entry', American Economic Review, 72, (1), March, 47-57.

DiLorenzo, Thomas and Jack High (1988), 'Antitrust and Competition, Historically Considered', Economic Inquiry, 26, July, 423-35.

Hayek, Friedrich A. (1948), 'The Meaning of Competition', reprinted in individualism and Economic Order, Chicago: University of Chicago Press, pp. 33-56.

Hayek, Friedrich A. (1978), 'Competition as a Discovery Procedure', in new Studies in Philosophy, Politics, Economics, and the History of Ideas, Chicago: University of Chicago Press.

High, Jack (1984-5), 'Bork's Paradox: Static vs. Dynamic Efficiency in Antitrust Analysis', Contemporary Policy Issues, 3, 21-34.

High, Jack and Wayne Gable (eds) (1992), 100 Years of the Sherman Act: A Century' of American Economic Opinion, Fairfax, VA: George Mason University Press.

Kirzner, Israel (1973), Competition and Entrepreneurship, Chicago: University of Chicago Press.

Kirzner, Israel (1985), Discovery and the Capitalist Process, Chicago: University of Chicago Press.

Knight, Frank (1971), Risk, Uncertainty, and Profit, Chicago: University of Chicago Press.

Mises, Ludwig von (1966), Human Action, 3rd revised edn, Chicago: Contemporary Books.

Nelson, Richard and Sidney Winter (1982), An Evolutionary Theory of Economic Change, Cambridge, Mass.: Harvard University Press.

O'Driscoll, Gerald P. Jr. and Mario Rizzo (1985), The Economics of Time and Ignorance, Oxford: Basil Blackwell.

Rothbard, Murray (1977), Power and Market, Mission, Kansas: Sheed Andrews & McMeel.

Schumpeter, Joseph (1942), Capitalism, Socialism, and Democracy, New York: Harper.

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