In physics we’re used to the idea that at different scales very different things happen. We inhabit Newton’s world of medium sized things and speeds – planets, trees, footballs and travel at walking, driving or flying speed – even space station speed. When things get very big or fast – intergalactic or close to the speed of light – very strange things happen that defy our own intuitions. Likewise inside atoms when things get even weirder.
Well something slightly similar has happened on the internet where transactions costs have fallen to near zero. And strange and fascinating things are happening. Anyway, I’ve been mulling over this for a while now, and verily, along comes this compelling OECD study of the internet. So I’ve written it up in this week’s column in the Age and SMH.
ECONOMISTS usually hate monopoly. But one of last century’s most flamboyant economists – Austrian finance minister turned Harvard professor, Joseph Schumpeter – thought it indispensable to economic progress.
Here’s his argument: Companies innovate to capture some fleeting market power with innovation until their competitors catch up. But they can’t innovate without funding research and development. And doing that requires them to use what monopoly or market power they have by raising prices above production costs.
In economists’ models, ”perfect competition” involves a multitude of companies disciplining each other so all are forced to take the price at which any are prepared to sell – the cost of production. But Schumpeter argued that this wasn’t just an unearthly ideal type that can never exist (in economists’ models, perfect competitors all exist in a timeless steady state with identical skills, technology and expectations). He argued that, even if it were possible it wasn’t desirable, because perfect competitors are so busy competing they have no margin to fund innovation.
If Schumpeter showed us the upside of monopoly, there is (alas), a mighty downside. Even if they’ve won their position from past innovation, even if they’re competing against others, large incumbent companies often become conservative and lazy.
Where fixed R&D costs are high enough – in pharmaceutical innovation for instance – perhaps we still can’t do without large monopolistic companies. But for a few decades now we’ve been running an experiment between two uses of our telecommunications infrastructure: The telephone network in which a few large companies are what economists call ”monopolistic competitors”, and the internet, which offers a close approximation to perfect competition. And the results are compelling – and fascinating. Continue reading