A reg’lar pollytician can’t give away an’ alley without blushin’, but a businessman who is in pollytics . . . will . . . charge an admission price to th’ lake front and make it a felony f’r annywan to buy stove polish outside iv his store, and have it all put down to public improvements. . . .
MR. DOOLEY
(Mr. Dooley was a fictional Irish barkeeper whose wisdom was popularized by the American humorist Finley Peter Dunne)
In the United States in this century the predominant form of monopoly has not been natural monopoly, artificial monopoly, or direct state monopoly, but state monopoly in private hands. Private firms, unable to establish monopolies or cartels because they had no way of keeping out competitors, turned to the government. This is the origin of the regulation of transportation — the Interstate Commerce Commission (ICC) and the Civil Aeronautics Board (CAB). A similar process is responsible for occupational licensing, which gives monopoly power to many craft unions, among them the most powerful and probably the most pernicious craft union of all, the American Medical Association.
The difficulties facing private cartels are nicely stated in Rockefeller‘s description, cited by McGee, of an unsuccessful attempt (in 1872) to control the production of crude oil and to drive up its price:
… the high price for the crude oil resulted, as it had always done before and will always do so long as oil comes out of the ground, in increasing the production, and they got too much oil. We could not find a market for it.
… of course, any who were not in this association were undertaking to produce all they possibly could; and as to those who were in the association, many of them men of honor and high standing, the temptation was very great to get a little more oil than they had promised their associates or us would come. It seemed very difficult to prevent the oil coming at that price … .
Rockefeller’s prediction was overly pessimistic. Today, although oil still comes out of the ground, federal and state governments have succeeded where the oil producers of 1872 failed. Through federal oil import quotas and state restrictions on production, they keep the price of oil high and the production low. Progress.
It is widely believed that railroads in the late nineteenth century wielded almost unlimited monopoly power. Actually, as Kolko shows, long distance transportation was highly competitive, freight rates were declining, and the number of railroads was increasing until after the turn of the century. One line might have a monopoly for short distances along its route, but a shipper operating between two major cities had a choice of many alternative routes — twenty existed between St. Louis and Atlanta, for instance. Railroad rebates, frequently cited as evidence of monopoly, were actually the opposite; they were discounts that major shippers were able to get from one railroad by threatening to ship via a competitor.
Rail executives often got together to try to fix rates, but most of these conspiracies broke down, often in a few months, for the reasons Rockefeller cites. Either the parties to the agreement surreptitiously cut rates (often by misclassifying freight or by offering secret rebates) in order to steal customers from each other or some outside railroad took advantage of the high rates and moved in. J. P. Morgan committed his enormous resources of money and reputation to cartelizing the industry, but met with almost unmitigated failure. In the beginning of 1889, for example, he formed the Interstate Commerce Railway Association to control rates among the western railroads. By March a rate war was going and by June the situation was back to where it had been before he intervened.
By this time a new factor was entering the situation. In 1887, the Interstate Commerce Commission was created by the federal government with (contrary to most history books) the support of much of the railroad industry. The ICC’s original powers were limited; Morgan attempted to use it to help enforce the 1889 agreement, but without success. During the next 31 years its powers were steadily increased, first in the direction of allowing it to prohibit rebates (which, Kolko estimates, were costing the railroads 10 percent of their gross income) and finally by giving it the power to set rates.
The people with the greatest interest in what the ICC did were the people in the rail industry. The result was that they dominated it and it rapidly became an instrument for achieving the monopoly prices that they had been unable to get on the free market. The pattern was clear as early as 1889, when Aldace Walker, one of the original appointees to the ICC, resigned to become head of Morgan’s Interstate Commerce Railway Association. He ended up as chairman of the board of the Atchison, Topeka, and Santa Fe. The ICC has served the railroads as a cartelizing agent up to the present day; in addition, it has expanded its authority to cover other forms of transportation and to prevent them, where possible, from undercutting the railroads.
It was in 1884 that railroad men in large numbers realized the advantages to them of federal control; it took 34 years to get the government to set their rates for them. The airline industry was born in a period more friendly to regulation. In 1938 the Civil Aeronautics Board (CAB), initially called the Civil Aeronautics Administration, was formed. It was given the power to regulate airline fares, to allocate routes among airlines, and to control the entry of new firms into the airline business. From that day until the deregulation of the industry in the late 1970s, no new trunk line—no major, scheduled, interstate passenger carrier—was started.
The CAB had one limitation: it could only regulate interstate airlines. There was one major intrastate route in the country, between San Francisco and Los Angeles. Pacific Southwest Airlines, which operated on that route, had no interstate operations and was therefore not subject to CAB rate fixing. Prior to deregulation, the fare between San Francisco and Los Angeles on PSA was about half that on any comparable interstate route anywhere in the country. That gives us a rough measure of the effect of the CAB on prices; it maintained them at about twice their competitive level.
Does this mean that half the money spent on airline fares went to monopoly profits for the airlines? No. The effects of regulation are far more wasteful than a simple transfer. If the fare between two cities is a hundred dollars and the cost to the airline of flying a passenger is fifty, each additional passenger is worth a fifty dollar profit to the airline. Each airline is willing to bear additional costs, up to fifty dollars per passenger, to lure passengers away from its competitors. Without the CAB airlines would compete on price until the fare fell to fifty dollars, thus wiping out the extra profit. With the CAB setting fares, they get the same effect by competing in less useful ways. They may spend money on advertising or fancy meals and fancier stewardesses. They may fly half-empty planes in order to offer the passengers more flights a day. The load factor, the percentage of seats filled, in the American airline industry ran at about 50 percent. It would be interesting to analyze the changes in the load factor after deregulation in order to estimate how many of those empty seats were the result of unavoidable uncertainty in demand and how many the result of airlines competing away the monopoly profit they had been given by regulation.
In this complicated world it is rare that a political argument can be proved with evidence readily accessible to everyone, but until deregulation the airline industry provided one such case. If you did not believe that the effect of government regulation of transportation was to drive prices up, you could call any reliable travel agent and ask how PSA’s fare between San Francisco and Los Angeles compared with the fare charged by the major airlines and how that fare compared with the fare on other major intercity routes of comparable length. If you do not believe that the ICC and the CAB are on the side of the industries they regulate, figure out why they set minimum as well as maximum fares.
The ICC and the CAB exemplify one sort of government-granted monopoly. Another, of comparable importance, is occupational licensing. The political logic is the same. A law is passed, political institutions are established, ostensibly to protect the consumers of some product or service. The producers, having a much more whole-hearted interest than the consumers in the operation of those institutions, take them over. They use them to raise prices and prevent competition.
The most notorious example is probably the licensing of skilled workers in the construction trades, such as plumbers and electricians. Licensing is under effective control of the respective craft unions, who use it to keep down the number of workers and to drive up their salaries, sometimes to astonishing levels. In order to maintain such salaries, the unions must keep down the number of workers licensed and use local laws to keep out unlicensed workers. This has sometimes led to conflict between blacks, who wanted to get into the building trades, and the unions, who wanted to exclude them and everyone else except friends and relations of the present union members. Craft unions also take advantage of building codes, using them to prohibit the adoption of technological advances which might threaten their jobs. Innovation in low-cost construction methods thus is effectively banned from the big cities, where it is most needed.
Of all the craft unions that exploit licensing, the most important is the American Medical Association, which is not usually considered a union at all. Physicians are licensed by the states; the state licensing boards are effectively controlled by the AMA. That is hardly surprising; if you were a state legislator, whom could you find more qualified to license physicians than other physicians? But it is in the interest of physicians to keep down the number of physicians for exactly the same reason that it is in the interest of plumbers to keep down the number of plumbers; the law of supply and demand drives up wages.
Physicians justify restricting the number of physicians, to others and doubtless to themselves as well, on the grounds of keeping up quality. Even if that were really what they were doing, the argument involves a fundamental error. Refusing to license the less qualified 50 percent of physicians may raise the average quality of physicians but it lowers the average quality of medical care. It does not mean that everyone gets better medical care but that half the people get no care or that everyone gets half as much.
Some of the restrictions the AMA has advocated, such as requiring applicants for medical licensing to be citizens and to take their licensing examinations in English, have a very dubious relationship to quality. They look more like an attempt to prevent immigrants from competing with American doctors. During the five years after 1933, when Hitler came to power in Germany, the same number of physicians trained abroad were admitted to practice in this country as during the previous five years, despite the large numbers of professional people fleeing here from Germany and Austria during that period. This is striking evidence of the power of organized medicine to limit entry to its profession.
How does the AMA control the number of doctors? Refusing to license doctors after they are trained would create a great deal of hostility among those rejected; that would be politically expensive. Instead, it relies mainly on the medical schools. In order to be licensed, an applicant must be a graduate of an approved medical school; the states get their list of approved schools from the Council on Medical Education and Hospitals of the AMA. For a medical school, removal from the list means ruin. In the 1930s, when doctors, like everyone else, were suffering the effects of the Great Depression, the Council on Medical Education and Hospitals wrote the medical schools complaining that they were admitting more students than they could train properly. In the next two years, every school reduced the number it was admitting. Since then the AMA has become less obvious in its methods, but the logic of the situation has not changed.
Many people, faced with the evidence on regulatory commissions and occupational licensure, argue that the solution is to retain the commissions and the licensing but to make them work in the public interest. This is tantamount to arguing that the consistent pattern of almost every regulatory agency and licensing body over the past century is merely accidental and could easily be altered. That is nonsense. Politics does not run on altruism or pious intentions. Politics runs on power.
A politician who can regulate an industry gets much more by helping the industry, whose members know and care about the effects of the regulation, than by helping the mass of consumers, who do not know they are being hurt and who would not know if they were being protected. An astute politician can—as many have—both help the industry and get credit for protecting the consumers. The consumers, whose relationship to the industry is a very small part of their lives, will never know what prices they would have been paying if there were no regulation.
The same principles apply to licensing. Once it exists, it must almost inevitably be taken over by the profession. Who else has either the concentrated interest in how it is done or the special knowledge required to do it? And the interest of the profession is directly contrary to the interest of the rest of us—in favor of keeping down its numbers instead of expanding them.
The subject of this chapter is government monopoly, not consumer protection; I cannot go into the question of what would happen if all forms of professional licensure, including licensure of physicians, were abolished, as I think they ought to be. That question is discussed in some detail in Capitalism and Freedom, by Milton Friedman, whose research more than fifty years ago first established the relationship between medical licensing and the high incomes of physicians.
In addition to regulation and licensing, the government also reduces competition somewhat by restraints on trade. For a given size firm, the larger the marketplace the more firms. The American automobile market supports only four manufacturers but the world market supports many more. By imposing tariffs on foreign cars, the government makes it more difficult for foreign firms to compete and thus decreases competition on the American market. The same is true in many other industries.
There is one more way in which government has encouraged monopoly; surprisingly enough, it was probably unintentional, a side effect of laws designed to help rich tax payers pay lower taxes. If a corporation pays out its profits in dividends, the stockholders must report the dividends as income and pay income tax on them. If the corporation invests the profits internally, increasing the value of its stock, the stockholders may avoid ever paying taxes on the increase and will, at the worst, eventually pay at capital gains rates, which are lower. So as long as capital gains are taxed at a lower rate than dividends it pays a corporation to invest internally, increasing its own size, even when the result is economically somewhat less efficient than giving the money to its stockholders to invest.
The conclusion of this and the previous chapter, taken together, is clear. Monopoly power exists only when a firm can control the prices charged by existing competitors and prevent the entry of new ones. The most effective way of doing so is by the use of government power. There are considerable elements of monopoly in our economy, but most are produced by government and could not exist under institutions of complete private property.