Should Government Regulate Monopolies?

Lynne Kiesling,

Release Date
February 29, 2012


Free Markets and Capitalism

Before considering government regulation of monopolies, Prof. Lynne Kiesling encourages us to think about the regulation that markets naturally provide. In any market, in the absence of government interference, each business is constrained by the following:

  1. Consumer demand
  2. The availability of substitutes
  3. The entry, or threat of entry, of new firms
Historically, despite these competitive pressures, people have identified what they feel are monopolies in markets. In order to fix the problem, they often advocate government regulation in the form of breaking up large firms or regulating profits. Although these regulations may have merits, they reduce the profit motive that lures the innovators to come in and compete against the monopoly. Additionally, government regulations often create legal barriers to entry, which crushes smaller competitors.
The good news is that markets, on top of naturally regulating monopolies, generate wealth and technologies that systemically reduce the cost of starting new ventures over time. This, in turn, increases the competitive pressures on larger firms and reduces the likelihood of monopoly.

Should Government Regulate Monopolies?
Is monopoly a justification for government regulation? A lot of people have been very concerned about monopolies in markets, and that concern leads people to ask, is there a form of government intervention that can mitigate that problem? Either by breaking up a big firm into smaller firms so that they can compete against each other or by regulating the profits a firm earns or the prices it can charge for its product.
Two things that really discipline a monopoly firm’s ability to charge high prices are consumer demand and how much we’re willing to pay for the product or service and the availability of competing products or services that are substitutes for that good. Another question that often comes up is the persistence of that monopoly over time. Even if there is some kind of market power or market dominance in a particular industry, does that erode over time or does it persist? And if it persists, is there some form of government regulation or intervention that would make consumers better off?
One of the challenges in coming up with that kind of policy, though, is that any regulation that is going to reduce the profits of a monopoly is going to reduce the motivation, the lure, the incentive to the innovator to come in and enter that market and compete against the monopolist. And that’s the core of the insight that we get from the economist Joseph Schumpeter, who really argued that the competitive process is one of competition for market dominance and that these monopoly profits are the lure, they’re the carrot that brings innovators in so that they can come up with a new, better product or service, a different product or service to compete against the monopolist.
When competition takes that form, any kind of government regulation or government activity to break up big firms into smaller firms that compete against each other may break up that temporary monopoly lure and may actually undermine innovation and undermine competition. What really keeps monopolies from persisting over time is entry, the ability of entrepreneurs, innovators, competitors, to enter the market and compete against the monopoly firm and offer consumers new or different products and services that will lead the original monopoly to reduce its prices because of this competition.
One other important idea to consider is that the form the government regulation can take may also itself provide an entry barrier, some kind of cost that makes it harder for competitors to come in and compete in markets. And this is one of the really important, transformational things that we’ve experienced in the past two decades with the Internet is that the Internet reduces those costs of starting up new business and communicating your value proposition to more consumers. And so innovation, such as the Internet, actually makes markets richer and more competitive because individuals strive for achieving that market dominance. But they’re all doing it at the same time and competing against each other, offering a wide variety of products and services.