I love the imaginary world of free enterprise where there is intense competition among businesses to provide the best quality products at the lowest possible prices, where consumers are always rational (at least on average) with infinite amounts of time and mental energy to compare all prices and qualities in that perfectly competitive world. It is a very democratic world. In that world, everyone is a consumer who can purchase anything without regard to race, creed, color, gender, sexual orientation, transgender status, national origin, or ethnicity. True believers in this imaginary world love to refer to this as Adam Smith’s invisible hand of competition in a free enterprise economy.
Unfortunately, that perfectly rational and perfectly competitive free enterprise economy does not exist.
Even something as simple and easily observed as gasoline prices are all over the place. People are often too busy and have too little time to get the best price for gasoline. GasBuddy tries to help us, but people often just go to the nearest or most convenient gasoline station regardless of the price. We are too often greatly constrained by a shortage of time and mental energy.
Certificates of deposit are another example of inherent disequilibrium where interest rates are all over the place. Many banks realize that most people do not have the time to compare rates, so they let their CDs roll over at whatever rate their bank has set, which is often very low and noncompetitive. Such people often have CDs for a standard fixed period such as 12 months. The banks realize this, and when they need more money to loan out, they offer higher interest rate “specials” for 11 months or 13 months. Some require that you also have a checking account with the bank to get the best rate on CDs. Instead of generally offering and widely advertising their best rates on CDs to all their customers, they offer their loyal customers “relationship banking.”
The idea that people operate rationally and independently as required (at least on average) for free enterprise to work efficiently and effectively has been refuted by Dan Ariely in his book: Predictably Irrational. New York: HarperCollins, 2008. Not only are people irrational, but they are predictably irrational. It is disappointing that the economics profession has taken so long to figure this out when the people in marketing have understood this and exploited this for hundreds of years.
More recently, the development of behavioral economics has greatly enhanced economics in making it much more realistic. Economics Nobel prize winner Richard Thaler (and others) have offered careful analysis of human behavior and discovered that people don’t always act in a rational manner but have inherent biases that produce inefficient and ineffective behavior from a strictly free market theory point of view. See Thaler’s books: Thaler, Richard H. and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth and Happiness. New York: Penguin Books, 2009. Thaler, Richard H. Misbehaving: The Making of Behavioral Economics. New York: W. W. Norton and Company, 2016.
Schumpeter’s “creative destruction” should really be called “competition destruction” when a small, efficient family-owned restaurant gets wiped out during a pandemic or a recession because it doesn’t have and can’t get the cash to ride out an economic downturn. With sufficient cash on hand, a large corporation (e.g., Amazon, Facebook, Google, etc.) can buy up or crush its competitors, especially when there are barriers to entry such as economies of scale or network effects.
But Adam Smith revealed a second invisible hand when he said: “People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.” Adam Smith’s second invisible hand is the invisible hand of collusion or market power.
The concentration of American industry into oligopolies, duopolies, and monopolies is well documented in the book by Jonathan Tepper with Denise Hearn called The Myth of Capitalism: Monopolies and the Death of Competition, (Hoboken, NJ: John Wiley & Sons, 2019), which I think they should have called “The Myth of Competition” since it reveals the extensive existence of industrial concentration in industry after industry in the United States.
For example, a pair of reading glasses can be purchased for just a few dollars, but as soon as a “prescription” is involved, the price jumps up to over one hundred dollars, because there are primarily just two companies that have been authorized to provide prescription glasses.
Patents, licenses and other restrictions are often effectively controlled by those who already are in the restricted enterprise, so they have a vested interest in not letting competitors into the business.
Patents were created to encourage innovation by giving businesses time to recoup their investments, but they have been extended way beyond that to the point where they are actually being used to restrict competition. We would have more innovation if we got rid of patents altogether. Government funding through the National Science Foundation (NSF) and Centers for Disease Control (CDC) can produce lots of new and innovative products by people who are more interested in promoting their professional reputations than in restricting competition and maximizing profits. NSF and CDC data, methods, and research techniques are made readily available to the public. Making lots of money is just one way of feeling good about yourself. Some people such as teachers and daycare attendants feel good about helping children even though they are often paid very little for their work. Creative entrepreneurs such as Steve Jobs and Elon Musk are frequently more focused on changing the world with new and innovative products than in making money per se.
The amazing creativity of government funded projects that have resulted in a broad range of creative innovations from interstate highways to rockets to the moon and the Internet is well documented in these three books by Mariana Mazzucato: Mazzucato, Mariana. The Entrepreneurial State: Debunking Public vs. Private Sector Myths. New York: PublicAffairs, 2015. Mazzucato, Mariana. The Value of Everything: Making & Taking in the Global Economy. New York: Hachette Book Group, Inc., 2018. Mazzucato, Mariana. Mission Economy: A Moonshot Guide to Changing Capitalism. New York: HarperCollins Publishers, 2021.
Doctors, lawyers, hairdressers, and a large number of other professions restrict entry. The boards that regulate the restricted professions are themselves made up of the people already in those professions, so they have a natural desire to avoid competition and restrict entry to keep their wages high. The interesting thing is that these restrictions vary enormously by city and state so not all of the professional restrictions are really necessary to protect the public.
The idea that businesses are efficient and government agencies are inefficient may be the opposite of the truth. Government agencies by law must be largely transparent. The federal government has to follow the federal open meetings law ( U.S. Code § 552b – Open meetings ). Government is often dismissed as inefficient, partly because it may have goals other than profit maximization, and also because, unlike private businesses, the government’s operations are subject to close public scrutiny such as under the Freedom of Information Act and the Open Meetings Act. State governments may impose additional restrictions requiring transparency in government.
Ironically, many of the most conservative states have the strongest government transparency requirements. Not trusting the government and requiring openness makes the government more efficient and effective. Revealing any government inefficiencies has two effects: (1) It puts immediate pressure on the government to clean up its act and get its house in order to be more efficient and more effective, and (2) It gives the general public the idea that government is inefficient, especially relative to business where inefficiencies are mostly hidden. In theory, inefficient businesses should be driven out of business by competitors, but many industries are dominated by a few firms that retain dominance through a wide variety of barriers to entry.
Businesses are not subject to transparency for the most part. They often impose non-compete clauses in their employee contracts that forbid passing along or in any way revealing company “secrets.” The idea that a business could not exist for long if it was inefficient is far from reality. Large corporations are prone to a range of efficient and inefficient departments. Excessive monopolistic profits can cover up a great deal of inefficiency. Natural monopolies such as local water, sewage and electric providers can get by without having to worry about being run off the road and replaced by competitors. Large businesses can be and often are more inefficient than government.
For example, Saluto Pizza started as a small pizza place in St. Joseph, Michigan. Its pizzas were so popular it started freezing them to sell to people to take home to reheat for consumption later. The frozen Saluto Pizzas were in such great demand that a frozen pizza manufacturing plant was created to produce them to sell to grocery chains around the nearby region. Their popularity was such that another factory for making the frozen Saluto Pizzas was created in Birmingham, Alabama. Then General Mills bought out Saluto Pizza. But following the financialization strategy of cutting costs, the Saluto Pizzas were then made with cheaper ingredients, which made them unpopular. Before long the Saluto Pizza brand was discontinued. Such cost cutting and removal of the resulting unpopular products is then described as enforcing efficiency in private business, in contrast to alleged government waste and inefficiency. The executives who cut costs and cut out unprofitable products were probably rewarded and promoted. By contrast, so-called government “bureaucrats” who serve the public are seen as unproductive and wasting the taxpayer’s money.
Some politicians like to discredit government employees who they refer to as “career bureaucrats” or collectively as “the deep state.” What such politicians really want is to replace these civil servants who have taken an oath to obey and defend the constitution of the United States with sycophants who will readily violate the constitution in pursuit of their political master’s political agenda. In Russia Vladimir Putin has learned that replacing “the deep state” with political sycophants in the Russian justice system has enabled him to charge and convict any political opponent with all sorts of invented and imaginary crimes. Removal of “the deep state” here in the United States could lead to a similar outcome. An autocratic leader’s political slogan of “Lock her up” “Lock her up” could become a reality for anyone opposing that autocratic leader once that politician is elected president and after the removal of the government employees referred to as “the deep state.”