Competition is a buzzword. Everyone loves it, but there are very different interpretations of this valuable concept. These different interpretations lead to strongly contradictory policy recommendations.
Imagine you and your super rich friend are betting on who will win the 100 meters at the Olympic Games. Your friend wins the bet. But then you find out the race was rigged. Your friend had bought seven of the eight competitors. “That’s unfair! So it wasn’t a real contest,” you exclaim. Now imagine your friend shrugging and responding, “It was a competition. See, there were so many runners.
This answer would seem ridiculous to all of us. The number of riders is irrelevant. For it to be a real competition and a real race, all the riders would have had to give their best to win. But that was not the case. And so, it wasn’t competition; it was not a race.
This story demonstrates valuable insight into economic theory. To see this, consider one of the dominant models in economics, that of perfect competition. Basically, this suggests that for a market to be perfectly competitive, goods must be homogeneous, there must be an infinite number of sellers, no transaction costs, and perfect information. Let’s just focus on the infinite number of sellers. In reality, there will never be an infinite number of them, but imagine that we have an industry with many such vendors that we would be satisfied that this condition of perfect competition holds for our practical considerations.
Remember the running example I mentioned earlier. There were eight runners. Would this number be “enough” to have competition? Initially, one might think so, in general it is so. When we have many runners (because they are the companies in the market), we should expect competition.
But not so fast. Recall that in our example, seven of the eight runners had been redeemed. They hadn’t given their best; they lost on purpose. There had been no competition, it was all a sham. As unrealistic as this example may be, it demonstrates an important lesson: we want a certain type of behavior when we want competition. We want runners to give their best to win the gold medal, we want athletes to train as hard as possible, and we want entrepreneurs, managers and workers to work tirelessly to improve their products, make them cheaper and better align them with what consumers want. What we want is not such and such a number of runners or sellers. What we want is a certain attitude.
Two lessons follow from this. First, a monopoly, in the sense of a firm that is the only seller in a market, can mean absolute competition. Because it is enough that the company has the right state of mind, that is to say that it acts in a competitive way by constantly striving to improve its product, etc. So what is needed is that competitive mindset. And for its emergence, potential competitors must have “freedom of entry”. The threat of competitors potentially entering the market keeps the company up on its toes. Then we can have only one seller – but this seller is in competition.
Second, a market with many companies does not have to be competitive. Imagine we have an economic system similar to the guild systems of centuries past. In such a scenario, there could be hundreds of blacksmiths in the land, but all with their specific area that they, and they alone, supply. There may not be a competitive spirit here, as blacksmiths do not have to worry about customers choosing a rival – as rivals are not allowed to enter the market .
Capitalism as an economic system aims to get entrepreneurs to produce what consumers want. To ensure that consumer desires are met, competition is imperative. But it is a state of mind, an attitude. It doesn’t matter that there is a spectacular entrepreneur in a market who outperforms others so that his business is the only seller. Instead, it’s about how entrepreneurs act: are they alert, striving, restless, constantly seeking improvement? If so, then we consumers have the competition we want. If not, we consumers must protest. And then we consumers have to remember that for sellers to have that competitive mindset, we need to “the complete absence of institutional restrictions on entry”. This freedom of entry (and exit) is what makes markets competitive. Not an arbitrarily defined number of sellers.
Max Molden is a PhD student at the University of Hamburg. He has worked with European Students for Freedom and Prometheus – Das Freiheitsinstitut. He regularly publishes with Der Freydenker.