Monopoly is a major theme in the Wealth of Nations, as reflected in 175 usages of the word in the work, and, when applied to a single business, Smith’s opening analysis will be well known to students of economics today:
“A monopoly granted either to an individual or to a trading company, has the same effect as a secret in trade or manufactures. The monopolists, by keeping the market constantly understocked by never fully supplying the effectual demand, sell their commodities much above the natural price, and raise their emoluments, whether they consist in wages or profit, greatly above their natural rate.”
Thus, the incentive structure faced by the monopolist induces commercial conduct that serves to lower the volume of transactional activity in a market (the volume of goods or services traded) and to raise the prices at which transactions are made.
For Smith, however, a monopoly position held by a single business was only a starting point and the great bulk of the usages of the word occur much later in the book, at the climax of his self-described “… very violent attack on the whole mercantile system of Great Britain”. His usage of the term extends to any group of businesses, even groups that are large in number and compete among themselves, who collectively enjoy a privileged position that leads to higher prices and lower transactional volumes, relative to prices and volumes that would otherwise pertain.
In Smithian terminology then, ‘monopoly’ is near synonymous with ‘restrictions of trade’: they have similar economic effects.
This wider meaning aligns with the etymology of the word: from Greek monopōlion, “right of exclusive sale” and monos “single, alone”. Rights of exclusive sale can be afforded to a group of entities with a specified, shared characteristic, like the ‘British merchants’ of Smith’s time whose conduct was the prime target of the “very violent attack”. For Smith they were monopolists.
However, at a deeper level, we do find a singular economic entity in the analysis, namely the state, which the German social theorist Max Weber defined as a political organization that successfully claims a monopoly on the legitimate use of physical force within a given territory. Almost tautologically, it is much the most significant monopoly in the socio-economic system.
The state’s exclusive right of legitimate coercion gives it the power to create all manner of subsidiary monopolies, a power that has been extensively used from time immemorial, all round the globe. It is the great spawner of selective economic privileges.
Smith’s analysis of monopoly leads directly to the economic programme advocated in the Wealth of Nations: de-monopolise by seeking to eliminate or lower privilege-creating barriers to mutually advantageous exchange transactions. This served as a star to guide a direction of travel, a guiding policy principle for an effective economic governance strategy or programme.
Interestingly, the most egregious deficiency of monopoly identified in the Wealth of Nations appears at a point where Smith examines the effects that high transport costs can have in creating local agricultural monopolies, comprising farmers located in the vicinity of a town or city. The high costs serve as barriers to a wider range of mutually beneficial exchange transactions and, since they are not created by the state, the local monopolies can, in Smithian terms, be said to be ‘natural’. In this context, Smith makes a general point of profound significance:
“Monopoly, besides, is a great enemy to good management, which can never be universally established, but in consequence of that free and universal competition which forces every body to have recourse to it for the sake of self defence.”
Competition leads to an incentive structure in which financial rewards are geared to business performance relative to others. As Hayek would later put it, this drives suppliers to seek to discover better ways of doing business in order to attract buyers. The pressure for betterment is not only continuously sustainable, but also ubiquitous: it’s in play whether a business is doing well or badly at any particular moment and whether it is a large or small economic entity. And poor relative performance can pose existential threats: it’s a ‘natural’ selection mechanism – an engine that drives increased productivity growth in a very direct way, adding to the growth induced more indirectly by a deepening of the division of labour (on which see our previous post in this series).
Returning to the specific context of local monopolies, Smith concluded that:
“Good roads, canals, and navigable rivers, by diminishing the expense of carriage, put the remote parts of the country more nearly upon a level with those in the neighbourhood of the town. They are upon that account the greatest of all improvements.”
Such ‘public works’ reduce barriers to trade – they erode local monopolies — and, on that account, they warrant state support. However, whilst the state might reasonably take responsibility for the provision of public works in the name of a wider de-monopolisation, Smith also raised an alternative option for consideration: the granting of exclusive rights to a contractor for an initial, pre-determined period:
“A temporary monopoly of this kind may be vindicated, upon the same principles upon which a like monopoly of a new machine is granted to its inventor, and that of a new book to its author.”
The guiding principle of de-monopolisation does not therefore obviate the need to examine the trade-offs entailed by specific contextual factors. The question to ask about policy options under consideration is: looking across the economy as a whole, would they likely tend to expand or restrict the scope of opportunities for mutually beneficial exchange transactions? More simply: do they facilitate or hinder commerce?
Speculatively, if Smith were looking at today’s issues, we think he would almost certainly judge that there is far too much in the woodwork that serves to hinder, but, at the same time, would likely point out that there are some areas of public policy where there is too little facilitation (as 19th century legislators recognised when it came to railways).