Can a 'free market' be bad for development?
Regional, Analysis, 6/17/2000

Can a 'free market' be bad for development ?

That may seem like a strange question to ask in light of current economic dogma that preaches the unqualified statement "the more competition the better."

Evidence however shows that regulated industries and services seem to provide higher wages to workers. Judged separately, these high wages should be a very clear indicator of the success of these industries, services or companies.

Examples abound in different areas of economic sectors, such as in the physicians labor market, and pharmaceutical industry, Union shops and companies, etc..

In the physicians labor market, the supply of physicians to the market is intentionally limited in medical schools by limiting admission to a certain number of slots.

For pharmaceutical companies, the competition is limited by the very high barrier to entry that extensive laws provide. Sure these regulations are for good safety reasons etc.., but they are nonetheless barriers to entry to this market. (Such laws are incidentally viewed by foreign countries as artificial barriers to competition, in a similar manner that the USA looked at the Japanese market car market in the 80's when the Japanese were set to have all sorts of regulations that U.S. car makers viewed as barriers to the Japanese market). Europe does the same to many industries, and so does Japan, Korea etc..

Union shops are another example of an environment that is supposed to be less competitive, yet they provide higher wages.

Also, the stock market loves and rewards monopolies or those who hold monopoly-type instruments or factors to their advantage, such as patents or other barriers to entry to the industry.

So the question becomes, why do people seemingly do much better financially in such a monopolistic or regulated industries and environments. Economists would say that: even though this particular doctor, company or union will benefit from such practices, the economy as a whole will suffer. But we are challenging this common view, and in a very nuanced way.

More broadly we ask, why do regulated so-called "free-market" economies do so much better (provide higher wages) then do unregulated "free-market" economies.

The answer to this overlooked and unexplained phenomenon lies in part due to the following factors:

The stock market rewards dominant and monopolistic companies and as such will provide capital to them to such an extent, whether the companies are efficient or not, profitable or not, so that they can sustain their position and overcome problems that a company without access to such public funding would not be able to do. Wall Street in some effect promotes predatory practices through the intentional bias of funding these types of companies. Note that we are not at this point dealing with the nuances of these statements, as the argument will become clear later. It can be easily shown that Wall Street strengthens companies that have no profit, or will for a long time based on future expectations, and will in the process weaken companies that are successful. (As one Wall Street financier once told an existing company that came to him for finance, once he liked what he heard, said: You either give me a part of this company or I will be your worst competitor!). Wall Street financiers can afford this kind of talk, because by having access to capital, this individual, with no experience in this particular industry, out of the clear blue sky, can by creating a new company of his own, and sustain it at no profit, and damage in the process the other company, all because of "funding bias," or access to capital that this other company will not be able to obtain or match.

Ideally, the fact that each company seeks for itself to become a monopoly is a natural and fundamental motivation in a competitive economy. So that is not the issue. The problem stems from practices that are anti-competitive, and from "funding biases."

While the practices of companies are monitored by regulatory institutions and is dealt with under the banner of anti-monopolistic laws, " funding biases " issues have never been discussed, as far as we know, as an anti-competitive issue.

One may ask " if such funding bias exists, then how come they are sustainable economically?"

The answer is that the stock market can be viewed from a practical sense as a large pool for investors, and so long as money is invested in a diverse manner, then the very large investor will always capture the gains of the economy no matter which single company wins or loses. To simplify and give an example for some understanding: a large investor can select a sector of the economy and invest in all the companies in this sector such that for example in microprocessors industry you would invest in Intel, AMD, IBM, Motorola etc.. and no matter which company wins or loses, it makes little difference so long as the whole industry is growing. In such a case you really don't care if you -- as a Wall Street financier -- are overfunding a company intentionally or unintentionally, so long as you capture the gains. Of course, the whole industry can do badly financially, and that is why this is a simplified example, as very large investors would invest in multiple industries and sectors to the same effect, ie, capturing the gains of the economy.

So now we can see how legally and through "biased funding" you can advantage a company dramatically giving this company the ability to suffocate another company, even if this other company is a better company and with better potential. So while the biases of Wall Street will not effect the economy as a whole in a detectable manner, they effect "who" in this economy will rise to the top and "who" will capture most of the gains. (Don't get distracted, we are still talking about monopolistic-like practices and their effects).

Monopolies, obviously, are capable of charging monopoly prices for products. This is unhealthy in a developed economy, But this is not necessarily unhealthy in a developing economy ( or its equivalent in a developed economy, so-called infant industries). It can be healthy because it allows the monopoly to accumulate " excess profit " , i.e. concentrate capital, to be invested in research, equipment and workers which is the mark of companies that develop and succeed and compete at the local and international level. Under such monopolistic environments, governmental regulation of such companies is "essential" to force these companies to use their profits for investment etc.. otherwise, these monopolies will simply become harmful rather than beneficial to the economy.

So for a capital-starved economy, in effect, monopolies are capable of generating capital with ease, thus giving the company one of the most essential factors for development and growth.

To expand further, we will assert that:

1. The less developed an industry, or any economy is, the more regulation it should have if the economy does not provide local companies access to capital. Usually, access to capital is not available to companies in poor countries, because they are poor, and all this talk about global capital markets, is just that, talk, as far as these economies are concerned. Evidence clearly shows, that capital is consumed in the same location where it is generated. So don't count on Boston money moving to an undeveloped country and finding its way to provide for the needs of most of the local companies.

2. The less developed an economy is, the more there is need for micro supervision of industries in it. Implicit in this assertion is that even though the economy of the country is underdeveloped, its regulatory and legislative bodies must be highly developed.

3. The more an industry or an economy develops, the less the tolerance should be for monopolistic practices, and regulations would need to be weighed against the cost it incurs on the economy.

So contrary to what is promoted, we are stating that the creations of monopolies and monopolistic type environments should be promoted or demoted based on the level of development of a particular economy or a particular sector of the economy, and thus poor economies should adopt different criteria to promote development.

Therefore, one of the crucial ingredients for development of economies is the availability of first-class regulatory institutions that create the proper environment for companies to grow and prosper, whether at first through managed-monopolistic practices or later through promoting competitive forces. A deep understanding of the particulars of each industry that is being regulated as a function of the development stage of this industry or the economy is essential.

In short, what works in the U.S. or in Japan or in France now may have no relevance to what would work in Egypt or Syria or Lebanon. But what the US or Japan or France did when they were at the same development stage as Egypt and Syria or Lebanon and what they practiced economically has a lot of relevance to learn from.

Here, we are not dealing with economic theory in the abstract and in an idealized environment, but rather we are looking at the application of economic theory based on the level of development of a particular economy, and where this range is a continuum.

So we are stating the opposite to what is taught and promoted, born by the fact that the most successful economies are those that are the most regulated by great regulatory bodies. Some of these successful economies are democracies, and some are not. But, democratic institutions will always outperform non-democratic institutions in the long run. (see references).

And now we get to the main factor of why well-regulated economies succeed. It is because "regulation" itself is a monopolistic practice. Regulation is by definition anti free-market, as a free market, is just that, free from any regulation or interference by non-market forces. So regulation, whether it increases the barrier to entry, or limits competition, or increases competition, or raises the cost of entering economic activity in a certain domain, if done properly, will allow for companies to have access to capital to grow and prosper. Later, the same regulatory bodies, when the economy develops, should drive these companies to grow under different forces, mostly market forces, i.e. free competition, and should prevent any monopolistic practices.

So states' law that says, that in order for you to be a hairdresser, you must attend a specialized school, immediately creates a barrier to entry to this profession, and is thus monopolistic in nature. Sure you can justify this on grounds that these people should know what they are doing, but no one was ever hurt in an undeveloped economy getting a hair cut. What is the big deal? Just let anyone who wants to cut hair do so, after all, the worst that can happen is that you get a bad hair cut, which you end up getting from a professional most of the time anyway. Moms do it to their kids without a license? Why not others? Similarly for other professions, let the market decide. But clearly, developed economies tell a very different "empirical" story of success than that promoted by no-regulation economies that litter the third world and others.

Looked at from a different perspective still, good regulation, even when it is not directed at creating greater competition, seeks to elevate the level of current standards, and as such, enriches the industry or the economy with a certain amount of 'preprogrammed knowledge,' that the economy in turn will benefit from. Knowledge, of course, is information, and as such it is a vital component of the development and worth of anything, be it a company, and industry or an economy. At a deep level, good regulation in effect serves to concentrate capital and to concentrate knowledge. The amount and usefulness of work that can be realized from capital and knowledge is related to its concentration. (Somewhat like a magnet, the more of its mass in one area the more work you can do with it). Also, regulation serves to specialize or "segment" knowledge, in a manner that is similar in effect to the division of labor, and the benefits that this carries.

To recap , for developing economies, in different sectors, it can be healthy to allow companies to acquire monopolistic positions, if there is lack of access to capital, and there exists "superb" regulatory institutions. We have not even mentioned how important this is when we consider international competition as an additional factor that developing economies have to contend with.

Looking at the most competitive industries or services that are not regulated in undeveloped economies, we see nothing except highly undeveloped industries, products and services that provide poor wages. It is time to reconsider economic development practices for undeveloped and developing countries. Previous advise on what to do has failed these economies.

So, asking the question in a different way still: At what point does too much competition becomes less beneficial? It becomes less beneficial when there is little access to capital and the competition is fierce enough that it prevents anyone involved from creating a "healthy profit" (i.e. capital) to be used for investment , where "investment is at the heart" of development, of workers, companies and economies, that provide the higher wages. (Labor's wages are related to the amount of capital stock of an economy has, and without investment, your wages will be low.) Don't assume that fierce competition always produce winners and losers! And the losers would bow out of the market to the winners and shift to a different niche so that the winners can grow! It often is the case in these economies that such competition results in many survivors who are willing to live on thin profit margins that does little more than sustain them indefinitely in these poor conditions. Progress through capital creation and investment is difficult under these kinds of conditions.

To summarize, good regulatory bodies are a necessary and "absolutely essential" condition for economic growth, for the creation of "good" monopolies or good non-monopolies. This must be done in an environment that is typically called "a free-market-economy."

Despite what everyone says, that is what the practice of all the successful and developed economies shows. We are not talking about exceptions to the rule, i.e. small and parasitic economies, as we will not explain the obvious about them for the sake of brevity. And we do not use the term "parasitic" in a pejorative way, but simply to imply that they are not economic engines and are dependent on other economies for their well being, and as such they are the exceptions.

So the next time you hear the US Congress talk about the price of milk, or pressing cereal manufacturers to lower the price of their products, or you hear the European Union talk about what the size an Apple should be before it can be sold, or what constitutes chocolate etc.. or if you are surprised by the multitude of laws and regulations that deal with every aspect of commercial life in a developed economy, don't be. Just remember, that "free-market-economy" means different things to different people, and what is to be concluded is that "good regulation is the essential component for the success of a developing economy, and regulation of the economy should be a function of the level of development of the particular economy, and its available resources." The governments of the west have shown that even with what seems to be contrary to common perceptions in terms of practice, have managed to produce very successful economies, by having well-regulated "free-market-economy."

The next question becomes, how do you develop good regulatory institutions. The short answer is: by starting with institutions that are transparent and accountable to citizens, or to competent autocrats as a lesser option.

Previous Stories:
  Culture and its role in development   (1/25/2000)
  Economic development strategies   (1/15/2000)
  A possible road map to international economic development   (1/14/2000)
  Arab common market: Low inter-trade reveals problem, part 2   (5/12/1999)

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