Friday, January 14, 2011

The Myth of Perfect Competition before Global Capitalism

Chris Meyer & Julia Kirby write in the Harvard Business Review, 13 January HERE:

“When Did the Invisible Hand Lose Its Grip?

“Sustainable competitive advantage, in other words, is the tying of the Invisible Hand. In Adam Smith's world, whenever a producer responded to a market opportunity with a uniquely valuable proposition to buyers, it had the ability to enjoy excess profits. Faced with multiple options, buyers would look for value differentials through lower pricing, and the profits would rapidly be competed away. This, to a firm, is a horror to be avoided: a buyer's market. The entire enterprise of management has been to find a way around it.

To underscore the point: The invisible hand is the enemy of sustainable competitive advantage — and any firm trying to gain a sustainable competitive advantage is an enemy of the invisible hand.

…. When oligopolistic conditions exist, therefore, where it is possible for a few major players to implicitly agree on how business will be done, the agreement that is arrived at looks nothing like constant, fierce competition. Rather, it's in all the leaders' interests to maintain a stable market and profitable prices. Oligopoly permits mutual understanding to develop, and then, because that understanding supports premium profits, the players have an incentive to maintain the oligopoly. Fat cats just don't fight like alley cats.

….. Sometimes it's hard to understand what self-described advocates of the free market do believe in since they so often defend the rights of the company that already has market power to do whatever it can to strengthen its position further. This is a point we really feel strongly about: we give huge market power to large corporations under the banner of free competition, when in fact what they are engaging in is not competition. It is pseudo competition”


Comment
Chris Meyer & Julia Kirby are probably correct to explore some of the manifest non-competitive practices of modern societies believed by many to be capitalistic in practice, though wildly different definition of ‘capitalism’ abound, as do the capitalistic societies which they purport to define.

However, I m not so sure that their grasp on history could be described as acute, which reflects their opaque understanding of Adam Smith’s two books, Moral Sentiments and Wealth of Nations.
Their unhistorical weakness is exhibited here:

In Adam Smith's world, whenever a producer responded to a market opportunity with a uniquely valuable proposition to buyers, it had the ability to enjoy excess profits. But immediately, those excess profits would be spotted and coveted by other producers, who would rush in with rival offerings.”

In Smith’s world, nothing of the kind was commonplace. It did not resemble perfect competition or any vestige of it. The mercantile economy was dominated by Town Trade Guilds, which monopolised both production and consumption by strictly controlling who and how many trades’ people – producers and shop keepers – could work or operate in the towns and cities. These trade monopolies were bolstered by legal restrictions from the Statutes of Apprentices, and by the Settlement Acts prohibiting labour from moving out of the parishes they were born in.

Moreover, the Combination Acts prevented on pain of public whipping for ringleaders and transportation of labourers from seeking higher wages or opposing wages cuts while leaving employers free to combine to refuse wage increases or impose wage cuts.

The details are discussed, without sentiment, by Adam Smith in Wealth Of Nations. Chris Meyer & Julia Kirby should be aware of these details (and by the readers of the Harvard Business Review) if readers are to make an appropriate judgement of Alfred Chandler’s ‘convincing’ assertions about changes in how modern ‘large scale industrial organisations’ somehow marked ‘a major new era in capitalism’ compared to ’something plausibly resembling perfect competition’, which is alleged to have been practised ‘before the 1850s’ (and, according to Chris Meyer & Julia Kirby, in ‘Adam Smith's world’ too).

My comment has nothing to do with a critique of capitalism or some such trendy ‘left’ moan about society. Far from it, but if we are understand its structural problems today we have to start from accurate history, especially where those facts are easily verifiable, especially when quoting from Adam Smith (try reading Books I and II of Wealth Of Nations, and not just a few quotes, or worse, believing what some modern Business Schools guru’s teach). As a "self-described advocate of the free markets", I am not an ideologue (neither was Adam Smith), I recognise that all human institutions, and the people in them, have flaws and it is more productive to start from understanding them and their history, not re-writing history to suit theories of perfection: 'Markets where possible; government where necessary'

“The invisible hand is the enemy of sustainable competitive advantage — and any firm trying to gain a sustainable competitive advantage is an enemy of the invisible hand.”

Chris Meyer & Julia Kirby have bought into the fable of the “invisible hand”. They believe, apparently, that some such entity exists. For Adam Smith it was a metaphor in Moral Sentiments (1759), which he used to describe how rich landlords fed their peasants from the produce of their lands. The metaphor was a way of describing in a “more striking and interesting manner” the necessity for landlords to maintain their dependent peasants (and retainers) because without food (obviously) the peasants would be unable to work the landlord’s fields, and in time would die, and so would his 'greatness'. The peasants worked to obtain their subsistence. This necessary mutual dependence ‘led’ landlords to feed their peasants, and not their 'humanity'.

Similarly, in Wealth Of Nations (1776), Adam Smith used the same metaphor to described how some (but not all) merchants chose to invest their scarce capital locally in Britain, rather than risk it in ventures in foreign countries and British colonies. Local investment added to the total of domestic investment, which added to total annual revenue and employment (the whole is the sum of its parts). These merchants were ‘led’ to invest ‘domestically’ by their ‘insecurity’, and the ‘invisible-hand’ metaphor described this action, and its consequence, in a ‘more striking and interesting manner’ (see Adam Smith: Lectures on Rhetoric and Belles Lettres, ([1762-3] 1983, p 29).

From this innocent usage, largely ignored by Smith’s contemporaries did not mention his use of it (the IH-metaphor was extremley common in 17th-18th century literature, sermons, and novels) and modern economists sort of ‘re-discovered’ it in the mid-20th century, and without considering Smith’s context or his teachings on metaphors, jumped on it as a noun to create a veritable fable of the invisible hand as a real entity in how markets work, completely ignoring that Smith never applied the metaphor to his writings - which are extensive – on markets.

Neither feudal landlords, nor 18th-century mercantile trade were remotely connected to perfect competition. And neither were 19th-century industrial organizations, nor modern Global capitalism.

Chris Meyer & Julia Kirby’s lack of awareness of history and Adam Smith’s Works, leads them to such statements that:
“The invisible hand is the enemy of sustainable competitive advantage — and any firm trying to gain a sustainable competitive advantage is an enemy of the invisible hand.”

A metaphor is not an “enemy” of anything. It is not a real entity and has no consciousness. It doesn’t exist. Nowhere does it appear in the equations of the believers in it.

Nobody can point to what ‘it’ does – other than expressing a “more striking and interesting manner” what tyrannical feudal landlords did (under the illusion that they were all-powerful and everybody else necessarily was ‘below’ them), or risk-averse merchants did from their cautions (many still went bankrupt).

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