Monopoly is as monopoly does: To study monopoly, look to actions, not the textbook definition

The U.S. residential construction industry appears competitive. There are often many contractors eager to bid for a project. Builders wrestle with tight margins. New firms are generally free to enter the market.

Minneapolis Fed Principal Research Economist James Schmitz Jr. looks at American homebuilders and sees a harmful monopoly. Schmitz argues we should similarly view lawyers, doctors, labor unions, and trade/professional organizations as forms of monopoly—just as economists and policymakers a century ago might have recognized them. Schmitz lays out his case, rooted in economic thought back to the 1700s and supported by colorful industrial vignettes, in “Economists Should Be Studying Monopoly Much More Extensively: How Our Interest in Monopoly Waned After We Began Thinking About Monopoly All Wrong” (Minneapolis Fed Staff Report 677).

Schmitz pins his profession’s “wrong turn” on a definition codified by economists such as George Stigler and Arnold Harberger in the mid-20th century. Their work yielded the monopoly diagram familiar to decades of microeconomics students: A sole seller of a product without close substitutes can sell less and charge more than if it was facing competition, maximizing the firm’s profit at the expense of consumers. Schmitz says subsequent theoretical refinements (oligopoly, monopolistic competition, concentration indexes) only doubled down on the original sin: Defining monopoly in terms of pricing power and the number of competitors in a market.

Rather than focus on concentration and price-cost margins, Schmitz argues for a definition based on actions and behaviors. He takes inspiration from Thurman Arnold, an aggressive leader of the Department of Justice Antitrust Division under Franklin Roosevelt. Like today’s “textbook” definition, Arnold recognized that monopolists restricted quantities and raised prices. But these were only part of a much longer list of offenses. Per Arnold (and Schmitz), monopolists block the introduction of new technology, reduce the efficiency of existing techniques, sabotage substitutes and competitors, infiltrate public and private institutions to rig regulations and trade barriers to their advantage, and maintain punitive discipline within their own ranks (as a means of preventing defection and innovation).

The great extent—and extensive harm—of monopoly behavior

The Latin root of “monopoly” means “single seller.” Schmitz’s approach, however, pulls a broad range of arrangements and entities into the tent: Housing construction is a “monopoly industry” that maneuvers to prevent modular, factory-built housing from becoming a viable option at any significant scale. The American Bar Association protects bar-certified lawyers as the sole purveyors of legal advice and prevents paralegals from providing other legal services independently. Lower-cost alternatives for dental care and the fitting of hearing aids meet fierce opposition from monopolies of dentists and audiologists. Historically, as Schmitz has documented in prior research, strict subdivision of tasks and other bargained labor arrangements amounted to monopoly behavior by the cement and iron ore industries—until those industries became so inefficient that foreign imports cracked the U.S. market and the arrangements collapsed.

Schmitz says economists before the 1950s understood monopoly in these qualitative, behavior-based terms. They perceived it all around them, Schmitz writes, and “as they saw the great extent of monopoly, they understood these losses inflicted harm on all of society.” Modern economic analyses have measured the societal loss from monopoly as relatively small. By Schmitz’s reasoning, this narrow focus on the “Harberger triangle” of the classic diagram (the deadweight loss that arises from firms with market power restricting quantities below the optimal level) misses other, larger costs. These include the opportunity costs of stunted technology, inhibited innovation, and blocked foreign and domestic competition, as well as the rent-seeking resources expended to secure and maintain monopoly status.

The focus on deadweight loss also sidesteps distributional effects—a primary concern of monopoly-focused economists of earlier eras. Schmitz lays today’s supply and affordability “crises” of housing and legal services, both issues that severely affect low-income people, at the feet of industry monopolies. “Many forebears concluded that monopolies were a major cause, if not the greatest, of poverty and inequality,” Schmitz writes (italics in the original).

Looking to economists of an earlier era

Those economist “forebears” include Anne-Robert-Jacques Turgot, the 18th-century bureaucrat who fought the actions of French trade guilds to block foreign competition, obtain favorable regulations, and keep members in line. Adam Smith wrote extensively of the countervailing forces of free trade and monopoly, applying “monopoly” broadly to industries and nations who acted to accrue and protect the economic power of the few at the expense of the many. William Stanley Jevons chronicled the resistance of 19th-century English bricklayers and farriers to technology that would lower the costs of housing and transportation.

Schmitz’s 20th-century economist-protagonist is the University of Chicago’s Henry Simons. In his influential 1934 pamphlet, A Positive Program for Laissez Faire, Simons wrote of monopoly not as a sole firm with pricing power but more generally, as “effective organized functional groups.” Simons saw the U.S. government’s failure to maintain the conditions for free economic competition as a principal cause of the Great Depression and a threat to the American experiment. “The great enemy of democracy,” Simons wrote, “is monopoly, in all its forms.”

In Schmitz’s analysis, entities or groups engaged in monopolistic behaviors are not strictly profit-maximizing. If they were, it would be hard to explain the extraordinary costs that pursuit of monopoly imposes upon the monopolists through lost innovation and misallocated resources. Schmitz and co-authors have documented how the New Deal–established sugar cartel, which persisted until 1973, subsidized money-losing sugar beet fields in California and Colorado, “destroying industry profits as the cartel progressed,” Schmitz writes in the new staff report. Across Schmitz’s many industry portraits, monopolies act often in pursuit of turf, tradition, and control—at the long-term expense of higher margins.

These losses accrue to the monopoly itself, something Schmitz believes helps explain certain economic “puzzles.” Economists (notably Gordon Tullock) have noted that corporate lobbying expenses—an explicit cost of building or maintaining a monopoly—appear exceedingly small relative to the benefits; firms competing for such valuable monopoly status should, in theory, be spending much more. Where are all of the costs? The answer, Schmitz argues, is that the monopoly raises its own cost curve through inefficiencies and forgone innovation.

Similarly, Schmitz says economists puzzled by the seemingly small gains from international trade are missing a key channel: the benefit of trade in preventing the formation of monopolies that never come to be.

Schmitz’s latest staff report provides a historical long view that complements his body of recent work arguing for the role of monopolies in economic inequality and low-income housing. Many of his contemporaries, he argues, continue “measuring monopoly without a definition,” applying price-cost margins and market concentration statistics. These not only miss many non-firm entities inflicting economic harm, Schmitz says, but also rope in companies that earn market dominance and profits by besting competitors fair and square in the marketplace (and thus are not, in Schmitz’s view, monopolies at all).

“That our profession, over the last 75 years since we ignored our forebears’ knowledge, has not been able to ‘see’ the role of monopolies in inequality, is almost surely a result of our following the current methodology,” Schmitz writes. To forge a new methodology, Schmitz suggests, economists should start by looking to the past, when economists and policymakers knew monopolies by the ways they behaved.

Read the Minneapolis Fed staff report: “Economists Should Be Studying Monopoly Much More Extensively: How Our Interest in Monopoly Waned After We Began Thinking About Monopoly All Wrong”