By: Dana Foarta, Steven Callander & Takuo Sugaya (Pro Market)
The operation of markets and of politics are in practice deeply intertwined. Political decisions set the rules of the game for market competition and, conversely, market competitors participate in and influence political decisions. Since at least the time of George Stigler (1971), the connection between the two domains has been formalized in economics, and the flourishing literature that emerged has deepened our understanding of how special interests can distort political outcomes and how political decisions shape market outcomes.
At its best, the intervention of politics into markets provides the guardrails that allow competition and innovation to flourish. Of course, reality rarely works out as well as we hope. The ever-present fear is that a symbiotic relationship develops between policymakers and dominant firms, and that together they work to strangle competition to the detriment of us all.
In our recent research, we show that those fears, if anything, are understated. Reality can be much worse, and a symbiotic relationship between dominant firms and policymakers can in fact have far-reaching negative consequences. In our paper, “Market Competition and Political Influence: An Integrated Approach,” we study a typical market with competing firms and a government policymaker who has the power to intervene into the market and favor one of the firms over the others. This type of market intervention is ubiquitous, such as state health care regulators who condition market entry on gaining approval of current market participants, or the ongoing baby formula shortage that arose because the US government had created de facto monopolies in production by signing exclusive procurement contracts with a single firm in each state.
The classic logic of capture is straightforward. In a competitive market, prices are low, as are profits, and consumers capture much of the value that is created. To instead capture some of the value themselves, the policymaker will partner with one of the firms, favoring it with regulations so that the other firms are excluded from the market, and this connected firm can operate as a monopolist. This drives prices–and profits–up, and the firm and the policymaker can share the spoils between themselves.
At a single point in time, this logic is airtight. But what happens over time? If the relationship between the policymaker and the firm holds, outcomes may not necessarily be very bad, or at least, they don’t need to get any worse. Although monopoly is bad for consumers, this does not imply that the industry cannot still be innovative. The desire of the monopolist to make as much profit as possible still drives investments in innovation. Products can still improve and processes can become more efficient. Perhaps gains may not be as high as in a competitive market, but improvements can still be significant.
Our insight is that even this won’t come about. To see how the market outcome can be much worse, the symbiotic relationship between the policymaker and the firm must hold over time. We point out that this is unlikely to be true…
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