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When Economists Didn't Buy the FreeMarket An Interview with MichaelPerelman
When Economists Didn't Buy the Free Market An Interview with MichaelPerelman
October 29, 2006 By Michael Perelman
Michael Perlman is a longtime professor of economics at California State University, Chico. A prolificauthor, his newest book is titled Railroading Economics: The Creation of the Free Market Mythology(Monthly Review Press, 2006). He has also written The Invention of Capitalism: The Secret Historyof Primitive Accumulation (Duke University Press, 2000) and Manufacturing Discontent: The Trapof Individualism in a Corporate Society (Pluto, 2005). Perelman also finds time to moderate theProgressive Economists Network List. This interview was conducted via e-mail.
Seth Sandronsky: What did the top economists of the late 19th century grasp as the U.S. railroad industrygrew?Michael Perelman: Economists who studied the railroad industry, which was by far the dominant industryin the country, realized that competition would necessarily drive prices so low that the railroads would become bankrupt.What they saw was similar to the airline industry today. The extra costs to fly me from San Francisco to New York might cost $20 at the most on a flight that was scheduled but had empty seats. Unbridledcompetition would drive prices down toward $20, which was not enough to cover the fixed costs.The economists at the time recognized that the industry's viability would require restricting market forces.They argued that the only hope for the industry was to restrict competition by allowing railroads tocombine and at least collude to keep prices high.SS: For non-economists, can you please explain what fixed costs are for industry, and the connections with prices in the marketplace?MP: Fixed costs are expenses that do not depend on the quantity of goods or services provided. For example, in the airline industry corporations must pay interest on the debt incurred or payment on theleases for the planes that they use. Once a plane is scheduled to run, payments for the pilots and flightattendants as well as the landing fees are set, regardless of how many seats on the plane are empty.According to economic theory, the relation between fixed costs and prices is nonexistent under strongcompetition. Prices depend on marginal costs -- the cost of supplying one more unit. In the case of theairlines, the marginal cost of filling an empty seat is merely the extra fuel required to carry the extra weight,maybe a lunch, and the cost of handling baggage. Processing of tickets used to cost about $20 but nowthrough computerization is practically nothing.Fixed costs are also related to but not the same thing as long-lived capital. Economists rarely pay muchattention to long-lived capital, except to applaud the concept of capital accumulation. The reason for their inattention is that capital goods require considerations of time, which complicates the simple economic
 
models with which they are enamored. Once a company has invested in such capital goods, it is stuck withthem because it will not get much for its investment on secondhand markets. Companies become desperateto utilize these capital goods as efficiently as possible.A large passenger airplane carrying only a couple people would be a disaster for the airline. They wouldhave to do something to fill up their seats.If all the airlines were in a similar situation, they would have no choice but to engage in the price war. Thissort of competition occurred in the 19th century railroads. Bankruptcy became commonplace until J.P.Morgan began to organize them into large cartels to prevent competition.Modern economics assumes away this tendency even though common sense shows that no reallycompetitive industry today is very profitable. Profits are highest in industries protected by intellectual property or by the influence necessary to garner government contracts.SS: What effects did the "Morganizing" of U.S. industries have on the economics profession?MP: At first, many of the most important economists of the time applauded Morganization. They arguedthat a consolidated firm could be more efficient and even offer lower prices to consumers -- much like thecontemporary justification of Wal-Mart. They also added that excessive competition was destructive.Within a short period of time, the concern about excessive competition fell away, although the efficiencyargument remained in vogue. After all, large corporations were coming to be common and conventionaleconomists were not about to challenge them. After all, business forces already wielded tremendousinfluence in academia.The Morgan-friendly economists introduced another argument, which fell out of fashion until it was re-adopted in the 1970s. This thesis proposed that elimination of competition was not necessarily bad becauseof potential competition. The idea was that if a company became too greedy and its profits soared, other companies would rush in to claim some of the profit.As a result, corporations would moderate their lust after profits, allowing the public to benefit from thelowered prices due to the efficiency of large business.A few decades later, Joseph Schumpeter offered another wrinkle to the debate. Even if a corporationmonopolized an entire sector, say, steel for example, other corporations that depended on steel could turn toother materials such as aluminum as a substitute. Using this argument, monopolistic power magicallydisappeared because of what economists call cross-product competition. I might mention that the dot.comera adopted Schumpeter as its patron saint because of his advocacy of the essential role of the entrepreneur.But now, such debates have subsided. Instead, economists exude confidence that the market operates as agiant computer or even a super-brain, which allows it to ensure that business performs in the most efficientmanner possible. So great is the divorce from reality that such theories persist even in the post-Enron era.SS: In your fifth chapter you cover welfare capitalism and war socialism.Please explain the terms and their connections in terms of free market myths.MP: During World War I, the United States adopted many features of socialism-- not the bottom-up socialism that we would applaud, but more of a state planning economy. At the time, just like World War II, the United States'
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