What Competition Is, And What It Is Not

Competition is a buzzword. Everyone loves it, but there are vastly different interpretations of this precious concept. These different interpretations lead to strongly conflicting policy recommendations.

Imagine you and your super wealthy friend bet on who will win the 100 metres at the Olympics. Your friend wins the bet. But then you find out that the race was rigged. Your friend had bought off seven of the eight contestants. “That’s unfair! Then it wasn’t a real contest” you cry out. Now, imagine your friend shrugging his shoulders and responding, “It was a competition. See, there were so many runners.”

That response would strike us all as ridiculous. The sheer number of racers is not relevant. What would have been necessary for it to be true competition and a true race is for all the runners to give their best to win. But that wasn’t the case. And thus, it wasn’t competition; it wasn’t a race.

This story demonstrates a precious insight into economic theory. To see that, consider one of the dominant models in economics, that of perfect competition. Roughly, this suggests that for a market to be perfectly competitive, goods must be homogenous, there must be an infinite number of sellers, no transaction costs, and perfect information. Let’s focus solely on the infinite number of sellers. In reality, there’ll never be an infinite number, but imagine that we have an industry with many sellers such that we would be content that this condition for perfect competition holds for our practical considerations.

Remember the race example I mentioned earlier. There were eight runners. Would this number be “enough” to have competition? Initially, one would think yes, in general this is so. When we have many runners (as these are the companies in the market), we should expect there to be competition.

But not so fast. Recall that in our example, seven of the eight runners had been bought off. They had not given their best; they lost on purpose. There had been no competition – it was all a sham. Unrealistic as this example may be, it demonstrates an important lesson: we want a certain kind of behaviour when we want competition. We want racers to give their best to win the gold medal, we want athletes to train as hard as possible, and we want entrepreneurs, managers, and workers to work relentlessly to improve their products, make them cheaper, and align them better to what the consumers want. What we want is not this or that number of runners or sellers. What we want is a certain attitude.

Two lessons follow from this. Firstly, a monopolist, in the sense of a company that is the sole seller in some market, can mean absolute competition. For it is enough that the company has the right mindset, i.e., acts competitively by relentlessly striving to improve their product etc. So, what is needed is this competitive mindset. And for its emergence it is necessary that potential competitors have “freedom of entry”. The threat of competitors potentially entering the market keeps the incumbent company on its toes. Then, we may have only one seller – but this seller is competing.

Secondly, a market that has many companies does not necessarily have to be competitive. Imagine we had an economic system akin to the guild systems of past centuries. In such a scenario, there could be hundreds of smiths in the country, but all of them with their specified area that they, and only they, supply. There may well be no competitive mindset here, as the smiths need not worry about customers choosing a rival – as rivals are not allowed to enter the market.

Capitalism as an economic system is intended to lead entrepreneurs to produce what consumers want. To ensure that consumer wants are satisfied, competition is imperative. But this is about a mindset, an attitude. It is irrelevant whether there is one spectacular entrepreneur in a market that outcompetes others such that his company is the only seller. Instead, it is about how entrepreneurs act: are they vigilant, striving, restless, endlessly looking for improvements? If yes, then we consumers have the competition we want. If not, then we consumers must protest. And then we consumers must recall that for sellers to have this competitive mindset, we need “the complete absence of institutional restrictions upon entry”. This freedom for entry (and for exit) is what makes for competitive markets. Not an arbitrarily defined number of sellers.

Max Molden is a PhD student at the University of Hamburg. He has worked with European Students for Liberty and Prometheus – Das Freiheitsinstitut. He regularly publishes at Der Freydenker.