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[Topics under debate]: GOOD GOVERNANCE
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Dear Mr. Datt,

Going by an earlier post of yours, you seem to believe that the market
is about giving free play to private capital or something like that. I
feel that is oxymoronic. The free market is not only a natural
self-regulating complex adaptive mechanism that restricts private
capital, but also channelises it. Generally speaking, therefore, I am
for decentralised free-market solutions to problems  even those caused
within the market. Giving more freedom to market forces is not the same
as giving free play to a particular market force  such as private
capital. Capitalism is something of a misnomer for this reason.

So I believe government regulation (because it is centralised) shouldnt
happen by default. The market should first be tried out as a systemic
solution wherever possible. Wherever the government is to be asked to
intervene, the burden of proof should be on those asking for it and they
should have to show that market forces wouldnt succeed in solving the

So, when you wrote that predatory pricing was a crime that needed to
be punished, I aired my doubts. Obviously, since I am not writing a
thesis on the subject, they were doubts raised by someone else. But the
fact remained that I hadnt been able to answer them. So I presented the
doubts to you in the hope that, since you seemed clear on the subject,
you would clear my doubts. Of course, as I have already said, if you
hadnt been able to answer them, I would have looked elsewhere.

Unfortunately, I didnt have time to present these doubts within the
posts themselves. So they remained in the articles where I found them.
But I also asked you some questions directly. You havent yet answered
them satisfactorily, nor any of the other doubts.

So I present some of the main ones here again, this time as part of my
post. You had also asked for Sowells statements and the evidence he
gives. They have also been summarised or quoted here.

I quote Sowell directly because they are his views, not mine. Your
reactions should preferably be directed at his views  and neither him
nor me.

It is one thing to theorise that predatory pricing may be possible. But
quite another to base legal action on it, to treat it as a crime based
on a theory that has yet to be confirmed. Microsoft may have done wrong
things but we arent talking about Microsoft here, but the theory of
predatory pricing.

So Sowell wrote:

The Justice Departments antitrust case against Microsoft relies on one
of the most popularly acceptedand most empirically unverifiedeconomic
theories, the theory of "predatory pricing."

It is a commentary on the development of antitrust law that the accused
must defend himself, not against actual evidence of wrongdoing, but
against a theory which predicts wrongdoing in the future. It is the
civil equivalent of "preventive detention" in criminal cases 
punishment without proof.

Perhaps you have the means to criticise this.

He also says:

The emotional or ideological power of a theory is shown, not by how
much evidence can be amassed in its favor, but precisely by the lack of
any necessity to produce evidence.

And he gives evidence in favour of his accusation:

A major antitrust case against the A&P grocery chain in the 1940s, when
it was the largest retail chain of any kind in the world, alleged
predatory pricing. Yet, despite a federally financed investigation
extending over many years, against a company with 15,000 stores, not one
concrete example could be found where A&P had in fact driven a competing
store out of business and then raised prices above the general market

The fact that the government won the case has become virtual proof to
some that A&P engaged in this practice. It should instead be proof of
how much the courts relied on preconceptions.

Lets examine the theory itself. Again, Sowell describes it quite well:

According to this theory, unprofitably low prices are used to destroy a
competitor financially, thereby permitting the surviving predator to
raise prices above a level that would have existed under competition.

It seems very obvious at first and very plausible. But there are
questions as to whether this will actually happen in real market

The strategy may not be such a rational profit-maximising strategy after

1. If prices are set below cost, the larger company will suffer most
losses because of a larger market share.

2. A price war is extremely risky  the large firm can never say how
long it will have to keep incurring losses in order to finally charge a
high price one day.

3. The targeted firm can just as well decide to shut shop temporarily
and re-open when the prices are back up.

4. Even if it did go bankrupt, as firms regularly do in the natural
course as well, another firm can buy off its facilities at distress
prices and re-enter when monopolistic prices are being charged.

Sowell gives the following example:
The Washington Post went bankrupt in 1933, though not because of
predatory pricing. But neither its physical plant, its people, or its
name disasppeared into thin air. Instead, publisher Eugene Meyer
acquired all threeat a fraction of what he had bid unsuccessfully for
the same newspaper just four years earlier. In the course of time, the
Post became the biggest newspaper in Washington.

You could also use your own example: KFC. Once it starts charging high
prices, what stops other restaurants from springing up?

5. The price war could spread to other markets as well, causing the
predator more losses

6. The opportunity cost of funds to be used for predation will have to
be taken into account. The rate of return has to be above the interest
rate and above other return from other investment decisions.

7. The consumers can stock up on the product during the low price period

8. The anticipated monopoly profits have to be discounted to their
present value. Which means that the large firm may believe that profits
now are better than profits in the future.

Besides, economists have devised counter strategies that the prey can

Another important question is the nature of competition:

Is it an act? Or a static state in which every product and firm is the
same and doesnt need to compete? If it is the former, then
price-cutting, even below cost is a real life example of it.

Price-cutting by itself can be a useful thing. For example:

1) It opens new markets for the firm, be it a new upstart or a big
2) Offers lower prices to the consumer, even if temporary (not that it
will go back to monopoly levels).
3) Low prices will drive down costs. It was Henry Ford who said:

Our policy is to reduce the price, extend the
operations, and improve the article. You will
note that the reduction of price comes first. We
have never considered any costs as fixed. There-
fore we first reduce the price to the point where
we believe more sales will result. Then we go
ahead and try to make the prices. We do not both-
er about the costs. The new price forces the
costs down.
Competitors are clearly distinct from competition itself. But in the
theory of predatory pricing, hurting a competitor is assumed to mean the
same as hurting competition. Which leads one of them to ask for
government protection  in the name of competition! Couldnt it be just
another instance of the corporate pressure on government policies that
you keep pointing out?

So Sowell writes:

In short, the financial demise of a competitor is not the same as
getting rid of competition. The courts have long paid lip service to the
distinction that economists make between competition  a set of economic
conditionsand existing competitors, though it is hard to see how much
difference that has made in judicial decisions. Too often, it seems, if
you have hurt competitors, then you have hurt competition, as far as the
judges are concerned.

However, courts havent always allowed the theory of predatory pricing
as valid ground. There have been cases where the courts have decided
that the theory isnt an economically tested one and therefore cannot be

You would assume, going by the theory, that the helpless prey would be
so financially worthless, that no one would want to invest in it. Then
why did AOL pay so much for Netscape?

Besides, it has also been asserted that a monopoly is very difficult to
maintain in the long term without government restrictions and

So, instead of deeming it a crime, perhaps we can see whether the market
can effectively deal with it. If not, there will surely be enough people
to go for the throats of the big monopoly.

Why give politicians the power to intervene in our economic life when it
may not be necessary?

Chirag Kasbekar
TYBA (Econ, Socio)
St. Xavier's College,
Mumbai (Bombay), India.

"What is ominous is the ease with which some people go from saying that
they don't like something to saying that the government should forbid
it.  When you go down that road, don't expect freedom to survive very
                                -- Thomas Sowell

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