Reader Dan finds this interview of Michael Perlman.
Michael Perlman offers another view on free market not staying free because of the nature of markets and maximization of profit. He describes a glitch that needs addressing.
…Fixed costs are also related to but not the same thing as long-lived capital. Economists rarely pay much attention 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 with them because it will not get much for its investment on secondhand markets. Companies become desperate to 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 would have 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. This sort 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 really competitive industry today is very profitable. Profits are highest in industries protected by intellectual property or by the influence necessary to garner government contracts. But now, such debates have subsided. Instead, economists exude confidence that the market operates as a giant computer or even a super-brain, which allows it to ensure that business performs in the most efficient manner possible. So great is the divorce from reality that such theories persist even in the post-Enron era.
Competition affects finance in two different ways. As in the rest of the economy, competitive forces drive financial institutions to increase efficiency (in the narrow sense of improving things like the cost of handling transactions). As in the non-financial sector, the outcome tends to be consolidation, which strengthens finance.
At the same time, competition in the non-financial sector tends to lower the rate of profit. Investors, seeking substantial profits, lose interest in the non-financial sector and turn to purely financial operations. This particular consequence of competition helps to explain the rise of hedge funds and the relative absence of investment in productive sectors of the economy.
Reader Dan asks…
Do markets have a developmental pattern inherent in the modern form? If you are always looking for 15% return or more, does this distort the free part of the market to a particular kind of market if the excess capital simply sloshes around in financial instruments?