States, more than regulators, matter in the 21st century

Jeremy Ghez, Affiliate Professor of Economics and International Affairs - March 11th, 2014
Globalization, states regulators

Comcast’s intention to buy its rival Time Warner Cable has sparked, yet again, a debate over competition policy in the United States and beyond.  The underlying question, in this debate, is about the ability of states and regulators to curb dominant firms in financially constrained times – when they may not have the means nor the political will to do so anymore.

Jérémy Ghez ©HEC Paris

Jeremy Ghez is an affiliate professor of economics and international affairs at HEC Paris and the co-director of the HEC Paris Center for Geopolitics. His research focuses on (...)

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More than a decade and a half ago, when the US Department of Justice presented its antitrust lawsuit against Microsoft, some voiced their concerns over the relevance of the approach.  Microsoft had grown organically over time thanks to the success of its products.  That growth, in turn, allowed the company to rely on the benefits of scale to innovate and to increase the productivity of those who used its products.  If the courts decided to split Microsoft up into different companies, who would still have an incentive to innovate and to build strong and successful companies anymore? What would such a decision do to the next generation of entrepreneurs whose only dream was to found the next Microsoft?  It is worth remembering that, at the time, the IPod hadn’t been released, Elon Musk just sold his first startup and Mark Zuckerberg was only 15…

Today, Microsoft is no where near the radar screen of antitrust regulators in the United States.  In fact, in the end, two competing – yet not mutually exclusive – narratives have explained how the dilemma that Microsoft set was solved.  The first narrative suggests that the 1999 lawsuit led Microsoft to act with caution – the stick of the regulators being so impressive that it was enough to durably influence Bill Gates to change the way his company’s practices.  The second narrative points to the rate at which Microsoft’s industry changed, leading tech giants including Google, Amazon, Apple and Facebook to erode Microsoft’s influence even if none offered the market with direct substitutes.

The temptation for the state and its regulators to intervene in order to curb a dominant firm remains high – and rightfully so if you believe the first narrative.  But such interventions are not only costly: they can also be extremely dangerous if they entail less than optimal changes in the way private actors, and entrepreneurs in particular, behave especially in terms of innovation and employment.  In fact, the paradox of state action lies in the fact that the smaller the imprint it leaves on markets, the more efficient and the more credible its action will be. 

In particular, in this era of globalization, states have far more leverage to make markets more competitive and to limit the period of dominance of firms than in the past.  Thanks to more opened borders, private companies may face more competition at home but also have far more opportunities abroad than ever before, especially in markets experiencing astounding levels of growth – such as China yesterday and the whole African continent perhaps tomorrow.  The European single market held a similar promise: rather than breaking previously state-owned monopolies who benefitted from economies of scale, the European construction aimed at making these compete with each other for the broaden European market.  To be sure, the mechanism is still faulty at best, but deserves some recognition as an attempt to instill greater competition without breaking actors into pieces.  Rather than obsessively focusing on the actual number of actors on a given market, states can get dominant firms to act as if they were facing more competition than they actual are by increasing the threat of entry. 

But the state’s mission does not stop here.  Conventional wisdom suggests that no matter how significant the public’s distrust of politicians, the state will always be uniquely placed to carry out key investments in education, fundamental research and infrastructure – fields in which efforts of the private sector are limited at best.  This line of thinking goes on to say that such investments, on the part of the state, can make a given economy more competitive.  While true, this reasoning misses another important argument: by improving the economic ecosystem and by favoring an entrepreneurial mindset, such investments also make it easier for the challengers of dominant firms to develop substitute products and to undermine the traditional actors’ market power. 

This is not the time for an omnipresent and omnipotent state.  But this does not mean that the state is doomed either, provided that it is creative and flexible enough to use all the levers at its disposal to increase competition.  These levers include but are not limited to traditional regulatory approaches.  The more the state can create a favorable ecosystem for growth, innovation and entrepreneurial change, the less it will have to worry about dominant firms and engage in breakups that are hard to manage and rarely lead to optimal outcomes.

This article was originally published in Forbes China, on March 3rd, 2014