can governments promote competition

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Can Governments Promote Competition?Some Reflections About the Knowledge Limitation of

Regulators for Undertaking Competition Policy Enforcement

Ignacio De LeonEconomics Department, Universidad Catolica Andres Bello

October 18, 2001

AbstractThis paper offers some reflections about the adequacy of the conventional Industrial Organization

view in providing a positive explanation of market behavior and economic causalities leading firms

to undertake business strategies deemed as "restrictive". We explore the convenience of using this

view as a normative yardstick for enforcing competition policy in a predictable way. This stems

from the inability of this view in providing knowledge to the regulator, so to undertake his

regulatory activity in a regular, predictable way. After exposing the intrinsic flaws of the

conventional view, we propose an alternative perspective, based on the notion of network

competition, which is rooted in the Austrian Economics understanding of market process, capable

of guiding government initiatives for the promotion of competition.

Keywords: antitrust economics, new learning of industrial organization, network competition, rule

of law, institutions, economic and institutional development, market power, entry barriers, Austrian

Economics, Kirzner, Freedom of entry

This paper can be downloaded from the

Social Science Research Network Electronic Paper Collection:

http://papers.ssrn.com/abstract=287887


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CAN GOVERNMENTS PROMOTE COMPETITION?

Some reflections about the knowledge limitation of regulators

for undertaking competition policy enforcement

Ignacio De Len1

INTRODUCTION: PURPOSE OF THIS PAPER.

This paper offers some reflections about the adequacy of the conventional Industrial

Organization view in providing a positive explanation of market behavior and economic

causalities leading firms to undertake business strategies deemed as restrictive. We explore the

convenience of using this view as a normative yardstick for enforcing competition policy in a

predictable way. This stems from the inability of this view in providing knowledge to the

regulator, so to undertake his regulatory activity in a regular, predictable way. After exposing the

intrinsic flaws of the conventional view, we propose an alternative perspective, based on the

notion of network competition, which is rooted in the Austrian Economics understanding of

market process, capable of guiding government initiatives for the promotion of competition.

In the last twenty years, much hope has been placed on the new learning of industrial

organization theory to guide antitrust policy enforcement in recent years.2

To a large extent, the

new learning came about as a result of the "contestability theory" (Baumol, Panzar and Willig,

1982). This theory eroded the older perception about the role which is played by entry barriers on

market competition. Until then, scholars had assumed the fundamental limitations of competition

arising from the pervasiveness of entry barriers, and their fundamental role in limiting the

possibility of competition from outsiders. Therefore, market concentration had, in this view, a

central role to play in determining the assumed effects of limiting competition. The contestability

theory challenged this view. According to this theory, market competition would flourish,

independently of the number of market participants (or indeed, of any other structuralconsideration), as long as entry barriers are low. For policy-making purposes, the stress would no

longer be made on examining the level of concentration, to ascertain the degree of competition.

Indeed, as Professor Kirzner states, the contestability theory, while [it] was largely developed

within the mainstream framework on market structures, it did much to widen economists'

horizons on the nature and role of competition. (Kirzner, 2000-B: 217) This is a fair statement,

compared to the rigidity of the older structural perception.

Nevertheless, the postulates of the new learning are increasing showing signs of exhaustion.

This is most evident in its insufficiency to deliver explanations about the causality of economic

events in industries such as those comprising the New Economy, (where the fast speed of

change seems to render antitrust analysis inadequate). A similar problem occurs in network

industries, such as telecommunications, where the predominant network outlook seems unable

1Professor Political Economy, Universidad Cat6lica Andres Bello, Caracas.

2The older perception of industrial organization related market performance to structural variables of market

analysis, such as the level of industrial concentration, firm size and market share. This perspective was

superseded in the 1980s by a new vision that emphasized the "dynamic" elements of market functioning,

such as business strategies.


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to be captured by the conventional individualistic emphasis of industrial organization theory (old

and new), thereby neglecting important network effects.

Evidently, this failure has impacted negatively on the capacity of antitrust theory to deliver

adequate policy enforcement initiatives. Insofar the New Economy, the recent antitrust judgments

on the Microsoft case reveal the inadequacy of the conceptual framework of the new teaming to

derive normative analysis of discrimination and market foreclosure in this industry, which

evolves at a very high rate of speed. In network industries, there is a potential risk that antitrusttheory will replicate much of the former conceptual basis of the public service rationale, which

in fact stifled competition for decades, on the basis that the fewer presence of competitors (due to

economies of scale) would leave consumers vulnerable to monopolistic abuses by the incumbent

firm.

This paper contends that the understanding brought about by the contestability theory did not, in

fact, bring a new perception of market functioning, but simply restated the older vision in a way

which eventually resulted more germane to the intuitive perception of policy makers about

reality. For this reason, it provided them with a theoretical way out from the empirical

inconsistencies of the older structural teaming, but it did not supply them with a better

understanding of market processes, as it kept virtually intact the essence of the structural marketperception, concentrated around the notion of market power and the structure-conduct

performance paradigm.

The preservation of the essential elements of the old understanding are clearly evidenced in the

realm of policy making. In this area, the contestability theory leaves the potential for discretional

government intervention on businesses, even though it displaces the focus of analysis from the

size of firms and level of industrial concentration, to the determination of the level of entry

barriers. Thus, the contestability theory is still too vague for guiding policy purposes, even

though it idealisticallyprovides a mental positive analysis of entry problems. Indeed, it shares the

same normative shortcoming of old industrial organization neoclassical models.

Ultimately, this paper develops an market process view of competition around the notion of

network competition, as alternative to the conventional market power view which pervades

current regulation, capable of providing an unified vision of market behavior in both the New

Economy and network industries, so to provide a more adequate basis for regulatory initiatives.

Notably, the notion of network competition of this paper attempts to overcome the hesitation

towards government intervention that predominates among Austrian scholars, by providing a

pro-market agenda for policy intervention. The current theoretical emphasis for deriving social

welfare implications from the analysis of entrepreneurial behavior, with no qualifications, is

inadequate, because it misrepresents the normative interpretation of social competition

mechanisms. Therefore, it leads the policy maker into the paradox of devising policies either too

intrusive on business affairs, or of total nihilism towards intervention. Even though Austrian

scholars have preferred the latter, this is a product of intuitive analysis, rather than logical

deduction. Thus, the thesis of this paper is that an unsuited individualistic emphasis on the

condition of single entrepreneurs, thereby neglecting the role of policy making in the

reinforcement of competition (and coordination) at the network level, which is not an individual,

but a social activity.


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Finally, this paper highlights the practical policy implications of this view, as shown in the

enforcement experience on vertical restraints, of Venezuela's Pro-Competencia

(Superintendencia para la Promocion y Proteccion de la Libre Competencia).

THE OLD LEARNING OF INDUSTRIAL ORGANIZATION.

Perhaps the most noticeable feature of antitrust economic analysis is the link the so-called

Structure-Conduct-Performance (SCP) paradigm builds between market concentration andperformance. This theoretical base appraises how the interaction between market structure and

business conduct influences market outcomes.

The conceptual basis of the SCP paradigm is the idea that firms aim to acquire market power or a

dominant position (or market dominance) from which they can attempt monopoly. Both notions

denote a situation where a market actor, due to his economic might, could disregard competition

from other participants. However, there are slight differences between the concept of "Abuse of a

Dominant Position," of the European competition rules, as defined under article 82 of the Treaty

of Amsterdam (ex article 86 of the Treaty of Rome) and the concept of market power, as defined

in Section 2 of the U.S. Sherman Act. Most commonly, market dominance is associated with the

freedom a firm enjoys from the constraints of competition, or the control it wields over upstreamor downstream trading partners. Generally, competition laws relying on this concept do not

prevent suppliers from holding a dominant position, but only from abusing that position.

Monopolists do not have to achieve a pure or quasi-pure monopoly in the market concerned; they

have to eliminate sufficient competition in order to impose a monopolistic price increase.

Moreover, market dominance is a concept influenced by political considerations of "fairness".

Therefore the antitrust schemes that meet the criterion of dominance tend to stress the need to

preserve multiple and independent outlets rather than to achieve economic efficiency, which

could eventually diminish multiplicity in favor of fewer, more efficient firms in the market.

In this analysis, the presence of significant entry barriers is crucial, as it, combined with market

power allows incumbent firms to undertake restrictive practices, and maintain supra-competitive(i.e. monopolistic) prices, either separately or together, with other firms. Under this perspective,

firms within competitively atomistic, structured markets have virtually no conduct options; they

are "price takers." A competitive market structure determines that the firms will be price takers

and cost-minimizers (or profit-maximizers). This price-taking behavior in turn results in superior

market performance. However, firms in highly concentrated markets can take advantage of a

variety of conduct options, many of which may yield very poor market performance. Collusive

output restriction in search of higher profits would be a prime example.

Scholars initially thought that the absence of entry barriers erected by incumbent firms was

decisive for establishing the competitiveness of markets. They believed that incumbents in

concentrated markets would be able to impose monopolistic conduct without the threat of new

competition more easily compared to markets where the presence of many competitors would

render such attempts worthless. Under this appraisal, concentrated market structures allowed

incumbent firms to raise entry barriers, because they would enjoy market power to do so. Under

these conditions, they could grow indefinitely until gaining "monopoly size," which would enable

them to restrict output, increase prices, or harm rivals. Thus, market concentration was viewed as

responsible for market competitiveness. In this perspective, market size is essential for

establishing the dominance or market power of a firm and, therefore, its capability of imposing

undue monopolistic conditions on other entrepreneurs or consumers.


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THE NEW LEARNING AND ITS POLICY IMPLICATIONS.

The theory of Contestable Markets eroded the significance attached to both the presence and the

strategies of incumbent firms as responsible of market outcomes. As long as barriers to entry are

low market performance will be "contested" due to the presence of potential entrants, thereby

preserving its competitiveness. Thus, cost-efficient market structure will evolve and firms willearn zero economic profits in the long run. Contestable markets, like competitive ones, exist in

the absence of entry or exit barriers. In contestable markets incumbent firms will be forced to

charge prices, which reflect their costs of production, due to the threat of competition from

outside, as long as entry conditions are insignificant. A distinctive sign of contestable markets,

therefore, is that they may be highly concentrated due to significant economies of scale or

economies of scope, and still be open to competitive pressure from potential competitors.

It increasingly became obvious that business competition had little to do with the presence or on

the contrived attempts of incumbent businesses to foreclose market entry to new firms. This

evolution in the conventional ideas about competition would also have important repercussions

on the normative appraisal of business behavior. The conventional belief regarded -logically- anyco-ordination or co-operation between firms as a prima facie evidence of their monopolistic

intent; indeed, this appeared particularly obvious in the concentrated Latin American industrial

markets. Later we shall substantiate the view that the intuition about the real sources of

competition restrictions -rather to be found in the lack of solid institutions and rent seeking

behavior; not in market concentration itself- has helped competition authorities to tame their

normative spin of conventional antitrust thinking.

Later versions of the paradigm on the role of firms' strategies to emphasize "dynamic" factors

behind, market performance. The "dynamism" of these models allegedly conveys a more realistic

picture of market functioning as they endeavor to place upon entrepreneurial business strategies,

rather than on market structure, the ultimate fate of market performance.

These "dynamic" hypotheses attempt to incorporate the numerous cases showing an apparent lack

of connection between concentration in an industry and the profit level of the most significant

firms. For example, Caves and Porter (1977) analyze the strategic behavior of incumbent firms in

the market. According to their view, the "deterrent" to new firms is not simply the result of entry

barriers that allow incumbent firms to use pricing limit strategies. Firms displayed a complex

array of dissuasive techniques to impede newcomers from entering the market, creating new

entry barriers. The new theory admitted that the conduct of incumbent firms could alter market

structure. Under this theory the role of strategic groups in the market structure is decisive. More

recently, this theory has been developed through game theory findings.3

On the basis of the "new learning" thus comprising a dynamic vision of markets, antitrust theory

abandoned much of its former structural bias, thereby adopting a better understanding of the

unlikely effects of market power, and also, it provided a new set of reasons justifying the

presence of business restrictions. The focus on contestability led the attention scholars and policy

3Foss provides a summary of the literature about the applications of game theory to explain business

strategies. See N. Foss Austrian Economics and Game Theory: A preliminary Methodological

Stocktaking," DRUID Working Paper, 98-28, (Nov. 1998) http:

www.business-auc.dk/druid/wp/pdf-files/98-28.pdf


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makers away from market structure and focused, instead, into the dynamics of markets, which

was essentially determined by the presence of both incumbent and potential entrants.

Thus, it is generally assumed that the new learning of industrial organization opened the door to a

more understandable policy making in this field. Accordingly, antitrust theory adopted a more

extensive rule of reason which "justified" restrictive conducts formerly viewed in negative terms,

and therefore, subject to per se prohibitions. (Arthur, 2000)

THE EPISTEMIC FLAWS OF CONVENTIONAL (OLD AND NEW) INDUSTRIAL

ORGANIZATION THEORY.

The assumption of full knowledge characterizes the models of both the old and new learning of

industrial organization. The implications of this are essentially, the perception that ideal markets

could somehow be identified, presumably at a point where market conditions approximate or

replicate the conditions present in the Perfect Competition Model. Therefore, regardless of the

particular version of SCP model used to approach market conditions, the normative results are

always the same: more government intervention.

Even the theory of contestability, which is taken to epitomize the most recent theoretical

guidepost for antitrust enforcement, falls into the same pit. Baumol criticizes conventional

industrial organization theories which linked market performance and competition to the number

of firms in the market and market share. Yet, his contestability theory assumes that competition

will exist as long as there are competitors that potentially can enter the market. This logic merely

extends the dimension of the market size, present in the older thinking, to encompass a wider

array of potential entrant firms, so to replicate perfect contestability to perfect competition.

Contestability leads the analysis into a similar way of viewing market functioning, by comparison

with an optimal ideal (i.e. perfect contestability) that cannot be attained anyway. Not

surprisingly, the normative conclusions about the conduct of incumbent firms are similar to thosereached under the old learning, even if the focus of attention is no longer the number of

incumbent firms in the market, or the size of the investigated firm, but the existence or relevance

of entry barriers.

In this regard, it is particularly illuminating the opinion that Baumol himself had on the

normative effects of his theory. (Baumol, 1991). Therefore, it can be fairly said that the notion of

contestability simply restates the old view, by arguing the presence of potential competitors as

sufficient condition for stimulating competition, but neglects the qualities and capabilities of

those either outside or inside the market to promote innovations. There is no qualitative change

for normative purposes between the notions of perfect contestability and perfect competition.4

4Notwithstanding this express acknowledgement, Baumol falls into the same epistemic trap of other

neoclassical thinkers, namely, to assume by implication that the comparison of reality with such models,

conveys a better capacity of predicting a future market outcome, and therefore, that they represent a better

tool of normative analysis. In this, Baumol sees no difference in the normative use cyiven to his model of

Perfect Contestability to examine markets, compared to the Perfect Competition model. He simply

underlines the superiority of the former in terms of its better predictive capacity as he assumes, like his

predecessors in the field of industrial organization, that the particular list of assumptions depicted by his

theory are more "realistic", compared to the extreme conditions of the perfect competition. (i.e. the presence

of large firms in markets featured by low entry barriers.) If anything, the contestability theory may have


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Furthermore, from the viewpoint of policymaking, the theory adds nothing to ease the knowledge

limitations of the regulator to i prove social welfare, because the model eliminates, by definition,

the analysis of entrepreneurship, thereby replacing it with the analysis of markets by reference to

optimal equilibrium. To put it differently, it subjects the analysis to a contrived vision of market

interaction, by reference to an optimum standard, namely, perfect contestability.5

Theories should be judged in their capacity to provide knowledge to those who intend to act uponthem to organize the market according to social welfare goals (i.e., regulators), so they can aptly

regulate. Yet, Baumols theory does not overcome the assumption of perfect information that

underlies previous industrial organization model. Baumol, like his predecessors, assumes that

competition depends on the force exercised by the presence of other economic actors, even

though, unlike his predecessors, these actors may only be potentially present in the market. In the

end it is the same idea that competition is an external force imposed upon economic agents, by

the number of competitors present in the market, actual or potential. This view does not provide

any insight to the regulator about the essence of competition as a phenomenon, because it distorts

its essence, by regarding it as an external force which is alien to the endeavors, resourcefulness

and capability of the entrepreneur, who constantly strives for discovering new ways of doing

business and satisfying customers. There is nothing in this view suggesting that whatever theentrepreneur does to outdo his competitors would impact them accordingly; indeed, his fate is

entirely dependent on exogenous factors, such as market structure.

Where does the epistemic flaw lie? As Machlup observed, "competition in the sense of easy entry

into the industry, and competition in the sense of many sellers in the industry [is] frequently

confused one with the other, or even confounded as one and the same thing (.... ) The confusion

is understandable: where there are many sellers already, why should there not easily be more

sellers when profits lure? In actual practice easy entry into a trade and large numbers in the trade

go well together." However, "even if a large number of sellers and an augmentable number of

sellers seem to be closely correlated, logically the two things are completely divorced from each

other. And, it will be seen, [they are concepts] of very different nature; indeed, they belong todifferent spheres of thought." (Machlup, 1942)

6Due to this misunderstanding, the conventional

learning does not pay attention to the condition or capabilities that either entrants or incumbents

must possess to create new products. Indeed, it depicts them as being defenseless against the

presence of other firms in the market. Simply, it relates competition to a formula that depends on

the number of participants, or on the existence of entry barriers, but tells nothing about the

disposition that market participants themselves may have (or may not have) to compete.

Evidently, in this understanding, both the old industrial organization theory and the new learning

share the same epistemological flaws. Under conventional -neoclassical- industrial organization

theories, "Interactions between firms have typically been seen by economists as evidence of the

search of market power, or, more recently, sometimes as efficiency-enhancing devices for

limited the number of instances where, for practical policy purposes, market power is regarded to exist, but

by no means this should be considered as a rejection of the logic implicit in the idea of market power itself.

5In fact, Baumol expressly acknowledges that his contestability theory, like the perfect competition one,

"precludes all genuine business voluntarism." (Id. p. 3)6

Also, Stigler explains evolution in the sense attributed to market phenomena like monopoly and

competition: "Until 1850 in Enalland the word monopoly was usually restricted to describinLo-, the

exclusive rights to trade which were conferred by Parliament. [Then] toward the end of the century the word

changed its meaning." (Stigler, 1988: 91-92)


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constraining, opportunism." (Loasby, 2000:151) This is the conventional understanding of

antitrust theories that prevails today in antitrust policy enforcement. As a result, they inevitably

lead to enhance government discretion to intervene as it sees fit, to enhance social welfare,

using a formula which is impossible to verify, as it is unfit to be subjected to accountability by a

regulator (third party) because it does not question what level of knowledge does the regulator

effectively has. It simply takes it for granted. Consequently, this formula is bound to lead to

unchecked government intervention.

STANDARDS FOR DEVELOPING PRO MARKET GOVERNMENT POLICIES.

In order to develop "market friendly" policy initiatives, government intervention should meet

certain standards of enforcement. (Arthur, 2000) These standard of legality should:

(1) Provide clear direction to facilitate voluntary compliance -and effective enforcement.

(2) Prevent the arbitrary and retroactive imposition of liability;

(3) Enforce the legal rule consistently with reference to previous similar cases;

(4) It should be predictable

(5) Must not be overly broad, in order to avoid excessive regulation.

(6) It must not be beyond the institutional competence of the decision maker; in other words,it must not place excessive knowledge constraints upon the enforcing authority;

otherwise, it will not be possible to determine, in a given case, whether the effects of the

measure are "better" or "worse."

The identification of these standards is necessary to determine what is "good" policy making, and

what it is unwarranted government discretion. If the reference to measure socially efficient

outcomes is the capacity of institutions to deliver a more transparent setting of rules then, clearly,

unaccountable government intervention leads to socially diminishing results.

Clearly, these standards are impossible to be fulfilled by any government intervention based on

the conventional -old and new- learning of industrial organization. This is the gist of the critiqueput forward by Austrian scholars since Hayek's paper "The Meaning of Competition" (1946). The

problem of the sort of intervention advocated by the conventional industrial organization learning

is that it entails a standard the implementation of which policy makers cannot undertake, since it

places on them an excessive knowledge demand. Essentially, the use of theoretical models that

assume the perfect information of market participants elicits the essential problem of how such

information is gained in the first place. Clearly, this oversight creates a gap between the model

used to examine reality, and reality itself. This is not a problem, in the opinion of neoclassical

scholars, since the role of the model is not to describe a real world, whatever that is, but to

predict results (Friedman, 1953). In response to this assertion, one could agree on this, even if

this exercise entails a rather awkward game of predicting ideal outcomes of relationships that can

never materialize in practice. The essential question, however, is to what extent this approach is

meaningful for policy-making purposes. The conclusion emphasized by Austrian scholars is that,

from a normative viewpoint, the use of these models as a referential source in order to calibrate

reality is entirely unacceptable. Clearly, no practical recommendations can arise to mold such

real world, on the basis of an understanding grounded on a different dimension level.

Thus, more than fifty years ago Hayek warned against this way of thinking (Hayek, 1946). Later,

Demsetz explained how this thinking always led to assume that the neighbor's garden was always

greener (Demsetz, 1969), and that this would entail the fallacy of comparing real markets with


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the Nirvana, thereby always appearing as imperfects. From the viewpoint of the policy making

design, the problem lies in the informational demands that such an approach places on the

regulator.

The practical problem that has to be solved is, therefore, to find a theory that enables policy

makers to design socially welfare-enhancing policies.

THE AUSTRIAN VIEW OF COMPETITION AND MONOPOLY.

Undoubtedly, Professor Kirzner has done the most accomplished work in developing an Austrian

perspective to competition ("Competition and Entrepreneurship"), and has given most extensive

thinking on the normative implications of this view for policy-making purposes. While this paper

will not deal extensively with Kirzner's view of competition, it will comment on the policy

making implications of Kirzners theory, particularly their usefulness in the field of competition

policies (in terms of giving knowledge to regulators).

Using a Misesian framework of analysis, Professor Kirzner regards competition as an exercise of

entrepreneurship, where alert entrepreneurs endeavor themselves to seize profits that other

entrepreneurs have failed to seize. This notion emphasizes on the process of rivalry that emergesin the marketplace in the absence of restraints on freedom of entry. Competition will flourish

whenever firms are free to display their alertness and seize profit opportunities, thus eliminating

gaps of information in the economic system.

Professor Kirzner's restatement of the Misesian emphasis on the normative limitations of the

conventional perfect competition model is particularly relevant in this discussion. He criticizes

the use of the conventional industrial organization notion of competition and monopoly, which

spin around the notion of elasticity of demand as the essential factor determining the existence of

either market structure.

In the vision of Austrians, the conventional belief cannot explain satisfactorily why, if the theoryassumes that a monopoly structure yields pure profit to the incumbent firm in the market, other

firms will not attempt to challenge this status quo, to grasp some of this profit. Demsetz (1968)

had already adumbrated this insight in his analysis of public utilities.7

In this analysis, Demsetz

criticized the logic of regulating utilities on the basis of considering them natural monopolies,

capable of imposing monopolistic price on consumers. This opinion, Demsetz contended,

ignored the auction that firms undertake in order to be chosen to operate in the market. There is

no reason why, we should assume that such firms would not compete at the bidding process, and

therefore, lower their prices. Thus, this analysis destroyed much of the conventional belief

according to which firms should be regulated in these sectors.

In Professor Kirzner's opinion, the assumption that no matter the absence of obstacles, entrant

firms will not challenge incumbent firms in the market, is the by-product of the equilibrium

vision. This vision regards pure monopoly in terms of contrast with perfect competition, as a

situation where the entrepreneurial drive has been excluded from the picture.8 Under this way of

7I am grateful to Professor Kirzner for pointing me Demsetz's insight, and the implications on the notion of

entry.8

Professor Kirzner clearly emphasizes why comparing real markets to ideal models, to deduce normative

policy implications is a by-product of the equilibrium thinking. He correctly states that it is a fallacy to

assume that the ideal polar extremes of perfect competition and pure monopoly somehow can define


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thinking, the only possible way of assuming the endurance of such unstable situation is by

eliminating the conditions that would make such challenge foreseeable, namely, the

entrepreneurial spirit. No wonder, then, that the convention learning must appeal to the existence

of constructs such as entry barriers, (Bain, 1956) to justify such exclusion, which would

otherwise be impossible. As a result, the picture of the conventional learning is one where

competition does not depend on what competitors do in the market (as they are assumed to do

nothing, since they already possess all the information they need), but on the existence of

artificial analytical constructs, which are necessary to round up the normative conclusions thatthe analysis has already postulated.

9In practice, the conventional learning applied in policy

making activities, will develop whatever postulates are necessary to reach the conclusion that

whenever firms are located in a pure monopoly position, (resulting from the ad-hoc construct)

certain social welfare consequences will follow. In doing so, it will be forced to build a pseudo

theory to fit normative convictions already reached, not the other way around.

To eliminate these flaws, Kirzner proposes to change the heuristic paradigm within which the

policy framework is conceived, thereby replacing the current one, which locates real markets

between two polar extremes of perfect competition and pure monopoly, respectively. This

framework is misleading because it conveys the assumption of full knowledge in all intermediate

points between the polar extremes (in fact, it even assumes perfect information -of the analyst- atthe point of pure monopoly).

Indeed, the conceptualization of markets as evolutionary processes impedes the visualization of

optima in the way equilibrium frameworks does. Thus, all markets are "competitive", no matter

how entrenched privileges and monopolies are, since entrepreneurs will, even under such

hardships, find some space to display their alertness. The only -but then again, exceptional- case

where this is not so occurs when governments absolutely prohibit such display.

From Professor Kirzner's perspective, several implications emerge:

o Entrepreneurs push the economic system towards equilibrium, even though the latter isnever attained. Nevertheless, it leads to assume, in normative terms, that narrowing

knowledge gaps is "desirable", since it will lead to a position closer to equilibrium.

intermediate models of competition as is understood in the real world. Indeed, those intermediate models,

are featured by the idealistic conditions which cannot be found in reality, namely, the existence of full

knowledge on the side of the analyst about the conditions that are necessary to drive the imperfect

intermediate market examined to the one depicted by the Perfect Competition model.9

In fact, antitrust policy makers overlook that in their own view, competition does not even depend on what

other firms do in the market; -as they normally assume to derive normative recommendations, since the

analysis has drawn all their entrepreneurship and resourcefulness out of the picture. Antitrust enforcing

authorities do not often see the subtleties involved in this.

o The essential condition, from the viewpoint of policy making aimed at promoting

competition, is the absence of restraints on entry. Such restraints should not be confused

with entry barriers in the neoclassical sense of the expression. Freedom to entry entails

the absence of legal obstacles.

o No matter what the institutional contours of the market, and no matter the economic

power possessed by market participants, the market process is necessarily competitive,

because in all of the entrepreneurs will be able to exercise their discovery capacity. Put it


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differently, all markets are competitive, save for those in which government intervention

is so overwhelming that it makes impossible to exercise any entrepreneurship.

o By implication, the only possible source of monopoly is the exclusive ownership of a

scarce essential resource in the market, which is a very exceptional case anyway.

o Policy makers should preserve freedom of entry to all market participants. However,

whenever is possible, they should avoid intervening on markets, since they do not reallyknow what goes on in them, and the only case where real concerns may arise -i.e.

monopoly of an essential resource- is so exceptional that it is not worth the effort of being

seriously considered.

FREEDOM OF ENTRY AS A NORMATIVE GOAL OF COMPETITION POLICY

MAKING: A PARADOX?

In order to examine the policy implications of Professor Kirzner's view of competition, it is

necessary to remind the reader about the optimal policy making standard, which we outlined

above. Optimal policymaking requires the definition of policy measures that place reasonable

knowledge burdens on regulators; otherwise, the measures applied will not satisfy the conditionsof the rule of law, to wit, predictability and consistency with precedent.

The Kirznerian theory of competition provides an important baseline of differentiation with

previous neoclassical thinking on industrial organization, and thus, it cuts through economic

theory by distinguishing the evident contradictions of the neoclassical analysis. Nevertheless, it

does not provide the policy maker with the adequate analytical tools to derive any possible policy

aimed at promoting pro-market institutional settings, because it does not give them any

meaningful criteria to follow for intervening on markets in order to improve their functioning.

It appears that, led by the need of explaining the conduct of individual entrepreneurs in

competitive markets (i.e. their discoveries of new information gaps), Professor Kirzner is forcedto conclude that such possibility is denied only when governments create absolute barriers. The

problem with this argument is that it does not distinguish all the possible instances where the

creativity of entrepreneurs is not totally impeded, but simply distorted. Or more importantly, it

does not indicate the policy maker what should he do in order to improve the level of poor

awareness of the entrepreneur in markets where some degree of awareness is tolerated by the

government. Thus, Professor Kirzner replicates the logic that he criticizes on conventional policy

thinking, namely, to assume that policy makers could have the full amount of knowledge the

require to decide which markets are entirely obstructed by governments and which are not.

This logic leads to conclude that there are two possible extremes in government intervention:

either when intervention impedes entirely entrepreneurial creativity to discover new things, or

when individuals are not disturbed to exercise their capacity (i.e. all other instances). There is no

possible way for the regulator to identify the two instances, so to propose regulatory amendments

and policy alternatives. Worse, we may be forced to conclude either that government

improvements on the social setting are undesirable altogether, or, at the other ideological

extreme, that individuals should tolerate intrusive governments, as long as their capacity to

discover new things is not entirely destroyed, but simply upset. The theory leaves the policy

maker with an informational gap, which he cannot overcome in order to perform policy-making

activities in a predictable way.


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Concluding that all markets are competitive, but that no competition will emerge whenever

governments foreclose it entails a circular reasoning. Following this logic, we would be forced to

conclude that governments might be in the position of promoting competition only -in the very

exceptional case of ubiquitous government intervention. In any other case of more or less

pervasive government intervention, it would be impossible to promote competition, simply

because would be impossible to identify what property arrangements are necessary to modify, or

what institutional constraints are necessary to eliminate, in order to promote more

entrepreneurship. From this viewpoint, the Kirznerian proposal to maintain competition in themarket by keeping freedom of entry posits an initial practical problem for the definition of the

measures needed by the regulator to implement in order to improve the institutional setting in a

pro-market way. Policy measures must identify the subjects to which the policy must apply, in

order to guide their course of action. But the individuals who would be favored by freedom of

entry are indeterminate at the time the policy is applied. Clearly, this reasoning does not help

policy makers to identify a set of policy measures aimed at improving competition in markets

where some degree of government intervention exists, that is, most of them.

Once more, theories should be judged in terms of their capacity to provide knowledge on

regulators to develop policy making. It is important to bear in mind that no such informational

constraints can be entirely eliminated, because policy makers are, fallible human beings, after all.They should not be construed according to the premises of the homo economicus, which are

criticized on economic analysis.

Bearing in mind these caveats, we shall examine the notion of "network competition" in the next

section, to determine its capacity to deliver information to policy makers, in order to identify

socially enhancing welfare policies.

TOWARDS A THEORY OF "NETWORK COMPETITION"

Noticeably, Hayek's 1946 article on "The "Meaning of Competition" explained how comparing

ideal markets should be regarded as a discovery process, where new information unfolded. Thisidea was developed by Professor Kirzner along Misesian lines, in his famous work "Competition

and Entrepreneurship" (1973).

However, Hayek did not only focus on the position of single entrepreneurs who discovered new

information through the exercise of alertness and acumen. Hayek's attention was placed at the

context where the entrepreneur interacts, which the view of equilibrium and the perfect

competition model had distorted, by assuming the perfect information of the analyst. In other

words, Hayek was concerned with the informational properties of the system where the

entrepreneur must interact, where competition facilitates the process of increasing his awareness

about new products and the likelihood of satisfying unseen consumer needs. For similar reasons,

he was concerned that, under the conventional analysis, the information needed by the regulator

to assist the market was simply assumed.

For this reason, any approach towards competition cannot be dissociated with the institutional

analysis of the context where the entrepreneur interacts and unfolds further information. This

institutional analysis is, of course, directly related to the notion of property rights. This is

necessary to create an institutional setting of coordinated entrepreneurial actions. The individual

disposition of each entrepreneur to discover new things and opportunities is related to the

perceptions he gets from the institutional environment where he interacts, or to put it differently,


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to the feedback he gets from everybody else in the system where he undertakes economic

activities.

An Austrian view of competition has to emphasize the perception of firms about the

opportunities presented to them as a result of experimentation. Some business environments are

more conducive than others for experimentation.

However, these opportunities are not only gaps of information. They also entail opportunitiesfor cooperation. Competition, then, does not simply entail the elimination of a rival, but also the

possibility of potential cooperation with him for developing new products and knowledge.

Sometimes this collaboration results from the perception that aggregate investments may be

wasted if there is no collaboration. (Richardson, 1960)

Here lies the usefulness of the metaphor of networks into the theory of competition. The idea

of networks emphasizes the connections that entrepreneurs develop, more than the individualistic

process of discovery, at each one, even in isolation, is assumed to develop. The stress of network

competition theory is on the ongoing process simultaneously linking cooperation and rivalry that

defines the relationship between entrepreneurs.

Entrepreneurs develop organizations, but how do these entities compete in the market place?

What determines the existence of competition in the market setting between firms, networks, and

standards, and what factors inhibit it? It is essential for governments to know certain guidelines

or rules of thumb from which they can develop practical policy enforcement.

Clearly, in an ongoing process of interaction the capabilities achieved through firms and

standards evolve as a result of the feedback received from exchanging ideas. In turn, this process

alters the business landscape. For example, firms initially possess undifferentiated capabilities,

but competition eventually leads them to differentiate product lines, and to attempt new

standards. Menger explains how firms initially undertaking activities in a given sector expand

into other sectors by concentrating on what they are better able to perform. (Menger, [1885]1981) Therefore, firms' capabilities determine the different directions in which companies grow,

depending on whether they (i.e. their capabilities) alter and expand into new areas, which become

standards if they are successful.

However, it is not always possible to draw a clear distinction on the bundle of capabilities.

Sometimes, the activities of firms trading in apparently different activities may be more similar

than they appear. However, random factors also have an influence in the decision of linking

complementary assets. In these cases, a firm's motivation for taking up an activity is not

determined by the prior possession and development of an appropriate capability, but by cheap

acquisition. At first sight, a firm may seem to be acquiring another one engaged in different

activities, but the activity could be interpreted as similar if the firm is bought to restore efficient

management before reselling. Management would be the particular capability in this case.

New products and services frequently emerge from the combination of different capabilities and

skills achieved under various business arrangements. Hence, the compatibility between the

activities developed by firms tells us how much co-operation we should expect from them.

The success of some entrepreneurs in combining their complementary capabilities and creating

new products prompts the emergence of imitators and, thus, of networks based on their


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standards, but at the same time, network standardization facilitates the discovery of new

compatible products. In turn, the success of this second generation of products depends on them

being connected to the network (i.e. on being perceived by consumers as compatible), because

this increases their own chances of succeeding in the market. Should they succeed, new imitators

will follow and the network develops one step further. In sum, innovation plants the seeds of

potentially new networks as much as it provides the means for connecting existing ones, by

developing complementary capabilities.

The growth of networks and organizations standardizes production, thereby reducing the costs of

processing, distributing, and acquiring information by subjecting these activities to low-cost

mechanistic routines and automated. In his time, Henri Ford reduced the costs of manufacturing

cars significantly simply by subjecting the production process to a pre-set automated series of

productive routines. Today, the standardization of the Internet around protocols facilitates the

discovery of new products thus increasing overall value.

The interpretation of network competition theory on these phenomena bear profound

implications for understanding the nature of the obstructions of competition in the marketplace.

Contrary to the neo-classical assumption according to which product value decreases with

quantity, the growth of networks and organizations connecting such production actually increasesits value. The implications of this are crucial for those attempting to compete, as will be

explained in the following section.

What happens once a network is developed? Entrepreneurs compete, but once a network is

developed, they will strive for sustain the network adopted, to maintain and enhance the

increasing returns already gained by developing more complementary products, which enhance

the value of the network. For this reason, entrepreneurs might find suitable to preserve an

"inferior" technology, which nevertheless, is less expensive for them to exploit compared to the

costs of developing a new network. Thus, individuals compete, but networks predominate in the

market.

In the opposite case price competition will often be the prime element of differentiation between

entrepreneurs possessing similar capabilities. In such case, it is likely, that they will compete for

a bigger share of the undifferentiated "aggregate" demand through price reductions. Assuming

that producers choose to make the same commodity with similar production processes,

competition between them is possible only as long as costs are reduced. Such reductions will

consist of minor improvements to the production process. However, if producers devise new

"production functions," combining resources in different ways to make the same or different

commodities, the field for active competitive warfare is greatly enlarged and there is wider scope

for innovation.

The process of competition and exploiting comparative advantages may develop particular lines

of products that could turn formerly similar activities into complementary ones, hence

encouraging co-operation between former rivals. This process explains why former foes may find

it desirable to co-operate in developing new products by mutually exploiting their respective

complementary capabilities, or why they may co-operate in one product line and yet compete

fiercely in another. It also explains why, during their initial stages, markets tend to consist of few

firms, each holding a strong position. As time passes, more entrepreneurs become capable of

seizing profit opportunities by imitating successful entrepreneurs. Consequently, markets become

less and less concentrated as technologies spread out among producers. As technologies are


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spread out among producers, production will tend to standardize around certain proven

successful solutions."

WHAT INSTITUTIONAL FACTORS CONDITION "NETWORK COMPETITION?

Competition depends on the competitive creativity of anyone willing to challenge established

conventions and standards to do so effectively, and develop new capabilities, either in isolation

or jointly with other entrepreneurs, for the development of new products and services capable of"connecting" with other products. Under such conditions, any firm, regardless of size, or any

entrepreneur, regardless of their ownership of productive factors, will be able to "plug" into the

market by connecting their complementary products to the standard network, if incumbent firms

decide to raise the prices of their own products beyond expected levels. The existence of

innovative new entrepreneurs capable of introducing their products will discipline anyone who

attempts to restrict investments in order to maintain a permanently excessive rate of profit.

Consequently, the presence of potential newcomers will stimulate the system to regain the

coordination lost by the price increase, by adapting to the plans of disappointed consumers. From

the viewpoint of the single entrepreneur, he is simply exploiting a discovered gap of information.

From the social welfare viewpoint, his competitive creativity wilt be a sure deterrent to any

incumbent firm attempting to lower the quality or increase the prices of products or services insuch a that reduces the level of overall co-ordination previously achieved in the market.

Competitive creativity is an attribute that will exist as long as government restrictions are absent,

which is certainly the case of very few markets. Thus, in practical terms, markets will be built on

the expectations of market participants, thereby creating routines and rules, some of which

possess government backup, and therefore, also subject to revision by competition authorities.

Institutional privileges impede competitive creativity because they discriminate between

entrepreneurs in a way that raises permanent barriers to the inventiveness of resourceful

entrepreneurs. These privileges may arise mainly from government fiat, but also from private

arrangements bearing similar effects. Laws, regulations, decrees, and other legal instrumentsbelong to the first group, whereas arrangements adopted by trade or business associations belong

to the second. The cartelisation undertaken by all members of an industry is a good example of

this, (not to be confused with the conventional antitrust condemnation of cartels, which may

encompass situations entailing co-operation among competitors. The effect of these private

arrangements is to rule the activities of an industry, just like a legal rule would, namely to

foreclose the resourcefulness of entrepreneurs willing to develop alternative complementary

products and standards.

These privileges prevent entrepreneurs from exercising their capabilities, and impair innovation,

because they prevent them from experimenting with new products and ideas, whose success

would otherwise encourage other entrepreneurs to follow suit, thus creating new patterns,

standards and networks. By contrast, privileges such as those referred to above curtail

entrepreneurial capacity to innovate, to seize valuable opportunities, and to improve the

coordination of the social system.

Given the dynamics of this evolving world, the existence of competition depends largely on the

possibility that the standardization of products does not preclude the possibility for entrepreneurs

to innovate on them, developing new capabilities and complementary products adding value the

original ones.


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The existence of increasing returns in the development of networks and organizations determines

that competition is for developing a successful product that becomes the reference standard in the

market. Entrepreneurs seek to dominate standards because in t1iis way their profits will rocket:

more people will connect their own products to the standard. Once successful products become

standards for a whole industry, the costs of connecting compatible products to them decreases,

because the marginal costs of creating new complementary information (i.e. new products) will

be minimal, and likely to diminish the more it is exploited. The users of VHS systems, CDs,MSDOS are all members of successful networks. The success of each of these networks

enhances that of complementary products: the prices of MS-DOS compatible hardware and

software are reduced and their sales blossom as more computers bearing MS-DOS systems are

produced and sold. Consumers will tend to purchase the products of firms with established

goodwill not only due to the higher risks involved in trying products from unknown

entrepreneurs, but also, due to the higher likelihood ceteris paribus, that older networks will

develop more complementary products and applications. In other words, a product that becomes

the standard in the market "leads" productive activities into products that are compatible with the

former. The initial cost of creating information is generally a sunk cost and the marginal cost of

producing additional copies of such products is usually small. Increasing volume will reduce the

average cost of information-based products. In fact, information-based products can be usedindefinitely at no additional cost. This evidence runs against conventional economic theory,

where it is assumed that marginal costs increase with quantity.

Networks and business organization grow if the standards and specification running its

functioning are sufficiently open to invite a critical mass of individuals to adhere to it.

Compatibility of production will ensue, encouraging customers and suppliers to provide products

whose presence complements the value of the net. Added to the minimal marginal cost of

reproducing information, standardization and compatibility will enhance the total value of the

network. A network's growth increases its value until all potential members have joined, in or the

network is displaced by another network.

Adam Smith clearly envisioned the working of evolutionary dynamics in the context of market

growth by arguing that the size of the market determines the division of labor (i.e. the

development of capabilities). (Smith, pp. 15-19) How would this natural condition affect the

position of third parties interested in developing their products? Again, under an institutional

framework preserving competitive creativity nothing should impede a candidate from penetrating

the market, as long as it develops its own capabilities complementary to those exploited inside by

other firms. Forcing the way of an unskilled firm into the market may lessen the optimal level of

co-ordination already achieved by incumbent firms, by lowering their standards of production.

Only firms whose entrance adds value to the network will be welcomed, and, indeed, only these

firms should be allowed admission.

In the "network" portrayal of competition just described the factors that inhibit competitive

creativity should not be confused with the conventional neo-classical notion ofmarket entry. In

the new perception, markets have no static boundaries but evolving capabilities, whose

development is essential for ensuring their holders that they will be able to link with somebody

else in the system, either a consumer or another - complementary - product or service. Therefore,

entrepreneurs do not "enter" to the market per se, but rather "innovate" their capabilities either in

isolation or jointly with other entrepreneurs in ways that enable them to link in the system.

Indeed, the capacity of developing one's own network is an entirely different matter different


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from "accessing markets". Competition policy should ensure that entrepreneurs are not prevented

from developing (i.e. discovering and implementing) new mental frameworks that can enable

them a better chance of identifying new possibilities for connecting their inventions with the

social network.

The organizational externalities produce impediments on third parties that are not dependent on

their lack of resources (i.e. capital, physical facilities, property of raw materials), but on the

capacity of generating capabilities and connecting these to the network. Shrewd entrepreneurswill likely displace rich ones from the market if the latter possess few new ideas about improving

their goods or services. No wonder that skilled individuals are the principal source of the New

Economy, because they are generally better positioned to develop capabilities, and to identify

new business opportunities of connecting these to the network.

Similarly, it is apparent that in the view of competition as a process, the conventional explanation

of market power and its alleged feasibility of imposing a monopolistic price on consumers or of

engaging in exclusionary conduct against competitors becomes dubious and unconvincing to

explain the causes that thwart competition.

In such a process, the position that a firm holds at any given point in time does not prevent otherfirms from operating freely. In other words, it does not give them any market dominance or

market power. The suspected monopolist may have the intention of gouging out additional profit

due to his pre-eminent position in the market, but that intention is only produced by his

expectation that the profit opportunity is there for him to reap. He may well be wrong. Indeed,

the fact that information about these opportunities is subjective and the position of our

entrepreneur is pervaded by sheer ignorance affects him too. As Professor Kirzner states, "no one

knows, and no one can possibly know, in advance, what 'the' market price 'ought to be'. ... once it

is recognized that no one does or can know the 'correct' price, it becomes apparent that a price

discriminator is simply 'feeling' his way, by grasping (or rather, by attempting to grasp) profit

opportunities he believes available to him." (Kirzner, 1998:18)

It soon becomes apparent that market power is non-existent in a changing environment as long as

competitive creativity remains unblocked. In this case, the relevant problem is not how many

firms interact within the market, thus enabling them command of productive resources. Indeed,

competitive creativity has little to do with the prior ownership of resources. Inequality in resource

ownership and in the power that such ownership provides is irrelevant to the ongoing process of

discovering future profit opportunities. It is superior entrepreneurial perceptiveness and

prescience alone which is necessary and sufficient for the grasping of pure profit opportunities.

(Kirzner, 1998: 10-11) Even those firms commanding large volumes of resources must depend

on their entrepreneurial foresight to find ways of deploying those resources in new ways.

Otherwise these resources will simply continue to be used conventionally, until shrewder and

more innovative entrepreneurs bid them away from larger but less entrepreneurial firms. The

relevant problem is not one of property, but whether those within the market will be threatened

by the entry of others, and whether those outside will be allowed to erode the position of

incumbents.

Size and pre-eminence in the market are not important factors when we consider the availability

of capital markets to alert entrepreneurs. Of course, the possession and ownership of productive

resources gives economic power. But this power does not become an essential factor in

forestalling the freedom of other entrepreneurs ifcompetitive creativity is ensured, because such


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entry is related to the inventiveness of entrepreneurs, rather than to their inherent capacity to

manipulate markets indefinitely. Therefore, the firms' incentives to compete in the market are not

determined by how much market power incumbent firms exercise either on those firms

attempting entry or on established firms.

Undoubtedly, "network competition" has little connection with, and even contradicts, perfect

competition - and its derivative notions of market power and market entry. How can markets ever

reach perfect competition if all entrepreneurs are aware and equally ready to seize the same profitopportunity? By definition, an opportunity open under the same conditions for all to seize, as

must happen to achieve perfect competition, is an opportunity denied to everyone.

ENHANCING MARKET CONNECTIONS AS A GOAL OF NETWORK

COMPETITION POLICY.

In order to develop guidelines for policy making, Austrian economic analysis has been too

concerned on determining whether policy measures drive the economic system into an

equilibrium of plans (Hayek, 1936). Like neoclassical equilibrium, this vision is deceptive for

policy purposes, even though it represents a step closer -compared to the neoclassical aggregation

of preferences- that links the conduct of real entrepreneurs in a social measurement of efficiency,in a way that attempts to introduce real time into the analysis. O'Driscoll and Rizzo (1985)

already noted the limitations of this attempt.

In any event, plan coordination is irrelevant for policy making purposes, because after all, the

measurement of efficiency is not dictated by any reference to an equilibrium point, but to the

capacity to coordinate an ongoing system that never stops (thus it never attains a point of

equilibrium), so to ensure the best possible chance to any individual in the system. Evidently

between two individuals "A" and "B" the change introduced by "A" may be equilibrating their

respective positions, but disequilibrating between them and say, "B" and "C". Similarly, the

disequilibrium created as a result of a failed transaction can be more equilibrating to say, the

seller and other potential buyers.

The system coordinates and discoordinates at the same time. Social equilibrium is neither

attainable nor we live in chaos. This is like asking whether the ex-post discovery made deprives

other entrepreneurs from a fair chance of making ex-ante discoveries of their own. Clearly, one

entrepreneur's discovery is the other's cause for upset.

From the viewpoint of the policy maker, it is impossible even to measure coordination in terms

of an equilibrated system, as this would entail for the analyst the contradiction of placing himself

simultaneously in the position of the participant and of a third party observer (to be able to grasp

the referential equilibrium "from above"), thereby solving a knowledge riddle which is

impossible for him to solve.

Theories guiding policy-making efforts should not be seen in a positivistic fashion, as ideal

devices which possess the capacity to explain how society leads to a given end. This way of

looking at theories neglects their limited capacity to predict future states. Instead, theories should

be regarded as "maps," which possess the same conceptual limitations of those who formulate

them, but nevertheless play an important role in guiding the perception of the analyst. (Louglin,

1992) The development of theories has to consider, therefore, some essential traits of perceived

phenomena, and derive from them certain logical implications.


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In our discussion, the development of a theory explaining how competition takes place requires

us to build up a connection between the entrepreneurial activity (which we know, from our

perceptions, how it takes place) and the development of networks (which is the social construct

which we attempt to explain through logical deduction). By concentrating on the systemic effects

of institutional systems on competition, this theory provides an alternative to the definition of

policies capable of analysis whether the system, does in fact, develop such predictable rules of

ownership. Of course, the theory acknowledges that the design of policy remedies on theinstitutional system unavoidably is preceded by the analysis of the individual entrepreneurial

level. However, this is only the beginning of the analysis, which eventually leads into the

systemic level of interaction between several entrepreneurs. The analyst must acknowledge some

special properties arising from the system, which are not found at the individual level, but that

nevertheless arise from individual interaction. It is here that the notion of network competition

possesses an advantage in terms of suggesting policy alternatives on the system.

Due to his research on the informational properties of institutions, G.B. Richardson (1960) was

able to identify two factors that shape the extension of productive activities. These two factors

are: the level of trust between entrepreneurs and production complexity.

Interestingly, Richardson used these two concepts to challenge the received view about trade

restrictive practices subject to antitrust prosecution. Our contention is that from these two

elements it is possible to develop some guidelines for policy intervention in the context of a

theory of networks.

The level of trust between the parties involved will have an impact upon the extent to which each

one will have confidence on the conduct of the other. Reputation -and contractual commitments

could impair the entry of new firms into the market. What duration should these elements be

before they create a contrived barrier to competitive creativity? In principle, lengthier restrictions

and stronger reputations make the entry of new entrants more difficult. Long-term contracts also

impose a limitation on the conduct of the negotiating parties that may impose constraints to theircapacity to negotiate with third parties.

On the other hand, production complexity may also influence the length of the contractual

commitments. The development of capabilities through innovation is essential for firms to

become integrated with networks. But capabilities are not easy to develop. Production

complexity also could represent a barrier impeding the competitive creativity of firms. What are

the constraints imposed on potential market entrants arising from the complexity of the tasks

imposed by product specialization of a given industry? Some networks require a minimum level

of standardization to function, yet all possible candidates willing to adhere the network may not

always fulfill this condition. Certain minimum level of skill, expertise, or capability may be

necessary to join the network and to exploit it to its fullest extent. In this context, the

standardization of rules imposed by networks works for those candidates with complementary

capabilities as much as it works for those of the firms operating the network. It demands from

both sides a minimum level of complementary co-ordination in the capabilities they exchange. It

may create a barrier to entry for new firms, and this is a question that has to be assessed by

competition authorities in judging whether barriers to entry are justified. If the commitment

involves the sale of a good bearing few complementary properties with other products (i.e. a

product that is not compatible with any other), there may not be competition problems, as the

sale will end the relationship between the contracting parties. However, if the sale involves the


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provision of post-sale services necessary for the functioning of the product sold, then customers

will be forced to tie themselves to a long-term relationship and, consequently, this may create a

barrier to potential entrants. Such barriers will be contrived if they last longer than what is

demanded by the nature of the relationship. If they do not, then competition authorities should

not challenge them.

Competition authorities should ensure that these natural barriers do not become "contrived",

thereby precluding outsiders from exercising their forecasts and inventiveness and develop newproducts and services that may become linked to existing networks. These are conditions found

in the willingness and ability of third parties to develop their capabilities; they are unrelated to

objective conditions of market power found within the incumbent firms.

The problem to be analyzed by policy makers is whether trust and production complexity impose

an undefeatable limitation on the capacity of third parties to compete. True, this is a difficult

balance for an outsider to measure. Competition authorities should not force the path for

potential entrants by challenging the duration of long term commitments, provided that their

duration is imposed by natural limitations of trust and production complexity indicated above.

Similarly, it may be very difficult for them to determine to what extent the complexity of

production forecloses the permanent entry of outsiders.

To identify the role of policy makers, it is necessary to see that network competition judges the

capacity of the economic system to achieve its full potential according to the capacity of firms to

innovate and develop products compatible with the standard network. The value of the net, - or

business organization, is increased the more information about entrepreneurial capabilities is

shared by participants, thereby generating increasing returns for each of them. Therefore,

contrary to the conventional wisdom, abundance, not scarcity, dictates economic decisions.

Therefore, competition authorities should visualize their role as one of providing the means for

generating and coordinating - thus increasing - knowledge, otherwise scattered,- not as one

focused on assigning scarce social resources. Network competition does not concentrate onchoosing alternative optimal "idealistic" social resource allocations that could be obtained by

government intervention, should the infringing firms have decided to avoid undertaking a market

restriction. Instead, it concentrates on achieving "realistic" economic results, based on the

improvement of the web communication. Therefore, they differ in the identification of normative

standards for measuring "good" or "bad" social performance. It does not take the conventional

assumption according to which markets fail. Rather, it assumes that markets can be improved by

changing the functioning rules followed by market actors in their transactions. Improving

coordination between economic agents therefore leads to superior social performance.

Procompetitive government intervention should improve the web communication of knowledge.

Any other intervention may be unacceptable, at least on economic "connectivity" efficiency

grounds.

Coordination means placing everyone at the same level. Thus, competition authorities should not

develop policies that endow with a special condition some firm vis--vis others. In other words,

government intervention should be non-discriminatory. But what is exactly this?

Hayek give us a definition: "Policy need not be guided by the striving for the achievement of

particular results, but may be directed towards securing an abstract overall order of such

character that it will secure for the members the best chance of achieving their different and


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largely unknown particular ends. The aim of policy in such a society would have to be to

increase equally the chances for any unknown member of society of pursuing with success his

equally unknown purposes, and to restrict the use of coercion ... to the enforcement of such rules

as will, if universally applied, tend in this sense to improve everyone's opportunities." (Our

emphasis) (Hayek, 1973, 114)

Following the concept of competitive creativity, the relevant question is whether both

entrepreneurs have an equal ex-ante chance for making discoveries; clearly they will not, as theywill be placed in different settings and have different endowments, but the law should give them

both a non-discriminatory treatment, meaning that both will be judged with impartiality, and

without regard of their particular condition in the market (i.e. small, medium or large enterprise)

and whether their condition affects future market outcomes.

The important caveat to bear in mind is whether the system develops predictable rules of

ownership, so to enhance the capacity of entrepreneurs to discover new knowledge, by providing

predictability on the reciprocal capacity of discovery and appropriation of discoveries made.

The creation of a transparent set of ownership rules may be interfered by governments. This

could result from undue government discretion driven from "social justice" considerationsdiverging from the discovery claim. Government discretion interferes with the chances of

entrepreneurs' plan making, because it gives him an artificial, contrived understanding of the

reality upon which he is to "create connections". Either by telling him that certain opportunities

are open for a certain period of time under certain conditions (i.e. subsidies) or that certain areas

of possible connections are foreclosed for a certain time, or under certain conditions (i.e. permits,

taxation, etc.), government intervention will make the environment less predictable, thus leading

the entrepreneur to fail in his planning endeavors.

These principles are changing the perception of competition policy as one aimed at improving the

co-ordination feasible in a given industry and not one dealing with attaining optimal social

resource allocation. This is hardly surprising, given the structural nature of the problems faced bymarkets in the region. It is difficult to think that competition agencies can overcome the

magnitude of the structural malfunctioning by appealing to antitrust remedies alone, without

influencing or challenging the rules of the game where economic agents develop their

relationships.

By applying these ideas in their practical policy enforcement, competition agencies in the region

are paying increasing attention to new areas of policy enforcement, which had been neglected in

favor of the conventional analysis of market power.

THE IMPLICATIONS OF NETWORK COMPETITION ON CONVENTIONAL

ANTITRUST PROHIBITIONS.

Our analysis emphasizes the elements of trust and production complexity identified by

Richardson, which shape the institutional landscape where competitive creativity is undertaken.

A closer attention is given to the merits of each conduct, as examined in the economic context

where takes place, rather than relying on the market power factor.

The new focus stresses on the need of enhancing the level of business co-ordination in complex

webs of shared knowledge and industries.Improving co-ordination in the system may eventually


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require that potential entrants in the system enjoy a fair chance of accessing the market, such as

a limitation of their capacity to innovate. Market access should not be impeded by discriminatory

measures. When dictated by governments, these are clearly identifiable; the problem arises with

the discrimination that emerges out of the spontaneous shape developed in a given market.

Consider the case of spontaneous arrangements arrived by competitors in a given industry to

standardize their products. The standardization of the web production may impose unexpected or

unnecessary costs to potential entrants, yet it may also be necessary to enhance scope economies,develop shared capabilities and deliver consumers the minimum quality they expect from the

products they purchase from the market. However, the compulsory imposition of such standards

either under joint trade association decisions, or by government fiat, may lessen the fair

opportunity of potential entrants to access the market. Where production is less complex and

goods are homogeneous -a condition that occurs in older industries-, it may be convenient to

prohibit any special imposition made upon an entrepreneur willing to depart from the standards

agreed, in order to let him innovate.

In vertical relationships, the problems of accessing networks may be more crucial if the network

is essential to the trade of downstream firms. Here the policy dilemma is more evident, because

the gains of allowing an unlimited number of entrants may discourage incumbent firms to makefurther investments in the improvement of the network (to preserve monopoly gains from

limiting access to everyone else) and therefore, hamper the standards of quality necessary to

preserver the very existence of the web. On the other hand, the disproportionate foreclosure of

the network may impair its future value, because it may limit the access of clients excessively

and thereby, of profits that could be otherwise reinvested in improving the network. Access to the

network is crucial to ensure that the network itself develops and gains more value. These

problems are evident in the case of infrastructure industries, such as telecommunications, water

supply, electricity and similar others. In these industries, the impediments placed on potential

entrants by incumbent firms at the point of entry not only undermine the rights of the former to a

fair chance of competing in the market, but also lessen the value of the infrastructure as a whole,

by limiting the number of potential competitors in it, and thus, of exchanging ideas andinnovations. It may be necessary to distinguish the length of time imposed on the new entrants.

Depending on the shape of the industry concerned, where production complexity demands the

combination of complex capabilities and stronger reciprocal commitments (trust) it may be

necessary to allow such restrictive undertakings to take place.

PRACTICAL GUIDELINES FOR PROMOTING NETWORK COMPETITION.

In sum, the social welfare goal of Austrian Competition Policy is to ensure, neither market access

(which would impose social justice considerations under the disguise of economics), nor

coordination of plans (which could upset the coordination of other plans), but the adequate

setting for developing networks through the development of creative capacity and display of

entrepreneurial capabilities.10 Governments could bank entrepreneurial ideas into a pool of

resources or to stir up existing ideas by encouraging the development of capabilities.

The ideas exposed above should lead to the formulation of practical policy recommendations. In

practical terms, this requires from competition authorities the following:

10This understanding of social welfare aligns closely with the Austrian view of social efficiency exposed by

Roy Cordato, that is, the capacity of individuals for achieving their own goals. (Cordato, 1992)


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o Emphasis on dynamic rather than static efficiency as the main objective of competition policy

in developing countries.

o Introduction of a concept of 'optimal degree of competition' (rather than that of maximum

competition) to promote long term growth of productivity;

o Introduction of a related concept of 'optimal combination of competition and cooperation'

between firms so that developing countries can achieve rapid long-term economic growth.

o The critical need of maintaining the private sector's propensity to invest at high levelsrequires a steady growth of profits; for this to occur there is a need for government

coordination of investment decisions which in turn requires close co-operation between

government and business;

o Introduction of the concept of 'simulated competition', which involves contests among those

seeking state support and which can be as powerful as real market competition,

o The recognition of the importance for developing countries of industrial policy and hence the

need for coherence between industrial and competition policies.

o The promotion of business incubators (where entrepreneurs are taught the techniques that

they need to make their connections to the social network more effectively and to enhance

their capacity of mutual awareness)

o The elimination of impediments placed by firms on the connectivity of other firms to theirown consumers and clients, thereby limiting their capacity for developing their own

networks. This may be the cause of fraudulent trademark copying (this would erode the

perception of consumers on the identity of the real producer) or deceiving advertising

(because this would erode the perception of consumers on the quality of the products sold,

whenever it is unlikely they would know, i.e. technical information)

o Reinforcing the capacity for developing impartial law making. Competition authorities

should point out government's discriminatory regulations favoring some firms at the expense

of others. It could, for example, enlighten the public opinion about the adverse consequences

of certain government policies on their welfare, and the general capacity of society for

displaying entrepreneurship. (policy reports).

o Competition authorities could also become the ombudsman of in

can governments promote competition

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