False Profit: How Paul Krugman’s Comments on Monopoly Distract From the Important Issues


Paul Krugman recently wrote a column for the New York Times in which he argued that profitability in contemporary capitalist firms in the US is presently coming from monopoly rent rather than from production. Krugman points to the growth of finance and also to the growth of industries, like Apple, that rely on their brand names to earn their rather large crust. He then contrasts this situation with that of General Motors in the 1950s and 1960s who he paints as old school producers.

Krugman’s story sounds nice but it is unclear what exactly he is referring to in theoretical terms. In neoclassical economics a monopolistic firm is one that is able to earn profits over and above their marginal cost (plus, in some cases, a “normal profit” for their trouble). They earn this monopolistic profit because they possess market power and this is reflected in the fact, already mentioned, that they avoid the competitive pressure to set their price in line with marginal cost.

Studies by the likes of Alan Blinder have shown quite clearly that only around 11% of US GDP can be said to be produced under conditions of rising marginal cost. The rest are presumably setting their prices in an entirely different manner. The neoclassical theory, which Krugman seems to be implicitly referring to, has it that competitive firms will face rising marginal costs. They will then compete with one another until marginal cost falls in line with marginal revenue – plus a “normal profit” – and this ensures that no one is engaged in monopolistic rent-seeking. So, if firms are not seeing rising marginal costs they must, according to neoclassical theory, be engaged in some sort of monopolistic pricing and thus accruing monopoly profits.

So far so good for Krugman’s argument, right? Well, not really. You see, such a study had been undertaken before back in 1952 by two economists named Wileford Eiteman and Glenn Guthrie and their results basically matched up with Blinder’s. Like Blinder, Eiteman and Guthrie surveyed businessmen and asked them what their cost curves looked like. They conclude that “the replies demonstrate a clear preference of businessmen for curves which do not offer great support to the argument of marginal theories”. So, even in Krugman’s idealised world of General Motors firms still seem to have been setting their prices in the same way as they do today. In fact, the results of Eiteman and Guthrie’s study was even more dramatic than Blinder’s, suggesting that some 95% of firms were not facing rising marginal costs versus the 89% that Blinder found more recently – indicating that today’s economy has less rather than more so-called uncompetitive firms.

In his piece Krugman says that he is “not making a moral judgment here”, but that appears to be precisely what he is doing. He is making out as if the Golden Era of post-war America was based on what he calls “production” and that profits accrued to those who produced. Krugman even admits at one point that “G.M. in its heyday had a lot of market power” but then quickly veneers over this rather obvious statement of fact. In this he seems to be saying very little indeed. He claims that the problem today is the extraction of monopoly rents and then contrasts this with the good old days of the 1950s and 1960s. But in the next breath he admits that firms in this era also had a good deal of market power. Krugman’s piece is then less a structured argument than it is a series of vague statements filled with allusion.

The unfortunate fact is that, like much of what Krugman writes, there is a grain of truth to what he is saying. Indeed, there is a good deal of wealth extraction taking place in the US economy today – far more than was going on in the 1950s and 1960s. And it is also true that employment in manufacturing has fallen substantially (whether this is or is not a problem is an entirely different question). But none of this has anything to do with the fantasy world idea that back in the 1950s and 1960s we lived in a world of neoclassical competition while today we live under the tyranny of monopoly which is what Krugman’s piece seems to be alluding to.

So, what then is Krugman avoiding by positing what seems to be an emotionally appealing narrative? Simple: class power. Those two words neoclassical economists cannot stand to hear. The fact is that the idea of neoclassical competition is, at best, a relic of the 19th century, at worst, a fantasy pure and simple and income distribution has far more to do with class power than anything else. Class power is, of course, a political issue first and an economic issue second – one of the reasons that neoclassicals, who claim to practice “pure economics”, tend to avoid it. But it is class power that underlies the manner in which income is distributed today – especially when we are considering the role of finance.

While it is nice that Krugman is finally taking a look at the structure of the contemporary US economy to search out hints as to why it is in such bad shape, his neoclassical ideas about how economies (should?) work blind him to the reality of the situation. They also lead to extremely weak policy prescriptions. For example, the populist call of “trust-busting”, which was as popular among 19th and early 20th century liberals as it was totally ineffective (monopoly power grew from strength to strength in the era of trust-busting). Such prescriptions have a populist edge, as everyone wants to see the Big Guys taken down a peg, but they just end up providing a soporific for the masses and directs their attention away from the real issues. Krugman’s argument thus rests on a heady blend of nostalgia, neoclassical theory and misdirected populism and while one cannot fault his intentions, one can certainly fault his results.


About pilkingtonphil

Philip Pilkington is a macroeconomist and investment professional. Writing about all things macro and investment. Views my own.You can follow him on Twitter at @philippilk.
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