Monopoly and Oligopoly

Trade occurs within a variety of market structures, the nature of which is complicated by the existence of both monopoly (single seller) and monopsony (single buyer) distortions. Thus, the organization of sellers can vary from perfectly competitive to pure monopoly, and the organization of buyers can vary from atomistic to monopsonistic. States traditionally have sought to enrich themselves, either directly or indirectly, by restricting access to the benefits of foreign trade. If states were not the sole exporter or importer of particular goods, then state-sanctioned companies were provided with privileged trading positions, allowing these firms to exercise monopoly power. This entry discusses the trading environment as it has evolved since the fifteenth century, paying special attention to the structure of both sides of the market in which trade occurs. In particular, the focus is on situations that created noncompetitive structures and on the institutions and forces that have worked to reduce or eliminate these structures.

EARLY TRADE MONOPOLIES

Very early in history, trade first occurred among tribes that had chance encounters during hunting expeditions. Organized trade evolved when agriculture-based societies developed and centers of production were established. The structure of this trading environment was naturally noncompetitive, as each tribe or local settlement established control over commerce within its purview. Eventually, private traders set up routes along which they conducted trade in several locations, often paying tribute to local authorities to ensure safe passage. Sea routes were subject to less interference and began to supplant the frequently contested land routes as the technology of shipbuilding and navigation improved.

From the early 1400s until the nineteenth century, trade was controlled by regional political forces: the Indian Ocean, from eastern Africa to south Asia; the Mediterranean, from Egypt and Arabia to Portugal; and the Atlantic, from the Nordic countries to western Africa and the New World. A particular country granted monopoly rights to specific companies or exercised these monopoly powers directly. As the mercantilist trade theory of the time indicated, countries that developed extensive colonial empires attempted to control trade with the colonies. The Dutch East India Company and the British East India Company were formed to facilitate trade with the outposts of the Netherlands and England, respectively. Each company was given exclusive trading rights to particular parts of the world. The British Navigation Acts of the second half of the seventeenth century were an attempt to ensure the monopoly position of the mother country. The Navigation Acts were repealed in 1851, allowing equal access to colonial markets.

RISE OF FREE TRADE

In 1776 Adam Smith (1723–1790) had completely discredited the mercantilist theory in his Wealth of Nations. Britain began to emphasize free trade during the last half of the nineteenth century and attempted to convince the rest of the world of its benefits. At the time, other countries argued that this was a self-serving policy, due to their lack of understanding of the gains from trade arguments and Britain's dominant position in world trade. These gains from trade arguments would become more widely accepted in the twentieth century.

China and especially Japan were for many years nearly autarkic, eschewing trade with any foreign power. Competitive forces by regional traders in Southeast Asia created institutions to circumvent restrictions on trade with foreigners. Britain and the United States played a major role in opening China and Japan to world trade, respectively. Trade between the United States and Europe and Japan and China increased during the last half of the nineteenth century as Britain promoted worldwide free trade.

United States tariff policy may well have contributed to the growth of domestic monopoly power during the last half of the nineteenth century, especially in such industries as steel, copper, nickel, and textiles. The same may be said for many industries in Germany and France. Trade decreased from 14 to 16 percent of gross national product (GNP) around 1900 to less than 7 to 8 percent or GNP by 1950. Beginning with the Reciprocal Trade Agreement Act in 1934, the United States took on the mantle of free-trade advocate, which the British had claimed prior to World War I. The General Agreement on Tariffs and Trade (GATT) was created in 1945 as a forum for countries to discuss the relative benefits from multilaterally reducing barriers to trade.

Through successive rounds of multilateral trade negotiations and extension of the Most Favored Nation (MFN) policy to all members of GATT, tariffs and other trade barriers were substantially reduced. The Kennedy Round (1967) and the Tokyo Round (1979) both succeeded in significantly reducing average tariff levels. The effect of these two rounds was to open the United States market to substantial foreign competition, reducing the market monopoly power of domestic steel and automobile producers in particular. The European Common Market and Japan significantly reduced tariffs as a result of these multilateral trade agreements. More recently, in 1995, the Uruguay Round of GATT negotiations succeeded in creating the World Trade Organization (WTO), which, as a result of its enhanced dispute settlement powers, may pave the way for freer trade and reduced domestic firm monopoly power. For example, the recent (2004) preliminary ruling against United States cotton subsidies, if upheld, may serve as precedent for proceedings against subsidy policies more generally. Such rulings will reduce the monopoly power of producers protected by the subsidies.

In conjunction with the WTO, the International Monetary Fund (IMF) has promoted trade liberalization and financial market liberalization for all countries as a means of stimulating economic growth. Although not without controversy, this IMF policy promotes a more competitive environment for international trade and finance. When financial institutions that were part of a state-run monopoly are forced to compete as private forprofit institutions, there are bound to be firm failures and disturbances as the institutional structure necessary for the smooth functioning of these competitive markets is put in place. There are limits to the extent that institutional structure can be put in place prior to trade and financial liberalization, due to the uniqueness of each country. Thus, much of the institutional structure must be adapted to the needs of the individual country after trade and financial liberalization has occurred.

Such adjustments are most prevalent in countries that either freely adopted or were forced to adopt some degree of central planning or industrial policy to promote economic growth. Successes of the Soviet Union in generating growth between 1917 and 1945 induced many countries to use central government–directed policy to stimulate domestic industrial growth. Several Latin American countries and India freely adopted import-substitution measures as a means to reduce dependency on developed countries, especially former colonial powers. The People's Republic of China, Eastern European countries, and Cuba were among those where the adoption of such policies was less voluntary. That is, the central government took control of all or most of the means of production. In Southeast Asia, Japan, Taiwan, South Korea, and others developed industrial policies that were export-oriented. The resounding successes and greater sustained economic growth realized by the Southeast Asian group, along with internal institutional failures in the countries following import substitution policies, resulted in opening of the latter group to freer trade during the 1980s and, more recently, membership in the WTO by the People's Republic of China. Problems inherent in the institutional structures that evolved in these countries, particularly in the financial sector, plague all of them.

MODERN TRADE THEORY

"Modern trade theory" deals with trade in an imperfect competition framework. One strain is best represented by the works of James Brander and Barbara Spencer (surveyed by Brander), and the second is best represented by the work of Elhanan Helpman and Paul Krugman. The first two scholars considered strategic trade policy options that would enable countries to shift profits toward domestic firms in oligopolistic industries, whereas the second two dealt with the monopolistic competition and intra-industry trade.

The work of Brander and Spencer, and those who expanded upon their work (surveyed by Brander), served as justification for the trade policy followed by the United States, and other nations, beginning after the completion of the Tokyo Round of GATT negotiations. The United States, which had traditionally been opposed to the formation of preferential trading agreements, began in the 1980s to aggressively pursue preferential trade treaties with one or a few countries, arguing that it was easier to come to an agreement when fewer countries were involved. A large body of literature exists that addresses the possibility of welfare gains for countries that engage in strategic trade policy, whether or not such policy involves the formation of preferential trade agreements.

The works of Helpman and Krugman have been expanded by many in an attempt to explain international trade patterns, pricing behavior, and the effect of exchange rate policy in the context of imperfectly competitive industries. These models explain the prevalence of a country's exports and imports of products in the same industry, whether as a result of horizontal or vertical product differentiation. Horizontal differentiation is concerned with exports and imports of differentiated products with similar quality characteristics, whereas vertical concerns exports and imports of similar products with differentiated quality attributes. As price makers, imperfectly competitive firms may choose whether to set prices for the export market differently than for the home market. Thus, production-cost or shipping-cost changes may or may not be passed through to the export market. Moreover, exchange-rate changes may or may not be passed through to the export market.

Since before the fifteenth century monopoly power has distorted international trade. Natural competitive forces among nation-states for the right to trade with a particular people were among the earliest forces to diminish the distortion generated by monopoly power. Following World War II major nations realized the benefits of freer trade and created institutions to reduce protective barriers that produced monopoly power for domestic firms.

SEE ALSO Trade Forms, Organizational, and Legal Institutions.

BIBLIOGRAPHY

Brander, James A. "Strategic Trade Policy." In Handbook of International Economics, vol. 3, ed. G. M. Grossman and Kenneth Rogoff. Amsterdam: North-Holland, 1995.

Curtin, Philip D. Cross-Cultural Trade in World History. Cambridge, U.K.: Cambridge University Press, 1984.

Helpman, Elhanan. "Increasing Returns, Imperfect Markets, and Trade Theory." In Handbook of International Economics, vol. 1, ed. Ronald W. Jones and Peter B. Kenen. Amsterdam: North-Holland, 1988.

Irwin, Douglas A., ed. Trade in the Pre-Modern Era, 1400–1700. Brookfield, VT: Edward Elgar, 1996.

Irwin, Douglas A. Free Trade Under Fire. Princeton, NJ: Princeton University Press, 2002.

Krugman, Paul R. "Increasing Returns, Imperfect Competition, and the Positive Theory of Trade." In Handbook of International Economics, vol. 3, ed. G. M. Grossman and Kenneth Rogoff. Amsterdam: North-Holland, 1995.

Smith, Adam. An Inquiry into the Nature and Causes of the Wealth of Nations. (1776). New York: Modern Library, 1937. See especially Book 4, Chapter 8.

William K. Hutchinson