Protected Markets

BIBLIOGRAPHY

A protected market is defined as one shielded from competition. The analytical concept dates back at least to Adam Smith, David Ricardo, Alfred Marshall, and other economists who analyzed the implications of imperfect competition, trade restrictions, and market power. Market protections may be natural or man-made, private or public, and welfare enhancing or depleting.

Some markets are naturally protected from competition by high costs of transportation because of distance, bulk, or terrain. A market isolated by high transport costs and characterized by economies of size so that only one firm can operate at low unit cost is called a natural monopoly. A cooperative form of business organization owned by patrons or government regulation of pricing has been used to avoid exploitation of producers and consumers in such naturally protected markets.

Naturally protected markets are the exception; protected markets more frequently emerge from deliberate action by firms, organizations, and government. Firms engage in exclusionary, predatory, and price-fixing behavior to create or exploit protected markets (Black 2002). Most nations have antitrust laws to avoid or countervail such exercise of market power. In the modern age of sophisticated science, technology, and information systems, firms turn to other strategies to protect markets. For example, a firm may protect its market by encouraging excessive standards (suited to the firm in question but not to other firms), by aggressive advertising, by exploitation of public ignorance (e.g., fear of chemicals or pathogens in tap water or in conventionally produced food), and by market power to expand shelf space in supermarkets.

In the case of organizations, workers form unions to protect their labor market from competition and so enable collective bargaining to raise wages and improve working conditions. Workers in some countries have lobbied successfully for laws requiring large severance payments, high minimum wages and unemployment compensation, long vacations, short workweeks, and strict work rules. A consequence, illustrated by France, is high overall labor costs that discourage employment, especially of young, inexperienced workers. These factors coupled with racism and discrimination in French labor markets brought long-term unemployment rates of 20 percent or more among Muslim youth in the banlieue neighborhoods across France, sparking massive social unrest in 2005.

Turning to markets protected by government, border controls attempt to protect domestic workers from immigrant laborers willing to work for low wages and benefits. The result is salutary for domestic workers but hurts would-be migrant workers. Thus, policies to protect labor and industry can be divisive, creating a dual labor market of cosseted job-secure workers with generous benefit packages on one hand and poor unemployed and under-employed workers with limited future prospects on the other.

Governments of some countries pursue an infant industry policy or industrial policy by protecting selected domestic firms through tariffs, quotas, and regulation of competing imports while also promoting the firms with subsidies in the form of cheap credit, low taxes, and concessional access to public research and educational benefits. Such market protection is intended to help new firms until they attain the critical mass necessary to compete in international markets without assistance. A problem is that governments are not very adept at picking industrial winners. Target industries and firms are likely to be favored for political rather than sound economic reasons. Partly because market protection invites complacency in industry, favored treatment tends to be institutionalized and continued even after the favored industry was expected to mature.

Instruments such as tariffs, licenses, and regulations used to protect markets create economic rents—the stream of income generated over time by such instruments. Individuals, firms, and organizations have reason to engage in unethical practices, lobbying and bribing politicians and bureaucrats to create or remove such instruments. The consequence is corruption in government.

However, some market protections are justified and raise real national income. Firms that protect their market by being a first mover or by innovating faster than competitors serve consumers and raise national income. Market protection is useful in supplying public goods. In a laissez-faire competitive market, firms can recover only the marginal cost of their products. Hence, a firm is dissuaded from developing a new soybean variety, for example, because it cannot recover the millions of dollars spent to develop the seed. Governments award patents, copyrights, and trademarks so that firms can protect their intellectual property. Thus, firms can exercise market power to charge prices above marginal costs and pay for research and development.

Charging above marginal cost is a second-best policy. The first-best “textbook” policy in such cases is to rely on the public rather than the private sector to develop and pay for such technology. But governments do not have a favorable record, suffering from a dearth of funding and a surfeit of political misdirection in providing such public goods.

Society benefits from grades, standards, and sanitary and phytosanitary regulations that improve private market performance. Unfortunately, these and other market protections sometimes are employed to the detriment of society. The World Bank (Anderson et al., pp. 346, 351, 352) estimates that elimination of 2006 barriers (tariff and nontariff impediments not justified by sound science) to international trade in goods would add $278 billion to world income each year by 2015 and beyond—nearly half of that accruing to developing countries.

Public protection of markets often is justified to serve the environment (Southgate et al. 2007, pp. 103-123). Natural resources such as oceans, the atmosphere, and land are frequently open-access property inviting overuse. The consequent overexploitation of open-access property is called the tragedy of the commons. Uncontrolled access leads users to exploit resources “before the hoarders get them.” In 1960 Nobel laureate Ronald Coase pointed out that creation of property rights to such resources can align private with social incentives to achieve efficient resource use.

An example is the “cap and trade” market employed successfully to reduce sulfur dioxide emissions at low economic cost in the United States. The system begins with emission permits issued to each firm. The permits, which can be sold to firms or given to firms (reduced appropriately from historic emission levels), are negotiable. Firms that can reduce emissions at low cost sell their permits to firms expanding emissions to produce highly valued products.

In conclusion, prudent public policy to privatize, deregulate, and open markets at home and abroad has the potential to improve the quality of life around the world. In some cases that means opening markets, as in international trade. In other cases that means protecting markets, as in cap and trade systems for effluents or in patents for intellectual property.

SEE ALSO Coase Theorem; Coase, Ronald; Competition; Infant Industry; Marshall, Alfred; Monopoly; Pollution; Predatory Pricing; Regulation; Returns, Increasing ; Ricardo, David; Smith, Adam; Theory of Second Best; Tragedy of the Commons

BIBLIOGRAPHY

Anderson, Kym, Will Martin, and Dominique van der Mensbrugghe. 2006. Market and Welfare Implications of Doha Reform Scenarios. In Agricultural Trade Reform and the Doha Development Agenda. Eds. Kym Anderson and Will Martin, Report No. 34206. New York: Palgrave Macmillan, and Washington, DC: World Bank. Chapter 12.

Black, John. 2002. Barriers to Entry. A Dictionary of Economics. Oxford University Press. Oxford Reference Online. http://www.oxfordreference.com/views/ENTRY.html.

Coase, Ronald. 1960. “The Problem of Social Cost.” Journal of Law and Economics 3 (1): 1–44. Reprinted in Economics of the Environment: Selected Readings. 4th ed. Ed. Robert Stavins. New York: Norton, 2000.

Southgate, Douglas, Douglas Graham, and Luther Tweeten. 2007. The World Food Economy. Malden, MA: Blackwell.

Luther Tweeten