Competition as a Discovery Procedure

Cournot’s complaint that economists before him “have not in the least improved on popular notions [on the effects of competition leaving such notions] as ill-defined and ill- applied in their works, as in popular language” (Cournot 1838 [1897]: 79) may be taken to mark the distance between the classical and the contemporary notion of competition.

(Kirzner 1973: ch. 3). Should we conclude that the transition from the ancient to the modern notion of competition is but a telling example of progress in economics? The answer to such a question is controversial (as is controversial the very notion of progress in economics: see Boehm et al. 2002). The price-taking notion of competition and the cognate analysis of different market structures are considered by some economists as a remarkable example of theoretical progress. Yet, a few others have questioned that these theoretical developments imply empirical progress too. For example, Demsetz (1982) claims that the perfect competition model is a valuable tool to understand the workings of the price system in a fully decentralized economy; but it is highly unsuited to under­stand any form of competitive activity. Within the perfect competition model, in fact:

firms and households increasingly represented mere calculating machines whose inner workings were of little interest. Markets became empirically empty conceptualizations of the forums in which exchange costlessly took place. The legal system and the government were relegated to the distant background by the simple device of stating, without clarification, that resources were “privately owned”.... [The perfect competition model] also encouraged the neglect of those islands of authority, firms and households, which, by exercising limited authority in a sea of prices, could translate [their] special knowledge into goods and services.

Accordingly, Demsetz proposes to rechristen the perfect competition model as the “perfect decentralization model” since it “adds much to our understanding of coordina­tion through price, nothing to our understanding of coordination through authority, and only little to our understanding of competitive actions” (Demsetz 1982: 6).

The idea that an understanding of the actual workings of competition requires the abandonment of the perfect competition model has been forcefully advocated by neo­Austrian and evolutionary economists (see McNulty 2008 and Witt 2008, respectively). Neo-Austrian economists have generally looked at the price-taking notion of competi­tion with a critical eye since the latter depicts “a state in which all essential conditions are assumed to be known - a state that theory curiously designates as perfect competi­tion, even though the opportunity for the activity we call competition no longer exists. Indeed, it is assumed that such activity has already performed its function” (Hayek 1968 [2002]: 13). Accordingly, for the neo-Austrians, competition is basically “a procedure for discovering facts which, if the procedure did not exist, would remain unknown or at least would not be used” (ibid.: 9). In the evolutionary scenario, economies seldom or never are in a situation of Walrasian equilibrium. Accordingly, analytical attention is devoted to non-equilibrium processes engendered by the interaction of intrinsically heterogeneous agents, endowed with idiosyncratic information and bounded rational­ity. Neo-Austrian and evolutionary economists put great emphasis on the active role of entrepreneurs who strive to get both static and dynamic profit differentials. The former arise from the discovery of arbitrage opportunities (Kirzner 1997), the latter from the process of creative destruction depicted in chapter 7 of Joseph Alois Schumpeter’s Capitalism, Socialism and Democracy (1942), namely, the discovery of new consumers’ goods, new methods of production or transportation, new markets, and new forms of industrial organization created by capitalist enterprises. From this point of view, the analysis of competition is intimately tied with that of economic development: the two “are isomorphic by virtues of being examples of the phenomenon of economic evolution” (Metcalfe et al.

While neo-Walrasian general equilibrium theory endorses a notion of competition as an (intertemporal) equilibrium end-state where any potential for Pareto-improving real­location is fully exhausted, classical, neo-Austrian and evolutionary economics describe competition as an intrinsically dynamic process of technological innovation and struc­tural change (Blaug 2003; Machovec 1995). Yet, notwithstanding their different notions of competition, classical, neo-classical, neo-Austrian and evolutionary economists basi­cally agree on the view that a competitive market economy is an economic system which promotes long-run growth and provides ample scope to the benign action of Adam Smith’s invisible hand. By contrast, Karl Marx and Marxian economists consider capi­talism and free markets as economic systems in which the process of capital accumula­tion goes hand in hand with the proletarianization of the masses, on the one side, and the concentration of social wealth into the hands of an elite controlling big corporations, on the other:

The battle of competition is fought by cheapening of commodities. The cheapness of commodi­ties depends, cateris paribus, on the productiveness of labour, and this again on the scale of production. Therefore, the larger capitals beat the smaller. It will further be remembered that, with the development of the capitalist mode of production, there is an increase in the minimum amount of individual capital necessary to carry on a business under its normal conditions. The smaller capitals, therefore, crowd into spheres of production which modern industry has only sporadically or incompletely got hold of. Here competition rages in direct proportion to the number, and in inverse proportion to the magnitudes, of the antagonistic capitals. It always ends in the ruin of many small capitalists, whose capitals partly pass into the hand of their conquerors, partly vanish. Apart from this, with capitalist production an altogether new force comes into play - the credit system.

Moreover, Marx emphasized that competition determines a falling rate of profits (Marx 1909 III.III). As a consequence, capitalist economies are plagued by recursive crises of realization. This aspect of Marxian contribution has been developed by Baran and Sweezy (1966). The two authors explore the way competition works in monopoly capitalism and argue that the law of the falling rate of profits does not apply to modern capitalism. In particular, they emphasize the role of stagnation, which is only inter­rupted by violent crises. Since Marx and Marxian authors generally view capitalism as an economic system characterized by deep-routed and violent contradictions, the literature on “Marx and Marxists on crisis” is huge. Sweezy (1946) keeps its status as a classic, while a recent assessment is provided by Clarke (1994). John E. Roemer (1982) provides a modern presentation of how society is partitioned into different classes by competition.