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How can we tell if regulating Google and Facebook is the right thing to do?

There are different economic approaches to dealing with monopolies and market dominance, but the nature of Google and Facebook defies easy answers

The Competition and Markets Authority (CMA) is taking aim at online advertising giants Google and Facebook. The problem here is that it opens up the most almighty catfight over what is the correct regulatory response to market power and/or monopoly situations.

Depending on what side of the economic, possibly political, argument you’re on, you can argue that nothing should be done or that we should be ripping the companies apart. Or even, not just that nothing should be done, but that doing something would be harmful.

The argument really boils down to, well, whose side are you on? That of producers, all of whom should get a fair shake? Or consumers, where we want them to be as well off as current circumstances allow them to be? You can be a free marketeer and be on either side of that; you can be of any political or economic persuasion and be on either side. This is what makes it such a difficult question.

As for being a monopoly, we are usually against it. Monopolists will, in a physical world, reduce their output so as to drive up prices and therefore profits. This clearly harms consumers and that is why we are against it.

We are against constructed monopolies because they are harmful to those consumers and also to everyone else who would like to try supplying. “Constructed” here means placing a barrier in the way of market entry – perhaps through legal constraints, political action, or even that old Mafia technique of taking out all those who intrude on your turf.

We also agree that there are certain things that just become natural monopolies. The electricity grid, the sewage system – there is no point in two sets of wires or pipes going round the place. So we accept that they will be monopolies and we then make sure that the market power they have isn’t used to harm consumers.

Which is where we start to have disagreement about the advertising giants. If they have deliberately gone out and strangled all competition, then they should indeed be stopped from doing so further. That is, if they have constructed a monopoly, we can tear it down again.

Different flavours

But what if that’s not quite it? The “not quite” comes in two flavours. The first is that they are simply better than anyone else today – but they still face people attempting to service the market. At this point, we call this a contestable monopoly and the general economic nostrum is that a contestable monopoly isn’t something to worry about because the holder of that market power won’t exploit it for fear of the competition. Or, if they do, then competition will come in and undercut them and they will lose their privileged position.

We have historical evidence that this has happened. Standard Oil certainly had market power and crushed an awful lot of competition by exercising it. Yet it continued to drive market prices down and down again – to ensure that no competition arose. This benefited consumers, so what’s our worry?

The second consideration is that perhaps the advertising market concentration around Google and Facebook is natural. We are, here in the computing world, well aware of network effects. An operating system (OS) becomes popular, more people write programs for it, this attracts OS users who gain access to programs, the larger number of OS users attracts more programmers, and so on.

An ad auction market fits rather well into the economic model that suggests just the one marketplace, just the one broker, will be efficient. So, it could be that having the one search advertiser or the one display advertiser dominating the market is that natural outcome. If this is true, then breaking up the companies isn’t going to work. Because any fragments that exist, one of them will grow to market dominance again because we’ve just insisted that the network effects make monopoly the efficient outcome.

Which leaves us in one of those positions described by the technical jargon as “a bit of a bugger”. For what do we do with a market where monopoly is the natural outcome? This is where the split comes.

Smith vs Keynes

We can take the old Adam Smith line that the only thing that matters is consumption. As long as consumers are as well off as they can be, then that’s that, no more needs to be done. Monopoly only matters if market position is exploited to make excessive profits.

We can also think that the simple existence of market power means that it needs to be regulated. Which is roughly where the split in economics is over what to do here – not just about digital advertising, but about the entire monopoly situation itself. Of course, in the long run, no monopoly lasts through every technological change but ,as Keynes remarked, in the long run, we’re all dead too.

I come down on the Smithian side, as you’d expect me to. But there’s more to it than just adhering to the ideas of some long-dead scribbler. Regulation or corporate break-up has costs. If the natural size is monopoly, then insisting on smaller producers means inefficiency in production – things become more expensive.

Regulation itself clearly has costs, as the smooth cheeks and fat wallets of regulators show. So, how do we decide when the undoubted market power of the advertising giants must have something done about it?

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My suggestion is whether we can identify consumer harm. No, large profit margins aren’t enough because those will flow naturally from the network effects – which is where I disagree with the CMA, which points to profit as evidence of consumer harm.

No, we need actual evidence that consumers are being made worse off to justify market intervention. And as no direct evidence is provided of how people can be made worse off by getting something for free, I can’t see the justification for intervention.

It has to be said that most of the world disagrees with me here, but it’s that conclusion that is the difference. The logic leading up to it is generally agreed. Monopolies and market power are bad things that we should do something about – except when they’re not.

How do we tell the difference? Only when we can, do we justify their breakup or regulation.  

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