Monopoly; Smith vs Schumpeter and the social cost

Monopoly markets, and the firms which dominate them, have since ancient times played an unequivocal and enduring role in shaping the current global economic landscape (Perloff, 2008). This have created concurrent contention surrounding the economic benefit of such structures, with debate by academics, national governments and Intergovernmental organisations over the benefits and costs of such arrangements, with some advocating for and others deploring against. The incongruence on opinions by the various institutions has seen many legal responses, from competition law which seeks to curb monopoly powers and collusion, to the state formation of monopoly firms and the implementation of patents for innovation. This essay shall provide a balanced encompassment of such differing views on monopolies, and the underlying theory which support such arguments, with a particular emphasis on how these are relevant to the economic environment of South Africa, and significant focus will be placed on the social costs of a monopoly.

Although many types of monopolies exist, for the purpose of this essay a monopoly shall be defined as, “the only supplier of a good for which there is no substitute” (Perloff, 2008:360).

Two renowned theoretical academic opinions on monopoly which largely conflict each other were propagated by Adam Smith and Joseph Schumpeter. Smith, who is widely regarded as the ‘father of modern economics’ and a proponent of free market principles, guided by the ‘invisible hand’, was a fierce opponent of monopoly markets (Wight, 2007). Schumpeter was of contrasting opinions with the belief that monopolies were essential for innovation, and the profits earned could be used for research and development; ultimately cultivating an efficient and dynamic economy (Gilbert, 2006).


According to Perloff (2008:380), two main reasons why monopolies exist include “a firm has a cost advantage over other firms” and “a government created the monopoly”. In South Africa the unique economic and political legacy of the apartheid regime and ensuing democratic elections resulted in the privatisation of many state institutions. These institutions had become monopolies due to earlier government controls, and were able to remain monopolistic – even after privatisation- because of their economies of scale. This is in addition to the relatively high barriers to entry. Many of these monopolies are evident in basic utilities such as the generating of power by monopoly giant Eskom, or the supply of telecommunications by Telkom.

The cost to society of monopoly is one that is often contested when discussing market structures. This will be discussed in relation to price and efficiency, and will evaluate the benefits and risks to the consumer, and to society as a whole. The South African relevance will too be explored in detail.

Naturally, most Invisible Hand theorists will fiercely deny any claims of benefit using a simple monopoly cost/price model as seen below. The basis of their argument will lie in the fact that monopolies charge higher prices for lower outputs (point A) and create a dead weight loss – the cost to society. Whereas in a perfectly competitive market structure, there would be no dead weight loss and production would occur at point B where marginal cost is equal to demand. This implies the assumption that no price discrimination was taking place in the monopoly, as price discrimination would minimize dead weight loss.



A Schumpeterian outlook would argue that while consumers “pay” in a monetary sense, they would benefit immeasurably from the innovation and creation that monopolies encourage. Schumpeter (1943) argues that the incentive of large profits and the availability of patent rights is the reason many firms are eager to invest in research and development. Furthermore, governments are quite capable of imposing high taxes, which parallel high profits, on monopolistic firms, and redirect the acquired funds into social welfare and development projects to benefit society (Perkins et al. 2006)

Currently in South Africa, most of the evident monopolies are natural; thus the market cannot support two firms and government regulation is required to ensure that consumers are protected (The Economist). A popular example of such a monopoly is the power generator, Eskom. In recent times Eskom has been scrutinised for price hikes coupled with power outages or “load shedding”, which detriment the consumer. Many calls have since been heard to end the monopoly in the hopes that competition would force the parastatal to improve their service delivery. In addition to these issues, Eskom has received numerous loans, from both the international community (World Bank granted Eskom $3-billion) and from the local government who agreed to fund a total of R350-billion over 3 years, raising questions around how the national budget would need to be cut to make provision for the needs of the monopoly. Interestingly, Schumpeter predicted that, just as is evident in the Eskom debacle, “monopolistic corporations will come to dominate economic life. But because of their necessarily bureaucratic structure, however, they will constrain innovation and become open to criticism.” (The Economist, 1983)

While many consumers agree that competition to Eskom would improve service delivery, it is important to note that the introduction of a new supplier of a basic utility would require large initial capital and is unlikely to drive the price of electricity down. In support of the consumer, Joseph E Stiglitz, Economic Science Nobel laureate and current expert on the Walmart Study Panel in South Africa, stated that “even if there were arbitrarily small sunk costs [they] would not suffice to limit the abuses of monopoly” (Stiglitz, 2001) Already in existence is the South African Competition Commission whose aim is to “investigate, control and evaluate restrictive business practices, abuse of dominant positions and mergers in order to achieve equity and efficiency in the South African economy” (Competition Commission, 2012). The commission has, to date, been effective in many competition disputes, most notoriously the bread price fixing scandal.

As shown in this essay, in the correct circumstances monopoly firms may fulfil a vital need in a market which can sustain one supplier only and may benefit the economy through innovation. In other instances the social costs vastly outweigh the economic value of such markets. These two opposing positivist outcomes are at the core of the theoretical arguments propounded by economists the world over. For this reason, an indiscriminate application in South Africa is not advisable. Rather specific context must be evaluated for positivist effects which are then related to varying theoretical nuances informing government response. The social cost of monopolies, especially in South Africa, will continue to be a pertinent factor for consideration due to the prevailing chronic economic divides, and will continue to raise questions and debates for many years to come.

Reference List

· Competition Commission. 2012. Competition Commision Website. [online] Available: http://www.compcom.co.za [2012, 29 April]
· Gilbert, RJ. 2006. Competition and Inovation. Journal of industrial organization education, 1.1 EconLit, Ebscohost, viewed 2012, 29 April.
· Perkins D.H., Radelet S. & Lindauer. 2006. Economics of Development, Sixth Edition. New York: Norton & Company.
· Perloff, J.M. 2008. Microeconomics, Theory and Applications with Calculus. Boston: Pearson Education.
· Schumpeter, J 1943. Capitalism, Socialism and Democracy. London and New-York: Routledge
· Stiglitz, JE 2001. Autobiography. [online] Available : http://www.nobelprize.org/nobel_prizes/economics/laureates/2001/stiglitz-autobio.html [2012, 1 May]
· The Economist, Economics A-Z. [online] Available: http://www.economist.com/economics-a-to-z/n#node-21529735 [2012, 28 April]
· The Economist, 1983 November. Schumpeter Centenery. [online] Available: http://www.economist.com/node/14488855 [2012, 1 May]
· The Mail and Guardian Online. 2011 November. Eskom Monopoly “at expense of consumers” [online] Available: http://mg.co.za/article/2010-11-22-eskom-wants-monopoly-at-expense-of-consumers [2012, 01 May]
· Wight, JB 2007. The Treatment of Smith’s Invisible Hand. Journal of Economic Education, 38,3. Pp 341-358, EconLit, Ebscohost, viewed 2012, 29 April.