Crovitz on creative Monopolies

L. Gordon Crovitz, "Three Cheers for ‘Creative Monopolies’," The Wall Street Journal, October 15, 2014

All Innovators have temporary market dominance. Peter Thiel knows this; so does Antonin Scalia. Too bad most lawyers and economists don’t.

 

Peter Thiel is larger than life even for a Silicon Valley billionaire. He co-founded PayPal, was the first investor in Facebook , and funded LinkedIn, Spotify, SpaceX and Airbnb. Now he has written a much-needed explanation of the information economy, masquerading as a breezy how-to book for entrepreneurs. “Zero to One: Notes on Startups, or How to Build the Future” is based on lectures Mr. Thiel gave at Stanford.

He hopes more entrepreneurs will focus on big ideas for health, energy and transportation; his venture firm’s tag line is “They promised us flying cars and all we got was 140 characters,” a reference to Twitter . His explanation of innovation is also a primer on how free markets work. He encourages entrepreneurs to ask: “What valuable company is nobody building?”

He warns against creating products that can be commoditized. “All happy companies are different: Each one earns a monopoly by solving a unique problem,” he writes. “All failed companies are the same: they failed to escape competition.” Example: Google , with its unique search advertising, is worth three times as much as all U.S. airlines combined.

Many reviewers are shocked by Mr. Thiel’s embrace of monopolies, but he is careful to defend only what he calls a “creative monopoly”—one that is “so good at what it does that no other firm can offer a close substitute.” In contrast with “illegal bullies or government favorites,” he observes, “creative monopolies give customers more choices by adding entirely new categories of abundance to the world.”

The Internet enables new creative monopolies. Companies can benefit from network effects, or what economists call demand-side economies of scale, to earn large market shares. PayPal became a favorite way to pay online once it achieved a critical mass of buyers and sellers. LinkedIn succeeded when enough people posted their work profiles to make the service valuable to employers and recruiters. Airbnb became attractive for homeowners to list residences as more people rented through the service.

Mr. Thiel’s contrarian claim that “monopoly is the condition of every successful business” echoes Joseph Schumpeter, the Austrian economist best known for coining “creative destruction.” Schumpeter explained in a 1942 book the key role of temporary monopolies in innovation: “The introduction of new methods of production and new commodities is hardly conceivable with perfect—and perfectly prompt—competition from the start. And this means that the bulk of what we call economic progress is incompatible with it. As a matter of fact, perfect competition is and always has been temporarily suspended whenever anything new is being introduced.”

Many academics and antitrust lawyers wrongly believe big is bad by definition. The Justice Department pursued IBM in the 1970s and Microsoft in the 1990s without understanding that in a dynamic market, where government doesn’t protect incumbents, new innovators displace old innovators. Apple undermined the dominance of Microsoft, which had ended IBM’s.

Mr. Thiel joins a long-running dispute. Justice Antonin Scalia set off a firestorm a decade ago when he defended monopolies in a majority opinion: “The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful, it is an important element of the free-market system. The opportunity to charge monopoly prices—at least for a short period—is what attracts ‘business acumen’ in the first place; it induces risk taking that produces innovation and economic growth.”

That outraged Silicon Valley-based antitrust lawyer Gary Reback. In his book “Free the Market! Why Only Government Can Keep the Marketplace Competitive,” he called Justice Scalia’s ruling “unbelievable.” Mr. Reback asserted, “No one needs the prospect of a monopoly to induce investment.” That would be a losing argument at Mr. Thiel’s venture-capital firm.

Academic Tim Wu, who coined the pro-regulation term “net neutrality,” likewise demanded in his 2010 book “The Master Switch” that the government break up Google, Facebook and Apple as new monopolists. But all are creative monopolies. Better services, not law or regulation, give them their advantages in search advertising, display advertising and design.

Activists who want to break up creative monopolists don’t understand that only government can create the uncreative kind of monopoly, by protecting it from competition. AT&T enjoyed a government-granted monopoly for decades. Cities protected taxis from competition until Uber and Lyft gave choice to consumers.

Asked last week about springing Schumpeterian analysis on unsuspecting readers, Mr. Thiel laughed. “It wouldn’t be that bad for readers to get some Austrian economics on monopoly,” he told me. “Zero to One” wasn’t intended as a policy manifesto, but it should help return Silicon Valley to its roots favoring big innovation and small government.