How Barriers to Entry Strangle Markets

Economists posit, that in a perfect market, companies will compete such that there is no economic profit, and prices will be as low as the market allows. However, no market is perfect. Barriers to Entry exist that dissuade competition, and prevent the usual market forces that we rely on from working correctly.

Many barriers to entry in the market are entirely natural. To become a programmer, you must first learn to program. To open a shop, you must own a piece of land and make agreements with wholesalers, etc. However, pesky governments across the world make policies that add artificial barriers to entry.

These vary from things we consider ‘necessary’, such as medical licenses, FDA approval for drugs, to things that are grossly unnecessary like licenses for hair stylists. They can also be hidden too, like having to comply with piles of regulations before even starting business. Some of them can cause inequalities, like barriers to selling across state lines.

The problem is, that barriers to entry destroy something very critical to how the market works: competition. While it has basically become a meme at this point, competition is important because it lowers prices and raises the general quality of goods.

An easy way to imagine how barriers to entry reduce competition is to imagine you had to pay a fee to buy a product for the first time. Say for example you’ve been drinking Coca Cola, but you’ve become dissatisfied with their product, so you want to try Pepsi. Unfortunately, to switch from Coca Cola to Pepsi you must first pay $1,000. Will you switch? Absolutely not, because what if Pepsi is worse? You’d have wasted 1 large on a failed endeavor – you’d have been better off staying with Coca Cola. Futhermore, even if Pepsi were to be better, will you ever recover the $1,000 of value? That alone can make the cost too high.

While this example seems extremely contrived, this is exactly the same issue entrepreneurs face when deciding to enter a new market. Starting a business is a big investment, so what if the market isn’t what you thought it would be? You end up losing that initial investment. So what happens when you raise the barriers to do something? Less people are going to do it.

If there are less people doing a job, and the same amount of people wanting the job done, the result is inevitable: prices go up. This happens whether or not the people left are competing or not. Unfortunately, the implications are often more insidious than simple raised prices.

When you add excessive barriers to entry to a market, there can be so few firms to the point that the remaining firms stop competing properly. When there are only a few, or even one, firm(s) in the market, you get monopolistic competition. This is of course because the few to one firm(s) left realize that they no longer have to compete on price, as either they are entirely unopposed or are only opposed by one or two competing firms who are (of course) also interested in making supernormal profits.

Examples of exactly this occurring are in the financial (banking and insurance) sector, law, medical care, and telecoms (which was recently… err… ‘fixed’ by Net Neutrality)

Obviously, these effects are not desirable. To get the best out of free markets, we need to harness competition. We want markets as close to perfect as possible, so that we the people get the best of our economy. However common government policies, though often aimed with good intentions, often have the opposite effect.

When the government adds ‘common sense’ licensing and regulation in an industry, they make it harder for individuals and new firms to enter that market. While, in the short term, this may seem to lead to better quality of goods and services in that industry, in the longer term the industry will suffer from increased centralization and reduction in competition.

Most of the time the effect is relatively minor. However, dometimes this can utterly destroy a market, even to the point where the average person expresses high dissatisfaction with the price/value of the service they are getting, like in the case of telecoms.

Unfortunately, as history has shown, governments are abysmal at correcting their mistakes. Rather than correcting the original error, making the regulations, governments often opt to simply add additional regulations to correct the problems caused by the first wave of regulations. This vicious cycle of government control ultimately leads to industries where nobody but established firms can compete on any meaningful level.

These ‘Artificial’ barriers to entry vary from natural barriers to entry (initial fixed costs), as governments frequently update existing regulations to an industry. What this means is that compliance becomes a greater burden on smaller firms as they have to spend roughly the same amount of time complying to the regulations as the larger firms do.

In a market, regulation rarely, if ever, makes a market ‘fair’. Instead of making things fair, it makes everyone new start from below sea level.


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