I realized recently that there’s an inherent paradox in the free market system: left to its own devices, the free market will create as little freedom as it possibly can.

The most obvious examples are the big famous monopolies like Standard Oil and AT&T, but this happens in much more subtle ways all the time. Here are just a few examples:

• Cell phone companies. Why is it that all carriers require two year contracts? Why doesn’t one company gain a competitive advantage over another by offering a one-year contract, or a six-month contract, or no contract at all? The answer is collusion. Maybe not the kind where men in expensive suits sit around smoking cigars and plotting, but there is clearly some kind of an "understanding" in the industry (which seems to have come about in response to number portability). As choices become more limited (exclusive handset deals, consolidation), I wouldn’t be surprised to see three-year contracts become the standard like in Canada. Carriers get away with this because the costs of anyone new getting into the industry are prohibitively high. No single mobile phone service provider can act as a monopoly, but acting in collusion, they can very easily limit consumers’ options, and apparently get away with it.
• Television providers. Not only do you have very little control over who provides your television/internet/phone service, but at least where I live, they are all starting to require contracts just like mobile phone carriers. As in the case of phone contracts, customers are expected to sign agreements with penalties before it’s even possible to know how good the hardware and services are, and how they compare with the (limited) competition. Often the only recourse consumers have is switching to another product or service which these contracts are explicitly designed to prohibit.
• Alarm companies. Same story. Every one of them in my area requires a three year contract. If you want wireless equipment (which is all anyone wants to install anymore), they also want to charge extra per month rather than a higher up-front cost. If you call them on the length of their contracts, they simply respond with something like "it’s the industry standard." In this case, "industry standard" is synonymous with collusion.
• The software industry. There are just too many examples to name in the world of software. Customer lock-in is standard operating procedure. Think about how difficult it is just switching to a new computer with the same operating system, and now imagine switching to a different operating system, or migrating years of data from one software package to another, or converting an entire company from one internal workflow to another. These challenges often aren’t accidental. In most cases, it’s easier and cheaper to put up with what you have than to switch to something better.
• The medical industry. Regardless of where you stand on the healthcare debate, unless you’re a highly paid specialist or an insurance executive, it’s hard to argue that the system isn’t out of control. Doctors and hospitals charge way too much because they know that individuals usually aren’t paying their own bills, and insurance companies therefore charge as much as they can for coverage and pay for as little treatment as they can get away with. The victims are the insured and uninsured alike who are locked into a system that doesn’t work and which doesn’t provide any better options.

The reality is that it’s cheaper and easier to lock customers in, stifle competition, and apply "leverage" than it is to truly innovate and compete on a level playing field. Even if it’s not good for the industry or for consumers in the long run, it’s better for next quarter’s earnings which, as we all know, is what leads to higher stock prices (aka executive compensation) and better bonuses.

All of this takes place in a free market system, and all of it is either perfectly legal, or at least legal enough that nothing is being done about it. All of these limitations and constraints and miserable experiences that we are all stuck with are actually rewarded by the free market which, in many cases, isn’t free at all. The only way to create a truly free market is to constantly regulate it — sort of like the government itself.

So what can be done about it? First and foremost, multi-year agreements should be illegal, plain and simple. If a company can’t provide a service which is valuable enough to keep you from switching to another service, you should be allowed to switch without penalty. Second, in any instance where the huge majority of dominant companies in an industry begin to adopt the same sets of practices, the government needs to investigate. I don’t like the idea of the government getting involved in private industry any more than anyone else, but the reality is that private industry has proven over and over again that it will not regulate itself, so the only entity with the power to do it for them is the federal government. And finally, wherever competition is lacking in a particular industry (or a particular industry which is strategic to the country is failing to prosper), the government should offer incentives to private industry through low interest loans, tax breaks, etc. This does not mean giving failing car companies who have a long history of mismanagement more money to mismanage; rather, it means giving entrepreneurs the opportunity to compete against the status quo.

It’s easy to argue that these kinds of solutions are unfair, but if businesses are offering quality products and controlling costs (i.e. executive compensation), nobody should have anything to worry about.

Update: Judging from the comments, I feel I should clarify some points in this post. By no means am I unconditionally in favor of more government and regulation, nor am I in favor of nationalizing private industry in any way. I believe we need the right amount of government which means less in some areas and more in others. And, of course, we need government that works. Often the assumption is that everything the government attempts to do will inevitably fail miserably. Obviously that’s not acceptable. Just as we should be able to drop our mobile phone carrier if their service is not what it should be, we need to vote out politicians who can’t ensure that government programs are run effectively.

Although I know this post could come across as sounding like I want a market that is less free, the irony is that I want just the opposite. That’s the paradox. I only want to see regulations placed on private industry where that industry is trying to limit freedom, choice, and innovation. I want freer markets. Maybe government regulation isn’t the best way to get there, but as I said above, these markets don’t appear to be willing to regulate themselves, so who else is going to do it?