On Natural Monopoly

From Zanecorpwiki

In a mature society^{[notes 1]} the only effective monopoly left is the natural monopoly.^{[notes 2]}

A natural monopoly is one in which there's a good reason for the monopoly to exist. This--as I use the term--always has to do with the relative cost of infrastructure and capital in relation to the units of commerce. I first read about natural monopolies was--as I recall--a book from the 1800's written by some descendant of one of the Founding Father's on how Railroads were a natural monopoly. The thing partially was a discussion of the government practice of granting railroad companies use of public land and utilizing eminent domain to seize land for the private use of railroads.

The main idea was first: a transcontinental railroad system is a public good, second: whoever controlled such a system would be guaranteed to become very wealthy so there was plenty of incentive to create one, and three: but because of the high capital cost deployment combined with normal market price controls would have insured that no such railroad ever be built. The problem is this: it costs a huge amount of money to lay the track for a line and it's worthless until you get it all laid. If more than one company lays the track to a destination, then they'll compete with each other on cost for service and each will go bankrupt because the price competition will keep them from ever recouping the capital cost of laying the track.

This theory fit the dominant narrative of the time, and was seen to be true. AFAIK, it's still more or less considered true. Two or more companies would lay track on the same route and each would go bankrupt, resulting in no service at all. What was needed was an exclusive grant combined with effective regulation to make sure the company receiving the grant did not abuse it (too much). Whether it's actually true or not, I have no idea, but honestly, that's not all that important.^{[notes 3]}

Throughout much of the rest of the paper, I speak of monopolies in general for two reasons. First, brevity. Second, most of the statements are applicable to any monopoly even though my main consideration is the natural monopoly.

Contents 1 Monopoly and Markets 1.1 Price, Value, and Monopolies 1.2 Extra-Market Controls 1.3 Credibility 2 Case Study: AT&T 3 Notes

Monopoly and Markets

A monopoly is necessarily an extra-market entity. Theoretically, this seems so in-so-far-as the axiomatic definition of "market" in most market theories preclude monopoly as a market actor. More important, monopolies violate our practical understanding of markets.^{[notes 4]}

Price, Value, and Monopolies

Most people understand--no economics training required--that monopolies are bad. The "why" of it tends to focus on negative consumer effects. A monopoly is by definition an unchallenged market actor who therefore has unilateral control over prices, distribution, service, innovation, etc. The only market check is the relative necessity of the good or service being offered. I.e., the only question is at what price the demand level might collapse, and the monopoly will provide the least service at the highest price right up to that point.

In practice, this is a part of what we observe. For those of used to competition providing good value, the value provided by monopolies correctly appears relatively expensive. We feel we are being ripped off, and in-so-far as we believe in the promise of free or fair markets, it is true. Monopolies rip us off.

Extra-Market Controls

What's less well understood is the problems the monopoly itself faces. To see these, we have to look outside the market theory, or--depending on your idea of scope--at least consider a very broad theory of markets.

First off, the monopoly's powers are limited by more than the potential for demand curve collapse. It's a bit simplistic, but a useful first approximation to say "where markets end, government begins". The less "well behaved" a monopoly, the more government interference it can expect.^{[notes 5]}

Now, government is no solution, just a factor in the mix. Even the most raging pro-government pick-your-ideology would have a hard time arguing that government has any ability to set fair prices, incentivize innovation, or rationally allocate goods. That's what markets do, it's not what governments do.^{[notes 6]}

Even without dejure government, defacto social forces would have the same (though probably diminished) effects. To be blunt, charge the masses too much for too long and they'll get together and kill the monopoly. Or the monopoly will kill them and--effectively being a parasite at this point--will itself die.

Credibility

In any kind of mature society, the more important problem isn't checks on monopoly, but credibility. The basic idea is this:

Maybe the phone company and customer would be better off if prices were raised $5 a month and customer service became something more than laughable, but customers will rightly accuse the phone company of rent seeking in the face of any raise. Even if the monopoly were to craft some deal with regulators and show without a doubt that the raise was both justified and left the consumer with greater value, there would still be resistance because customers would--again rightly--question whether the phone company shouldn't already be providing that service at the current price.

The problem is that without something like a classic market, there's no justification for anything. Everything is arbitrary and suspect.

This makes monopolies brittle, inflexible, and suspect. This is why monopolies find it hard to grow over the long term and usually (and often quickly) enter into a phase of protracted decline. The end game is usually total reliance of government for protection, or out and out destruction by disruptive technology.

Case Study: AT&T

• traditional business is a relatively clear natural monopoly: the connectivity provided by phones came to be considered (with good cause) a public good, and the cost of laying cable everywhere and creating switches with early 20th century technology was staggering. I suspect that the per-customer cost of creating the phone system was higher than that of the railroads.
• once restrained by regulation, the company is now hampered as technology changes
• competition from cable and wireless internet that it cannot deal with
• phone (physical line) separate from DSL -- crazy from business standpoint, but driven by history and regulation
• wireless and uverse (internet, phone, TV fiber) combined -- far less clear from business standpoint, but possible

Result: calling about DSL problems is mind numbingly terrible. You end up spending hours acting as coordinator between different divisions within AT&T, the result being you're ready to jump ship at thefirst opportunity.

On the flip side, calling to cancel to phone because you're fed up with the company results in a tremendous deal with uverse and no need to coordinate physical and service providers.

Notes

1. ↑ By this I mean society with a mature, relatively strong economy with strong civil institutions, strong respect for laws and government, with effective checks on the excesses of each estate.
2. ↑ Other dejure monopolies may appear from time to time, but these are almost always not so much true monopolies as they are relatively monopolistic. It may be right and proper to pay attention to these as well, but as far as this essay goes, the point is that true classic monopolies, such as we saw with royal patents and exclusive grants like East India Tea Company an the like are exceedingly rare in these societies.
3. ↑ First off, what would "actually true" mean? Many argue that there's no such thing as natural monopoly on two points. First, any good can be considered a public or necessary good, so this metric is meaningless. Second, drawing a bright line around some industries due to some combination of capital vs long term costs and prices is entirely unnecessary. These are valid points which should be given their due, but they argue from a purely market perspective, which is not the view I'm taking. Economics is always cultural and it's pretty clear that society has decided that water and sewage are public goods while Bentleys are not. Over time, society changes it's mind and generally the list of public goods expands, but this is right and proper as far as I'm concerned. I'm not saying that the economists arguing against the idea or wrong. Within their own model, they are right. However, their model lacks the full dimensions of reality, and may at most be useful in some cases, but should never be considered true or final.
4. ↑ The practical understanding of markets is more important because, at the present time we have very little consensus on any workable theory of the markets.
5. ↑ I'm speaking primarily from a democratic theory of government here, though I suspect it's true of non-democratic governments as well. A discussion of the full spectrum of monopoly-government interaction would easily fill volumes on it's own, so I feel more or less compelled to leave it at this embarrassing reduction.
6. ↑ Under normal circumstances of course--though there is good evidence that markets respond and deal with some aspects of some emergencies better than the government as well, though this is a fine point that deals at the margins.