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Privatising monopolies

November 22, 2010

The ALP is in the process of re-creating a government communications monopoly — NBN Co. They had originally promised that it would only be a government business for five years, but now the Greens have succeeded in watering that down so that any future government will just consider the possibility of some day having an inquiry into privatisation. In other words, it looks like the government NBN monopoly is here for the long term.

The case for government monopoly is a fairly mainstream argument. The broadband network has an element of “natural monopoly” due to the high costs of the original infrastructure. It is debatable how much of a natural monopoly the communication infrastructure is since it is easily possible to duplicate and there are other substitutes… but putting that aside it is worth addressing the difficult idea of how we should best deal with monopolies.

In this case, the first place to look is the late great Milton Friedman. The following is a short video on monopoly, where Friedman points out that most instances of monopoly come from government protection, and are not “natural” monopolies:

While it is hard to think of real cases of natural monopolies, there remains the question of how we should deal with them if they do exist. This is the answer Friedman gave 37 years ago in an interview with playboy magazine:

PLAYBOY: How do you feel about private monopolies? Should they be either broken up or closely regulated by the government?

FRIEDMAN: The problem in this kind of discussion is making a distinction between the real world and the ideal world. For an ideal free market, you want a large number of producers. For an ideal government, you want a saint. In the absence of both, you have three choices: unregulated private monopoly, private monopoly regulated by government and government monopoly. All three are bad, but, in my opinion, the best of the bad lot is unregulated private monopoly. The ICC and the railroads provide a good example of regulated private monopoly; the Postal Service is a good example of public monopoly. Those aren’t really appealing cases.

To expand on Friedman’s point, the cost of an unregulated private monopoly is that they keep the price higher than it would be in a perfectly competitive market. But the advantage is that they use their resources effectively and they are more likely to make the necessary investments in infrastructure. And the price premium can often be over-stated, because there is often some sort of indirect competition. For example, rainwater and an occasional water delivery provides competition to piped water (this is how my family lived for many years on the Sunshine Coast hinterland). The Brisbane airport does have competition from the Gold Coast (and increasingly the Sunshine Coast).

A public monopoly uses their resources badly, often make poor decisions regarding future infrastructure, and their pricing is set by political whim and so could be anything, depending on the price of tea in china. Indeed, the price mistake in a public monopoly (generally too low, subsidised by taxpayers) can often by larger than the price mistake in a private monopoly, leading to a significant waste of resources. This takes away any potential benefit from government ownership.

A regulated private monopoly is an improvement over a public monopoly because they use their resources more effectively and don’t under-price their product… but the problem here comes from the potential for the regulators to set the price too low. Regulators have political pressures to control prices, but if they set the price too low then they create an incentive for the private monopoly to under-invest in infrastructure. This works fine for a few years, until we get water shortages and brown-outs.

This is exactly what happened in the semi-privatised electricity system in California. The government introduced some private companies, but set up a maze of regulations that effectively ensured a lack of investment… leading to brown-outs. The fault belonged to the government, but the blame was often placed at the feet of private sector.

To quote Thomas Sowell:

“As an economist, whenever I hear the word “shortage” I wait for the other shoe to drop. That other shoe is usually “price control.” So it was no great surprise to discover, after the electric power shortage in California made headlines, that there were price controls holding down the price of electricity to the consumers.

“In the absence of price control, a shortage is usually a passing thing. When prices are free to rise, that causes consumers to buy less and producers to produce more, eliminating the shortage. But when the price is artificially prevented from rising, the shortage is prevented from ending.”

In short, while it is true that competition is often preferable to monopoly, that does not mean that the government should necessarily get involved to own or regulate monopolies. My reason is not that I have perfect faith in the private sector. I don’t. They will make mistakes. My reason is that I have realistic expectations of politicians and bureaucrats. Contrary to what the left will have us believe, politicians are not angels and bureaucrats are not omnipotent. Public choice theory tells us that politicians will tend to do whatever is convenient, easy and populist and that bureaucrats will tend to be “captured” by special interest groups. In contrast, the profit motive of business might not be so bad.
Categories: Economics
  1. TerjeP
    November 22, 2010 at 7:31 am

    Nicely put.

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