Monopoly and Regulation: Excerpt from Two Lessons book
Here’s another excerpt from my book-in-progress, Economics in Two Lessons. As usual, praise is welcome, useful criticism even more so. You can find a draft of the opening sections here.
In the section over the fold, I’m looking at public ownership.
While the US adopted trustbusting and regulation as solutions to the monopoly power, most other developed countries preferred direct public ownership. This was in part due to the greater popularity of socialist ideas and in part due to the perceived failure of regulated monopolies to deliver adequate outcomes.
By the middle of the 20th century, infrastructure services such as railways, telecommunications, water supply and electricity were provided by public enterprises in most developed countries. These enterprises charged market prices for their services, typically designed to cover the opportunity costs of the resources used in providing the service and a surplus sufficient to cover depreciation and finance new investment. Over time, many of these enterprise were converted to a corporatised form and paid dividends, which provide a source of revenue for governments.
Along with redistributive policies of various kinds, the public ownership of monopoly enterprises contributed to the historically unprecedented reduction in inequality that took place in the decades after 1945, sometimes referred to as ‘The Great Compression’.
Moreover, the period of public ownership was one of substantial expansion of infrastructure networks. Electricity supply, which had previously been patchy and often confined to urban areas, became almost universal. Highway systems expanded greatly, with such developments US Interstate System as the most prominent examples. Telephone systems grew from local services to national and international networks, with steadily declining costs
However, public enterprises were subject to two significant criticisms. First, they were seen as overstaffed and inefficient. Second, although they generated sufficient revenue to cover the opportunity costs of production in aggregate, the prices charged for particular services did not necessarily reflect the opportunity cost of providing those services. There were extensive cross-subsidies, for example between rural and urban users and between households and business.
These criticisms emerged gradually over the post war decades. However, as long as Keynesian macroeconomic policies delivered full employment and continued economic growth, faith in the ability of governments to manage the economy extended to a judgement that the benefits of public enterprise outweighed the costs. Although there were shifts back and forth, with enterprises being nationalised for various reasons, and others privatised (fn: this term was not much used; the prevailing term denationalised reflected the fact that such movements were counter to the general trend) the general trend was towards greater public ownership.
The economic crises of the 1970s, and the failure of Keynesian policies to control them put an end to this. From the 1980s onwards, the trend towards greater public ownership was reversed. Beginning with the Thatcher government in the United Kingdom, public enterprises of all kinds were privatised.
Much of the political appeal of privatisation arose from the appearance of a ‘free lunch’ for governments selling assets. The proceeds of the asset sales could be used to finance current government expenditure, or new investments in desirable infrastructure, without the need to raise taxes or issue debt.
As is usually the case, the appearance of a free lunch was illusory. The opportunity cost of privatising a public asset is the loss of the income flowing to the government from ownership of the asset (dividends or earnings retained and reinvested).
In most of the privatisations undertaken after 1980, assets were underpriced, so that the value realised in the sale was less than the opportunity cost associated with lower future income. Once the sale proceeds were spent, governments were permanently poorer because of the loss of earnings flowing from the now-private enterprises.
Although free-market economists who advocated privatisation were mostly happy to let governments chase the free lunch of revenue from asset sales, their real hope was that, with government enterprisess out of the way, competitive markets would emerge, and that Lesson 1 would once gain be relevant.
Advocates of privatisation produced a range of studies suggesting that the problems of natural monopoly had been overstated and was easily soluble (fn contestability). As a result, they largely ignored the earlier failures of regulation, assuming that regulation would be needed only for a transitional period, until a fully competitive market emerged.
They disregarded concerns about the distribution of income and wealth, believing that the efficiency benefits associated with privatisation would be sufficient to provide lower prices for consumers, higher returns for investors and even some kind of compensation for displaced workers.
Initial evaluations of privatisation were highly positive. The World Bank, in particular, was an influential booster, and continues to promote the idea, though with an increasingly defensive tone.
Over time, however, problems became more evident. The cost savings from firing large numbers of technical workers were partially or completely offset by the expansion of marketing and finance divisions, and by an explosion in the salaries and bonuses paid to a growing number of senior managers, who also required support staff.
Moreover, the promised benefits to consumers often did not arise. Sometimes prices rose instead of falling. In other cases, lower prices were accompanied by reduced quality of services. Other costs have been slower to become apparent. A UN report in 2014 noted that privatisation of education had harmed educational opportunities for women and girls.
On the other hand, privatisation has proved a highly reliable method of enriching those who have managed to secure control of the process. Many of the great fortunes that symbolise the rise of the global “1 per cent”, from those of Russian oligarchs to the world’s richest man, Mexican Carlos Slim, have been derived from privatisation.
These failures have led to a slowing down in the push to privatisation, and even to some reversals. Examples include the renationalisation of the British railway track system and of the entire New Zealand rail network and Australia’s creation of a publicly owned National Broadband Network following the failure of its privatised telecom company to create such a network.
In the end, the choice between public ownership and regulated private monopoly involves the need to strike a balance between different opportunity costs. That balance has shifted over time, partly in response to technological changes and partly as a result of ideological shifts in thinking. Since the 1970s, excessive faith in Lesson 1 has led to a sharp movement away from public ownership, without any clear attempt to assess the balance of costs and benefits. Such a reassessment is long overdue.