Natural monopoly

My piece on oligopolies gave rise to a lively, and often vituperative, comments thread. As is usually the case, the substantive issues got lost in the name-calling (entertaining though the latter was at times). Attempting to extract some coherent issues from the thread, I focused on two:

  • whether some industries are naturally monopolistic and
  • what, if anything should be the role of competition policy (for historical reasons, this is called ‘antitrust’ in the US).

In this post, I’ll stick to natural monopoly. I think economists have tended to underplay the importance of natural monopoly, particularly in the period of microeconomic reform that began in the 1980s. There are three main factors leading to natural monopoly (or maybe, I like threeway classifications, and have organised a diverse set of factors into three classes).

First, physical economies of scale are important in a lot of different contexts. For a city the size of Brisbane (a million or so people), it makes sense to have just one airport, one major brewery, a handful of major hospitals and so on. For network distribution services (phones, electricity, water supply etc) the same point arises a bit differently. In physical terms, it’s optimal to have only a single distribution network in any given local area. This is pretty obvious, but there were a lot of silly claims in the 1990s based on the fact that since microcomputers had displaced mainframes, it was obvious that technology would in future be small-scale and inherently favorable to competition. The fact that the world’s microcomputer chips were made in a steadily shrinking number of plants costing a billion dollars apiece (and rising) escaped the attention of these gurus.

Second, the economic importance of information is increasing all the time and information is nonrival in consumption – giving information to me doesn’t make it any less available to you. So, the technically efficient procedure is for information to be produced once and shared freely. Again in the 1990s, the slogan ‘information wants to be free’ was repeated a lot. Unlike the idea that new technology is inherently small-scale, this slogan was at least half-right. Once information has been discovered it’s costly and wasteful to keep it secret or restrict its use. But the slogan is also half false. Discovering/producing information in the first place is costly and those who discover/produce it want to be paid in some way.

So far I’ve been talking about information of the “E=MC-squared” type, but another sort of information is equally important or more so in explaining the prevalence of natural monopoly. Human relationships, including long-term economic relationships depend on the beliefs, preferences and intentions of those involved, and these are hard to discover. I can discover my own intentions and beliefs by introspection and I can infer those of other people from observation and experience – the human capacity for self-deceptions means that the latter kind of information is sometimes more reliable than the former.

As a trivial example, when I write a column for the Financial Review, the opinion editor expects that I will check my facts before I submit the column – (I flagged my uncertainty about the authorship of the airlines cartoon I cited recently, but as it turned out I should have asked on my blog first). For some columnists and some papers, this isn’t a problem of course, but for papers that aspire to accuracy, it’s easier to rely on contributors who are known to be reliable than to take on new writers who may require more careful checking. This kind of problem arises in all kinds of employment and contractual relationships.

As Ronald Coase pointed out over 60 years ago, it is the transactions costs associated with this kind of information that explain why so much economic activity is arranged through firms and other organisations (governments, households, clubs, and now Internet-based virtual communities) rather than through markets. If it were not for transactions costs, even physical economies of scale would not produce monopoly, since the same asset could be shared by an arbitrarily large number of firms.

I’m going to leave the question of competition policy for another post, but I’ll observe that one factual implication of the arguments above is that competition policy makes a difference. If it were not for restrictions on mergers and for the tight regulation to which monopolies are often subject, a lot of industries that are currently oligopolies (dominated by a few firms) would be monopolies.

War reading

As I said a few days ago, I’ve decided to stop posting on the war for the moment – I can’t see anything good coming out of it, or propose anything that is likely to produce a better outcome. But, as usual, I agree with nearly everything Tim Dunlop has written.

Carr wins again

Although it took place eons ago in blogtime, I haven’t got around to commenting on last weekend’s New South Wales state election until now. The result is a striking one, giving another landslide victory to a government that’s looked pretty tired at times in the last few years. It seems to me that Labor has become the natural party of government at the State level in Australia, simply because people want more public expenditure and services and don’t think the Liberals will deliver them. The fact that the Federal government raises most of the revenue while the states do most of the spending (and that most voters aren’t really aware of this) means that this factor isn’t as significant at the Federal level. Even so, without Tampa and other foreign policy crises, the Howard government would almost certainly have lost in 2001.

In quite a few recent state elections, the combined Liberal-National vote has been near, and sometimes below, 33 per cent. This is a critical value in a preferential system (for overseas readers, this is the same as an instant runoff). As long as a party can hold its vote above 33 per cent, it is guaranteed of finishing first or second in the primary vote, and cannot be displaced by a third party. Below 33 per cent, and the possibility of a wholesale loss of seats to a new party becomes real. This happened with Pauline Hanson’s One Nation in Queensland in 1998, but the fortunate implosion of Hanson’s party gave the Coalition another chance.

As an aside, the other crucial figure in relation to three party contests is 25 per cent. If you have less than 25 per cent of the ‘three-party preferred vote’ you can’t win. Either you finish third and are eliminated, or you finish second, but the first-placed party already has more than 50 per cent.

Thought for Thursday

My AFR piece today subscription required is about oligopolies (industries with a few dominant firms) and why they can be such a pain to deal with. It was prompted by a particularly painful experience with one of the major banks, and begins

Although the two airlines policy was the subject of many analytical studies, it was perhaps best summed up by a cartoon that ran in the 1980s (as I recall it was by Pryor in the Canberra Times). An employee of one of the duopolists, dealing with an irate customer, is on the phone to his opposite number at the ‘competing’ airline, saying: ‘Bloke here says he’s going to take his business elsewhere – you take care of him will you, Macca?’.
In the language of academic political theory, the irate customer was trying to exercise both ‘voice’ and ‘exit’ and failing in both endeavours.

It’s a real longshot, but if any readers remember the cartoon and can point me to the original, I’d be very grateful.

Update Loads of fun in the comments section, especially for those with an ANU connection.

Stupidity is always with us

In sad times, there are always those who provide us with innocent diversion. Here’s the full text of a letter from one of our elected representatives to the Financial Review (subscription required

French are inherently treacherous

I agree with Gregory Viscusi (“US attacks on France ignore the facts”, AFR, March 25), that it is probably disingenuous to say France is against the war on Iraq purely on commercial grounds. After all, the French are inherently treacherous.

They betrayed Joan of Arc one of their greatest, who liberated France to the stake, and obviously they have not changed since 1431.

Julian McGauran ,

Senator, National Party, Victoria.

Ain't gonna study war no more

I’ve decided not to post anything more about the war for the moment. I can see nothing but disaster ahead – huge Iraqi casualties, both military and civilian, then a long and bitter occupation, with the likelihood of substantial Coalition losses over time in subsequent ‘counter-terrorist’ actions.

Unfortunately, I also can’t see any way of averting this outcome. A withdrawal, leading to victory for Saddam, would be an even greater disaster than what can only be a Pyrrhic victory for the Coalition. If there is some sort of possible compromise, I have no idea what it is.

Life, and especially war, is unpredictable. Perhaps things will take a sudden turn for the better. I hope for a quick end to war and bloodshed, even though I see no reason to expect it.

Every day, another falsehood

My observation that “One of the most striking features of the war so far has been the fact that, on a wide range of issues, Iraqi official statements have been a more reliable source of information than those of the US and allied governments” drew some derision from my friendly nemesis, Jason Soon, though he did not give any counterarguments. Following the same line, Catallaxy contributors Heath Gibson and Jack Strocchi reproduced as fact British reports of an uprising in Basra, despite denials not only from Iraqi officials but from the much more credible Al-Jazeera. The same reports predicted an imminent British assault in support of the rising.

A day later, the British defence minister, Geoff Hoon is quoted as saying the situation is ‘unclear’, and there has been no move to assist the putative rising with ground troops, as opposed to shelling. Either the Shias have been left in the lurch yet again or, as seems more likely, the original reports were bogus, just like:

The crowds cheering the liberation of Safwan
The Scud attacks on Kuwait
Saddam’s death
The effortless victory at Umm Qasr
The effortless victory at Nasariyah
The chemical weapons factory at Al Najaf
The surrender of entire Iraqi divisions
The 8000 prisoners taken in the first two days

This would be bad enough if these falsehoods were the product of deliberate propaganda aimed at shoring up public support. The worst of it is that the Coalition leaders believe them and act on them, producing yet more disasters.

And as I write this comes the news of a Coalition hit on a crowded market in Baghdad – shades of Sarajevo.