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.

24 thoughts on “Monopoly and Regulation: Excerpt from Two Lessons book

  1. Was there really a trend to public ownership up to ca. 1980? In the UK and France, there was a wave of nationalusation right after 1945, then not much change up to Thatcher. France even nationalised the big banks; I think this was undone before her arrival in Downing Street.

    You might give some credit to Thatcher’s electricity privatisation, the one she got right. The key thing here was to leave the technical monopoly of the grid alone, split it from generation, and privatise the latter in such a way as to increase competition. This was copied in Texas and other places, notably China and India. It’s hard to imagine the great Indian solar boom without the electricity market reform.

    JQ leaves out innovation. The great failure of Soviet central planning was not an imaginary failure to solve the Hayek coordination problem – the system had a high waste overhead, but it ran – but the very real one of lack of incentives to improve. Market systems really do have a much better record here.

    The failure of the Australian telcos on broadband is an outlier. France is more typical. The monopoly France Telecom developed and rolled out the revolutionary Minitel system long before the Internet got going – but failed to improve it, and lost a golden opportunity. The elite learned the lesson. France now has excellent broadband, supplied competitively.

  2. A key argument for public provision is that regulating monopolies is tough. Pricing at MC or AC provides adverse effects on innovation etc. Public enterprises on the other hand became subject to the tyranny of sweetheart deals with unions. Governments are weak. The unions became rent-seekers just as the owners would with privatized firms. What you want are smart public utilities with the unions being brought to heel.

  3. Interested to know that, after a decade of contributing to this blog, my comments are sometimes still being “moderated”.

  4. Great work as usual John. Look at Mike Baird and his rampant privitisations and his corporate mates (crony capitalism writ large). Electricity sell offs to get a higher price (and to fund sports stadiums). Once sold off renewable energy is crimped. Also look at John Howard’s disastrous sell off Sydney Airport and the resulting price gouging and terrible service. Now with the first right of refusal for Badgerys Creek Airport we have a standoff. The lawyers will do well from this one.

  5. @hc

    I have no control over the whims of the WordPress moderation algorithm. You’re not on automoderation, which I do control.

  6. @John Quiggin Your “public sector” is doing a great deal of work in the invention of the Internet. What it wasn’t was the creation of large public-sector monopolies like France Télécom. The key players, as is well known were:
    – the Pentagon’s DARPA;
    – the American university laboratories funded by the Pentagon for non-sensitive research, on the correct theory that a strong, open and decentralised fundamental research base was key to America’s winning the Cold War (see Kennan);
    – in the later creationof the Web, CERN, the European fundamental research organization for particle physics largely buried under Geneva. CERN was very lucky in its choice of IT managers, Caillaux and Berners-Lee. HTML was only partly an accident: CERN’s research community was all over the place; the cost of the equipment imposes large collaborating teams; the massive data files are often images as well as text.

    The Internet is still largely run as an anarchist cooptative meritocracy, not a classic bureaucracy of any form. So far, the engineers have held off attempts to bring it under a normal intergovernmemental organization. Have you seen the ITU’s choice of an email address protocol, X-400?

    These instances of the defence / science research complex are parts of the “public sector” that would have been recognizable to Rudolf II of Bohemia and the British instigators of the Longitude Prize. They are irrelevant to the narrower question of nationalization and privatization of utilities and manufacturing industry.

  7. hc :
    Public enterprises on the other hand became subject to the tyranny of sweetheart deals with unions. Governments are weak. The unions became rent-seekers just as the owners would with privatized firms. What you want are smart public utilities with the unions being brought to heel.

    Its not clear to me why it was a bad thing that workers, through their union, received a greater share of the public firm’s revenue, if that is what happened. And often the non-union workers received the benefits of union negotiations anyway.

    I was grimly amused at how Turnbull and Co. were complaining about the increase in wages going to construction workers as one reason for the need for the Australian Building and Construction Commission – as if once workers get a good increase in income its time to bring in the attack dogs. But of course no such action when firm managers give themselves million dollar plus incomes.

    The declining share of firm revenue going to workers, with an increasing slice going to the 1%, seems to me to be placing a significant drag on the economy, as well as being morally dubious.

    Why shouldn’t a firm’s financial flows go increasingly to those that actually do the work?

  8. Hi John I tend to place you in a centre of politics as you tend to point out the faults of both the extreme left an d also the extreme right … Any extremes are bad as too much unionism is not good however too much Palmerism is also bad for good economy …

    No one took a Soviet dissident named Andrei Amalrik seriously in 1969 when he wrote an essay called “Will the Soviet Union Survive Until 1984?” Andrei was out by 5 years … Ullike most observers, Andrei was well aware of the saying that there are two things that rise to the top cream and s**** Class Of ‘1938 gave Russians many s**** idiots like Leonid Brezhnev …

    Leonid Brezhnev wasn’t the brightest man. Brezhnev also wasn’t much of a Communist: he collected cars and jewelry, chased girls, and generally partied hard. A Soviet joke of that era has Brezhnev’s mother surveying all of his luxuries with a worried eye, and when her son asks what’s wrong, she says: “Leonid, this is all very nice, but what will you do if the Communists come back?”

    Economists often forget that culture will eat any economic strategies for breakfast (as Warren Bufffett loves to remind us that he was not mentored by Stalin’s Class of 1938 that was full of impotent and incompetent leaders)

    One of the shortest yet most thought provoking article about public versus private was set in stone by Christopher Stone …
    Misunderstanding efficiency not only biases some towards outsourcing or privatisation, it can also cause those who support the public provision of a service, to argue against efficiency or argue it is not important. This is a mistake as pursuing efficiency is critical tool in achieving any aim. Given the scale and significance of the work that the public sector undertakes, it’s clearly important to have it operate efficiently. Allowing mistaken notions of efficiency to drive policy will result in “efficiency reforms” that actually increase waste

    PS: A Satire Story re Privatising Parliaments

  9. These instances of the defence / science research complex are parts of the “public sector” that would have been recognizable to Rudolf II of Bohemia and the British instigators of the Longitude Prize. They are irrelevant to the narrower question of nationalization and privatization of utilities and manufacturing industry.

    The allusion to Rudolf of Bohemia escapes me, but I’ll certainly be talking about the Longitude Prize as an alternative to private sector monopolies for rewarding innovation.

    As regards relevance, your claim was “Market systems really do have a much better record here.” I pointed out that the market, and competition had nothing to do with it, and that the public sector was responsible. Your rejoinder if I read it correctly is a variant on “No True Scotsman”, that this is “not the true public sector”. Even granting this, how do you go from “not done by a public monopoly” to “done by the market”?

  10. @John Quiggin
    Can you really put Brezhnev and Pinochet in the same box?Brezhnev inherited an existing system, probably much worse than what he ran it as. Pinochet was instrumental in initiating a new system of repression after murdering a democratically elected president and overthrowing his govt. Seriously, Pinochet deserved to go to jail for his crimes but got away as usual, just like GWBush, Tony Blair, and John Howard. Such is life! (apologies to Ned Kelly)

  11. @John Quiggin
    You are writing about public vs. private ownership of industrial, utility and service businesses. My claim is that public ownership of these does not on balance have a good record on innovation. The counter-examples here are things like high-speed trains (Japan Railways and SNCF), not the Internet and Longitude Prize. The Minitel is a interesting case of a radical innovation generated and deployed at scale by a state monopoly telco, which nonetheless failed because the standard and procurement were closed, unlike IBM’s PC, and did not evolve at the pace allowed by the underlying technology. These few cases clearly do not outweigh say the computer and mobile communications industry, or the early British Industrial Revolution in textiles.

    Nobody here, let alone me, is arguing that for-profit business can substitute for the public and nonprofit private sector. in fundamental research. (Universities are still self-governing mediaeval guild corporations operating under state charters that don’t make them anything like limited liability companies.) Bell Labs was a freakish exercise in monopoliste oblige. The case for heavy public involvement is almost as strong in applied research, as with MITI and Fraunhofer, and much earlier with the promotion of better weapons by armies and navies. These have all worked through complex partnerships of a state funder with usually competitive capitalist firms.

  12. @John Quiggin
    PS: Rudolf II was keen on alchemy and funded a large-scale research effort, the ITER of its day. The wider alchemy project did not work in narrow terms (turning lead into gold, the philosopher’s stone). It did generate a large amount of practical chemical knowledge, which fed into modern chemistry, after more false starts like phlogiston.

  13. “The Minitel is a interesting case of a radical innovation generated and deployed at scale by a state monopoly telco, which nonetheless failed […]”

    It didn’t fail. It became obsolete. Like compact discs and cassettes and fixed-line telephones and a million other private and public sector innovations from the 20C. Whatever happened to IBM’s Satellite Business Systems?

  14. @James Wimberley

    I’m now lost as to what you are claiming.

    The topic is natural monopoly infrastructure industries, and whether they should be public or private. You claim (I think) that private monopolies are more innovative, but your only example is that of the Internet where the innovations of public infrastructure monopolies (not just Minitel, but the British Teletext) were eventually superseded by the publicly developed Internet. This appears to be evidence against your position

    Then you suddenly switch to the personal computer industry. Leaving aside the fact that computers were originally a public sector invention, this industry isn’t infrastructure, and has never had a significant public sector presence.

    So, maybe you should restate your claim in general terms, and then give an example that fits it.

    SO, can

  15. “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.”

    I am not convinced the suggested policy dichotomy between the USA approach and ‘most other developed countries’ is watertight.

    During the period in question, Denmark and the Netherland were unambiguously part of the group of countries often referred to as ‘developed’. However, these 2 countries differ from the USA in several ways. Denmark and the Netherlands are geographically small countries and with small populations relative to the USA. In contrast to the USA, their head of state is a royal. While both have a long history of social-democratic policies, ‘socialist’ ideas don’t seem to be a characteristic of these countries.

    I am suggesting the size of a country (in terms of land and population), relative to the USA, as well as the institutional history are possible alternative explanations for the stated differences in the policy approaches to natural monopolies.

    France, still a relatively small country in comparison with the USA, has a long history of centralised administration. Maps of major roads and major railway lines reflects this history; all land based longer distance travel goes via Paris. To the best of my knowledge, socialist ideas are more widespread in the south than in the north. I understand public ownership of railways is in the constitution. (This did not prevent innovation. But isn’t their competition involving national pride? We want to do better than our neighbour, and, luckily, we have longer distances between major cities than our neighbours, etc, etc, …. until one realises that the profit motive isn’t the only possible competitive force.)

    Then there is Argentina.

    And so forth.

  16. @John Quiggin
    “The topic is natural monopoly infrastructure industries..” Is it? Earlier you state that these include electricity and telecommunications. The extent to which these are natural monopolies varies, and is decreasing.

    The natural monopoly component of electricity is the grid: you don’t want or need two sets of wires, and it’s positively bad to have multiple voltages and unsynchronised AC frequencies. As Thatcher showed, it is perfectly possible, and generally desirable (see Texas and India) to combine this with competitive generation, the grid becoming a common carrier and market enabler. The thorniest current regulatory problem is the fair access of millions of solar rooftop owners to the grid as generators as well as consumers. Nobody wants or needs innovation in the product, so innovation has to all about generation and marketing.

    Telecoms are more complicated. The only natural monopoly here is the last mile of wire into houses and workplaces, and even there multiple wires (phone plus cable) are quite common. The old silo telco monopolies, public or private, are a thing of the past. There is little point in debating whether ATT or France Télécom was more innovative in their heyday.

    Semi-competitive oligopolistic markets in telecoms are possible, and have become the norm. The high technical demands and capital requirements, need for common standards, and policing of access to shared resources, mean that these markets are artificial and need a strong and vigilant regulator. The same holds of mobile telecoms: there is a somewhat scarce public good (spectrum), which can be shared out among competing oligopolies. The need to build comprehensive networks of base stations limits the number that can operate profitably. SFIK no country of any size has a monopoly mobile operator, and it’s surely rare to have more than half-a-dozen.

    The new regulated oligopolistic telecom markets, fixed and mobile, have shown a very high rate of innovation, much higher than the silo monopolies that preceded them. Surely this is not controversial. One example is the arrival of cheap live video communication. Soviet Russia had a handful of public videophones in the 1930s, but it was not developed. Now we Skype across the world – I have family in Korea and New Zealand – and the cost is included in my monthly ISP subscription in Spain. Another innovation is mobile payments in Africa, initially developed bythe Commonwealth Secretariat in London and taken up by a large mobile telco in Kenya, Vodsafone’s subsidiary Safaricom. These are both major changes. I could go on.

    Clearly water supply does not lend itself to competition. There is hardly any innovation, and does not need to be. On paper, and even in practice, it is possible for competing train operators to run on the natural-monopoly rail network, as competing airlines use the skies and airports. The experience of the UK does not suggest that this offers significant benefits in quality or cost of service. There is a little more innovation in the sector than in water supply, but not much – the high-speed rail concept was fully worked out in Japan in the 1960s.

    Is the Internet a piece of infrastructure at all? Physically, it isn’t. Its substrate is the wired telco phone and optical cable network, and a large number of servers (specialised computers) owned by a miscellany of providers connected to it. Its defining asset is a common addressing system and communications protocol (TCP/IP). It does not fit into your historical categories of monopoly at all. I suggest treating it as a sui generis common global asset, like the system of international law.

  17. OK, the above was more of a digression than ananswer to JQ n innovation. I’ll try to summarize. I’ll leave his list of sectors for now, arguendo – rail, water, electricity, telecoms.
    1. Public-sector monopolies don’t have a good record on innovation. This is also a problem in manufacturing.
    2.. Private-sector monopolies don’t innovate much either. So under monopoly, neither nationalisation nor privatisation will help.
    3. In the two sectors where innovation has been available (electricity and telecoms), privatisation plus competition has raised innovation where it’s been done right.
    4. Getting the regulation of this right is fiendishly difficult. It worked in electricity in Texas but not California. France has much better and cheaper broadband than most of the USA or Australia. Utility solar in sunny Australia is twice the price they get in cloudy Denmark, with identical technology.
    5. Would competition without privatisation work too? We don’t know because it’s not been tried much, and most of the examples are historical (municipal socialism in late Victorian England). US electricity cooperatives are numerous in the Midwest but are timid and have largely been captured by capitalist large utilities. However, in Germany village cooperatives have been active and successful in renewable energy, until the recent “reforms” favouring large capitalist corporations at their expense, eg replacing FITs with auctions. Decentralised public-sector research through universities, and in Germany through cooperation with industry associations (Fraunhofer), works fine.

    Another aside, not controversial here I think: the system of promoting innovation through artificial IP private monopolies used in pharmaceuticals is running out of steam and is being heavily gamed though me-too reformulations. Free IP (open access, as with the Internet protocols, penicillin, and Barry Marshall’s helicobacter pylori discovery) and big prizes are promising alternatives.

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