Sunday, May 15, 2011

The Myth of Natural Monopoly: Why Your Utilities Are So High

Mises:

Six electric light companies were organized in the one year of 1887 in New York City. Forty-five electric light enterprises had the legal right to operate in Chicago in 1907. Prior to 1895, Duluth, Minnesota, was served by five electric lighting companies, and Scranton, Pennsylvania, had four in 1906. … During the latter part of the 19th century, competition was the usual situation in the gas industry in this country. Before 1884, six competing companies were operating in New York City … competition was common and especially persistent in the telephone industry … Baltimore, Chicago, Cleveland, Columbus, Detroit, Kansas City, Minneapolis, Philadelphia, Pittsburgh, and St. Louis, among the larger cities, had at least two telephone services in 1905.
[...]The history of the Gas Light Company of Baltimore is that, from its founding in 1816, it constantly struggled with new competitors. Its response was not only to try to compete in the marketplace, but also to lobby the state and local government authorities to refrain from granting corporate charters to its competitors. The company operated with economies of scale, but that did not prevent numerous competitors from cropping up.

[...]In 1880 there were three competing gas companies in Baltimore who fiercely competed with one another. They tried to merge and operate as a monopolist in 1888, but a new competitor foiled their plans: "Thomas Aha Edison introduced the electric light which threatened the existence of all gas companies."[21] From that point on there was competition between both gas and electric companies, all of which incurred heavy fixed costs which led to economies of scale. Nevertheless, no free-market or "natural" monopoly ever materialized.

When monopoly did appear, it was solely because of government intervention. For example, in 1890 a bill was introduced into the Maryland legislature that "called for an annual payment to the city from the Consolidated [Gas Company] of $10,000 a year and 3 percent of all dividends declared in return for the privilege of enjoying a 25-year monopoly.[22] This is the now-familiar approach of government officials colluding with industry executives to establish a monopoly that will gouge the consumers, and then sharing the loot with the politicians in the form of franchise fees and taxes on monopoly revenues. This approach is especially pervasive today in the cable TV industry.

[...]More recent economic research supports Gray's analysis. In one of the first statistical studies of the effects of rate regulation in the electric utilities industry, published in 1962, George Stigler and Claire Friedland found no significant differences in prices and profits of utilities with and without regulatory commissions from 1917 to 1932.[30] Early rate regulators did not benefit the consumer, but were rather "captured" by the industry, as happened in so many other industries, from trucking to airlines to cable television. It is noteworthy — but not very laudable — that it took economists almost 50 years to begin studying the actual, as opposed to the theoretical, effects of rate regulation.
[...]Sixteen years after the Stigler-Friedland study, Gregg Jarrell observed that 25 states substituted state for municipal regulation of electric power ratemaking between 1912 and 1917, the effects of which were to raise prices by 46 percent and profits by 38 percent, while reducing the level of output by 23 percent.
[...]Economist Walter J. Primeaux has studied electric utility competition for more than 20 years. In his 1986 book, Direct Utility Competition: The Natural Monopoly Myth, he concludes that in those cities where there is direct competition in the electric utility industries:
  • Direct rivalry between two competing firms has existed for very long periods of time — for over 80 years in some cities;
  • The rival electric utilities compete vigorously through prices and services;
  • Customers have gained substantial benefits from the competition, compared to cities were there are electric utility monopolies;
  • Contrary to natural-monopoly theory, costs are actually lower where there are two firms operating;
  • Contrary to natural-monopoly theory, there is no more excess capacity under competition than under monopoly in the electric utility industry;
  • The theory of natural monopoly fails on every count: competition exists, price wars are not "serious," there is better consumer service and lower prices with competition, competition persists for very long periods of time, and consumers themselves prefer competition to regulated monopoly; and
  • Any consumer satisfaction problems caused by dual power lines are considered by consumers to be less significant than the benefits from competition.[42]
[...]When the TVAwas faced with competition from Duke Power in 1988, it managed to hold its rates steady without an increase for the next several years.

The potential benefits to the US economy from demonopolization of the electric utility industry are enormous. Competition will initially save consumers at least $40 billion per year, according to utility economist Robert Michaels.[45] It will also spawn the development of new technologies that will be economical to develop because of lower energy costs. For example, "automakers and other metal benders would make much more intensive use of laser cutting tools and laser welding machines, both of which are electron guzzlers.[46]

[...]Like electricity, there are dozens of cities in the United States where there are competing cable firms. "Direct competition … currently occurs in at least three dozen jurisdictions nationally."

[...]Also like the case of electric power, researchers have found that in those cities where there are competing cable companies prices are about 23 percent below those of monopolistic cable operators.

[...]In Presque Isle, Maine, when the city government invited competition, the incumbent firm quickly upgraded its service from only 12 to 54 channels.[51]

[...]The city was forced to adopt a competitive cable policy, the result of which was that the incumbent cable operator, Scripps Howard, dropped its monthly price from $14.50 to $10 to meet a competitor's price. The company also offered free installation and three months free service in every area where it had competition.

[...]As former FCC chief economist Thomas Hazlett, who is perhaps the nation's foremost authority on the economics of the cable TV industry, has concluded, "we may characterize the franchising process as nakedly inefficient from a welfare perspective, although it does produce benefits for municipal franchiser."[53] The barrier to entry in the cable TV industry is not economies of scale, but the political price-fixing conspiracy that exists between local politicians and cable operators.

[...]Once AT&T's initial patents expired in 1893, dozens of competitors sprung up. "By the end of 1894 over 80 new independent competitors had already grabbed 5 percent of total market share … after the turn of the century, over 3,000 competitors existed.[55] In some states there were over 200 telephone companies operating simultaneously. By 1907, AT&T's competitors had captured 51 percent of the telephone market and prices were being driven sharply down by the competition. Moreover, there was no evidence of economies of scale, and entry barriers were obviously almost nonexistent, contrary to the standard account of the theory of natural monopoly as applied to the telephone industry.

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