Monday, July 29, 2002

Rand-om Numbers

I read another extreme libertarian viewpoint on slashdot about the supremacy of the free market the other day. I believe that the free market is usually the right way to decide things - I would rather this than the dead hand of government subsidies and/or national tariffs in quite a large number of industries. However, in this case the free market argument was the typical 'there is no value in anti-trust law - the free market creates the optimal result and anti-trust law just allows the government to crack down on big businesses to the detriment of the rest of society'.

Now, there's a very good reason for 'anti-trust', 'restraint of trade', call it whatever you will. That reason (there may well be others, please
let me know if you come up with any others) is natural monopolies.

WARNING: Introductory economics lesson follows. If you (a) fear economics, (b) hate economics, or (c) hate economists, feel free to leave the discussion now. I won't be offended (unless it's because you fall into group (c), being an economist of sorts myself.)

A classic natural monopoly exists where there are huge costs to setting up the operation, but extremely minute (or possibly even zero) costs to provide an extra unit of whatever it is you are producing within some reasonable bound. Take, for example, the telephone network in your area. There is some theoretical capacity constraint to the number of calls it can handle, but, once the huge amount spent on keeping the overall network running is spent, the cost to the phone company of providing one extra call is as close to zero as it gets.

This creates a conundrum. Market price in classic economics is achieved at the point where the amount a consumer is willing to pay equals the cost of additional production ('cost' here being an economist's weasel word which includes all opportunity costs, up to and including getting a reasonable return on the money people have invested in this effort). If this was in place for this natural monopoly, however, it would lose money, because the large upfront investment would never be recouped. So, there are a couple of options available to ensure that the natural monopoly remains in place:

  1. A subsidy is provided to enable pricing at this 'marginal cost' to continue without the monopoly losing money. Or at least the government attempts to find this level of subsidy - as there is a strong incentive for the managers of the monopoly to fiddle their stated costs in a way which maximises the money they get.
  2. The natural monopoly raises its prices. People buy fewer units, but do so at a higher price which enables the natural monopoly to break even or make a monopoly profit.

That's fine, and fair enough. However, the trick with a natural monopoly that is established is that no one can compete with it. Do I see anyone setting up a duplicate power grid? Water supply? Complete telephone network including local loop? No - it's too much additional expense given that the incumbent has already spent it.
Now, take that natural monopoly, and leave it in the marketplace with no constraints blocking it from extending into other markets. As the anti-trust types would say, eliminate the rules against vertical integration. What could you see happening?

Well, what if the electricity company bought one electrical goods manufacturer, and then cut off the power to anyone who wasn't using that brand of goods? Crazy, you say. It couldn't happen, you say. And you're right - provided that we have anti-trust restrictions in place. After all, without those restrictions, what would stop it from happening?

OK, that's the extreme version, but it illustrates the point that you can't live without anti-trust legislation in a world where natural monopolies exist. If any of you anti-anti-trust libertarians out there have a problem with this, or a counter-argument you'd just love to launch, drop me a line.