Monday, August 3, 2009

Natural Monopolies, Part 1

It is frequently argued that certain services--particularly utilities--are "natural monopolies", which Wikipedia explains as:

In economics, a natural monopoly occurs when, due to the economies of scale of a particular industry, the maximum efficiency of production and distribution is realized through a single supplier.

Natural monopolies arise where the largest supplier in an industry, often the first supplier in a market, has an overwhelming cost advantage over other actual or potential competitors. This tends to be the case in industries where capital costs predominate, creating economies of scale which are large in relation to the size of the market, and hence high barriers to entry; examples include water services and electricity. [links removed]

This argument has plausibility, until one actually looks at reality. It is founded on economic fallacies and moral perversions.

Certainly it is true that many of the services considered "natural monopolies" require substantial investment in infrastructure. But so do many industries, such as Internet service providers, television, and retail chains. Yet, despite the investment required to launch a new business or expand one's market, each of these industries has an abundance of competition.

The fact is, the investment required is seldom an impediment to providing a service or starting a new business that has the potential to make investors a lot of money. The capital markets--whose purpose is to identify promising business ideas--will gladly direct the necessary financing to any business that is judged to offer profits. A cursory examination of the Wall Street Journal demonstrates this fact almost daily.

There may be instances in which only one business provides a particular service in a specific geographic area--a small town that can only support one drug store is a common example. However, the threat of future competition acts as a regulator on what that business will charge. If it attempts to raise prices to an outrageous level, it will attract competitors. The same holds true of any product or service.

Economically, the “natural monopoly” argument amounts to: Since it costs a lot to build the necessary infrastructure in an industry, government will do everyone a favor and prohibit anyone from even trying. In short, government knows what is best. Rather than allow anyone to be innovative and act on his own judgment, government will declare the issue resolved once and for all.

If this is true of “natural monopolies”, why isn’t it true of other industries? If government can decree that some services are best provided by one entity, then what is to stop government from making a similar decree regarding all industries? The principle of economies of scale is not limited to power lines or water mains.

The enormous material prosperity enjoyed by Americans is the result of freedom—of men acting without interference from others. Thirty years ago, innovations like satellite television and cellular phones were unknown. Had the government decreed the infrastructure requirements for these industries to be too expensive, we would not enjoy the choices we have today.

The economic fallacies underlying the “natural monopoly” argument are not the most important reason for opposing government intervention. Tomorrow I will look at the moral premises that serve as the foundation for these violations of rights.

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