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Hank Sedan

Natural Monopoly redux

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There has been a little discussion of the objectivist view on natural monopolies, but I haven’t seen any answers which fairly square up to the problem, so I’ll re-ask the question: Why should or shouldn’t the government regulate a natural monopoly?

It’s important to understand, first off, what is meant by natural monopoly because there is often confusion over this. A natural monopoly does not exist merely because initial investment costs are high, though this is a central feature of a natural monopoly. Additionally, a natural monopoly does not exist merely because a duplication of infrastructure is messy. And lastly, though there have been industries wrongly treated as natural monopolies, this does not preclude the existence of natural monopolies.

A natural monopoly situation exists where initial investment costs (fixed costs) are high, but after that it is very cheap to add new customers, to provided more and more of a product. I’ll use as an example a company that transports natural gas across long distances. It’s very expensive to acquire tracts of land and lay down miles of 48” pipelines, but once those investments are made operating costs are fairly low. That is, relative to the initial cost, delivering a high volume of gas is not that much more expansive than the delivering a low volume; the cost of servicing 10 customers is not much different than the cost of servicing 100 customers. In this situation, costs are typically recovered over a long period of time, often decades. The problem in this situation is the market naturally does not support more than one provider. In a true natural monopoly it is economically irrational (unprofitable) for a competitor to enter the market.

Here's explanation, which can be skipped if all the above makes sense:

Say Company AA invests a billion dollars into a pipeline, with plans to cover those costs over a ten or twenty year period. Assume Company BB has the same technology/efficiency as AA. It doesn’t make sense for them to come in and duplicate this infrastructure, because they would have to split the customer base with AA. Were BB to enter the market, it is likely that neither AA nor BB would be able to make a profit. Now, perhaps BB has a much more efficient way of doing something. (And keep in mind that it can’t be just slightly more efficient, it has to be significantly cheaper.) Often in a natural monopoly context, if a competitor does enter the market the earlier company, in order to keep its turf, often undercuts the new competitor, taking temporary losses but only until the competitor goes bankrupt, then ratcheting up prices again when there is no more competition. (Some forms of price regulation exist to restrict this undercutting and permit entry of new competitors, particularly when technology is changing.)

With all that said, my question again is: Do objectivists believe that it is wrong for the government to regulate pricing in this context? Why?

I really hope to get an answer that squarely works within the parameters of a natural monopoly context. Meaning, please do not say “there are always alternatives,” or “no one needs natural gas” or “government regulation of pricing is inherently wrong.” This is skirting the question.

Just to be clear, not everything is a natural monopoly. Often something gets labelled a natural monopoly when it isn’t one. A company that wants to build and sell cruise ships requires enormous resources at the outset, but no one would call this a natural monopoly context. People used to think air travel was a natural monopoly, but this turned out to be wrong; regulating airlines was only for the benefit of the airlines, the regulators, and perhaps some politicians. Still, there are instances where it is simply economically irrational for more than one company to enter the market. The result of this is a natural monopoly, and it isn’t a government creation. Rather it is a complex implication of economic laws operating in the real world.

My understanding is that Objectivism doesn’t posit that government regulation is simply inherently wrong; rather, it’s that government interference in the market is a fundamental deprivation to individuals because competition in a free market is the medium through which individual self-realization is possible. But if the market will not support competition, I don’t understand how regulation could be wrong.

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With all that said, my question again is: Do objectivists believe that it is wrong for the government to regulate pricing in this context? Why?

This thread covers that question- utilities is used as an example of a natural monopoly.

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There has been a little discussion of the objectivist view on natural monopolies, but I haven’t seen any answers which fairly square up to the problem, so I’ll re-ask the question: Why should or shouldn’t the government regulate a natural monopoly?

It’s important to understand, first off, what is meant by natural monopoly because there is often confusion over this. A natural monopoly does not exist merely because initial investment costs are high, though this is a central feature of a natural monopoly. Additionally, a natural monopoly does not exist merely because a duplication of infrastructure is messy. And lastly, though there have been industries wrongly treated as natural monopolies, this does not preclude the existence of natural monopolies.

A natural monopoly situation exists where initial investment costs (fixed costs) are high, but after that it is very cheap to add new customers, to provided more and more of a product. I’ll use as an example a company that transports natural gas across long distances. It’s very expensive to acquire tracts of land and lay down miles of 48” pipelines, but once those investments are made operating costs are fairly low. That is, relative to the initial cost, delivering a high volume of gas is not that much more expansive than the delivering a low volume; the cost of servicing 10 customers is not much different than the cost of servicing 100 customers. In this situation, costs are typically recovered over a long period of time, often decades. The problem in this situation is the market naturally does not support more than one provider. In a true natural monopoly it is economically irrational (unprofitable) for a competitor to enter the market.

Here's explanation, which can be skipped if all the above makes sense:

With all that said, my question again is: Do objectivists believe that it is wrong for the government to regulate pricing in this context? Why?

I really hope to get an answer that squarely works within the parameters of a natural monopoly context. Meaning, please do not say “there are always alternatives,” or “no one needs natural gas” or “government regulation of pricing is inherently wrong.” This is skirting the question.

Just to be clear, not everything is a natural monopoly. Often something gets labelled a natural monopoly when it isn’t one. A company that wants to build and sell cruise ships requires enormous resources at the outset, but no one would call this a natural monopoly context. People used to think air travel was a natural monopoly, but this turned out to be wrong; regulating airlines was only for the benefit of the airlines, the regulators, and perhaps some politicians. Still, there are instances where it is simply economically irrational for more than one company to enter the market. The result of this is a natural monopoly, and it isn’t a government creation. Rather it is a complex implication of economic laws operating in the real world.

My understanding is that Objectivism doesn’t posit that government regulation is simply inherently wrong; rather, it’s that government interference in the market is a fundamental deprivation to individuals because competition in a free market is the medium through which individual self-realization is possible. But if the market will not support competition, I don’t understand how regulation could be wrong.

Objectivism says that forcing yourself on another man is wrong, because it is wrong to do that. First and foremost, regulations are coercion designed to restrict the life of another human being against his will. A good example in this case was the brutal evisceration the Feds did to Rockefeller when they took his life and ripped it from him because he made the mistake of being too good at his work. It is an ethical issue, not one of utility.

Why did you take a bunch of arguments off the table?

Anyway, in your example start up costs are still no issue since anyone can still raise the money or fund it themselves if there is a ROI. The fact some businesses don’t lend themselves to being a cottage industry is not a bad thing, for example I would hardly want a nuclear power plant started up on the cheap in someone’s garage. But it would not be hard for someone who has built capital to do something large scale if the restrictions where not there, and if the monopoly is not good there will be a break point of profitability that will generate a ROI. If there is no ROI breakpoint them the monopoly has to be doing one hell of a job satisfying its customers.

Especially when you consider product lifecycles and customer adoption and retention patterns in business.

In your example, your utility company may have built pipes into someone’s house then they have invested a lot of money and should be in a position of strength. It does not however stop someone from doing it themselves, the development of new technologies (satellite companies replacing the cable company), or other business plan innovations (perhaps a new competitor will purchase the infrastructure). If the current company undercuts them, well then to bad. They should have planned for it. If someone was trying to steal my customer I’d act to stop them too. Why such tactics are considered bad is beyond me – We want companies fighting over customers.

Finally, innovation drives such things and it is through innovation that we as a society grow. You don’t get innovation if no one has incentive due to regulations. You get innovation if someone has to work to overcome an obstacle.

But still, at the end of the day it is an ethical argument.

Edited by Spiral Architect

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The question you ask makes some interesting assumptions. What is it about any product that onces it exists, makes people think that they are entitled to it? The evil is not in being the only source of a product, but believing you are entitled to the product of another. What you want is to make theft legal.

As an aside, you have ignored an important fact, there are always alternatives. 1st alternative transport like rail or roads. 2nd alternative products like wood, propane, electricity, coal, solar, geothermal. In a very fundamental sense monopolies do not exist, they are entirely a fictional concept.

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to Spiral Architect

Objectivism says that forcing yourself on another man is wrong, because it is wrong to do that. First and foremost, regulations are coercion designed to restrict the life of another human being against his will. A good example in this case was the brutal evisceration the Feds did to Rockefeller when they took his life and ripped it from him because he made the mistake of being too good at his work. It is an ethical issue, not one of utility.

Why did you take a bunch of arguments off the table?

Objectivism says that forcing yourself on another man is wrong, because it is wrong to do that. First and foremost, regulations are coercion designed to restrict the life of another human being against his will. A good example in this case was the brutal evisceration the Feds did to Rockefeller when they took his life and ripped it from him because he made the mistake of being too good at his work. It is an ethical issue, not one of utility.

Why did you take a bunch of arguments off the table?

My idea was to conjure up the clearest circumstances in which regulation provides for a more optimal allocation of resources. Objectivists on this forum seem to frequently conflate two types of arguments. One is empirical: unregulated capitalism is the most efficient allocation of resources. The other is normative: government regulation, as a form of coercion that restricts the will of some human being, is wrong. But these aren’t the same. Randian capitalism would in many instances lead to market failures. While there is a normative argument that gov’t ought not interfere with an individual’s right to accumulate capital, there is a priori basis for thinking that unrestricted capitalism would, economically speaking, work very well.

Anyway, in your example start up costs are still no issue since anyone can still raise the money or fund it themselves if there is a ROI. The fact some businesses don’t lend themselves to being a cottage industry is not a bad thing, for example I would hardly want a nuclear power plant started up on the cheap in someone’s garage. But it would not be hard for someone who has built capital to do something large scale if the restrictions where not there, and if the monopoly is not good there will be a break point of profitability that will generate a ROI. If there is no ROI breakpoint them the monopoly has to be doing one hell of a job satisfying its customers.

A natural monopoly does not exist because there are high start-up costs. I tried to emphasize in my initial post that high initial costs are just one aspect of a natural monopoly.

Especially when you consider product lifecycles and customer adoption and retention patterns in business.

In your example, your utility company may have built pipes into someone’s house then they have invested a lot of money and should be in a position of strength. It does not however stop someone from doing it themselves, the development of new technologies (satellite companies replacing the cable company), or other business plan innovations (perhaps a new competitor will purchase the infrastructure). If the current company undercuts them, well then to bad. They should have planned for it. If someone was trying to steal my customer I’d act to stop them too. Why such tactics are considered bad is beyond me – We want companies fighting over customers.

This rejects the factual premises of my hypothetical, which is that there are not substitutes. This is an example of the normative-empirical conflation I mentioned above. There seems to be an irresistable impulse by users of this forum to find any way possible to force the economic argument, even if that requires changing the facts so to make them fit.

The (proper) regulation of a natural monopoly will not prohibit the development of alternative technologies. What it restricts is (1) entry narrowly defined, the duplication of parallel operations, e.g. re-building existing infrastructures, and (2) prices, what the monopolist can charge. Proper regulation won’t prevent cell phone systems from developing because they compete with land lines. They prevent the restringing of a land-line infrastructure. (One bad form of regulation, in my view, occured in the 1970s. MCI came up with a way to transmit phone calls for businesses long-distance over microwave, and the government wouldn't let them operate initially because the MCI system competed with AT&T's long-distance landlines, and AT&T was charging a lot to business to subsidize residential long-distance costs. This was bad regulation.)

Finally, innovation drives such things and it is through innovation that we as a society grow. You don’t get innovation if no one has incentive due to regulations. You get innovation if someone has to work to overcome an obstacle.

That’s too general. Even Rand accepted intellectual property balance between which is merely regulation by another name. An IP rights regime is simply a balance, struck by lawmakers, between rewarding the creator and permitting others’ use of.

But still, at the end of the day it is an ethical argument.

I appreciate that.

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to ToyoHabu

The question you ask makes some interesting assumptions. What is it about any product that onces it exists, makes people think that they are entitled to it? The evil is not in being the only source of a product, but believing you are entitled to the product of another. What you want is to make theft legal.

I don’t think I’m saying people are entitled to anything. I still have to pay for the natural gas I use. I’m saying that the market doesn’t work well unless there is regulation, and that regulation is in fact in everyone’s interest -- buyers and sellers. Rational companies in natural monopoly situation won’t even get into the market if they think there is a likely chance that there will be competition that will preclude the recovery of the initial costs.

As an aside, you have ignored an important fact, there are always alternatives. 1st alternative transport like rail or roads. 2nd alternative products like wood, propane, electricity, coal, solar, geothermal. In a very fundamental sense monopolies do not exist, they are entirely a fictional concept.

This is too unspecific. “there are always alternatives” is not a priori true. Why make this assumption?

My suspicion is that you are wrongly assuming an unlimited time frame. But if you are more specific, and take a discrete time frame, say a 40 year period, there may be no comparable alternatives to a product in that period. Try telling someone in 1910 that they should ship something by truck instead of train. Those weren’t alternatives then, though they are now.

The argument that there are always alternatives seems like a case of trying to skew the underlying facts to construe an ethical stance as leading to the most economically efficient outcome.

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Hold on, I'm a bit confused. If you're capable of understanding the difference between descriptive (economic) arguments and normative (ethical) arguments, then what kind of answer are you looking for? Your OP asked what would follow from objectivism, and if you know of the natural rights position of objectivism then it seems likely that you would realize price controls are incompatible with this philosophy's non-aggression principle. This seems to me the functional equivalent of saying intervention is inherently wrong.

As it turns out though, objectivism will hold that justice has good consequences, and thus most of them will adhere to a more Austrian type theory of market failure. Rothbard and Kirzner hold in regards the economies of scale argument that competition is always ongoing, as long as there remains no barrier to entry, thus there is no such thing as not supporting competition. They deny the coherence of any non-legal barrier to entry. The market is competitive by definition. This school holds that there is no scientific way to establish whether any given price on the market is monopolistic or not. Non-Austrians such as Bork and Demsetz have also criticized the economies of scale argument for natural monopoly. As far as the empirical (historical) case goes, there doesn't seem to be any such thing as a natural monopoly. The theory was an ex-post rationale for grants of franchise and privilege intended to benefit the utility.

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