Competition Series Part III: History

Often forgotten in the competition debate are the reasons for a monopoly’s existence in the first place? A few are:

1. Mergers and economies of scale of private enterprise
2. Government development for its own needs (including defence)
3. Government intervention due to natural monopoly features (either too high risk for private enterprise or too much scope for price gouging)
4. Government intervention due to positive externalities (for example, cleanliness and health benefits of sewerage)
5. Government intervention due to fairness and equitable access – once a technology becomes a necessity it is politically expedient to promote fair access (including regional development)

While many may disagree that government involvement in some infrastructure networks was necessary from the start, citing the textbook benefits of the profit maximising natural monopolist, the onus should be on those promoting change to demonstrate that the world has changed sufficiently for competition and/or private firms to now deliver these services.

Historically, with the advent of new technology, government will typically step in if it sees benefits to centralisation - creating an entity tasked with equitable provision of the new service. Prior to centralised water and sewerage in cities, each property owner would have had a rainwater tank, bore or well to supply water, and a thunderbox for waste. Health benefits of newly designed reticulated sewerage systems were overwhelming (although it took some time before waste was treated in any fashion before being dumped into waterways). Private investment in sewerage reticulation could only recover cost from those who accessed the system, yet the social benefits were much broader. A government established (and subsidised) monopoly was the only way to go. A similar story can be told for water reticulation.

These water and sewerage examples confirm points 2-4 above. While a private enterprise could have undertaken sewerage works, there were positive externalities, and issues of equitable access. Furthermore, a private company would expose themselves to competition with existing methods of treating waste and capturing water supply.

On a more technical note, electricity generation was originally the domain of manufacturers who generated and used their own power onsite. With the wide acceptance of Tesla’s AC power, which could be sent vast distances with greatly reduced losses, the centralisation of electricity began. In this industry economies of scale were so great that governments typically took control of all generation and distribution to reduce costs. Ironically, we now believe that competition will in fact reduce costs and subsequently consumer electricity prices – a situation yet to transpire is State’s where this has happened.

The history of water supply in Britain follows a similar pattern, with government intervening in the 1860s to take ownership of the private supply market due to massive inefficiencies from infrastructure duplication required for competition (water in 1851 was about 60% privately supplied). The costs from these inefficiencies were hindering uptake of reticulated water which proved to have external benefits of improved sanitation and health in the cities. Much of the water industry was then reprivatised in 1989.

The unfortunate part of these stories is that once an industry is in the hand of a government entity, there is no risk, and therefore no incentive to innovate. Rather than government showing the willpower to provide incentives to reduce price and improve service provision of its own monopoly, it instead decides that competitive pressure is the best way to go. To maximise social benefits, government is now required to properly regulate a market of smart, influential, profit seeking firms, instead of properly regulating or managing its own corporation properly. While I am generally pro-competition, one wonders if those in charge of competition reform appreciate this irony.

In somewhat of a return to the past, the federal government is now keen on subsidising the rollout of a fibre broadband network. The justification for government provision is the same –characteristics of natural monopoly, positive externalities of information access, and fairness of access. This is perfectly in keeping with the theory and evidence discussed above, apart from the intention to vertically separate at the wholesale level (a rather grey distinction if you ask me). It seems we have come full circle.

The turning of the tide against privatization predated the financial crisis. Internationally, a number of major privatizations have been reversed. The UK government was forced to renationalize its rail network after the failure of the privately owned operator. In Australia, dissatisfaction with the privatized telecommunications monopoly has led the government to announce that it will get back into the telecommunications business by constructing a publicly-owned national broadband network. New Zealand, where market liberalism was implemented in a radical form in the 1980s and 1990s, renationalized its national airline in 2001 and its railways a couple of years later. And even relabeled as “choice”, Social Security privatization proved so politically unsaleable that it was abandoned early in Bush’s second term.

While the economic evidence suggests it is socially optimal for government to proceed with its rollout of the NBN, I have reservations. New fibre internet connections will have to compete with existing broadband on the copper network, and with developing wireless technologies. I expect there to be a significant cost to go from existing 20Mbps connections to 100Mbps, yet most users will not notice the difference, and may not be willing to pay. If the government goes ahead, it needs be aware that cost recovery may be very low for some time and the justification for its involvement are the positive externalities.

In the long run I still believe the NBN will be a socially beneficial investment. As technology develops on fibre networks, who knows what speeds will become standard and the opportunities this technology will provide.

An understanding of the history of competition and privatisation is necessary to better critique arguments from both sides.