It’s Only Natural

From stockyards to communications, natural monopolies need to be watched closely.

Listener: 25 November, 1995.

Keywords: Regulation & Taxation;

A decade ago the Australian stock and station agents, Elders Pastoral, decided to enter New Zealand. A key activity is selling livestock, commonly done through stockyards. It is expensive to build one’s own yards, and most yards are under-utilized, with just one per region. So the firm wrote to each stockyard in the country, and asked if they might lease it for their sales on commercial terms.

There were two classes of response. The first was a prompt “yes, of course you can”. The other was no answer, or a sullen acknowledgement of the request followed by tedious negotiation which a year on had not been resolved. The distinction was simple. The eager stockyards were owned by a local farmer’s cooperative, which welcomed additional competition. The diffident response came from yards owned by competing firms, a reluctance understandable because “yes” would have increased competitive pressure on them.

A stockyard is an example of a general phenomenon in economics called a “natural monopoly”, where it is efficient to have only one physical facility to supply a service. Other examples include the phone connection, the domestic electricity connection, the electricity grid, gas pipelines, airports, seaports, water supply, roads, wool auction rooms, and dairy factories (for it is rare for a dairy farmer to have a choice of factories to supply).

The stockyard example suggests there is a certain merit in ownership of the natural monopolies by the consumers of its services, with their leasing out the facilities to users. If the ownership is private you might think there was a need for some sort of regulation to ensure the owner did not use the monopoly to exclude competition.

Fortunately the issue of stockyards came up under the 1975 Commerce Act, and as a part of conditions for a merger the incumbent private owners agreed to let the yards out on commercial terms to competitors. (Something similar happened with wool auction rooms). Shortly after the Act was replaced by the 1986 Commerce Act, which has much less teeth. Meanwhile the government has been converting (or forcing) a number of natural monopolies into private ownership, creating private monopolies form publicly owned and cooperatively owned facilities: Telecom, electricity distribution, airports, seaports …

In the case of telecommunications the result has been an expensive farce, as Clear Communications tried to obtain fair access to local connections. The specific issue is a complex one. After those involved spending perhaps $100 million in legal costs, the Privy Council ruled that under New Zealand law, Telecom had to provide access to Clear at a particular pricing formula which meant that even were Telecom to lose all its business to its competitors, the competitors would have to compensate Telecom for all of its lost profit.

This is hardly a competitive solution. Indeed the outcome was so outrageously against common sense that even government officials were moved to propose changing the law (reported in “Access to Vertically-Integrated Natural Monopolies” published by the Ministry of Commerce and the Treasury). Shortly after Telecom and Clear came to an interconnection agreement satisfactory to the latter.

You might think this resolves the problem, and the law change is unnecessary – one can already hear the feet dragging over the proposals to increase competition where there are natural monopolies. But spending millions of dollars getting to this outcome is hardly efficient, especially as ultimately it is the phone user who pays. Moreover suppose a third company wanted to enter the market. They know that under the present law they have to go into a lengthy negotiation involving millions of dollars. That is hardly an incentive for competitive entry. So the current situation is a cosy duopoly, which may be better than the monopoly of the past, but may not be that much better.

Nor should we forget that there are numerous other natural monopolies in private hands, and that they are increasing as a result of the government’s privatization policies. At the moment millions of dollars are being spent on buying and selling electricity distribution monopolies, which ultimately the consumer will have to pay.

How did this all come about? Recall that these changes were under an umbrella of a radical ideology that took it for granted that private ownership with a minimum of government intervention was a good thing. The Chicago School slogan of “public monopoly bad, private monopoly good” makes sense if your concern is nothing to do with the nouns, while you have strong ideological views about the adjectives. Private monopoly is a good thing to the private owners, such as those of Telecom which has reported yet another record profit, for there is no restraint on their exploitive powers. It is however, less beneficial to the users of those monopolies – consumers like you and me. (An odd twist is the business sector can often insulate itself so the burden is carried by the domestic consumer – strange that.)

It will be interesting to see how purposefully the government tackles the problem. One fears that it is too busy creating further private monopolies by privatization to have time to think about an appropriate regulatory framework for them.