Organized Crime

One of the things that every college student who takes a course in principles of economics is taught is that the so-called public utilities (electricity, water supply, natural gas, etc.) have been government-regulated monopolies ever since the early twentieth century because government stepped in to save Americans from the evils of free-market or “natural” monopolies. The story goes like this: In industries with large fixed costs (such as the expense of building an electric power plant) the cost of serving each customer declines precipitously once the plant is up and running. This is called “economies of scale.” This is said to have been true of all of the public utilities in the early twentieth century.

The supposed problem is that one large company might achieve such low costs (and prices) that it will be able to drive all other competitors from the market and hence become a “natural” monopoly. It will, at that point, charge monopolistic prices. A corollary to this “market failure” theory is that government stepped in and created licensed, “franchise monopolies” on purpose, and then regulated prices “in the public interest,” which presumably means at a level that is not monopolistic.

There is no evidence of any kind that this story is true. There never was any evolution in the direction of free market or “natural” monopoly. Public utility monopolies were all created by government, for the benefit of government and its corporate welfare state allies in the electric power, water supply, natural gas, and other industries.

In his book Efficiency, Competition, and Public Policy, economist Harold Demsetz quoted fellow economist Burton Gehling as saying:

Six electric light companies were organized in the one year of 1887 in New York City. Forty five electric light enterprises had the legal right to operate in Chicago in 1907. Prior to 1895, Duluth, Minnesota was served by five electric lighting companies, and Scranton, Pennsylvania, had four in 1906. . . . During the latter part of the nineteenth century, competition was the usual situation in the gas industry in this country. Before 1884, six competing companies were operating in New York City . . . competition was common and especially persistent in the telephone industry. . . . Baltimore, Chicago, Cleveland, Columbus, Detroit, Kansas City, Minneapolis, Philadelphia, Pittsburgh, and St. Louis, among other larger cities, had at least two telephone services in 1905.

The real story (as opposed to the fable told in introductory economics textbooks) of how public utility monopoly came about was explained in a 1936 book by economist George T. Brown entitled The Gas Light Company of Baltimore. It is a case study of the creation of public utility monopoly in Baltimore, Maryland, but its lessons apply to all cities in America.

The history of the Gas Light Company of Baltimore is that, from its founding in 1816, it constantly struggled with new competitors. Its response was to compete in the marketplace but also to lobby the state and local government authorities to deny the granting of corporate charters to its competitors. There may have been economies of scale in the industry, but they did not prohibit vigorous competition.

Brown cites an 1851 editorial in the Baltimore Sun as declaring that “competition is the life of business” as the paper welcomed news of several new competitors in the gas light business. By 1880 there were three competing gas and light companies in Baltimore that fiercely competed with each other. They did attempt to merge and operate as a monopolist in 1888, but a fourth competitor foiled their plans when “Thomas Alva Edison introduced the electric light which threatened the existence of all gas companies,” wrote Brown. From that point on there was competition between gas and electric companies.

When monopoly did appear it was solely because of government intervention. For example, in 1890 a bill was introduced into the Maryland legislature that “called for an annual payment to the city from the consolidated Gas Company of $10,000 a year and 3 percent of all dividends declared in return for the privilege of enjoying a 25-year monopoly.” In other words, the creation of public utility monopoly was a share-the-monopoly-loot scheme between politicians and corporations at the expense of the hapless taxpayers and consumers. Some of the economics textbooks do euphemistically refer to this scheme as a form of “indirect taxation.”

Consumers suffer from paying monopolistic prices and the poor service that all government-run or supported monopolies are famous for. The blame is placed on “greedy corporations” who are happy to take the blame as long as the politicians who place the blame on them keep their monopoly in place. George T. Brown concluded in his book that “the development of utility regulation in Maryland typified the experience of other states.”

Another economist who was skeptical of the “natural monopoly” story was Horace M. Gray, an assistant dean at the University of Illinois who published an article entitled “The Passing of the Public Utility Concept” in the Journal of Land and Public Utility Economics in 1940. “During the nineteenth century,” Gray observed, it was believed by some that “the public interest would best be promoted by grants of special privilege to private persons and to corporations” in many industries. Of course, it was those private persons and corporations who spread the absurd tale that their special privileges were really in “the public interest” and not just their own personal self interests.

Advocates of this “public interest” nonsense advocated patents, direct subsidies, protectionist tariffs, land grants to railroads, and monopoly franchises for “public utilities.” Hundreds of monopoly franchises were awarded all over the U.S. in share-the-loot monopoly schemes just like the one in Maryland in the late nineteenth and early twentieth centuries. From that time on, wrote Gray, “the public utility status was to be the haven of refuge for all aspiring monopolists who found it too difficult, too costly, or too precarious to secure and maintain monopoly by private action alone.”

Gray entertainingly pointed out how virtually every aspiring monopolist in the U.S. claimed that whatever enterprise he was involved in was a “public utility” and should therefore be granted monopoly status by the state. This included the radio, real estate, milk, airline, coal, oil, and agricultural industries, to name but a few. In fact “the whole NRA (National Recovery Act) experiment may be regarded as an effort by big business to secure legal sanction for its monopolistic practices.” Here Gray was referring to the fact that the 1933 National Recovery Act was an attempt to raise prices by creating government-enforced cartels in every manufacturing industry, complete with thousands of price-code police who enforced the government’s price floor regulations.

The role of “mainstream” economists in this whole scheme was to construct what Gray called a “confused rationalization” for “the sinister forces of private privilege and monopoly.” It is this “confused rationalization” that is still to this day taught in all of the introductory economics textbooks.

Not all cities in America participated in the share-the-monopoly-loot scheme of “regulated” public utility monopoly, and not all economists became apologists for it. In his book, Direct Utility Competition: The Natural Monopoly Myth, University of Illinois economist Walter J. Primeaux described how direct competition existed in the electric utility industry for decades. Buttressed by hundreds of pages of statistical analysis, Primeaux concluded that in those cities where there was direct, head-to-head competition (as opposed to market-sharing schemes where one company served half of a city and another company served the other half), there was vigorous competition, lower costs and prices, and no more “excess capacity” than in the monopoly cities. He concluded that the theory of natural monopoly fails on every count: competition existed for decades; price “wars” were not threatening to the survival of the companies; there is better customer service and lower prices; and consumers themselves prefer competition over monopoly, whereas the public utility executives generally hold the opposite view. What a surprise!

Economist Thomas Hazlett arrived at similar conclusions based on his research on the cable television industry. In a 1990 article in the Journal of Law and Economics Hazlett documented how about three dozen cities allowed direct competition in the cable industry as of 1990 despite the fact that cable television at the time was defined as a “natural monopoly.” In those cities where competition was permitted prices were on average 23 percent lower, more channels were offered, and customer service was superior to the monopoly franchise cities.

The theory of natural monopoly is an economic fiction. Horace M. Gray had it right when he wrote that “by a soothing process of rationalization men are able to oppose monopolies in general but to approve certain types of monopolies. . . . [And] since these monopolies were ‘natural’ and since nature is beneficent, it followed that they were ‘good’ monopolies” and “government was therefore justified in establishing ‘good’ monopolies.”