Thu | Dec 8, 2016

What drives natural monopolies

Published:Sunday | January 25, 2015 | 12:00 AM

Peter-John Gordon, Guest Columnist

A natural monopoly is said to exist when the market, left to itself,
results in a single producer. This occurs because only one firm can
profitably operate in this market. If a second firm enters, at least one
firm, and maybe both, will make a loss.

Such a situation arises when the cost of providing the commodity is high relative to the size of the market. The cost of providing the good or service is determined by technology and economics, while the size of the market is affected by economic factors (which could include the size of the population).

Electricity distribution in Jamaica is a natural monopoly. The delivery of electricity requires a network of poles, lines, transformers, etc. It would not make economic sense for a second company to duplicate the existing network and then compete for customers, unless the ultimate objective is to drive the incumbent (Jamaica Public Service Company) out of the market and then to become the monopolist.

Doubling the amount of electricity poles, lines and other infrastructure required for the distribution of electricity to serve the existing customer base, would result in the entrant and/or the incumbent making losses. One firm would eventually leave the market and we would return to a situation of a single provider, be that the incumbent or the entrant.

The reason all Jamaican communities do not currently have electricity is that the cost of taking electricity to the remaining places is greater than the revenue these communities will generate for the company. The market, left to itself, would never provide electricity to these communities.

Public utilities are usually candidates for natural monopolies. If the underlying technology changes, an industry that was previously a natural monopoly might cease to be one.

Telephone service at one stage was a natural monopoly. A network of poles, lines, etc. was required to deliver telephony service. Even with a sharing of poles between the electricity distributor and the telephone company, it still was not feasible to have more than one telephone company.

A CHANGE IN TECHNOLOGY

A change in technology changed the natural monopoly status of the telephone industry. The delivery of telephone service no longer relies on a network of poles and lines connecting customers. The use of radio waves changed the cost of delivering telephone services, thus making it possible for more than one firm to operate within the industry profitably.

If it became possible to deliver electricity by radio waves, or if it became possible for a wired network that carried other traffic such as cable television,to also carry electricity, electricity distribution would lose its natural monopoly status.

Sometimes, unbridled competition is not permitted in order to increase overall well-being. An example is the transportation sector. Not all routes are profitable. If there is competition within the transportation sector, suppliers would all seek to service the most profitable routes and ignore those which are unprofitable.

Using law/government discretion to allow a monopoly situation is one way to ensure that there is universal coverage. If there is no competition on the profitable routes and so profits on these routes are not driven down, the provider of transportation services would be willing to cross-subsidise the unprofitable routes. If there is competition on the profitable routes resulting in low profits, no service will be supplied on the unprofitable routes. Even in the case of a natural monopoly such as electricity distribution, a regulator can extract some concessions from the monopolist in terms of extending services to areas that are loss-making for the company.

Recently, the Court of Appeal ruled on a case brought by a group calling itself Citizens United to Reduce Electricity (CURE), which challenged the minister's authority to grant a monopoly license to JPS. No doubt, there were interesting legal arguments advanced. If, however, the plaintiff had prevailed, what would have changed on the ground? Electricity distribution is a natural monopoly; JPSCo's position is not due primarily to the minister's action. Are there deep-pocketed persons willing to duplicate the electricity distribution network in order to challenge JPS's position, with a clear understanding that when the dust settles, only one company would be left standing? Would JPS be willing to rent its poles to a competitor? If it was forced to do so by the regulator, what impact would this have on its incentives to maintain and expand the network?

In some countries, there has been experimentation with multiple distributors using a common network. When the network is owned by one of the distributors, a complex set of problems arises. These include the price charged for access, as well as who decides which firm uses the network when. Unless there is the technical capacity to properly deal with these issues, the maintenance of the network would be threatened.

Peter-John Gordon is lecturer in the Department of Economics, UWI, Mona. Email feedback to columns@gleanerjm.com and peterjohn.gordon@uwimona.edu.jm.