Thoughts on economics and liberty

Ronald Coase on JS Mill’s false doctrine of “natural monopoly”

This is a brilliant chat between Richard Epstein and Coase. [I had earlier thought it was Epstein but was wrong – corrected Aristides Hatzis].

As part of it it he discusses the economics of utilities and demonstrates why competition is so essential in these areas. I’ve extracted Coase’s insights into monopolies – particularly in relation to utilities. I admire Coase’s empirical approach. This turns out to be much better in many ways than the theoretical approaches of people like JS Mill and Alfred Marshall.

TRANSCRIPT

Anyway I went on to the London School of Economics and there my duties consisted in part of helping Plant (Arnold Plant was the only LSE economist whose (some) courses Coase attended) in his work but I also had to give lectures on the economics of public utilities

Epstein: Have you been trained in that in any way or shape?

Coase: Not at all. I knew nothing about the subject and the man who’d give the course before a man called Batts (who belongs to) South Africa, and so I had this this course and I pretty soon discovered that nobody knew anything about public utilities. So I began a series of historical studies of public utilities in Britain.

Epstein: And which ones did you look at looked at?

Coase: I looked at water, gas, electricity, the post office, boat casting (?)

Epstein: A huge portion of the economy, by the way, which resides in these industries.

Coase: That right.

Epstein: And if you were to look at them what were the sort of general conclusions you reached, say, when you looked at the gas industry or the electric industry?

Coase: Well, I studied how they priced and so on. studied the regulation of entry. And one of the things I really want to write up sometime is the whole origin of the doctrine of the natural monopoly which emerged actually in in water supply in England, and I have a lot of material on that. … There was competition between water companies in London in the early 19th century as a result of which it was concluded that it would be better to have one company rather than several. A dubious conclusion, but the one that was reached and was actually written up by John Stuart Mill.

Epstein: And what were the reasons for the unification of all these rival water companies that was given by the proponents of the system?

Coase: That it was going to be so much cheaper to have one company in with each district.

Epstein: So this was a very static model.

Coase: That’s right and I’m glad you mentioned that because the whole point of competition is not to decide what to do at a given point of time but it is concerned with the introduction of new products and new methods of distribution, and so on. And these he [JS Mill] found actually during the competition. One doesn’t realize that the quality of water can be so changed, but at that time where the water was pulled out of the Thames in the same place the human waste was deposited, you can see that there were really grounds for improvement. And another thing is that there was the way in which water was distributed then – it was through water wooden pipes made out of trees. They bored a hole in the trunk of a tree. And this was very inefficient because you couldn’t get a high pressure without producing so many leaks, and so on. And during the competition iron pipes were introduced. People also tried pottery pipes and so on. There were various experiments made. But what one sees is that competition is not to be just regarded as the way in which people would compete with given methods of production, but it leads to the introduction of new ones. And of course that was the weakness of the whole doctrine of the natural monopoly.

Epstein: And so one of the puzzles of course that one has is – that I take it historically that you could measure rather tangible signs of improvement in water distribution under a competitive regime; why then did it lose out politically in your judgment?

Coase: Because the companies were interested in having what they call a district arrangement.

Epstein: So that each of them would have a local monopoly by territory?

Coase. That’s right, and so it was the new river company of the directors of a new river company that were most influential in getting this doctrine across and John Stuart Mill in popularizing it.

Epstein: So you have this peculiar alliance between an intellectual socialist on the one hand and ground-level monopolist on the other and the poor unorganized consumer was the one who suffered from that alliance?

Coase: That’s right.

Epstein: Now was public utilities a mainstream subject in economics in the immediate post-world period or were you in some sort of by way?

Coase: It was some sort of by way which had never been studied much. It was an American subject and the textbooks we used were American. I found the study of public utilities very interesting partly because nobody knew anything about it in Britain and I wrote about the post office, for example.

Epstein: And what did you conclude about it?

Coase: Well, it had several problems. One was a uniform price, for example. How did it come about and I discussed how it came about and what its effects were.

Epstein: And how did it came about?

Coase: Rowland Hill was the man who was responsible for the introduction of uniform postage and he argued that. Previously the way in which had been paid is that when the letter was delivered the person receiving it made the payment.

Epstein: So you had to be home to take your mail?

Coase: And you had to be willing to pay for it. If you didn’t want to pay for it you didn’t get the letter. And they introduced at that time prepayment – a uniform system which was supposed to be a cheaper way to administer it. Actually the original proposal involved areas where the cuts were higher where there was a higher cost – even though uniform; but that got abandoned in the course of the parliamentary discussions.

Epstein: Were these private companies or state companies that were delivering the mail?

Coase: Oh, it’s always been the state companies. And one of the things I went into is why was it that the state got involved. And it’s very easy to see why the state got involved. It wanted to control the distribution of information because it wanted to put down sedition. The origin of the monopoly which finally got taken over in the United States has nothing to do with economics and everything to do with politics.

Epstein: And yet did they ever exercise the power to exclude from the mail seditious activities and seditious letters, or is it a justification that was used to create the system and then sort of fell by the wayside?

Coase: No, people would look at the communications and I’m sure that quite a number of people lost their heads as a result of letters that were found.

Epstein: Does this concern with sedition help explain why it was that the post office was intimately involved in the creation of, and the control of the broadcast networks in Britain?

Coase: No it isn’t. What happened was in – I can’t remember the date exactly – but in the 1860s it was decided that the various telegraph companies in England should be taken over and made a single operation, operated by the state, because it would be cheaper. Of course, it didn’t prove to be cheaper and it raised all sorts of other problems, for example, the employees of the telegraph companies became active in politics. It also was important in other respects. When the telephone was invented, the government – as it was operating the telegraph system – wanted the telephone companies to be hindered in their operations. So legislation place which restricted the operations of the telephone. Anyway, the monopoly of the telegraph was given to the government operating in the post office. And a telegram was the described as a message conveyed by electricity. When broadcasting came along, it was quite clear that what was involved was a telegram, because it was clearly a message conveyed by electricity and in that way the authority of the post office was established – to control the broadcasting.

Epstein: So in your view much of the history of the regulation of public utilities in the late 19th and early 20th centuries in England had to do with the expansion of the post office which controlled first the mail, then the telegraph, and then the telephones and then broadcasting to some extent. Do you think this was a good or bad type of system both in in terms of its merits and also how did it happen?

Coase: Well, the results were extremely bad. You had the telephone industry which was hampered in its development by the need to protect the telegraph industry, and in the case of broadcasting it was something quite different. It was that since you had defined a telegram as a message conveyed by electricity, broadcasting was therefore a telegram, and the post office had powers to regulate it – which it exercised.

Epstein: And how did it exercise those powers?

Coase: In granting licenses to people to operate.

Epstein: And how did it decide who received a license?

Coase: It is a complicated story, but they finally decided that there should be a monopoly. The post office always wanted a monopoly, and the Marconi company wanted a monopoly, because it would be the dominant firm in that case. And so in England when broadcasting started as a service it started as a monopolized service – a single, the British Broadcasting Company – as it was in those days.

Epstein: And so this would reduce the range of choices and the level of innovations that were available to consumers?

Coase: Well, that was the whole idea, because the BBC – particularly after it became the British Broadcasting Corporation as a state enterprise – the idea was the BBC gave people what they ought to have, and therefore we should prevent getting broadcasts of a different sort.

Epstein: So this ties into the very powerful anti-market theme that one of the reasons why markets are terrible is they satisfy the preferences that people actually have and reveal in their purchasing decisions?

Coase: Particularly the lower classes. Because the educated classes on the whole felt they got what they wanted from the British Broadcasting Corporation, and it was the lower classes that didn’t get what they wanted.

Epstein: So essentially a lot of the time when you studied public utilities it became a lesson to you about the dangers associated with government sponsored and organised monopoly? And it’s a lesson which we could continue to learn today, I suppose.

Coase: Well, I think so, but my change of view which came gradually was just through finding out how things operated rather than some philosophical arguments and so on.

Epstein: That’s right, in other words you never did start from the proposition that in a just society what you would want to do is to minimize the use of force and fraud? That would never have been an equation or a proposition that crossed your mind.

Coase: That never entered my mind.

Epstein: And so essentially it was just watching a series of ad hoc adjustments and seeing which ones worked and which ones did not that eventually led you to believe that certain forms of industrial arrangements were better than others.

Coase: That’s right.

Sanjeev Sabhlok

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