Why Regulate Utilities

CURRENT economic doctrine offers to its students a basic relationship between the number of firms that produce for a given market and the degree to which competitive results will prevail. Stated explicitly or suggested implicitly is the doctrine that price and output can be expected to diverge to a greater extent from their competitive levels the fewer the firms that produce the product for the market. This relationship has provided the logic that motivates much of the research devoted to studying industrial concentration, and it has given considerable support to utility regulation.' In this paper, I shall argue that the asserted relationship between market concentration and competition cannot be derived from existing theoretical considerations and that it is based largely on an incorrect understanding of the concept of competition or rivalry. The strongest application of the asserted relationship is in the area of utility regulation since, if we assume scale economies in production, it can be deduced that only one firm will produce the commodity. The logical validity or falsity of the asserted relationship should reveal itself most clearly in this case. Although public utility regulation recently has been criticized because of its ineffectiveness or because of the undesirable indirect effects it produces,2 the basic intellectual arguments for believing that truly effective regulation is desirable have not been challenged. Even those who are inclined to reject government regulation or ownership of public utilities because they believe these alternatives are more undesirable than private monopoly, implicitly accept the intellectual arguments that underlie regulation.8 * The author is indebted to R. H. Coase, who was unconvinced by the natural monopoly argument long before this paper was written, and to George J. Stigler and Joel Segall for helpful comments and criticisms. 1 Antitrust legislation and judicial decision, to the extent that they have been motivated by a concern for bigness and concentration, per se, have also benefited from the asserted relationship between monopoly power and industry structure. 2 Cf., George J. Stigler and Claire Friedland, What Can Regulators Regulate? The Case of Electricity, 5 J. Law & Econ. 1 (1962); H. Averch and L. Johnson, The Firm under Regulatory Constraint, 52 Am. Econ. Rev. 1052 (1962); Armen Alchian and Reuben Kessel, Competition, Monopoly, and the Pursuit of Pecuniary Gain, in Aspects of Labor Economics 157 (1962). 3 Thus, Milton Friedman, while stating his preference for private monopoly over public monopoly or public regulation, writes: