Are monopolies always bad?

Monopolies are commonly associated with notions of overcharging, anti-competitive behavior, and excessive profits. But setting aside such issues, monopolies aren’t always that bad. At times they may even be preferred to competitive market structures.

Natural monopolies

Take the case of public utilities, such as water and electricity services. Firms in such industries are called natural monopolies because they are inherently more efficient than when there are many firms providing such services. Imagine several firms, each setting up its own pipelines or electrical wires throughout the metro: all utilities and infrastructure will needlessly double and lead to inefficiency. All these give rise to the need for natural monopolies. Society is better off restricting the market to one firm because by producing more it is able to reduce its costs, something many firms cannot do by themselves.

Of course, as in all imperfectly competitive settings, natural monopolies have some bad sides. They still have the incentive to reduce their sales and charge at a higher price than in a competitive market, leading to losses to society and profits for them. Also, they may engage in activities that seek to maintain their market position – activities known as rent-seeking.

Research & development

Perhaps the most recognized benefit of monopolies deals with research and development. In perfectly competitive settings, long-run profits are nil. Therefore there is very little opportunity for them to venture into R&D – which is an inherently risky business. If firms are protected from competition for some time, they may be able to enjoy some profits and therefore be able to invest in innovation – as in the case of industries concerning pharmaceuticals, telecommunications, subways, and computer technology.

However, take note that this R&D benefit does not justify the proliferation of monopolies in society, but instead proposes that innovators must be accorded some market power for them to recover their costs and benefit, for some time only, from the fruits of their labor, which may or may not eventually lead to a monopoly. Here market power comes mainly in the form of intellectual property (e.g. patents, copyrights).

Regulating natural monopolies

But remember that natural monopolies aren’t completely desirable institutions. Although they are preferable at times, they still pose some social waste and may get ahead of themselves and exploit their market power. This is why governments find ways to regulate natural monopolies. But by forcing them to approximate a competitive outcome, regulation schemes may bring forth rather disputatious distributional issues (as it may need much subsidies and more taxes) and various pricing mechanisms, that have long been the bone of contention in policy debates around the world.