Tag Archives: competition

Where are the Broadband Mutuals?

I’ve argued (here and here, for instance) against worrying too much about the monopolization of Internet access. Broadband is pretty clearly an industry in which there are increasing returns to scale, and when returns to scale are severe enough, that results in natural monopoly. There are not clear welfare gains from regulatory solutions to natural monopoly problems generally, and broadband in particular is a case where many of the problems associated with monopolization are ameliorated by price discrimination.

Nevertheless, I accept that most people are not persuaded by this logic. Let me try a different tack, explaining what I would expect to see if profit-centered monopolists were really as bad for consumers as their critics claim.

The answer can be summed up in one word: mutuals. Mutual companies are not especially common in today’s economy, but they are worth pondering at some length. Mutuals are firms in which customers, in virtue of their ongoing patronage of the firm, are also its owners. A mutual company generally has no other shareholders to please, and it does not typically distribute dividends. Instead, if it makes a profit it will distribute it to its customers in the form of lower prices in the future.

Managers at mutual companies have pretty cushy lives. They can’t earn multi-million dollar bonuses, and their salaries are capped by the firm’s charter or by state regulation. But the modest restrictions on compensation are made up for with quality of life. They don’t work too hard, maybe they spend a lot of the firm’s money on nice offices with plush carpet, and they don’t worry about squeezing every last penny out of the business.

The managers have weak incentives to maximize profit because of the firm’s distributed ownership. While in theory, customers could band together and oust the management team at the annual meeting, in practice it is hard to get 51 percent of the customers to sign and mail in their proxy forms. So instead of maximizing profit, the management team works hard to make sure the product works and nothing terrible goes wrong. As long as everything runs relatively smoothly, their jobs are secure and they can be out on the golf course at 3pm.

In some cases, weaker incentives to run the business efficiently are a feature, not a bug. As Eric Rasmusen pointed out in his excellent JLE article on mutual banks, the mutual form was popular in the financial sector before the New Deal, when federal deposit insurance largely displaced it. The reason is simple: a strong profit motive can lead to excess risk-taking, and depositors preferred that their banks be conservative. Managers at a mutual bank have an incentive to limit risk-taking because their profits are capped anyway. Why risk the assets of depositors when you have no upside? N.b., Washington Mutual, which collapsed in 2008, had actually demutualized in 1983, although it was allowed to keep its name.

Mutuals still exist today, but they are much less common. Vanguard is a familiar mutual company, though this fact is not to be confused with the product they sell, mutual funds. One reason the load on Vanguard funds is so low is that the managers have a very weak incentive to squeeze customers; instead, the firm focuses on basic, reliable service. Mutual companies are also common forms for utility companies in rural areas. Since utilities have increasing returns to scale and rural areas have low scale, the natural monopoly problem is particularly severe in this sector. Mutuals solve this problem by weakening the incentive to opportunistically charge a high price to rural consumers who have only one choice in service provider.

Incidentally, whenever someone challenges my extreme libertarianism by asking if I would privatize water service, I say yes: I would replace the regulated water monopoly with a mutual water company. Mutuals have some similarities to government-run firms, but also some important differences. They are similar in that the profit motive is weak, and that consumers frequently have to rely on voice more than exit to express their displeasure. However, if a mutual provides a truly horrific service, at some point a competing firm (perhaps a competing mutual) becomes a possibility. In that regard, mutuals are superior to government provision. Furthermore, mutuals don’t require me to bundle my purchases with a host of other products, whereas if I want to dump government provision of some good, I basically have to overthrow the state. Why should education spending be bundled with my water service?

My question, then, is predictable. If the state of broadband is so terrible, if broadband monopolists are engaging in harmful net neutrality violations, if infrastructure providers are using their market power to foreclose in the content market, where are the broadband mutuals? Why aren’t neighborhood associations setting up mutual companies to run high-speed local networks and buying transit from a competitive market of upstream providers? A little Googling shows that there are some broadband mutuals, but they operate mostly in rural areas, and they benefit from federal subsidies. Why don’t we see more of this corporate form?

Some possibilities:

  1. Economies of scale make it impossible to enter the market at all. I don’t believe this one. At a minimum, we would expect real estate developers to build new neighborhoods pre-wired for mutual Internet access if they believed that such an amenity would increase the value of the property.
  2. Regulatory barriers make it impossible in practice to enter the market. Maybe. To the extent such barriers exist, I favor removing them. But most of the critics of the broadband monopolies are not calling for deregulation; they are calling for additional regulation.
  3. The broadband monopolies are running their businesses in basically a socially efficient manner, and there is not much room for broadband mutuals to come in and provide a better product. Most observed net neutrality violations are welfare-enhancing, and most of the weird pricing schemes are forms of price discrimination used to underwrite the large fixed costs of running an ISP.

I still think the answer is #3. But if you don’t, you should be pushing to start a mutual broadband company in your neighborhood or city, not advocating for greater regulation or state-run broadband.

Obligatory Unions Post

The kerfuffle over public-sector unions in Wisconsin has captured the imagination of the chattering class to the point that unless I wish for my blog to lapse further into irrelevance I must break my silence on this topic. I am not a labor economist, and I have never had the privilege of visiting Wisconsin, which strikes me as an exotic land of people who walk around with cheese on their heads. So I am clearly an expert.

The labor economics literature on unions is as vast as it is boring. Instead of troubling with it, let’s try to think systematically about market power more generally, and then we can apply our findings to unions specifically.

A simple model of market power has P > MC, a deadweight loss triangle, and a monopoly rent rectangle. Most economists freak out about deadweight loss triangles and consider the monopoly rent rectangle a transfer. Transfers don’t matter for efficiency, but may matter for reasons of equity.

The simple model is wrong because it’s static. In a dynamic model, the monopoly rent rectangle is a prize for winning at some competition. People expend resources to capture supranormal profits.

The question, therefore, is not “how can we eliminate deadweight loss triangles?” or “how can we equitably divide surplus between management and labor?” but “what sorts of competition do we want to reward?” The monopoly rent could be a prize for shrewd risk-taking, for jumping through hoops, for being politically connected, etc.

In general, I’d say that to the extent that people are risk-averse, set in their ways, lazy, and ignorant, we want to reward things like shrewd risk-taking, innovation, productivity, and skill acquisition. We don’t want to reward things like political clout, corruption, or credentials. We want to dismantle monopolies that are based on political privilege (e.g., your local cable company), and tolerate market power that is based on investment of the kind that we want to encourage.

Back to unions. Unions have market power, but we can’t say whether a particular union is good or bad until we ask what its supranormal profits are rewarding. On what margins do people compete to get into the club? I don’t know enough to say for sure, but it seems to me that public-sector unions reward meaningless credentials, low ambition, luck, and getting along with other public-sector workers. On the other hand, if employees in other industries are bearing the costs of investing in firm-specific skills, the monopoly rent that comes with unionization can incentivize efficient investment (though of course, the employer can also bear the cost of investment, or the employees can buy the firm).

Most people who favor unions don’t do so for the reasons I’ve outlined. They favor them for expressive reasons: yay, labor! boo, management! But in my model, there is no reason why generic, unskilled labor (or generic, unskilled management) should ever earn more than its marginal product. We want to reward the human capital and risk-taking components of labor. We can debate whether laissez-faire and freedom of association get us close enough to optimal rewards, but it seems pretty clear that busting public-sector unions in Wisconsin is unlikely to hurt anything.