Monopoly and the State: A Rebuttal (Part 5)
The Natural Monopoly Mirage
By this point in the series, we've made a clear case: many monopolies are not a result of market dynamics, but of political engineering, through licensing, regulatory insulation, subsidies, and privilege.
Yet even sympathetic readers may ask:
What about industries where monopoly seems inevitable?
Where the structure of costs and scale makes one firm the “natural” winner?
Think: electricity grids, water lines, telecommunications infrastructure, search engines. In mainstream economics, these are categorized as natural monopolies, situations where a single firm can provide goods or services more efficiently than multiple competitors.
It sounds intuitive. But this concept is far less settled, historically and theoretically, than it appears.
1. The Origins of the Natural Monopoly Idea
The term natural monopoly gained popularity in the late 19th century alongside the rapid industrialization of utility and infrastructure networks. Economists began observing that certain industries (like railways or water systems) exhibited strong economies of scale, where the average cost per unit fell as output increased. If fixed costs were high and marginal costs low, it appeared inefficient to have multiple firms duplicating expensive infrastructure.
The idea took institutional form in the Progressive Era, when American cities began granting exclusive municipal franchises to utility providers. The theory came after the policy: monopolies were already being formed by law, and economists retroactively constructed a framework to justify them.
By the mid-20th century, this framework became standard in regulatory economics, used to defend everything from government-run utilities to public transit monopolies.
Yet this theory commits a central fallacy: it assumes static conditions and ignores the evolutionary, trial-and-error nature of real markets.
2. Schumpeter’s Complication: Monopoly as a Phase
The monopoly story is more nuanced than textbook models suggest. Joseph Schumpeter, no anarcho-capitalist, nonetheless viewed monopoly as a transitional, not terminal feature of capitalism.
In Capitalism, Socialism and Democracy, he argued that temporary monopoly profits were often the reward for innovation, what he called “creative destruction.” These profits were not a threat to capitalism, but rather its fuel. He believed the real danger lay not in monopoly itself, but in the cultural and institutional decay of capitalist values that could make monopoly permanent through the state.
In Can Capitalism Survive?, he warned that:
“Capitalism, inevitably and by virtue of the very logic of its civilization, creates, educates and subsidizes a vested interest in social unrest.”
To Schumpeter, the long-run threat wasn’t corporate dominance. It was bureaucratic entrenchment, the fusion of state and industry in a stagnant technocracy.
3. What Is a Natural Monopoly—Really?
In standard terms, a natural monopoly is said to exist when:
An industry has high fixed costs and low marginal costs,
A single firm can serve the entire market more efficiently than multiple firms,
And allowing competition would supposedly lead to “wasteful duplication” of infrastructure.
Classic examples include water systems, power grids, railroads, and (more recently) digital platforms with strong network effects.
But, I want to ask a deeper question:
Even if such a cost structure exists, does it necessarily lead to harmful monopoly behavior? Does it justify legal exclusion of competition?
No, because market structures are never fixed. They evolve in response to information, incentives, and innovation.
4. Markets Adapt to Scale—Without the State
Even in industries with high fixed costs, history shows that competition often emerges anyway, not in spite of scale, but because entrepreneurs are constantly searching for ways to serve underserved margins or build more flexible systems.
Consider:
Airlines and telecommunications were once considered natural monopolies, until deregulation in the 1970s and 1980s introduced competition, drove down prices, and accelerated innovation.
Entrepreneurs find creative ways to enter markets: bundling, unbundling, niche targeting, infrastructure sharing.
Capital flows to opportunity: when margins are high, investors fund challengers.
And technology itself changes cost structures, making fixed-cost advantages obsolete.
As Hayek noted, static models of competition fail to capture the true nature of markets as discovery processes. Economies of scale may exist, but they are conditional, not deterministic.
5. Network Effects Aren’t Moats Forever
Digital platforms offer a modern version of the natural monopoly thesis: “winner-take-all” dynamics where early movers gain advantage because each new user makes the platform more valuable.
Yet these effects are far from permanent:
MySpace lost to Facebook.
Internet Explorer lost to Chrome.
BlackBerry lost to the iPhone.
Even Facebook is now losing younger users to TikTok, Discord, and decentralized platforms.
Network effects are real, but they’re two-sided. The same users who made a platform dominant can unmake it just as quickly when alternatives arise.
And if entry remains legal, challengers always have a path.
6. “Too Efficient” Isn’t a Problem
Suppose a firm really is the most efficient. It offers the best prices and service. Should we break it up for being too good?
The answer is no, because this is what markets are supposed to do. Dominance earned by excellence, not by exclusion, is not a problem to fix.
As Rothbard pointed out, in a free market, the term “monopoly price” is analytically incoherent. Prices emerge from voluntary exchange. Unless the firm is legally shielded from competition, it faces discipline from the possibility of entry.
Dominance is a temporary reward, under constant threat.
7. Government Turns the Mirage into Reality
The real danger is not “natural monopoly.” It’s legally enforced monopoly, under the guise of protecting efficiency or avoiding chaos.
Electric companies lobbied for exclusive service areas, then used regulatory commissions to fix rates.
Phone companies were shielded from rivals for decades, leading to stagnation until the breakup of AT&T.
Cable providers secured municipal franchises that excluded competitors for years.
In each case, government force, not economic law, preserved dominance. And once protected, firms turned regulatory costs into moats, insulating themselves from disruption.
The Mirage Fades in the Light of Innovation
“Natural monopoly” is not a law of economics, it’s a snapshot, taken at a moment in time, under specific legal conditions.
In dynamic markets:
Technology lowers fixed costs.
Consumers shift preferences.
New entrants discover new models.
And dominant firms lose discipline, opening the door.
The response is clear:
Let every monopoly face the test of the market.
If it survives without legal protection, it deserves to.
If it needs the state to survive, it doesn’t.
If you found this post valuable, pass it along.
Part 6 drops next week:
“Monopolies Without Coercion? The Final Word.”
The views and opinions expressed on this blog are solely my own and do not reflect the official position of any organization with which I am affiliated.
Agreed. Government should never choose winners or losers. Great points. Keep up the good work!