END THE POSTAL MONOPOLY James C. Miller III

 Earlier this year, the cost of mailing a first-class letter went from 20 cents to 22 cents. It was the third increase in four years, the seventh since the Post Office became the independent US. Postal Service in 1970. As usual, politicians decried the inefficiency of postal delivery and promised to “do something.” But few seemed willingto consider the one action likely tohave a real effect on the efficiency ofthe U.S. postal system: let others compete in the delivery of first-class mail. The Evolution ofthe Postal Monopoly While the Constitution provides Congress with the power “to establish post offices and post roads,” it does not require that the carriage of mail be a monopoly, much less a government monopoly. Throughout the first half of the 19th century, however, Congress enacted ever move restrictive measures limiting the private carriage of mail. For example, an 1825 statute that reserved to the federal government the exclusive right to carry letters for hire in vehicles over post roads was amended two years later to prevent private carriage on horseback or foot. Thispresumably made life difficult for the Pony Express, which although often used as a symbol of U.S. mail service, was a creature of private enterprise. Finally, Congress passed the Postal Act of 1845—the so-called private express statutes—which directly prohibited private companies from carrying letters for hire.’ These statutes (with a few modifications) remain the law today. They grant the government a monopCato journal, Vol.5, No. 1 (SpringiSummer 1985). Copyright © Cato Institote, All rights resorved. The aothor is Chairman oftho Federal Trade Commission. The views oxpressed here arc his own and do not necessarily reflect thoso of the other commissioners. Portions of this article are drawn from his testimony heforo the Subcommittee on Economic Goals and Intergovernmental Policy of the Joint Economic Committee, 21 Juno 1982. ‘5 Stat. 732(3 March 1845). 149 CATO JOURNAL oly in the delivery ofletters (first-class mail). The monopoly does not extend tonewspapers and magazines (second-class mail), direct-mail advertising (third-class mail), or parcels (fourth-class mail). Through its ability to define a “]etter,” the Postal Service is in the enviable position of being able to determine the extent of its own monopoly. While the service has “suspended” its monopoly for certain letters (such as time-sensitive materials), it has also expanded its monopoly by defining lettersto include bills,receipts, IBM cards, magnetic cards, magnetic tapes, and other business documents.2Typically, as new services such as express mail have developed, the Postal Service has first asserted that these services fall within its monopoly and then announced a suspension of the monopoly with respect to some aspects of the new service.3 Is the Postal Monopoly Economically Justified? The standard economic rationale for production by a regulated franchise monopoly, whether privately or publicly owned, is that, under certain technical conditions, production may be accomplished at least cost by a single firm. Government may wish to impose maximum rate-of-return regulation on such “natural monopolies” in an attempt to reduce the allocative efficiency costs associated with unregulated monopolies. But even in the case of a proven natural monopoly, economists are ambivalent about the desirability of regulation because ofits direct and indirect costs.4 There is, however, no convincing evidence that mail service is a natural monopoly. Indeed, most of the relevant studies have failed to find significant economies of scale.5 2 The USPS currently defines a “lettcr” as any “message directed to a specific person or address and recorded in or on a tangible object.” 39 C.F.R. §310.1(a). 3 The USPS has asserted that it has authority to exempt materials from the postal monopoly porsoar,t to 39 USC. §601(b), ‘See, for example, Paul U. Joskow and Roger C. Noll, “Regulation in Theory and Practice: An Overview,” in Gary Fromm, editor, Studies in Public Regulation (Cambridge: MIT Press, 1981), p. 10. ~Forinstance, an empirical study by the Post Office itself did not uncover economies of scale. Sec Bureau ol’ Finance and Administration, U.S. Post Office Department, Summary Report of Cost Sy8tern Task Force on Incre,nental Costs (Washington, D.C., May 1970). See also the review ofstudies in Leonard Merewit’z, “Economies of Scale in Postal Service” (U.S. Postal Rate Commission (PRC); 3oAugnst 1973) andthe review contained in Initial Decision, PRC Docket No. R74-1,pp. 78—90. Nogeneraleconomies ofscale were fcund in Rodney E,Stevenson, “Postal Pricing Problems and Production Functions” (Ph.D. dissertation, Michigan State University, 1973), and the Department r’ijustice Ibund virtually no credible evidence that this lie., economies ofscalel is actually the case.” See U.S. Department ofjustice, Changing the Prieate Express Laws (1977). 150 THE POSTAL MONOPOLY Most importantly, if mail service were a natural monopoly, competitors would find it very difficult to provide the same level of service at the same or lower cost.6 Consequently, the Postal Service’s position would be secure without legal protection. The Economic Costs ofthe Postal Monopoly The Postal Service provides a classic illustration of the problems inherent in trying to determine efficient prices and hold down costs for a regulated monopoly. The existence oflarge common costs in enterprises like the Postal Service makes it impossible to allocate total costs to individual services in a nonarbitrary manner. 7This makesratemaking very difficult. While it is conceptually possible to determine efficient prices by looking at both cost and demand conditions, the necessary information is typically not available in sufficient detail. As a result, there is no reason to believe that prices will be efficient—even before allowing for the influence of a variety of political pressures that make themselves felt during the ratemaking process. Moreover, with restricted entiy, an inefficient rate structure is easy to maintain, because new firms cannot enter in response to a price that is set too high. Thus, cross-subsidization, which is virtually impossible under competitive conditions, occurs with some frequency in regulated industries. It is, in fact, a major source of the economic inefficiency associated with the Postal Service. In addition, postal costs are generally higher because the Postal Service faces only limited incentives to produce in the least-cost manner. ‘Underspecial circumstances, it is theoretically possible for an entrant to provide one ofa natural monopolist’s services at a price lower than themost efficient price, in which case the natural monoply is said to be “unsustainable.” See John C. Panzar and Robert D, willig, “Free Entry and the Sustainahility of Natural Monopoly,” Bell Journal of Economics (1977), pp. 1—22. But we have no evidence that the postal monopoly is unsustainahle. In fact, “there is no evidence that the cost conditions for that are present in postal services.” See Bruce M. Owen and Robert D. Willig, “Economics and Postal Pricing Policy,” in Joel L. Fleishman, ed., The Future ofthe Postal Service (NewYork: Praeger Publishers, 1983), p. 231. More generally, the sustainahility literature is “too specialized and insufficiently operational” to support entry restrictions as a policy prescription. See Joskow arid Noll, p. 17. 7 See Melvyn A. Fuss, “Cost Allocation: How Can the Costs of Postal Services Be Determined,” in Roger Sherman, ed. Perspectives on Postal Service Issues (washington: American Enterprise Institute, 1980), pp. 30—46; Owen and Willig, pp. 227—45; and Rodney E. Stevenson, “The Pricing of Postal Services,” in Harry M. Trehing, ed., New Dimensions in Public Utility Pricing (East Lansing: Michigan State University, 1976), pp. 427—52. 151 CATO JOURNAL Inefficient Rate Structure Because ofthe problems involved in allocating costs, precise quantitative estimates of cross-subsidies within the postal system are difficult to obtain, It is generally conceded, however, that high-density urban service subsidizes low-density rural service. It is also alleged that first-class mail in general subsidizes some or all ofthe other classes. The subsidy from urban torural users arises primarily because the Postal Service charges the same ratefor all first-classmail, regardless of the distance the mail travels and the costs of delivering it. Some first-class mail is therefore overpriced and some isunderpriced. Consequently, as the Postal Service itself has stated, “if the Private Express Statuteswere repealed, private enterprise ... would be free to move into the most economically attractive market’i One of those areas would undoubtedly be transaction mail—bills, bank statements, and so forth. This mail, which tends to be generated by a few, high-volume local business mailers (for example, banks, utilities, and department stores) and tends to be destined for highdensity areas, is relatively inexpensive to deliver.a If entry were permitted, the price for delivering transaction mail (which constitutes a significant portion of first-class mail) would fall. This is what the competitive process is all about, notwithstanding the fact that the Postal Service refers to it as “cream-skimming.”°Such cream-skimming opportunities only occur when prices exceed costs. The existence ofsuch opportunities is therefore evidence that current pricing misallocates resources.” Whetherthere is an additional subsidy going from first-class mail to other classes is an issue of some contention. However, the Postal Rate Commission’s chief administrative law judge concluded that such a subsidy did exist, and that “the Postal Service has become a tax-collecting agency collecting money from first-class mailers to ‘U.S. Postat Service, Statutes Restricting Private Carriage of Mail and their Administration (House Committee on Post Office and Civil Service, 93d Cong., 1st Sess., Committee Print 1973), p. 6. ‘The Postal Service offers discounts for presorted first-class mail of 500 or more pieces. It also offers discounts for first-class mail addressed with machine-readable “Zip + four” address labels. However, these discounts do not take into account the number of separate places to which the mail is addressed, nor the population density of those locations. “Ibid., p. 5. “See, for example, Alfred B. Kahn, The Ecoromicr of Regulation: Principles and Institutions, Volume II: Institutional Issues (New York: John Wiley and Sons, 1971), pp. 220—46. 152 THE POSTAL MONOPOLY distribute to otherfavored classes.”~Ifthis is the case, entering firms would be able to lower the average price charged for first-class mail. Higher Overall Costs The postal system is a particularly good source (in the event that one is needed) for evidence that private enterprise performs better than government enterprise and that competitive markets perform better than nionopolies.5 a The costs ofthe Postal Service are significantly higher than they should be because the incentive to hold down costs—most notably, labor costs—is limited. Postal workers are paid far more than is necessary to retain their services.’4 Because entry into postal markets is restricted, the Postal Service is able to pass those higher costs along to its customers. Higher costs also result from failure to innovate. For example, as of 1974, the Postal Service still shipped all of its parcels in bags, which resulted in high breakage rates and handling costs. When the United Parcel Service (UPS)—a private competitor—introduced mechanization and containerization, breakage was reduced and han- “See James C. Miller 111 and Roger Sherman, “Hasthe 1970 ActBeen Fairto Mailers?” in Sherman, Perspectices, pp. 64—65. ‘ 3 There are, of course, many other sources. See Roger Ahlbrandt, “Efficiency in the Provision ofFire Services,” PublicChoice 16(1973): 1—15 (flndingprivate firmprovides goods at lower cost than government agency); W. Mark Cram and Asghar Zardkoohi, “A Test ofthe Property-Rights Theory ofthe Firm: Water Utilities in the United States,” Journal of Law and Economics 21(1978): 395—408 (finding higher operating costs in publicly owned water utilities); David C. Davies, “The Efficiency ofPublic v, Private Firms: The Case ofAustralia’s Two Airlines,”Journal ofLaw and Economics 14(1971): 149—65 (finding private company more efficient than public firm); Cotton M. Lindsay, ‘A Theory of Government Enterprise,”Journal ofPolitical Economy 84(1976): 1061— 77 (determining government ma~agersmaximize self-interest by producing output Congress is likely to value more hi~hlythan consumers do); and Sam Peltzman, “Pricing in Public and Private Enterprises: Electric Utilities in the United States,’ Journal of Law and Economics 14 (1977): 109—47 (finding that government-owned firms adopt pricing policiesthat enhance their political support, not consumer welfare), A number of FederalCommunications Commission (FCC) decisions that altered the monoply conditions formerly prevailing in the common carrier communications field provide empirical evidence that competitive markets perform better than monopolized ones. The Chairman ofAT&T, for example, testified that as a direct result ofthe FCC’s rulings, the Bell System companies were forced to become more innovative and to deploy the results ofthat innovation more rapidly. In addition, the prices Bell charged were generally reduced and new policies reflecting more cost-related pricing were adopted. See generally letter from FCC Chairman R. E. Wiley to All Members of Congress on HR. 12323,25 May 1976; and FCC, Second Report in Docket 20003, FCC 80-5, released 29 January 1980. ‘ 1 See Douglas K. Adie, “How Have Postal Workers Faired Since the 1970 Act?” in Sherman, PerspectIves, pp. 74—93. 153 CATO JOURNAL dling costs lowered. As a result, the Postal Service has steadily lost business to UPS.’5 The success of private express mail service is also indicative ofthe benefits of competition. Despite the threat of suit by the Postal Service, numerous private carriers developed in the 1960s and 1970s, specializing in the rapid and reliable transportation of commercial documents. In 1973 the Postal Service responded and established its own express delivery service called “Express Mail.” Despite attempts to expand the postal monopoly to include express mail services, private services now compete openly and freely. Indeed, private companies such as Federal Express and Purolator deliver overnight to more cities than does the Postal Service. Fears of Higher Prices and Reduced Service If repeal ofthe private express statutes will reduce rates for some postal services, will it also raise rates for others P This is a major fear, particularly for residents of rural areas. There are, however, two reasons for believing that such fears are exaggerated. First, ifcompetition reduces the overall level costs, this will benefit everyone, including consumers of high-cost services. Second, our experience with the deregulation of trucking and airlines suggests that fears ofsignificant reductions in ruralservice due to postalderegulation are probably unfounded. Some small cities are no longer served by largejets, but commuter airlines have used smaller planes to serve small communities at far lower costs. Thousands of new companies have gone into trucking, and as a result trucking service to rural areas has improved. Ifwe can obtain airline and trucking service throughout the country without a government monopoly, competition canalso work for letter delivery. The configuration of service may change somewhat, but surely everyone would have access to affordable mail delivery. If a subsidy is deemed necessary, it might be patterned after the small-community air service program implemented along with airline deregulation. This program now subsidizes air service to 145 communities at an annual cost of $51 million. This cost has declined significantly since the program began in 1978, and the program is that The USPS tried to learnfrom UPS’s success by building a one billion dollar hnlk mail system to improve its handling of parcel post mail. Hut that effort has been such a failore that the General Accounting Office has suggested USPS write the investment off as a loss. See, for example, Joel L. Fleishman, “Postal Policy and Public Accountability: Is the 1970 Bargain Coming Unglued?” Manuscript, Harvard University, Program on Information Resources Policy, 1981, p. 94, 154 THE POSTAL MONOPOLY scheduled to be phased out. Yet, on the whole air service to small communities has improved since deregulation. The cost of the small-community air service program has been running at about 0.2 percent of total domestic airline revenues. The analogous figure for the Postal Service would be $26 million—a paltry sum for ensuring that there will be universal mail delivery, and for enabling the benefits that competition would bring to this industry. Conclusion The burden of showing that the postal monopoly is necessary or desirable has not been met. All the available evidence suggests that competition in the market for first-class letter delivery would create substantial benefits. If the private-express statutes were repealed, existing mail firms would expand and new ones would enter the market, Probably just as important, the spur of competition would mean improvements in the Postal Service itself Private enterprise will get the mail delivered—just as it did in the Old West.