A Test for Natural Monopoly with Application to Norwegian Electricity Distribution

Reorganization of public utilities is on the current political agenda in many European countries. However, in many cases the most fundamental question in terms of public policy towards these industries is not tested; does the underlying cost structure indicate a natural monopoly or not? Evans and Heckman's analysis of the US Bell System is one of the few exceptions, but their method has a serious problem as their estimated cost function is not well behaved (negative marginal costs). To solve this problem we propose to use the consistency region (i.e., the region where the estimated cost function is well behaved) as the test region. We apply our testing procedure to Norwegian electricity distribution and find that local electricity distribution is characterised as a natural monopoly. Policy implications of the result is also discussed.