Technological change, culture, and a “social license to operate”

Technological change is disruptive, and in the long sweep of human history, that disruption is one of the fundamental sources of economic growth and what Deirdre McCloskey calls the Great Enrichment:

In 1800 the average income per person…all over the planet was…an average of $3 a day. Imagine living in present-day Rio or Athens or Johannesburg on $3 a day…That’s three-fourths of a cappuccino at Starbucks. It was and is appalling. (Now)… the average person makes and consumes over $100 a day…And that doesn’t take account of the great improvement in the quality of many things, from electric lights to antibiotics.

McCloskey credits a culture that embraces change and commercial activity as having moral weight as well as yielding material improvement. Joseph Schumpeter himself characterizes such creative destruction as:

The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates. […] This process of Creative Destruction is the essential fact about capitalism. It is what capitalism consists in and what every capitalist concern has got to live in.

Much of the support for this perspective comes from the dramatic increase in consumer well-being, whether through material consumption or better health or more available enriching experiences. Producers create new products and services, make old ones obsolete, and create and destroy profits and industries in the process, all to the better on average over time.

Through those two lenses, the creative destruction in process because of the disruptive transportation platform Uber is a microcosm of the McCloskeyian-Schumpeterian process in action. Economist Eduardo Porter observed in the New York Times in January that

Customers have flocked to its service. In the final three months of last year, its so-called driver-partners made $656.8 million, according to an analysis of Uber data released last week by the Princeton economist Alan B. Krueger, who served as President Obama’s chief economic adviser during his first term, and Uber’s Jonathan V. Hall.

Drivers like it, too. By the end of last year, the service had grown to over 160,000 active drivers offering at least four drives a month, from near zero in mid-2012. And the analysis by Mr. Krueger and Mr. Hall suggests they make at least as much as regular taxi drivers and chauffeurs, on flexible hours. Often, they make more.

This kind of exponential growth confirms what every New Yorker and cab riders in many other cities have long suspected: Taxi service is woefully inefficient.

Consumers and drivers like Uber, despite a few bad events and missteps. The parties who dislike Uber are, of course, incumbent taxi drivers who are invested in the regulatory status quo; as I observed last July,

The more popular Uber becomes with more people, the harder it will be for existing taxi interests to succeed in shutting them down.

The ease, the transparency, the convenience, the lower transaction costs, the ability to see and submit driver ratings, the consumer assessment of whether Uber’s reputation and driver certification provides him/her with enough expectation of safety — all of these are things that consumers can now assess for themselves, without a regulator’s judgment substitution for their own judgment. The technology, the business model, and the reputation mechanism diminish the public safety justification for taxi regulation.

Uber creates value for consumers and for non-taxi drivers (who are not, repeat not, Uber employees, despite California’s wishes to the contrary). But its fairly abrupt erosion of the regulatory rents of taxi drivers leads them to use a variety of means to stop Uber from facilitating mutually beneficial interaction between consumers and drivers.

In France, one of those means is violence, which erupted last week when taxi drivers protested, lit tires on fire, and overturned cars (including ambushing musician Courtney Love’s car and egging it). A second form of violence took the form last week of the French government’s arrest of Uber for operating “an illegal taxi service” (as analyzed by Matthew Feeney at Forbes). Feeney suggests that

The technology that allows Uber to operate is not going anywhere. No matter how many cars French taxi drivers set on fire or how many regulations French lawmakers pass, demand for Uber’s technology will remain high.

If French taxi drivers want to survive in the long term perhaps they should consider developing an app to rival Uber’s or changing their business model. The absurd and embarrassing Luddite behavior on French streets last week and the arrest of Uber executives ought to prompt French lawmakers to consider a policy of taxi deregulation that will allow taxis to compete more easily with Uber. Unfortunately, French regulators and officials have a history of preferring protectionism over promoting innovation.

Does anyone think that France will succeed in standing athwart this McCloskeyian-Schumpeterian process? The culture has broadly changed along the lines McCloskey outlines — many, many consumers and drivers demonstrably value Uber’s facilitation platform, itself a Schumpeterian disruptive innovation. The Wall Street Journal opines similarly that

France isn’t the first place to have failed what might be called the Uber Test: namely, whether governments are willing to embrace disruptive innovations such as Uber or act as enforcers for local cartels. … But the French are failing the test at a particularly bad time for their economy, which foreign investors are fleeing at a faster rate than from almost any other developed country.

Taxi drivers are not the only people who do not accept these cultural and technological evolutions. Writing last week at Bloomberg View, the Berlin-based writer Leonid Bershidsky argued that the French are correct not to trust Uber:

The company is not doing enough to convince governments or the European public that it isn’t a scam. … Uber is not just a victim; it has invited much of the trouble. Katherine Teh-White, managing director of management consulting firm Futureye, says new businesses need to build up what she calls a “social license to operate”

He then goes on to list several reasons why he believes that Uber has not built a “social license to operate”, or what we might more generally call social capital. In his critique he fails to hold taxi companies to the same standards of safety, privacy, and fiduciary responsibility that he wants to impose on Uber.

But rather than a point-by-point refutation of his critique, I want to disagree most vigorously with his argument for a “social license to operate”. He quotes Teh-White as defining the concept as

This is the agreement by society or a community that an organization’s practices and products are acceptable and aligned with society’s values. If society begins to feel that an industry or company’s actions are no longer acceptable, then it can withdraw its agreement, demand new and costly dimensions, or simply ‘cancel’ the license. And that’s basically what you’re seeing in Europe and other parts of the world with Uber.

Bershidsky assumes that the government is the entity with the authority to “cancel” the “social license to operate”. Wrong. This is the McCloskey point: in a successful, dynamic society that is open to the capacity for commercial activity to enable widespread individual well-being, the social license to operate is distributed and informal, and it shows up in commercial activity patterns as well as social norms.

If French people, along with their bureaucrats, cede to their government the authority to revoke a social license to operate, then Matthew Feeney’s comments above are even more apt. By centralizing that social license to operate they maintain barriers to precisely the kinds of innovation that improve well-being, health, and happiness in a widespread manner over time. And they do so to protect a government-granted cartel. Feeney calls it embarrassing; I call it pathetic.

Al Roth’s new book on matchmaking and market design

Alex Tabarrok reviews Al Roth‘s new book, Who Gets What — and Why: The New Economics of Matchmaking and Market Design, in the Wall Street Journal. An excerpt:

Most economic theory focuses on commodity markets, in which anyone willing to pay the price gets the good and anyone not willing to pay the price doesn’t. In matching markets, price isn’t the only determinant of who gets what. Willingness to pay the price is one determinant of who gets into Harvard but not the only one. Willingness to accept a certain wage is one part of who gets a job but not the only one. In some cases, such as assigning kidneys to dialysis patients, price isn’t part of the equation at all—at least in the United States.

Mr. Roth’s work has been to discover the most efficient and equitable methods of matching and implement them in the world. He writes with verve and style, describing many market malfunctions—from aboriginal tribes in Australia arranging marriages for children not yet born to judges bending every rule in the book to hire law clerks years before they have graduated from law school—and how we ought to think about them.

Mr. Roth’s approach contrasts with standard debates over free markets versus government regulation. We want markets to be thick, quick, timely and trustworthy, but without careful design markets can become thin, slow, ill-timed and dangerous for the honest. The solution to these problems is unlikely to be regulation legislated from on high. Instead what Mr. Roth practices is nuanced market design created mostly by market participants.

We have discussed Roth’s work and market design topics many times here at Knowledge Problem (link to links). Tabarrok mentions the review at Marginal Revolution. Al Roth’s Market Design blog is here.

NOTE: If the WSJ link does not work for you, here is a link to review on the Mercatus website.

Social costs of oil and gas leasing on federal lands, carefully considered

OVERVIEW: A report filed with the US Department of the Interior recommended that terms governing the leasing of federal land for oil and gas development be updated to reflect social costs associated with such development. While such costs may be policy relevant, I suggest social costs are smaller than the report indicates and the recommended policy changes are not well focused.

The U.S. Department of the Interior (“Interior”) has begun an effort to update financial terms for oil and gas leases on federal lands. These financial aspects – royalties, minimum acceptable bids, annual rental rates, bonding requirements, and penalty rates – are collectively referred to as “government take.” One issue raised in the effort concerns social costs associated with oil and gas development on federal lands. (As noted earlier, Shawn Regan and I have filed a comment with Interior on the issue.)


Social costs of such development are also among issues addressed in a report filed in the Interior rulemaking docket by Jayni Foley Hein of New York University’s Institute for Policy Integrity. The report provides an overview of the legal requirements governing government take and recommends Interior’s regulations be revised to reflect option value and social costs. Here I focus on social costs.

Hein said social costs are imposed by oil and gas development on federal lands both during development and during production. She wrote:

America’s public lands offer millions of people a place to hike, camp, hunt, fish, and enjoy scenic beauty. They provide drinking water, clean air, critical habitat for wildlife, sites for renewable energy development, as well as natural resources including timber, minerals, oil, and natural gas. As soon as energy exploration begins, competing uses of federal land such as recreational enjoyment, commercial fishing, and renewable energy development are impaired, and continue to be foreclosed for the duration of production.

Hein listed the following social costs of oil and gas activity on federal lands*:

  • Loss of use values (including loss of recreational value, renewable energy development potential, timber value, scenic value, and wildlife habitat)
  • Local air pollution (local effects of methane leakage, emissions from diesel or gas-fueled pumps and other engines)
  • Global air pollution (methane leaks, carbon dioxide)
  • Induced earthquakes from disposal of hydraulic fracturing wastewater
  • Potential oil or wastewater spills and subsequent water contamination from wastewater stored in pits and tanks
  • Noise pollution
  • Increased traffic (wear and tear on roadways, traffic-related fatalities).

She recommended increasing rental rates and royalties to reflect social costs associated with development and production of oil and gas on federal lands.


Naïve application of Hein’s list would likely produce significant over-counting of social costs. Regan and I described social costs as “the sum of all future benefits foregone by one or more persons due to oil and gas development activity on federal lands.” We were imprecise. We cannot simply sum up all possible future foregone benefits, but rather we should focus on the difference in benefits between two specific cases: one case with oil and gas resources leased for development, and a second case in which the land is not leased.

The social costs of oil and gas leasing is the sum of the specific incremental differences in the stream of future benefits associated with the land leased for oil and gas development as compared to the best alternative use. Specification of the second case is key. Assume, for example, that if the property is not leased for oil and gas development, then it would be leased for PV solar power development. Leasing the land for PV solar power also involves some loss of timber value, wildlife habitat, recreational value, and so on. In counting the social costs of oil and gas leasing associated with, say, wildlife habitat, we need to focus on just the difference in wildlife habitat between the two cases. If recreational use is impaired equally, the loss of recreation value is not properly counted as a cost of oil and gas leasing.

Consequences, or rather, the differences in consequences beyond the property itself matter too. It is likely holding a specific tract of property out of oil production has no effect on total world oil production and consumption, and therefore there would be no difference in total air pollution, traffic, potential for oil leaks, and so on. Withholding a particular property out of development primarily would affect the location, not the total amount, of these costs. Location can matter: we likely do not want to increase traffic and local air pollution in already crowded areas. But location does not always matter: the greenhouse gas implications are the same whether a methane leak arises from development on federal land or elsewhere.


A careful identification of the social costs of oil and gas leasing associated with specific federal properties would reveal these social costs to be smaller than a naïve application of Hein’s list may suggest. Federal oil and gas policies governing the government take primarily affect the distribution of social costs, not the total amount. Most relevant social costs are highly localized to the area of development, a feature which should make them easier to manage.

Other issues arise with Hein’s proposal to increase rental rates and royalty rates to account for social costs. While charging a higher royalty rate, for example, would discourage development of federal lands at the margin, it would not encourage operators to minimize social costs on properties that are developed. Other policy levers may be more useful.

*NOTE: The list of social costs is my summary drawn from Hein’s report. We might dispute aspects of the list, but for purposes of this post I am more interested in the social cost concept rather than the particular items listed.

How cool is this? A transparent solar cell

I’ve not been sharing enough of my “how cool is this?” moments, and believe me, I’ve had plenty of them in the digital and clean tech areas lately. I find this one very exciting: Michigan State researchers have developed a fully transparent solar cell that could be used for windows or device screens:

Instead of trying to create a transparent photovoltaic cell (which is nigh impossible), they use a transparent luminescent solar concentrator (TLSC). The TLSC consists of organic salts that absorb specific non-visible wavelengths of ultraviolet and infrared light, which they then luminesce (glow) as another wavelength of infrared light (also non-visible). This emitted infrared light is guided to the edge of plastic, where thin strips of conventional photovoltaic solar cell convert it into electricity. [Research paper: DOI: 10.1002/adom.201400103– “Near-Infrared Harvesting Transparent Luminescent Solar Concentrators”] …

So far, one of the larger barriers to large-scale adoption of solar power is the intrusive and ugly nature of solar panels — obviously, if we can produce large amounts of solar power from sheets of glass and plastic that look like normal sheets of glass and plastic, then that would be big.

The energy efficiency numbers are low, 1%, but they estimate they could go up to 5%. Figuring out how much cost this TLSC technology adds to large panes of glass and comparing that to alternative electricity prices is the next step in assessing its commercial viability. But the technology is seriously cool.


Government failure and the California drought

Yesterday the New York Times had a story about California’s four-year drought, complete with apocalyptic imagery and despair over whether conservation would succeed. Alex Tabarrok used that article as a springboard for a very informative and link-filled post at Marginal Revolution digging into the ongoing California drought, including some useful data and comment participation from David Zetland:

California has plenty of water…just not enough to satisfy every possible use of water that people can imagine when the price is close to zero. As David Zetland points out in an excellent interview with Russ Roberts, people in San Diego county use around 150 gallons of water a day. Meanwhile in Sydney Australia, with a roughly comparable climate and standard of living, people use about half that amount. Trust me, no one in Sydney is going thirsty.

California’s drought is a failure to implement institutional change consistent with environmental and economic sustainability. One failure that Alex discusses (and that every economist who pays attention to water agrees on) is the artificially low retail price of water, both to residential consumers and agricultural consumers. And Alex combines David’s insights with some analysis from Matthew Kahn to conclude that the income effect arguments against higher water prices have no analytical or moral foundation — San Diego residents pay approximately 0.5 cents per gallon (yes, that’s half a penny per gallon) for their tap water, so even increasing that price by 50% would only decrease incomes by about 1%.

There’s another institutional failure in California, which is the lack of water markets and the fact that the transfer of water across different uses has been illegal. Farmers have not been able to sell any of their agricultural allocation to other users, even if the value of the water in those other uses is higher. According to the California Water Code as summarized by the State Water Resource Board,

In recent years, temporary transfers of water from one water user to another have been used increasingly as a way of meeting statewide water demands, particularly in drought years. Temporary transfers of post 1914 water rights are initiated by petition to the State Board. If the Board finds the proposed transfer will not injure any other legal user of water and will not unreasonably affect fish, wildlife or other instream users, then the transfer is approved. If the Board cannot make the required findings within 60 days, a hearing is held prior to Board action on the proposed transfer. Temporary transfers are defined to be for a period of one year or less. A similar review and approval process applies to long-term transfers in excess of one year.

Thus in a semi-arid region like California there’s a large rice industry, represented in Sacramento by an active trade association. Think of this rule through the lens of permissionless innovation — these farmers have to ask permission before they can make temporary transfers, Board approval is not guaranteed, and they are barred from making permanent transfers of their use rights. One justification for this rule is the economic viability of small farming communities, which the water bureaucrats believe would suffer if farmers sold their water rights and exited the industry. This narrow view of economic viability, assuming away the dynamism that means that residents of those communities could create more valuable lives for themselves and others if they use their resources and talents differently, is a depressing but not surprising piece of bureaucratic hubris.

Not surprisingly in year 4 of a drought, these temporary water transfers are increasing in value. Just yesterday, the Metropolitan Water District of Southern California made an offer to the Western Canal Water District in Northern California at the highest prices yet.

The offer from the Metropolitan Water District of Southern California and others to buy water from the Sacramento Valley for $700 per acre-foot reflects how dire the situation is as the state suffers through its fourth year of drought. In 2010 — also a drought year — it bought water but only paid between $244 and $300 for the same amount. The district stretches from Los Angeles to San Diego County. …

The offer is a hard one to turn down for farmers like Tennis, who also sits on the Western Canal Water District Board. Farmers can make around $900 an acre, after costs, growing rice, Tennis said. But because each acre of rice takes a little more than 3 acre-feet of water, they could make around $2,100 by selling the water that would be used. …

If the deal is made, Tennis said farmers like himself will treat it as a windfall rather than a long-term enterprise.

“We’re not water sellers, we’re farmers,” he said.

And that’s the problem.

Forthcoming paper: Implications of Smart Grid Innovation for Organizational Models in Electricity Distribution

Back in 2001 I participated in a year-long forum on the future of the electricity distribution model. Convened by the Center for the Advancement of Energy Markets, the DISCO of the Future Forum brought together many stakeholders to develop several scenarios and analyze their implications (and several of those folks remain friends, playmates in the intellectual sandbox, and commenters here at KP [waves at Ed]!). As noted in this 2002 Electric Light and Power article,

Among the 100 recommendations that CAEM discusses in the report, the forum gave suggestions ranging from small issues-that regulators should consider requiring a standard form (or a “consumer label”) on pricing and terms and conditions of service for small customers to be provided to customers at the tie of the initial offer (as well as upon request)-to larger ones, including the suggestions that regulators should establish a standard distribution utility reporting format for all significant distribution upgrades and extensions, and that regulated DISCOs should be permitted to recover their reasonable costs for development of grid interface designs and grid interconnect application review.

“The technology exists to support a competitive retail market responsive to price signals and demand constraints,” the report concludes. “The extent to which the market is opened to competition and the extent to which these technologies are applied by suppliers, DISCOS and customers will, in large part, be determined by state legislatures and regulators.”

Now in 2015, technological dynamism has brought to a head many of the same questions, regulatory models, and business models that we “penciled out” 14 years ago.

In a new paper, forthcoming in the Wiley Handbook of Smart Grid Development, I grapple with that question: what are the implications of this technological dynamism for the organizational form of the distribution company? What transactions in the vertically-integrated supply chain should be unbundled, what assets should it own, and what are the practical policy issues being tackled in various places around the world as they deal with these questions? I analyze these questions using a theoretical framework from the economics of organization and new institutional economics. And I start off with a historical overview of the industry’s technology, regulation, and organizational model.

Implications of Smart Grid Innovation for Organizational Models in Electricity Distribution

Abstract: Digital technologies from outside the electricity industry are prompting changes in both regulatory institutions and electric utility business models, leading to the disaggregation or unbundling of historically vertically integrated electricity firms in some jurisdictions and not others, and simultaneously opening the door for competition with the traditional electric utility business. This chapter uses the technological and organizational history of the industry, combined with the transactions cost theory of the firm and of vertical integration, to explore the implications of smart grid technologies for future distribution company business models. Smart grid technologies reduce transactions costs, changing economical firm boundaries and reducing the traditional drivers of vertical integration. Possible business models for the distribution company include an integrated utility, a network manager, or a coordinating platform provider.

The New York REV and the distribution company of the future

We live in interesting times in the electricity industry. Vibrant technological dynamism, the very dynamism that has transformed how we work, play, and live, puts increasing pressure on the early-20th-century physical network, regulatory model, and resulting business model of the vertically-integrated distribution utility.

While the utility “death spiral” rhetoric is overblown, these pressures are real. They reflect the extent to which regulatory and organizational institutions, as well as the architecture of the network, are incompatible with a general social objective of not obstructing such innovation. Boosting my innovation-focused claim is the synthesis of relatively new environmental objectives into the policy mix. Innovation, particularly innovation at the distribution edge, is an expression of human creativity that fosters both older economic policy objectives of consumer protection from concentrations of market power and newer environmental policy objectives of a cleaner and prosperous energy future.

But institutions change slowly, especially bureaucratic institutions where decision-makers have a stake in the direction and magnitude of institutional change. Institutional change requires imagination to see a different world as possible, practical vision to see how to get from today’s reality toward that different world, and courage to exercise the leadership and navigate the tough tradeoffs that inevitably arise.

That’s the sense in which the New York Reforming the Energy Vision (REV) proceeding of the New York State Public Service Commission (Greentech) is compelling and encouraging. Launched in spring 2014 with a staff paper, REV is looking squarely at institutional change to align the regulatory framework and the business model of the distribution utility more with these policy objectives and with fostering innovation. As Katherine Tweed summarized the goals in the Greentech Media article linked above,

The report calls for an overhaul of the regulation of the state’s distribution utilities to achieve five policy objectives:

  • Increasing customer knowledge and providing tools that support effective management of their total energy bill
  • Market animation and leverage of ratepayer contributions
  • System-wide efficiency
  • Fuel and resource diversity
  • System reliability and resiliency

The PSC acknowledges that the current ratemaking procedure simply doesn’t work and that the distribution system is not equipped for the changes coming to the energy market. New York is already a deregulated market in which distribution is separated from generation and there is retail choice for electricity. Although that’s a step beyond many states, it is hardly enough for what’s coming in the market.

Last week the NY PSC issued its first order in the REV proceeding, that the incumbent distribution utilities will serve as distributed system platform providers (DSPPs) and should start planning accordingly. As noted by RTO Insider,

The framework envisions utilities serving a central role in the transition as distributed system platform (DSP) providers, responsible for integrated system planning and grid and market operations.

In most cases, however, utilities will be barred from owning distributed energy resources (DER): demand response, distributed generation, distributed storage and end-use energy efficiency.

The planning function will be reflected in the utilities’ distributed system implementation plan (DSIP), a multi-year forecast proposing capital and operating expenditures to serve the DSP functions and provide third parties the system information they need to plan for market participation.

A platform business model is not a cut and dry thing, though, especially in a regulated industry where the regulatory institutions reinforced and perpetuated a vertically integrated model for over a century (with that model only really modified due to generator technological change in the 1980s leading to generation unbundling). Institutional design and market design, the symbiosis of technology and institutions, will have to be front and center, if the vertically-integrated uni-directional delivery model of the 20th century is to evolve into a distribution facilitator of the 21st century.

In fact, the institutional design issues at stake here have been the focus of my research during my sabbatical, so I hope to have more to add to the discussion based on some of my forthcoming work on the subject.