Tragedy of the commons, Yugoslavian apartment building laundry room edition

The tragedy of the commons story is well known and examples abound, but I still enjoy finding new examples in unexpected places. Here is one such example, first published in 1992 but new to me.

The building referred to is an apartment building in Yugoslavia; the time described isn’t exactly identified in the article, but perhaps 1960s or early in the 1970s:

In the cellar of our building there was a washing room with a huge concrete washing basin and three new washing machines. At the beginning, everyone washed their clothes downstairs. There was a schedule hung on the door and each family took its turn once a week. The machines didn’t work for long. To put it mildly, people didn’t take very good care of them. After all, these machines didn’t belong to anyone in person, so no one felt responsible for repairing, or even cleaning them. The first machine broke after about a year, then the second one, then the third. In the washing room, people started to store broken chairs, children’s bicycles, beach umbrellas, charcoal for barbecues, skis, mattresses. … The basins were filled with supplies for winter: bags of potatoes, green and red peppers, and wooden barrels of sauerkraut.

We’d lost our common laundry room precisely because it was common. But by that time the standard of living in the country was high enough so, instead of forty people using three common machines, everyone could buy an imported washing machine for themselves, however unnecessary and irrational this really was. Even our own country started to produce them, except that they all were very expensive. This, strangely enough, became a reason to buy one, to prove that you were earning enough, that your social status was high enough, so you could afford household appliances. Social differentiation, starting with cars and TV sets, continued in bathrooms and kitchens. A washing machine became an item of prestige, and it was good for women, even if it really wasn’t meant to ease their lives in the first place.

From “On doing laundry,”
How we survived communism and even laughed, Slavenka Drakulić.

Drakulić’s description of her grandmother doing laundry (in 1950s Yugoslavia) reminded me of Hans Rosling’s TED Talk, “The magic washing machine.”

I have only read a few of the essays in Drakulić’s book, but so far it impresses me as a good collection of sharply-observed and reported essays on life in communist Eastern Europe.

Ride sharing and overcoming taxi discrimination

An interesting story from NPR caught my eye: how ride sharing apps make it easier for riders to overcome racial discrimination. The story tells the tale of Skinny Pants Guy, “a dude who was in his mid-20s — slim, with neat, shoulder-length locks, skinny chinos, loafers and a leather briefcase slung across his torso — standing on the corner, his arm raised skyward. He was trying without luck to hail a cab. …”If I was carrying a gun, where could I even hide it?” he said to us in exasperation.”

Although technically illegal and opening taxi drivers to regulatory punishment and fines if they refuse to accept passengers, racial discrimination among taxi drivers does occur.

Many people of color are embracing these services as a way to avoid discrimination from traditional taxicab drivers. There’s more than anecdotal evidence that that discrimination is widespread. A yearlong investigation by a local reporter in Washington, Russ Ptacek, found last year that taxicab drivers were significantly less likely to stop for black fares than for white fares who were dressed the same.

Phenomena like taxi driver discrimination are an economic conundrum — even in the case of Skinny Pants Guy, who is professionally dressed and unlikely to pose a threat to the driver, why choose no fare rather than pick up the passenger?

Gary Becker’s 1957 book The Economics of Discrimination analyzed this phenomenon, and Becker’s model (inserting a “race taste” parameter into a standard utility function) showed that such discrimination was harmful to both the person discriminated against and the person practicing the discrimination. This model has its limits, of course; if you’re working in a standard framework with stable preferences, this taste parameter represents inherent racism and uses that framework to estimate the cost of such preferences. It doesn’t allow for changing preferences as time and circumstances change. An alternative model that can explain the same phenomenon without such a taste parameter would be a screening model — based on location (good/bad neighborhood) and/or race and/or clothing, a taxi driver could draw inferences based on history or preconceptions and choose whether or not to accept the passenger.

Ride sharing, and technology features such as the ability of riders to rate drivers and vice versa, give riders competing alternatives. What drives this beneficial outcome? Are drivers more willing to pick up riders because they know that they will get to submit a rider rating ex post? Are drivers more willing to pick up riders because the fact that they actively chose Uber or Lyft signals to the driver that such a rider in less likely to be a threat? If that’s the case, why is that the case?

Whatever the motivation, I’m intrigued by this aspect of ride sharing because it’s an unintended benefit, and a broader social benefit of ride sharing. One reason why I’m so interested in ride sharing (see how many posts Mike and I have done!) is that in the process of enabling asset owners to monetize their “dead capital”, it taps into what Adam Smith called our “fellow-feeling” — it inclines us more to sympathy (in the Smithian sense) with the other person, and to act with tolerance. I also think that the reciprocal/mutual ratings system is an institutional design that harnesses fellow-feeling, by giving both drivers and riders an incentive to imagine being in the situation of the other party, and to consider the effects of their behavior on the other party.

Platform economics and “unscaling” the electricity industry

A few weeks ago I mused over the question of whether there would ever be an Uber or AirBnB for the electricity grid. This question is a platform question — both Uber and AirBnB have business models in which they bring together two parties for mutual benefit, and the platform provider’s revenue stream can come from charging one or both parties for facilitating the transaction (although there are other means too). I said that a “P2P platform very explicitly reduces transaction costs that prevent exchanges between buyer and seller”, and that’s really the core of a platform business model. Platform providers exist to make exchanges feasible that were not before, to make them easier, and ultimately to make them either cheaper or more valuable (or some combination of the two).

In this sense the Nobel Prize award to Jean Tirole (pdf, very good summary of his work) this week was timely, because one of the areas of economics to which he has contributed is the economics of two-sided platform markets. Alex Tabarrok wrote an excellent summary of Tirole’s platform economics work. As Alex observes,

Antitrust and regulation of two-sided markets is challenging because the two sets of prices [that the platform firm charges to the two parties] may look discriminatory or unfair even when they are welfare enhancing. … Platform markets mean that pricing at marginal cost can no longer be considered optimal in every market and pricing above marginal cost can no longer be considered as an indication of monopoly power.

One aspect of platform firms is that they connect distinct users in a network. Platform firms are network firms. Not all network firms/industries operate or think of their business models as platform firms, though. That will change.

What role does a network firm provide? It’s connection, facilitating exchange between two parties. This idea is not novel, not original in the digital age. Go back in economic history to the beginnings of canals, say, or rail networks. Transportation is a quintessential non-digital network platform industry. I think you can characterize all network infrastructure industries as having some aspects of platform or two-sided markets; rail networks bring together transportation providers and passengers/freight, postal networks bring together correspondents, pipeline networks bring together buyers and sellers of oil or natural gas, electric wires networks bring together generators and consumers.

What’s novel in the digital age is that by changing transaction costs, the technology changes the transactional boundary of the firm and reduces the economic impetus for vertical integration. A digital platform firm, like Google or Uber, is not vertically integrated upstream or downstream in any of the value chains that its platform enables (although some of Google’s acquisitions are changing that somewhat), whereas historically, railroads and gas companies and electric companies started out vertically integrated. Rail network owners were vertically integrated upstream into train ownership and transportation provision, and electric utilities were integrated upstream into generation. In network infrastructure industries, the platform is physical, and firms bundled the network service into their offering. But they have not been seen or thought of as platforms in the sense that we are coming to understand as such firms and industries emerge; I suspect that’s because of the economic benefit and the historical path dependence of the vertical integration.

Another distinguishing feature of platforms and two-sided markets is that the cost-revenue relationship is not uni-directional, a point summarized well in this Harvard Business Review article overview from 2006:

Two-sided networks can be found in many industries, sharing the space with traditional product and service offerings. However, two-sided networks differ from other offerings in a fundamental way. In the traditional value chain, value moves from left to right: To the left of the company is cost; to the right is revenue. In two-sided networks, cost and revenue are both to the left and the right, because the platform has a distinct group of users on each side. The platform incurs costs in serving both groups and can collect revenue from each, although one side is often subsidized, as we’ll see.

In this sense, I still think that the electricity network and its transactions has platform characteristics — the wires firm incurs costs to deliver energy from generators to consumers, and those costs arise in serving both distinct groups.

As I apply these concepts to the electricity industry, I think digital technologies have two platform-related types of effects. The first is the reduction in transaction costs that were a big part of the economic drive for vertical integration in the first place — digital technologies make distributed digital sensing, monitoring, and measurement of energy flow and system status possible in ways that were inconceivable or impossibly costly before the invention of the transistor.

The second is the ability that digital technologies create for the network firm to handle more diverse and heterogenous types of agents in a two-sided market. For example, digital sensors and automated digital switches make it possible to automate rules for the interconnection of distributed generation, electric vehicles, microgrids, and other diverse users into the distribution grid in ways that can be mutually beneficial in a two-sided market sense. The old electro-mechanical sensors could not do that.

This is the sense in which I think a lot of tech entrepreneurs talk about “unscaling the electricity industry”:

If we want secure, clean and affordable energy, we can’t continue down this path. Instead, we need to grow in a very different way, one more akin to the Silicon Valley playbook of unscaling an industry by aggregating individual users onto platforms.

Digitally-enabled distributed resources are becoming increasingly economical at smaller scales, and some of these types of resources — microgrids, electric vehicles — can either be producers or consumers, each having associated costs and revenues and with their identities changing depending on whether they are selling excess energy or buying it.

This is a substantive, meaningful sense in which the distribution wires firm can, and should, operate as a platform and think about platform strategies as the utility business model evolves. An electric distribution platform facilitates exchange in two-sided electricity and energy service markets, charging a fee for doing so. In the near term, much of that facilitation takes the form of distribution, of the transportation and delivery. As distributed resources proliferate, the platform firm must rethink how it creates value, and reaps revenues, by facilitating beneficial exchange in two-sided markets.

Solar generation in key states

I’ve been playing around with some ownership type and fuel source data on electricity generation, using the EIA’s annual data going back to 1990. I looked at solar’s share of the total MWH of generated electricity in eight states (AZ CA IL NC NJ NY OH TX), 1990-2012, and express it as a percentage of that total, here’s what I got:

solar share since 1990

In looking at the data and at this graph, a few things catch my attention. California (the green line) clearly has an active solar market throughout the entire period, much of which I attribute to the implementation of PURPA qualifying facilities regulations starting in 1978 (although I’m happy to be corrected if I’m mistaken). The other seven states here have little or no solar market until the mid-2010s; Arizona (starts having solar in 2001) and Texas (some solar before restructuring, then none, then an increase) are exceptions to the general pattern.

Of course the most striking pattern in these data is the large uptick in solar shares in 2011 and 2012. That uptick is driven by several factors, both economic and regulatory, and trying to distentangle that is part of what I’m working on currently. I’m interested in the development and change in residential solar market, and how the extent and type of regulatory policy influences the extent and type of innovation and changing market boundaries that ensue. Another way to parse the data is by ownership type, and how that varies by state depending on the regulatory institutions in place. In a state like North Carolina (teal), still vertically-integrated, both the regulated utility and independent power producers own solar. The path to market, and indeed whether or not you can actually say that a residential solar market qua market exists, differs in a vertically-integrated state from, say, New Jersey (orange) or Illinois (purple, but barely visible), where thus far the residential solar market is independent, and the regulated utility does not participate (again, please correct me if I’m mistaken).

It will be interesting to see what the 2013 data tell us, when the EIA release it in November. But even in California with that large uptick, solar’s share of total MWH generated does not go above 2 percent, and is substantially smaller in other states.

What do you see here? I know some of you will want to snark about subsidies for the uptick, but please keep it substantive :-).

The sharing economy and the electricity industry

In a recent essay, the Rocky Mountain Institute’s Matthew Crosby asks “will there ever be an AirBnB or Uber for the electricity grid?” It’s a good question, a complicated question, and one that I have pondered myself a few times. He correctly identifies the characteristics of such platforms that have made them attractive and successful, and relates them to distributed energy resources (DERs):

What’s been missing so far is a trusted, open peer-to-peer (P2P) platform that will allow DERs to “play” in a shared economy. An independent platform underlies the success of many shared economy businesses. At its core, the platform monetizes trust and interconnection among market actors — a driver and a passenger, a homeowner and a visitor, and soon, a power producer and consumer — and allows users to both bypass the central incumbent (such as a taxi service, hotel, or electric utility) and go through a new service provider (Uber, Airbnb, or in the power sector, Google).

Now, as millions gain experience and trust with Airbnb, Uber and Lyft, they may likely begin to ask, “Why couldn’t I share, sell or buy the energy services of consumer-owned and -sited DERs like rooftop solar panels or smart thermostats?” The answer may lie in emerging business models that enable both peer-to-peer sharing of the benefits of DERs and the increased utilization of the electric system and DERs.

A P2P platform very explicitly reduces transaction costs that prevent exchanges between buyer and seller, earning revenue via a commission per transaction (and this is why Uber has in its sights such things as running your errands for you (video)). That reduction allows owners of underutilized assets (cars, apartments, solar panels, and who knows what else will evolve) to make someone else better off by selling them the use of that asset. Saying it that way makes the static welfare gain to the two parties obvious, but think also about the dynamic welfare gain — you are more likely, all other things equal, to invest in such an asset or to invest in a bigger/nicer asset if you can increase its capacity utilization. Deregulation catalyzed this process in the airline industry, and digital technology is catalyzing it now in rides and rooms. This prospect is exciting for those interested in accelerating the growth of DERs.

Note also that Crosby makes an insightful observation when he says that such P2P networks are more beneficial if they have access to a central backbone, which in this case would be the existing electricity distribution grid. Technologically, the edge of the network (where all of the cool distributed stuff is getting created) and the core of the network are complements, not substitutes. That is not and has not been the case in the electricity network, in large part because regulation has largely prevented “innovation at the edge of the network” since approximately the early 20th century and the creation of a standard plug for lights and appliances!

The standard static and dynamic welfare gain arguments, though, are not a deep enough analysis — we need to layer on the political economy analysis of the process of getting from here to there. As the controversies over Uber have shown, this process is often contentious and not straightforward, particularly in industries like rides and electricity, the incumbents in which have had regulatory entry barriers to create and protect regulatory rents. The incumbents may be in a transitional gains trap, where the rents are capitalized into their asset values, and thus to avoid economic losses to themselves and/or their shareholders, they must argue for the maintenance of the regulatory entry barrier even if overall social welfare is higher without it (i.e., if a Kaldor-Hicks improvement is possible). The concentration of benefits from maintaining the entry barrier may make this regulation persist, even if in aggregate the diffuse benefits across the non-incumbents is larger than the costs.

That’s one way to frame the current institutional design challenge in electricity. Given that the incumbent utility business model is a regulatory construct, what’s a useful and feasible way to adapt the regulatory environment to the new value propositions that new digital and distributed energy technologies have made possible? If it is likely that the diffuse economic and environmental benefits of P2P electricity exchange are larger than the costs, what does a regulatory environment look like that would enable P2P networks and the distribution grid to be complements and not substitutes? And how would we transfer the resources to the incumbents to get them out of the transitional gains trap, to get them to agree that they will serve as the intelligent digital platform for such innovation?

I think this is the question at the guts of all of the debate over the utility “death spiral”, the future utility business model, and other such innovation-induced dynamism in this industry. I’ve long argued that my vision of a technology-enabled value-creating electricity industry would have such P2P characteristics, with plug-level sensors that enable transactive automated control within the home, and with meshed connections that enable neighbors with electric vehicles and/or rooftop solar to exchange with each other (one place I made that argument was in my 2009 Beesley lecture at the IEA, captured in this 2010 Economic Affairs article). Crosby’s analysis here is consistent with that vision, and that future.

Should regulated utilities participate in the residential solar market?

I recently argued that the regulated utility is not likely to enter a “death spiral”, but that the regulated utility business model is indeed under pressure, and the conversation about the future of that business model is a valuable one.

One area of pressure on the regulated utility business model is the market for residential solar power. Even two years hence, this New York Times Magazine article on the residential solar market is fresh and relevant, and even more so given the declining production costs of solar technologies: “Thanks to increased Chinese production of photovoltaic panels, innovative financing techniques, investment from large institutional investors and a patchwork of semi-effective public-policy efforts, residential solar power has never been more affordable.” In states like California, a combination of plentiful sun and state policies designed to induce more use of renewables brought growth in the residential solar market starting in the 1980s. This growth was also grounded in the PURPA (1978) federal legislation (“conservation by decree”) that required regulated utilities to buy some of their generated energy from renewable and cogeneration providers at a price determined by the state public utility commission.

Since then, a small but growing independent solar industry has developed in California and elsewhere, and the NYT Magazine article ably summarizes that development as well as the historical disinterest of regulated utilities in getting involved in renewables themselves. Why generate using a fuel and enabling technology that is intermittent, for which economical storage does not exist, and that does not have the economies of scale that drive the economics of the regulated vertically-integrated cost-recovery-based business model? Why indeed.

Over the ensuing decades, though, policy priorities have changed, and environmental quality now joins energy security and the social objectives of utility regulation. Air quality and global warming concerns joined the mix, and at the margin shifted the policy balance, leading several states to adopt renewable portfolio standards (RPSs) and net metering regulations. California, always a pioneer, has a portfolio of residential renewables policies, including net metering, although it does not have a state RPS. Note, in particular, the recent changes in California policy regarding residential renewables:

The CPUC’s California Solar Initiative (CPUC ruling – R.04-03-017) moved the consumer renewable energy rebate program for existing homes from the Energy Commission to the utility companies under the direction of the CPUC. This incentive program also provides cash back for solar energy systems of less than one megawatt to existing and new commercial, industrial, government, nonprofit, and agricultural properties. The CSI has a budget of $2 billion over 10 years, and the goal is to reach 1,940 MW of installed solar capacity by 2016.

The CSI provides rebates to residential customers installing solar technologies who are retail customers of one of the state’s investor-owned utilities. Each IOU has a cap on the number of its residential customers who can receive these subsidies, and PG&E has already reached that cap.

Whether the policy is rebates to induce the renewables switch, allowing net metering, or a state RPS (or feed-in tariffs such as used in Spain and Germany), these policies reflect a new objective in the portfolio of utility regulation, and at the margin they have changed the incentives of regulated utilities. Starting in 2012 when residential solar installations increased, regulated utilities increased their objections to solar power both on reliability grounds and based on the inequities and existing cross-subsidization built in to regulated retail rates (in a state like California, the smallest monthly users of electricity pay much less than their proportional share of the fixed costs of what they consume). My reading has also left me with the impression that if the regulated utilities are going to be subject to renewables mandates to achieve environmental objectives, they would prefer not to have to compete with the existing, and growing, independent producers operating in the residential solar market. The way a regulated monopolist benefits from environmental mandates is by owning assets to meet the mandates.

While this case requires much deeper analysis, as a first pass I want to step back and ask why the regulated distribution utility should be involved in the residential solar market at all. The growth of producers in the residential solar market (Sungevity, SunEdison, Solar City, etc.) suggests that this is a competitive or potentially competitive market.

I remember asking that question back when this NYT Magazine article first came out, and I stand by my observation then:

Consider an alternative scenario in which regulated distribution monopolists like PG&E are precluded from offering retail services, including rooftop solar, and the competing firms that Himmelman profiled can compete both in how they structure the transactions (equipment purchase, lease, PPA, etc.) and in the prices they offer. One of Rubin’s complaints is that the regulated net metering rate reimburses the rooftop solar homeowner at the full regulated retail price per kilowatt hour, which over-compensates the homeowner for the market value of the electricity product. In a rivalrous market, competing solar services firms would experiment with different prices, perhaps, say, reimbursing the homeowner a fixed price based on a long-term contract, or a varying price based on the wholesale market spot price in the hours in which the homeowner puts power back into the grid. Then it’s up to the retailer to contract with the wires company for the wires charge for those customers — that’s the source of the regulated monopolist’s revenue stream, the wires charge, and it can and should be separated from the net metering transaction and contract.

The presence of the regulated monopolist in that retail market for rooftop solar services is a distortion in and of itself, in addition to the regulation-induced distortions that Rubin identified.

The regulated distribution utility’s main objective is, and should be, reliable delivery of energy. The existing regulatory structure gives regulated utilities incentives to increase their asset base to increase their rate base, and thus when a new environmental policy objective joins the exiting ones, if regulated utilities can acquire new solar assets to meet that objective, then they have an incentive to do so. Cost recovery and a guaranteed rate of return is a powerful motivator. But why should they even be a participant in that market, given the demonstrable degree of competition that already exists?

Energy poverty and clean technology

For the past three years, I’ve team-taught a class that’s part of our Institute for Energy and Sustainability at Northwestern (ISEN) curriculum. It’s an introductory class, primarily focused on ethics and philosophy. One of my earth science colleagues kicks us off with the carbon cycle, the evidence for anthropogenic global warming, and interpretations of that evidence. Then one of my philosophy colleagues presents moral theories that we can use to think about the morality of our relationship with nature, environmental ethics, moral obligations to future generations, and so on. Consequentialism, Kantian ethics, virtue ethics. I learn so much from my colleagues every time!

Then I, the social scientist, come in and throw cold water on everyone’s utopias and dystopias — “no, really, this is how people really are going to behave, and the likely outcomes we’ll see from political processes.” Basic economic principles (scarcity, opportunity cost, tradeoffs, incentives, property rights, intertemporal substitution, discounting), tied in with the philosophical foundations of these principles, and then used to generate an economic analysis of politics (i.e., public choice). We finish up with a discussion of technological dynamism and the role that human creativity and innovation can play in making the balance of economic well-being and environmental sustainability more aligned and harmonious.

Energy poverty emerges as an overarching theme in the course — long-term environmental sustainability is an important issue to bear in mind when we think about consumption, investment, and innovation actions we take in the near term … but so are living standards, human health, and longevity. If people in developing countries have the basic human right to the liberty to flourish and to improve their living standards, then energy use is part of that process.

Thus when I saw this post from Bill Gates on the Gates Foundation blog it caught my attention, particularly where he says succinctly that

But even as we push to get serious about confronting climate change, we should not try to solve the problem on the backs of the poor. For one thing, poor countries represent a small part of the carbon-emissions problem. And they desperately need cheap sources of energy now to fuel the economic growth that lifts families out of poverty. They can’t afford today’s expensive clean energy solutions, and we can’t expect them wait for the technology to get cheaper.

Instead of putting constraints on poor countries that will hold back their ability to fight poverty, we should be investing dramatically more money in R&D to make fossil fuels cleaner and make clean energy cheaper than any fossil fuel.

 

In it Gates highlights two short videos from Bjorn Lomborg that emphasize two things: enabling people in poverty to get out of poverty using inexpensive natural gas rather than expensive renewables will improve the lives of many millions more people, and innovation and new ideas are the processes through which we will drive down the costs of currently-expensive clean energy. The first video makes the R&D claim and offers some useful data for contextualizing the extent of energy poverty in Africa. The second video points out that 3 billion people burn dung and twigs inside their homes as fuel sources, and that access to modern energy (i.e., electricity) would improve their health conditions.

The post and videos are worth your time. I would add one logical step in the chain, to make the economics-sustainability alignment point even more explicit — the argument that environmental quality is a normal good, and that as people leave poverty and their incomes rise, at the margin they will shift toward consumption bundles that include more environmental quality. At lower income increases there may still be incrementally more emissions (offset by the reduction in emissions from dung fires in the home), but if environmental quality is a normal good, as incomes continue to rise, consumption bundles will shift. If you know the economics literature on the environmental Kuznets curve, this argument sounds familiar. One of the best summary articles on the EKC is David Stern (2004), and he shows that there is little statistical evidence for a simple EKC, although better models have been developed and if we tell a more nuanced story and use better statistical techniques we may be able to decompose all of the effects.

Gates is paying more attention to energy because he thinks the anti-poverty agenda should include a focus on affordable energy, and energy that’s cleaner than what’s currently being used indoors for cooking in many places.