Rent-seeking diary: State dealer franchise laws and Tesla

By now you’ve probably heard that last week the New Jersey Motor Vehicle Commission passed a rule stipulating that automobile sales in the state cannot be direct-to-consumer, and must instead take place via dealer franchises. Tesla Motors was the clear target of this regulation, with its innovative electric vehicles and direct-to-consumer sales model. New Jersey is not the first state in which this regulatory tangle is occurring; last summer Tesla ran into dealer franchise law hurdles in Virginia and New York, as I discussed here in July.

The SF Gate blog post above notes:

Tesla said the administration had “gone back on its word,” claiming two top Christie aides had agreed not to move forward with the regulation. …

But a Christie spokesman rejected the accusations of a double-cross. The regulation, he said, won’t prevent Tesla from seeking legislation to allow direct sales in New Jersey.

Note that the political establishment response is to engage with the political process to get legislation passed to allow direct sales. What would such engagement entail? Will it entail the kind of crony relationships that have led to the entanglement of so many businesses and politicians in the past — will Tesla have to find its own politicians to fund in the hopes of a favorable legislative outcome? If so, that will vindicate my sad statement last July:

When innovative and environmentally correct meets the crony corporatism of existing legislation, is the entrenched incumbent dealer industry sufficiently politically powerful to succeed in retaining their enabling legislation that raises their new rival’s costs?

In New Jersey, it appears that the answer is yes, at least for now, as established car dealers cling to their old business model and hope to avoid being disintermediated. Tesla has thus far avoided the crony trap, and has instead focused on relabeling their New Jersey showrooms as “galleries” while encouraging customers to purchase the vehicle online. Will that legalistic sleight of hand suffice to enable an end-run around status-quo-protecting obstacles?

Alex Tabarrok discusses the Tesla-New Jersey case today, and analyzes it very usefully with a brief history of the evolution of state dealer franchise laws and how they served as a Coasean solution to an incentive problem:

Franchising rules evolved in Coasean fashion so that manufacturers could not expropriate dealers and dealers could not expropriate manufacturers. To encourage dealers to invest in a knowledgeable sales and repair staff, for example, manufactures promised dealers exclusive franchise (i.e. they would not license a competitor next door). But with exclusive franchises dealers would have an incentive to take advantage of their monopoly power and increase profits by selling fewer units at higher profits. Selling fewer units, however, works to the detriment of the manufacturer and the public (aka the double marginalization problem (video)). Thus the manufactures required dealers buy and sell a minimum quantity of cars, so-called quantity forcing. Selling more units is exactly what we want a monopoly to do, so these restrictions benefited manufactures and consumers.

Here Alex’s account dovetails with the history that Elon Musk provided in his open letter to the people of New Jersey on Friday:

Many decades ago, the incumbent auto manufacturers sold franchises to generate capital and gain a salesforce. The franchisees then further invested a lot of their money and time in building up the dealerships. That’s a fair deal and it should not be broken. However, some of the big auto companies later engaged in pressure tactics to get the franchisees to sell their dealerships back at a low price. The franchisees rightly sought protection from their state legislatures, which resulted in the laws on the books today throughout the United States (these laws are not present anywhere else in the world).

Musk’s letter is well worth reading in its entirety, as an eloquent and well-argued statement about regulatory and legislative entry barriers that enable incumbent firms to raise the costs of their rivals. He also provides a thoughtful and economically sophisticated (and accurate, I think) explanation for why they don’t want to sell Tesla vehicles through established dealers.

Here Alex adds another political economy detail of the economic leverage of the franchise dealers in the states — they provided jobs and their sales generated a large share of a state’s sales tax revenue, so politicians found it in their interest to shore up the state-level dealer franchise laws to protect the dealers. Thus a set of laws that initially benefitted both producers and consumers has evolved into industry-protecting regulation.

One other theme I’ve noted in the discussion of Tesla’s reaction to New Jersey cronyism is to criticize Tesla for the benefits it derives from government protection. Tesla’s business intersects with government programs in three areas: (1) taking a DOE-guaranteed loan of $465 million during the financial crisis, which has been paid back in full (and was smaller than the multi-billion-dollar loans to the Big Three); (2) the federal $7,500 income tax credit to individuals purchasing electric vehicles, from which all manufacturers of electric vehicles benefit and which is probably not decisive at the margin for Tesla’s high-income target customers; (3) revenue arising from the existence of a regulation-generated market for vehicle emission credits (ZEV) credits in California, in which Toyota and Nissan also sell ZEV credits to GM and Chrysler. I expect that being practical and not leaving money on the table is a sufficient motive to induce Tesla’s management to engage in those programs. But these benefits from government social engineering and regulation differ in kind from the kind of industry-protecting regulatory cronyism evident in New Jersey (and Texas, and other states forbidding direct-to-consumer car sales).

Permissionless innovation in electricity: the benefits of experimentation

Last Monday I was scheduled to participate in the Utility Industry of the Future Symposium at the NYU Law School. Risk aversion about getting back for Tuesday classes in the face of a forecast 7″ snowfall in New York kept me from attending (and the snow never materialized, which makes the cost even more bitter!), so I missed out on the great talks and panels. But I’ve edited my remarks into the essay below, with helpful comments and critical readings from Mark Silberg and Jim Speta. Happy thinking!

If you look through the lens of an economist, especially an economic historian, the modern world looks marvelous – innovation enables us to live very different lives than even 20 years ago, lives that are richer in experience and value in many ways. We are surrounded by dynamism, by the change arising from creativity, experimentation, and new ideas. The benefits of such dynamism are cumulative and compound upon each other. Economic history teaches us that well-being emerges from the compounding of incremental changes over time, until two decades later you look at your old, say, computer and you wonder that you ever accomplished anything that way at all.

The digital technology that allows us to flourish in unanticipated ways, large and small, is an expression of human creativity in an environment in which experimentation is rife and entry barriers are low. That combination of experimentation and low entry barriers is what has made the Internet such a rich, interesting, useful platform for us to use to make ourselves better off, in the different ways and meanings we each have.

And yet, very little (if any) of this dynamism has originated in the electricity industry, and little of this dynamism has affected how most people transact in and engage with electricity. Digital technologies now exist that consumers could use to observe and manage their electricity consumption in a more timely way than after the fact, at the end of the month, and to transact for services they value – different pricing, different fuel sources, and automating their consumption responses to changes in those. From the service convergence in telecom (“triple play”) we have experimented with and learned the value of bundling. Such bundling of retail electricity service with home entertainment, home security, etc. are services that companies like ADT and Verizon are exploring, but have been extremely slow to develop and have not commercialized yet, due to the combination of regulatory entry barriers that restrict producers and reinforce customer inertia. All of these examples of technologies, of pricing, of bundling, are examples of stalled innovation, of foregone innovation in this space.

Although we do not observe it directly, the cost of foregone innovation is high. Today residential consumers still generally have low-cost, plain-vanilla commodity electricity service, with untapped potential to create new value beyond basic service. Producers earn guaranteed, regulation-constrained profits by providing these services, and the persistence of regulated “default service contracts” in nominally competitive states is an entry barrier facing producers that might otherwise experiment with new services, pricing, and bundles. If producers don’t experiment, consumers can’t experiment, and thus both parties suffer the cost of foregone innovation – consumers lose the opportunity to choose services they may value more, and producers lose the opportunity to profit by providing them. By (imperfect) analogy, think about what your life would be like if Apple had not been allowed to set up retail stores that enable consumers to engage in learning while shopping. It would be poorer (and that’s true even if you don’t own any Apple devices, because the experimentation and learning and low entry barriers even benefits you because it encourages new products and entry).

This process of producer and consumer experimentation and learning is the essence of how we create value through exchange and market processes. What Internet pioneer Vint Cerf calls permissionless innovation, what writer Matt Ridley calls ideas having sex — these are the processes by which we humans create, strive, learn, adapt, and thrive.

But regulation is a permission-based system, and regulation slows or stifles innovation in electricity by cutting off this permissionless innovation. Legal entry barriers, the bureaucratic procedures for cost recovery, the risk aversion of both regulator and regulated, all undermine precisely the processes that enable innovation to yield consumer benefits and producer profits. In this way regulation that dictates business models and entry barriers discourages activities that benefit society, that are in the public interest.

The question of public interest is of course central to any analysis of electricity regulation’s effects. Our current model of utility regulation has been built on the late 19th century idea that cost-based regulation and restricting entry would make reliable electric service ubiquitous and as cheap as is feasible. Up through the 1960s, while exploiting the economies of scale and scope in the conventional mechanical technologies, that concept of the public interest was generally beneficial. But by so doing, utility regulation entrenched “iron in the ground” technologies in the bureaucratic process. It also entrenched an attitude and a culture of prudential preference for those conventional technologies on the part of both regulator and regulated.

This entrenchment becomes a problem because the substance of what constitutes the public interest is not static. It has changed since the late 19th century, as has so much in our lives, and it has changed to incorporate the dimension of environmental quality as we have learned of the environmental effects of fossil fuel consumption. But the concept of the public interest of central generation and low prices that is fossilized in regulatory rules does not reflect that change. I argue that the “Rube Goldberg” machine accretion of RPS, tax credits, and energy efficiency mandates to regulated utilities reflects just how poorly situated the traditional regulated environment is to adapting to the largely unforeseeable changes arising from the combination of dynamic economic and environmental considerations. Traditional regulation is not flexible enough to be adaptive.

The other entrenchment that we observe with regulation is the entrenchment of interests. Even if regulation was initiated as a mechanism for protecting consumer interests, in the administrative and legal process it creates entrenched interests in maintaining the legal and technological status quo. What we learn from public choice theory, and what we observe in regulated industries including electricity, is that regulation becomes industry-protecting regulation. Industry-protecting regulation cultivates constituency interests, and those constituency interests generally prefer to thwart innovation and retain entry barriers to restrict interconnection and third-party and consumer experimentation. This political economy dynamic contributes to the stifling of innovation.

As I’ve been thinking through this aloud with you, you’ve probably been thinking “but what about reliability and permissionless innovation – doesn’t the physical nature of our interconnected network necessitate permission to innovate?” In the centralized electro-mechanical T&D network that is more true, and in such an environment regulation provides stability of investments and returns. But again we see the cost of foregone innovation staring us in the face. Digital switches, open interconnection and interoperability standards (that haven’t been compromised by the NSA), and more economical small-scale generation are innovations that make high reliability in a resilient distributed system more possible (for example, a “system of systems” of microgrids and rooftop solar and EVs). Those are the types of conditions that hold in the Internet – digital switches, traffic rules, TCP-IP and other open data protocols — and as long as innovators abide by those physical rules, they can enter, enabling experimentation, trial and error, and learning.

Thus I conclude that for electricity policy to focus on facilitating what is socially beneficial, it should focus on clear, transparent, and just physical rules for the operation of the grid, on reducing entry barriers that prevent producer and consumer experimentation and learning, and on enabling a legal and technological environment in which consumers can use competition and technology to protect themselves.

Politicized implementation of U.S. oil import quotas, 1959-1973

The oil import quota system in place from 1959 to 1973 restricted imports to an amount equal to the difference between the federal government’s estimate of domestic oil demand and the estimate of domestic oil supply. But, of course, nothing in industry-protection policy can be easy, so the policy contained a number of adjustments and exclusions.

Chief among exclusion was the “overland exemption” for imports from Canada and Mexico. Hilarity ensues.

120. There is an overland “exemption” for imports from Canada and Mexico. The overland exemption has been construed to include imports from Mexico which are transported by tanker to Brownsville, Texas, where they are entered in bond, transferred to trucks which cross the Mexican border, then re-enter the United States where they are released from bond and are said to have entered by overland means. The oil is reloaded aboard tankers for shipment by sea to the U.S. East Coast. On the other hand, the exemption has not been extended to shipments from Canada across the Great Lakes or to rail shipments from Canada to Ketchikan in Southern Alaska because of a short inland waterway crossing by rail car ferry. The “overland exemption” for both Canadian and Mexican imports are further limited quantitatively by intergovernmental agreements.

From Cabinet Task Force on Oil Import Control, The Oil Import Question, (1970), at pp. 9-10.

 

Raisin’ a complaint against USDA marketing orders

Can raisin growers pack and sell all of the raisins they grow? Yes, but only if the USDA permits it. Sometimes the USDA claims the right to take raisins off the market in the effort to keep the price to consumers higher. If a raisin grower doesn’t comply with the USDA’s demands, then the government’s attorneys will come a knocking. That is what happened to Marvin Horne and his wife, raisin growers in California, when they chose not to comply with the USDA’s demand to hand over a 47% share of the Horne’s 2002 crop without any payment from the government.

It is, as Planet Money describes it in a radio segment, kind of crazy. In most industries the federal government tries to block industry collusion–it is bad for consumers, they say–but with raisins and a number of other crops the federal government requires it. Your tax dollars at work.

The Planet Money broadcast is worth a listen. Here also is ReasonTV on the story: Feds vs. Raisins: Small Farmers Stand Up to the USDA

This 2002 act of non-compliance is, more than 10 years later, still bouncing around the courts. In a recent decision the Supreme Court declared that Horne et al. could raise a takings claim without first paying the USDA’s proposed fine of about half-a-million dollars, but that small victory only allows them to continue the legal fight.

MORE: The Cato Institute filed a legal brief at the Supreme Court in support of the Horne et al. position. Links: Summary of brief; Full brief. See also coverage at SCOTUSblog.

Bruce Yandle on bootleggers & Baptists

Bruce Yandle’s “bootleggers & Baptists” model of political coalition formation is one of the most useful models in the political economy of regulation (and one that both Mike and I employ frequently, as seen by our many posts using the model).

Here’s a great new Learn Liberty video featuring Bruce himself describing how coalitions of seemingly-unlikely interests can form to enact particular regulations. He describes the original formulation, and then applies it to environmental regulation.

 

Disruptive innovation and the regulated utility

Over the weekend the New York Times ran a good story about how rooftop solar and regulatory rules allowing net metering are putting pressure on the regulated distribution utility business model:

The struggle over the California incentives is only the most recent and visible dust-up as many utilities cling to their established business, and its centralized distribution of energy, until they can figure out a new way to make money. …

“Net metering right now is the only way for customers to get value for their rooftop solar systems,” said Adam Browning, executive director of the advocacy group Vote Solar.

Mr. Browning and other proponents say that solar customers deserve fair payment not only for the electricity they transmit but for the value that smaller, more dispersed power generators give to utilities. Making more power closer to where it is used, advocates say, can reduce stress on the grid and make it more reliable, as well as save utilities from having to build and maintain more infrastructure and large, centralized generators.

But utility executives say that when solar customers no longer pay for electricity, they also stop paying for the grid, shifting those costs to other customers. Utilities generally make their profits by making investments in infrastructure and designing customer rates to earn that money back with a guaranteed return, set on average at about 10 percent.

In a nutshell, what’s happening is that environmental and global warming policy initiatives are resulting in government subsidies and tax credits for consumer investments in rooftop solar, especially in states like California. As more consumers install rooftop solar they both make less use of the electricity distribution network to receive electricity and can put the excess power generated from their solar panels onto the distribution grid (called net metering). Under net metering they receive a per-kilowatt-hour payment that ranges between the averaged, regulated retail rate and the wholesale price of electricity at that time, depending on the net metering rules that are in operation in that state. From the regulated utility’s perspective, this move creates a double whammy — it reduces the amount of electricity sold and distributed using the wires network, which reduces revenue and the ability of the utility to charge the customer for use of the wires, but since most of the costs for the network are fixed costs and the utility is guaranteed a particular rate of return on those assets, that means increasing rates for other customers who have not installed solar.

Offsetting some of that revenue decrease/fixed cost dilemma is the fact that net metering means that the utility is purchasing power from rooftop solar owners at a price lower than the spot price they would have to pay to purchase power in the wholesale market in that hour (i.e., wholesale price as avoided cost) … except what happens when they have already entered long-term contracts for power and have to pay anyway? And in California, the net metering payment to the customer is the fully-loaded retail rate, not just the energy portion of the rate, so even though the customer is essentially still using the network (to sell excess power to other users via the regulated utility instead of buying it), the utility is not receiving the wires charge portion of the per-kilowatt-hour regulated rate.

Sounds like a mess, right? It sure is. And, as Katie Fehrenbacher pointed out yesterday on Gigaom, the disruption of the regulated electric utility in the same way that Kodak, Blockbuster, and Borders have been disrupted out of existence is not a new idea. In fact, I made the same argument here at KP back in 2003, building on a paper I co-authored for the International Association of Energy Economics meetings in 2002 (and here are other KP posts that both Mike and I have made on net metering). I summarized that paper in this Reason Foundation column, in which I argued

Many technological and market innovations have reduced the natural monopoly rationale for traditional electric industry regulation. For example, consider distributed generation. Distributed generation (DG) is the use of an energy source (gas turbines, gas engines, fuel cells, for example) to generate electricity close to where it will be used. Technological change in the past decade and deregulation in the natural gas industry have made DG an economically viable alternative to buying electricity from a monopoly utility and receiving it over the utility’s transmission and distribution grid. The potential for this competition to discipline a transmission owner’s prices for transmission services is immense, but it still faces some obstacles. …

Technological change and market dynamics have made the natural monopoly model of electricity regulation obsolete. While technological changes and market innovations that shape the electricity industry’s evolution have received some attention, their roles in making natural monopoly regulation of transmission and distribution obsolete have not received systematic treatment. For that reason, the policy debate has focused on creating regional transmission organizations to rationalize grid construction, but has not dug more deeply into the possible benefits of dramatically rethinking the foundations of natural monopoly regulation.

I may have been a bit ahead of my time in making this argument, but the improvements in energy efficiency and production costs for solar technology and the shale gas revolution have made this point even more important.

Think a bit about how the regulated utilities and regulators have come to this point. They have come to this point by trying to retain much of the physical and legal structure of traditional regulation, and by trying to fold innovation into that structure. The top-down system-level imposition of requirements for the regulated utility to purchase excess solar-generated electricity and to pay a specific, fixed price for it. The attempts of regulated utilities to block such efforts, and to charge high “standby charges” to customers who install distributed generation but want to retain their grid interconnection as an insurance policy. The fact that regulation ensures cost recovery for the wires company and how that implies that a reduction in number of customers means a price increase to those customers staying on the wires network. And adding on top of that the subsidies and tax credits to induce residential customers to purchase and install rooftop solar. I don’t think we could design a worse process and set of institutions if we tried.

You may respond that there’s no real alternative, and I’d say you’re wrong. You can see the hint in my remarks above from 2003 — if these states had robust retail competition, then retailers could offer a variety of different contracts, products, and services associated with distributed generation. Wires companies could essentially charge standard per-unit transportation rates (assuming they would still be regulated). In that market design, much of the pressure on the business model of the wires company from distributed generation gets diluted. The wires company would still have to be forward-looking and think (with the regulators) about what increased penetration of distributed generation would mean for the required distribution capacity of the wires network and how to invest in it and recover the costs. But the wires company would be just that, a wires company, and not the party with the retail relationship with the residential customer, so all of these distortions arising from net metering would diminish. If I were a wires company I would certainly use digital meters and monitors to measure the amount of current flow and the direction of current flow, and I would charge a per-kilowatt-hour wires transportation charge regardless of direction of flow, whether the residential customer is consuming or producing. Digital technology makes that granular observation possible, which makes that revenue model possible.

That’s why states like California have created such an entangled mess for themselves by retaining the traditional regulated utility structure for integrated distribution and retail and trying to both absorb and incentivize disruptive distributed generation innovation in that traditional structure. Not surprisingly, Texas with its more deregulated and dis-integrated structure has escaped this mess — the only regulated entity is the wires (transmission and distribution) company, and retailers are free to offer residential customers compensation for any excess generation from distributed renewable generation sources, at a price mutually agreed upon between the retailer and the customer in their contract. In fact, Green Mountain Energy offers such a contract to residential customers in Texas. See how much easier that is than what is happening in California?

Adam Thierer on regulating media platforms

The Mercatus Center’s Adam Thierer analyzes communications technologies and the policies influencing the development and use of them, and I’ve always found his work extremely valuable in my own thinking. Adam and Brent Skorup have a new Mercatus study on lobbying in the information technology sector, A History of Cronyism and Capture in the Information Technology Sector.

One area where Adam and I have common cause is in the interaction of regulation and technological change, and the extent to which regulation may not yield the desired outcomes when regulation dilutes incentives to innovate and stifles change, due to some static definition of “public interest” that is inconsistent with dynamism and experimentation.

I recommend this Surprisingly Free podcast, in which Adam discusses proposals to regulate Facebook and other social media platform companies as public utilities; the podcast page also has links to some of Adam’s written work. In particular, if you want to explore these ideas I suggest Adam’s Mercatus paper on the perils of classifying social media companies as public utilities, in which he argues:

Social media aren’t public utilities for two key reasons:

  1. Social Media do not possess the potential to become natural monopolies. They are virtually no costs to consumers and competitors have the ability to duplicate such platforms. The hottest networks are changing every year, and there is no way for the government to determine which platform is going to become popular next.  Remember MySpace or CompuServe?
  2. Social Media are not essential facilities. Those who claim that Facebook is a “social utility” or “social commons” must admit that such sites are not essential to survival, economic success, or online life. Unlike water and electricity, life can go on without social networking services.

Public utility regulation would instead stifle digital innovation and raise prices of these services for users. Not only are social media sites largely free and universally available, but they are also constantly innovating.

I am going to be digging into a new research project later this summer using some of Adam’s arguments, so I am particularly interested in your comments and thoughts.

Lessons from Lance

Lynne Kiesling

So now we at least know something direct from the horse’s mouth about Lance Armstrong’s use of performance-enhancing drugs before and during his long run of commanding Tour de France performances. In addition to the interview with Oprah Winfrey, this CBS 60 Minutes segment and this Cycling News interview with Armstrong provide fuller details. If you do not follow cycling or have not been following these events, Juliet Macur’s New York Times story from January 6 provides a good summary. (By the way, Juliet Macur, ESPN’s Bonnie Ford, and WSJ’s Jason Gay (here and here recently) are outstanding journalists and writers whose insights and knowledge have been essential reading on cycling for years, not just in dissecting l’affaire Armstrong).

Having followed cycling since the mid-1980s, my sense is that Armstrong is right that PED use is endemic in quite a few sports, including cycling. But it’s not universal. I also think that Armstrong is choosing his words carefully, and in a very calculated manner is trying to walk the fine line between saying enough to get some reputation capital back and be readmitted to professional racing (in triathlon this time, as in his early career) and saying so much that he re-triggers the federal lawsuit about his alleged conspiracy to distribute and use illegal substances, which would land him in jail.

What I find the most personally disturbing is his callous willingness to treat other people as means to an end, one end, his winning the Tour as many times as possible. The bullying and the backing of young, eager, naive athletes into Faustian corners is unforgivable. For that alone I’d deny him a USA Triathlon license. But I’m a very strong believer in private ordering through reputation and strong social norms, probably a stronger believer in them than the general population.

Some observers, including my good friends at Reason, argue that we should allow PED use in professional sports. I disagree, for two reasons, one physiological and one moral. In sports like cycling, the blood doping is intended to increase the oxygen content of the blood and to accelerate recovery from endurance activity. It does that, but it does that differently for each person, because each person has a different baseline blood oxygen content (hematocrit) and each person responds differently to augmentation. It’s not just a parallel shift that “raises all boats” equivalently. So if you are a rider with a low hematocrit who responds well to doping and you beat a rider with a higher hematocrit who responds less to doping, what have you achieved? Who’s the better cyclist on that day?

And that gets to the moral reason why I think we should continue to have sanctions against PED use in sports. Sports, whether professional or recreational, are meaningless unless they are grounded in the deeply human institutions of fair play. We have evolved a sense of fair play for a reason. Abandoning that institution with respect to PED use in professional sports would abandon fair play, would turn sports into nothing more than a “bread and circus” spectacle to entertain the masses in the manner of the Roman gladiators, and would feed back into youth sports with very perverse and negative incentives that would undermine the physical, psychological, and moral benefits we derive from participating in sports. If we relinquish fair play in sports we relegate sports to meaningless decadence. I can’t support that. Nor does the evolution of our institutions through human history match with that decision.

Which gets me to Roger Pielke Jr.’s very insightful post in which he argues that sports need stronger institutions. I really encourage you to read his post, because he does a very good job of summarizing the complicated institutional framework in which many sports operate. Cycling is an Olympic sport, and it also involves competitions (like the Tour de France and the Giro d’Italia) run by international organizations. It also has a governance organization, the UCI, which has come in for a lot of justifiable criticism regarding its transparency and its enforcement of its private rules against doping (in fact, I think it hasn’t come in for enough criticism and that lots of heads need to roll, but that’s for another post). Roger’s post also highlights the awkward nexus of the International Olympic Committee (and the USOC) and its private sanctions against doping, the non-governmental organization that is charged with monitoring and enforcing these sanctions (WADA, and in the US, USADA), and the treatment of PED use in sports by various international governments. In particular, in many other countries enforcement does involve governments and PED use violations are subject to criminal prosecution, while under US law they are treated as private matters as long as the substances are not themselves illegal. Of course, this line gets crossed all the time, as we see when Congress gets a burr under its saddle and hauls ex-baseball players up to testify about PED use.

And that’s where I think l’affaire Armstrong and the US government’s pursuit of him and how USADA plays into that should make us all pause and consider the implications of this government power more broadly. Last week in Wired, Brian Alexander wrote that the Armstrong case and USADA’s role in it should make you, and me, and each of us worry:

So here’s the thing you need to know: The USADA takedown of Armstrong matters, and it could effect everybody. Because it will enhance the power and reach of a private, non-profit business that has managed to harness the power of the federal government in what’s quickly becoming a brand new war on drugs … with all the same pitfalls brought to you by the first war on drugs.

The USADA is a private outfit. Yet it gets taxpayer money. And it has existed in this weird legal nether world since its creation in 1999 at the instigation of the International Olympic Committee, United States Olympic Committee, and President Clinton’s White House Office of National Drug Control Policy. The USADA is designated by the U.S. Congress as the company that handles anti-doping for this country, because the World Anti-Doping Treaty — a UNESCO-promulgated document that the U.S. signed with almost no discussion – obligates the U.S. to do a number of things, which includes conforming our laws to the international anti-doping code. …

The USADA has wanted Armstrong for years. To it, and to the World Anti-Doping Agency (WADA), Armstrong was Moby Dick: If they could kill the whale – and do it without a raft of positive tests to show Armstrong doped – a new model of anti-doping would be enshrined into practice. And that’s just what happened.

Piggy-backing on a federal investigation, the USADA was able to pressure Armstrong teammates to confess to doping and implicate Armstrong … with no positive test results. It was an FBI-style investigation spanning multiple countries, but there was no “smoking syringe” found stuck in Armstrong’s arm. …

So while you might wish athletes didn’t dope — I do, too — and want action taken to combat doping, you might also want to be careful about what you’re wishing for. Especially since sports is taking on a broader definition that includes amateurs, low-level marathon runners, and even your kid’s high school football team.

I’ve excerpted Alexander’s argument, but I do encourage you to read it fully for a better understanding of exactly how sobering the implications are.

That’s what I think there are a lot of disturbing lessons from Lance, and from the USADA’s pursuit of him. Both his craven conduct and lack of character and the sinister implications of his prosecution bode ill in ways that will diminish sports that we love, as spectators and as participants. And they increase the authority of the state in ways that we’ve already seen are destructive.

What is regulatory capture?

Lynne Kiesling

Regulatory capture is one of the defining phenomena in the political economy of regulation. What is regulatory capture, exactly? In a Tech Liberation post from 2010, Adam Thierer offers this definition:

“Regulatory capture” occurs when special interests co-opt policymakers or political bodies — regulatory agencies, in particular — to further their own ends.  Capture theory is closely related to the “rent-seeking” and “political failure” theories developed by the public choice school of economics.  Another term for regulatory capture is “client politics,” which according to James Q. Wilson, “occurs when most or all of the benefits of a program go to some single, reasonably small interest (and industry, profession, or locality) but most or all of the costs will be borne by a large number of people (for example, all taxpayers).”  (James Q. Wilson, Bureaucracy, 1989, at 76).

This short video from Susan Dudley at George Washington University provides a concise introduction to the concept:

As she points out, one of the consistent outcomes arising from regulatory capture is that the regulated industry can use regulation in ways to increase its benefits at the expense of consumers.

In the post quoted above, Adam does a great service by generating a compendium of quotes from economists and other analysts about regulatory capture and he’s added to this list since the original post. His chronological list gives you a good sense of how pervasive the phenomenon is of politically-connected interests to shape regulation to their own advantage.

Regulatory capture: putting the “crony” in crony capitalism for as long as regulations and politics have existed.

Regulation’s effects on innovation in energy technologies: the experimentation connection

Lynne Kiesling

Remember the first time you bought a mobile phone (which in my case was 1995). You may have been happy with your land line phone, but this new mobile phone thing looks like it would be really handy in an emergency, so you-in-1995 said sure, I’ll get a cell phone, but not really use it that much. Then, the technology improved, and more of your friends and family got phones, so you used it more. Then you saw others with cool flip phones, in colors, and you did some searching to see if other phones had features you might like. Then came text messaging, and you experimented with learning a new shorthand language (or, if you’re like me, you stayed a pedant about spelling even in text messages that you had to tap out on number pad keys). You adopted text messaging, or not. Then came the touch screen, largely via the disruptive iPhone, and the cluster of smartphone innovation was upon us.  Maybe you have a smartphone, maybe you don’t; maybe your smartphone is an iPhone, maybe it isn’t. But since 1995, your choice of communication technology, and the set from which you can choose, has changed dramatically.

This change didn’t happen overnight, and for most people was not a discrete move from old choice to new choice, A to B, without any other choices along the way. Similarly for technological change and the production of goods and services. For both consumers and producers, our choices in markets are the consequence of a process of experimentation, trial and error, and learning. Indeed, whether your perspective on dynamic competition is based on Schumpeter or Hayek or Kirzner (or all of the above), the fundamental essence of competition in market processes is that it’s a process of experimentation, trial and error, and learning, on the part of both producers and consumers. That’s how we get new products and services, that’s how we signal to producers whether their innovations are valuable to us as consumers, that’s how innovation creates economic growth and vibrancy, through the application of our creativity and our taste for creating and experiencing novelty.

This kind of dynamism is common in our world, and is increasingly an aspect of our lives that creates value for us; mobile telephony is the most obvious example, but even in products as mundane as milk, the fundamental aspect of the market process is this experimentation, trial and error, and learning. How else would Organic Valley have started coming out with a line of milk that is entirely from pasture-raised cows? (I am happily consuming this milk; pasture-raised cows make milk with more essential fatty acids and conjugated linoleic acid, very important for health)

But this kind of dynamism, while common, is not pervasive. Institutions matter, and in particular, various forms of government regulation can influence the extent to which such technological dynamism occurs in a market. The example I have in mind as a counterpoint, the example I want to explain and understand, is consumer-facing electricity technologies, like thermostats and home energy management systems. For the past several years there has been considerable innovation in this space, due to the application and extension of digital communication technology innovations. But despite the frequent claims over the past few years that this year will be the year of the consumer energy technology, it keeps not happening.

Tomorrow in New Orleans, at the Southern Economic Association meetings, I’ll be presenting a paper that grapples with this question. My argument is that traditional economic regulation of the electricity industry slows or stifles innovation because regulation undercuts the experimentation, trial and error, and learning of both producers and consumers. As I state in the abstract:

Persistent regulation in potentially competitive markets can undermine consumer benefits when technological change both makes those markets competitive and creates new opportunities for market experimentation. This paper applies the Bell Doctrine precedent of “quarantine the monopoly” to the electricity industry, and extends the Bell Doctrine by analyzing the role of market experimentation in generating the benefits of competition. The general failure to quarantine the monopoly wires segment and its regulated monopolist from the potentially competitive downstream retail market contributes to the slow pace and lackluster performance of retail electricity markets for residential customers. The form of this failure to quarantine the monopoly is the persistence of an incumbent default service contract that was intended to be a transition mechanism to full retail competition, coupled with the regulatory definition of product characteristics and market boundaries that is necessary to define the default product and evaluate the regulated monopolist’s performance in providing it. The consequence of the incumbent’s incomplete exit from the retail market suggests that as regulated monopolists and regulators evaluate customer-facing smart grid investments, regulators and other policymakers should consider the potential anti-competitive effects of the failure to quarantine the monopoly with respect to the default service contract and in-home energy management technology.

In August 2011 I wrote about the Bell Doctrine, Baxter’s precedent from the U.S. v. AT&T divestiture case, and how we have failed to quarantine the monopoly in electricity. This paper is an extension of that argument, and I welcome comments!

If you’ll be at the SEA meetings, I hope to see you there; I am headed to NOLA tonight, and look forward to a fun weekend full of good economic brain candy.