Posts Tagged ‘Regulation’

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Breaking news: State regulatory procedures do not favor consumers

December 22, 2011

Lynne Kiesling

As is the vernacular these days, your response to the title of this post is probably “I know, right?” Or, if you prefer sarcasm, you may say “no, really?” This is the conclusion of an all-too-rare piece of investigative journalism from Dan Garino at the Columbus Dispatch:

Ohio’s unique system for setting electricity rates has created a quagmire of regulations that have benefited industry over consumers. …

The rate increases stem from a complex regulatory approach unlike any other in the country, one that combines elements of both regulated and free-market systems.

Beyond that, The Dispatch found during a yearlong investigation that the state’s regulatory structure misses what many observers see as the underlying problem: Utility companies have tremendous political power that tends to overshadow consumers’ needs in the process.

This lengthy article goes into detail on the legislative history of electricity restructuring in Ohio and the political economy of utility lobbying of legislators, as well as the role of the Public Utility Commission as regulator in this hybrid restructured state. If you are interested in electricity or the political economy of regulation, it’s a worthwhile read — a case study in public choice theory.

In its early years of restructuring, Ohio was held out as a leader with strong potential for consumer-oriented retail competition, but over time that competition has not emerged. One of Ohio’s institutional innovations was “aggregation”, or allowing municipalities to act as a retail aggregator on behalf of a set of customers, in that case its residents. But Ohio’s legislators and regulators did not pay adequate attention to the unintended consequences of the political compromises they made that would continue to serve as entry barriers to potential retail competitors, including aggregation.

In terms of the PUCO regulatory procedures and the processes through which debate and discussion are supposed to happen, the article makes a lot out of the unanimity of the Commission’s decisions, but does not dig into the very formal (and formulaic, I think) procedures for filing comments on cases. That process, and its positive and negative consequences, is in and of itself worthy of a lengthy analysis; because of that process, most issues that the commissioners have are likely to be resolved before the ultimate vote, so unanimity is not that surprising. It’s not unique to Ohio, though.

I don’t want to comment on the particulars of Ohio, but I think that most of the states that have implemented regulatory restructuring have a similarly tortured legislative and regulatory story to tell. This Franken-restructured status arises out of a politically-motivated desire to “ring-fence” competition, to capture the benefits of utilities being able to purchase power in competitive wholesale markets, but to control and manage the retail market in ways that create the (realistic, IMO) impression that retail customers are still subject to the regulated monopoly. Ohio’s record on that front is not good, but Ohio is not alone in that camp.

Posted in Economics, Electricity, Regulation | Tagged , , | 1 Comment »

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“Market failure”: you keep using that term. I do not think it means what you think it means.

December 8, 2011

Lynne Kiesling

Steve Horwitz’s column in The Freeman today is a great explication of why the phrase “market failure” is so problematic, and so often misused and abused in public policy analysis when employed to criticize market outcomes. Steve does a good job of explaining the origins of the phrase in the standard textbook case of “perfect competition”: in equilibrium that simple benchmark model, resources are allocated to their highest-valued use, all Pareto-improving trades have occurred, and while firms have earned inframarginal profit, the marginal profit at the equilibrium level of output is zero. More simply, all gains from trade have been exploited and no one has left any money on the table. Thus, the argument goes, in applying that model to reality when we see outcomes that deviate from that and do have misallocation or some unrealized gains from trade, the logical conclusion is that the market has failed to enable agents to achieve that optimal outcome.

Steve highlights two reasons why this interpretation is incorrect; the first reason is a misunderstanding of the nature of competition and the market process as it operates in real conditions of the knowledge problem, imperfect foresight, differentiated products, small numbers of agents, etc. People making the above critique of markets expect a threshold of unrealistic perfection, and consequently make an unfair comparison of a simplified benchmark model with the complications and nuances of a real-world application. I encounter this argument all the time in electricity regulation, which is predicated precisely on this type of false, over-simplified argument, and has a century’s worth of regulatory institutions built upon the false presumption that achieving such a static outcome in reality is possible.

One thing I particularly like about Steve’s argument is how he points out that these cognitive-epistemological characteristics of the real world are features, not bugs, with respect to how market processes create value and gains from trade:

… these sorts of imperfections (a better term than “failure”) are not only part and parcel of real markets; they also are what drive entrepreneurship and competition to find ways to improve outcomes.  In other words, what markets do best is enable people to spot imperfections and attempt to improve on them, even as those attempts at improvement (whether successful or not) lead to new imperfections.  Once we realize that people aren’t fully informed, that we don’t know what the ideal product should look like, and that we don’t know what the optimal firm size is, we understand that these deviations from the ideal are not failures but opportunities.  The effort to improve market outcomes is the entrepreneurship that lies at the heart of the competitive market.

Thus the value of markets is not that they will achieve perfection, but that they have endogenous processes of discovery that enable people to correct the market’s imperfections.  Just as it’s the very friction of the soles of our shoes on the floor that enable us to walk, it is the imperfections of the market that encourage us to find the new and better ways to do things.

He then counters a second aspect of the “market failure” argument: this argument is typically coupled with a recommendation for some form of government intervention or regulation to “correct” the perceived failure. But if market processes in realistic contexts have imperfections, don’t government intervention and regulation have imperfections too? The relevant comparison is between the results of market institutions and government institutions in realistic contexts, not in simplified blackboard theory.

I would add a third point to this analysis. Often when I encounter the “market failure” argument I make a quick riposte of “markets don’t fail, they fail to exist”, which is the Coase/transactions cost response. Transactions costs interfere with the ability of parties to find mutually beneficial trades, thus impeding optimal resource allocation and the creation of maximum gains from trade. Transactions costs lead to missing markets, as in the case of environmental pollution and other common-pool resource situations. This driver of so-called “market failure” complements Steve’s process-oriented argument and reinforces his points … and it implies that one high-priority objective of public policy should be to reduce transactions costs, not to impose regulations that are intended to “correct” market failures but have little realistic hope of doing so effectively.

[Thanks to Aeon Skoble for the Princess Bride hook I used in the title.]

Posted in Economics | Tagged , , | 7 Comments »

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Exelon’s John Rowe and Google’s Eric Schmidt: Truth to power?

October 24, 2011

Lynne Kiesling

Here’s an interesting juxtaposition of two prominent executives performing sound public choice analyses, and I think they complement each other, at least in my work! This weekend’s Wall Street Journal featured an interview with Exelon’s John Rowe, A Life in Energy and (Therefore) Politics. Exelon is the third largest investor-owned utility/generation owner in the country, with one of the largest nuclear generation fleets outside of France. Between the growth of Exelon through mergers and the provenance of Commonwealth Edison (a substantial chunk of Exelon) as Samuel Insull’s pioneering origins of the electricity industry, Rowe has experienced many of the crucial business and policy aspects that have characterized this industry for the past century.

And for my part he pretty much nails the public choice analysis. In discussing the politics of electricity in general, and in particular Exelon’s support of active federal carbon policy:

In a visit to The Wall Street Journal’s offices recently, Mr. Rowe was eager to strip the altar of green jobs—and the many other political pieties that distort the energy industry, even a few that he says belong to the Journal editorial page.

“The utility business is a funny business and almost no one in any political authority in either party really believes in orderly markets in electricity,” Mr. Rowe says. …

The reason for this seeming contradiction—between simultaneously supporting free markets and interventions like an economy-wide CO2-reduction plan—is that “we’re always being asked to do things that are in our view bleeding crazy,” as he’ll go on to explain.

For starters, the anti-market demands made on Mr. Rowe are bipartisan.

He discusses the cost differential between, in this instance, wind power and other lower-carbon means of generation, such as natural gas, and the bipartisan political support for wind despite the reality that we get more carbon reduction “bang for the buck” from natural gas. Interestingly, in this interview he does not tout nuclear as the be-all-end-all carbon-free energy approach, given construction costs; he also dismisses clean coal.

Rowe is also an enthusiastic amateur historian, so is very well-versed in the origins of the politicization of the electricity industry:

This political economy is an artifact of the historical electricity market—which, through most of the 20th century, was not really a market at all. Until recently, almost all consumers bought electricity from a monopoly supplier at rates set by the government, with a guaranteed return for utilities. That model eroded amid deregulation in the 1980s and ’90s, and the rise of more efficient wholesale electricity markets and independent generators. Commercial and now even some residential consumers are no longer captive, but the political habits persist. …

Mr. Rowe continues that “Somebody else wants clean coal; it’s a non sequitur and it’s not economic either. Somebody else wants wind or solar, and meanwhile . . . the market says the only thing that makes sense for a decade, maybe two, is for new generation to be gas-fired. Natural gas is cheaper than everything else,” thanks to domestic shale finds via fracking and other factors. “It’s likely to stay that way for a long time—but it isn’t what politicians want.”

I encourage you to read the entire interview; I’ve omitted a very interesting discussion of the debate over the extent to which EPA rules would shut down sufficient coal-fired generation to cause reliability problems, which has been asserted in, for example, Texas (but I don’t see how that makes sense, given the loooooong portion of the generation supply stack that is natural gas).

Rowe’s public choice analysis of his industry is complementary to one offered by Eric Schmidt of Google in this Washington Post interview in early October, on the heels of his first-ever Senate testimony experience (Gordon Crovitz analyzes Schmidt’s interview in today’s WSJ, Google Speaks Truth to Power). It’s an absolute must-read in its entirety, but here’s one piece of sound public choice analysis:

Washington—having spent a lot of time there, I grew up there and have spent a lot of time there recently—is largely defined by detailed analytical views and policy choices that are not very good. You know, each policy choice has a winner and a loser, right? Somebody’s ox is getting gored. They’re complex arguments: They’re economic and political and social, and everyone has an opinion on those. Here, the arguments are, how do we make something that affects a million people? How do we change the economics of an industry?

And one of the consequences of regulation is regulation prohibits real innovation, because the regulation essentially defines a path to follow—which by definition has a bias to the current outcome, because it’s a path for the current outcome. …

Come on. Give me a break. The press is so young, they don’t understand the history here. We’re still a small component of what a whole bunch of other companies have done, and certainly most other industries. So I reject all such charges [about the magnitude of Google's lobbying]. And I’m very clear on that because people can’t do math. Take the numbers of the amounts of money that go into the regulated industries of all sorts—and then compare high tech, and compare Google in specific, and it’s miniscule.

And privately the politicians will say, “Look, you need to participate in our system. You need to participate at a personal level, you need to participate at a corporate level.” We, after some debate, set up a PAC, as other companies have. And it’s basically in the interest of our customers to do this, because the government can make mistakes. And for every one of these Internet-savvy senators, there’s another senator who doesn’t get it at all. And it’s not a partisan issue. It’s true in both parties.

This excerpt highlights two timely insights. First, note the “you need to participate in our system” dynamic that defines the corporatist political system. Companies like Google feel compelled to engage in lobbying to rectify what they see as ill-informed political decisions (a reasonable stance, given the lack of technological sophistication in Congress) that would impair their ability to create value for consumers and profit from doing so. Add this incentive to the more cynical and craven one of manipulating the political process and ensuing legislation to favor your company, and you have a range of high-powered and low-powered incentives that drive toward increasing corporatism in politics.

Second, note his observation that “… one of the consequences of regulation is regulation prohibits real innovation, because the regulation essentially defines a path to follow—which by definition has a bias to the current outcome, because it’s a path for the current outcome.” This is the clearest articulation I’ve seen of a hypothesis that I’m currently working on with respect to electricity regulation (here’s the complementarity between the two analyses). Regardless of industry, regulation does specify a path to follow, and it’s a backward-looking definition. Combine Schmidt’s observation with the summary of the history of electricity regulation from the Rowe article, and you get a potent combination leading to technological inertia … which, when you’re talking about an industry that enables and is the driving force of a lot of our productivity and lifestyle, is a costly impediment to economic growth.

Combining these two interviews shows the breadth and depth, and costliness, of today’s corporatist regulatory and political environment.

Posted in Economics, Electricity, Regulation, Technology | Tagged , , | 3 Comments »

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A political economy model for Occupy Wall Street

October 10, 2011

Lynne Kiesling

What’s a political economy-oriented economist to make of Occupy Wall Street? So far I’ve found two complementary commentaries that reflect my analysis of the deeply flawed policies of the past couple of decades that have enabled the crony corporatism that seems to be at the core of the protest (just in my phrasing it that way you can see what my model is). The first is summarized in this Venn diagram from James Sinclair, in his insightful post about the false dichotomy between Occupy Wall Street and the Tea Party:

His entire analysis is worth reading (and is consistent with this excellent investigative citizen journalism from the protest in New York, thanks to Nick Gillespie for the link), concluding with

In other words, aren’t these two groups—Occupy Wall Street and the Tea Party—raging against different halves of the same machine? Do I have to draw a Venn diagram here? …

Yeah, I’m oversimplifying, but only a little. The greatest threat to our economy is neither corporations nor the government. The greatest threat to our economy is both of them working together. There are currently two sizable coalitions of angry citizens that are almost on the same page about that, and they’re too busy insulting each other to notice.

Hitting a complementary note (and hitting the nail on the head, from my perspective) is Sheldon Richman at the Freeman, noting that Wall Street couldn’t have done it alone:

To: Occupy Wall Street:

Wall Street couldn’t have done it alone. It takes a government and/or its central bank, the Federal Reserve System, to:

  • Create barriers to entry for the purpose of sheltering existing banks from competition and radical innovation, then regulate for the benefit of the privileged industry;
  • Issue artificially cheap, economy-distorting credit in order to, among other things, give banks incentives to make shaky but profitable mortgage loans (and also to grease the war machine through deficit spending);
  • Make it lucrative for banks – and their bonus-collecting executives — to bundle thousands of shaky mortgages into securities and other derivatives with the knowledge that government-sponsored enterprises Fannie Mae and Freddie Mac and other companies, all subject to powerful congressmen looking for campaign contributions, will buy them after a government-licensed rating cartel scores them AAA;
  • Inflate an unsustainable housing bubble by the foregoing and other methods, enticing people to foolishly overinvest in real estate.
  • Work closely with lending companies to establish a variety of programs designed to lure people with few resources or bad credit into buying houses they can’t afford;
  • Attract workers to the home-construction bubble, setting them up for long-term unemployment when the bubble inevitably bursts;
  • Implicitly guarantee big financial companies and/or their creditors that if they get into trouble they will be rescued;
  • Compel the taxpayers to bail out those companies and/or creditors when the roof finally falls in.

No bank or group of banks could do these things on its own in a freed market. It takes a government-Wall Street partnership – the corporate state — to create such misery and exploitation.

So demonstrators, you are right. Something is dreadfully wrong. But your list of culprits is far from complete. So go ahead and protest outside Goldman Sachs and Bank of America. But also spend some time outside the White House, the Fed, the Treasury, and the Capitol Building. Together they are responsible for our current economic woes. These are the entities that control our fate and over which we have no real say. It’s time for things to change.

The freed market is the alternative to what you properly despise.

Yep, that about sums it up.

Posted in Economics, Liberty, Regulation | Tagged , , , | 8 Comments »

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Resiliency comes from more risk of bank failure, not less

September 21, 2011

Lynne Kiesling

In the always-smart-and-interesting City AM paper from London, Anthony Evans makes an important argument that has been overlooked in financial regulation debates: risk of failure is what creates system resilience, and regulation creates brittle monocultures. He writes in the context of last week’s Independent Commission on Banking (ICB) recommendations for creating regulatory divisions between retail banking and investment banking and implementing other structural changes, with the objective of a more resilient financial system. Evans critiques the over-simplified concept of risk that the report employs:

We can’t say that one thing is more risky than another – only that different activities expose people to different types of risk. Bodies like the ICB needs to shift from trying to – impossibly – reduce risk to placing responsibility on those who are choosing between different risks.

For example, ordinary depositors should not be protected from risk – they need to confront it. It can seem counterintuitive, but the genuine threat of bank runs is probably the best disciplinary device to prevent them from happening.

Evans’ argument stems from an assertion that he makes later in his column, that risk cannot be reduced but can only be transferred from one party to another. While I think that assertion is debatable, the important insight from this part of his argument is that resiliency in complex market systems arises from agents having responsibility for losses associated with taking additional risks, in addition to their receiving profits associated with taking additional risks. Breaking that connection among risk, profit, and loss is one of the core causes of the brittleness of the financial system over the past two decades, and the transmission and magnification of those losses.

Evans makes a second important observation: when regulation imposes a higher degree of uniformity in a complex system, it reduces resilience of the overall system by creating separated monocultures:

By making arbitrary decisions about what must stay within fences and what doesn’t, or about the level of equity capital that banks will be required to keep, regulators make banking more homogenous. Banks are already free to set up their own ring fences, and a competitive system would be one where they can experiment with different ones. …

All regulations create clusters of errors – by their nature they harmonise behaviour and therefore increase systemic dangers. Policy efforts need to focus on reducing barriers to exit, making it easier for banks to fail, making the costs of failure more visible and ensuring they fall on those who make bad decisions – bankers, regulators, or even the public.

We see this paradox of control in all forms of economic regulation; in this case in financial regulation, but also in the electricity regulation that is the focus of my attention. Regulators believe that by increasing control, by limiting the range of actions that agents can take in complex systems, they are reducing the risk of bad outcomes. But what they do not realize (or choose to ignore) is, as Evans points out here, that by imposing more top-down centralized control on their actions and interactions, they reduce the incentives of the agents to develop their own forms of individual control based on their local knowledge and their own experimentation. Thus regulation makes this complex system more rigid, more brittle, less resilient, and therefore regulation does not achieve its stated goals.

Note here that I am using the tools and language of complexity science and complexity economics, but you can see in this discussion where moral hazard shows up, where you could talk about the failures of corporate governance (as does Charlie Calomiris), etc. Framing the objective as a resilient system broadens the focus beyond top-down regulation to include the individual, decentralized institutions that can keep dangers from becoming systemic. Thinking about regulation in terms of the locus of control and the consequences of the imposition of control in a complex system is more likely to enable us to incorporate the costs of imposing control into the analysis, and to harness decentralized institutions to enable a more resilient system.

Posted in Complexity, Economics | Tagged , , , | 1 Comment »

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Whales and electricity, and sustainability

August 29, 2011

Lynne Kiesling

A few weeks ago I was thrilled to speak at the inaugural Summer Institute on Sustainability and Energy, organized by the University of Illinois-Chicago in partnership with Argonne National Laboratory, Northwestern University, Illinois Institute of Technology, and the University of Chicago. The students were from diverse fields and between them and the other speakers I learned a lot (including some cool vertical farming design!).

My talk focused on the history of the electricity industry, the economics of the industry and of its regulation, and how technological change is changing the economics of the industry and making its regulation maladaptive. When thinking about the history of electricity through the lens of technological change, I like to start with lighting, because better-quality lighting was the primary consumer objective toward which entrepreneurs and innovators were driving electricity technology. Talking about lighting in the 18th-19th century in the US means talking about whale oil, which was the dominant lamp fuel because of the bright clarity of its light. You can think through the rest of the story — demand for whale oil shifts to the right, prices rise, whalers have to go further and harder to catch whales from a declining population, which shifts supply to the left, which increases prices … ultimately the increase in the price of whale oil saved the whales, inducing innovators to create new lighting technologies: first kerosene lamps, and then electric lighting. That’s why when you’re thinking about the confluence of energy, why consumers use energy, technological change, and sustainability, whale oil is a good place to start.

My NU colleague Beth Herbert is the Assistant Director of Science in Society, a really good science outreach effort at NU, and she attended SISE that day and blogged about my presentation (thanks Beth!). She draws out the innovation and sustainability lesson and makes it explicit:

There was a time not too long ago when a significant portion of the American public looked to whale oil as its source of power, and the companies who procured and sold the oil were very powerful. But it was a limited resource, and fortunately we looked to alternatives (unfortunately, not entirely sustainable alternatives) before depleting the entire whale population. So the moral of the story? What you think you “need” today—say, lots of fossil fuels—might not seem so necessary in the future, if we continue to apply our creativity and innovation to finding and developing sustainable energy sources.

She also makes some other great observations, so I encourage you to click through and check out the rest of her post, and of Science and Society.

And a reading recommendation: for the history of the evolution from whale oil to kerosene lighting, and the innovation in the kerosene lamp as a great example of the innovation process, Daniel Yergin’s The Prize has an excellent chapter on the subject. The rest of the book also provides a thorough and well-told history of the global oil industry.

Posted in Economics, Electricity | Tagged , , , | 3 Comments »

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Free the electricity consumer!

August 23, 2011

Lynne Kiesling

In late July I spoke at Cato University, which was great; I met so many interesting and thoughtful people, and learned a lot from my fellow participants and speakers. I’m also happy that Cato has made the presentation notes and recordings of the presentations available on their website, so you can see and hear them too!

One of my talks was called “The Economics of Intervention”, which is a large topic … so I focused on the interplay of technological change and regulation, ranging from Schumpeterian disruptive innovation to the history of the electricity industry and its regulation to current smart grid issues. You can also listen to a recording of my talk. If you are a regular KP reader you will recognize the themes and connections that I drew in the talk — innovation makes monopolies temporary, regulation that purports to “stand in for competition” cannot do so, and unless smart grid includes transactive technology and transactive market options, it’s not smart. The best way to deliver these potential benefits, and to avoid the distrust and Orwellian concerns attached to having such technology at the behest of government-granted monopolies and regulators is to open up retail electricity markets, reduce entry barriers, and enable innovators and entrepreneurs to transition electricity from a commodity product to a service that can be differentiated, bundled with other services, etc.

While I was there I also talked with Caleb Brown about the potential value creation from smart grid technologies and customer-focused business models, and he has posted our conversation as a podcast. I like his framing of the issue: free the electricity consumer!

Posted in Economics, Electricity, Regulation, Technology | Tagged , , , | 1 Comment »

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Lomborg and Haab on light bulbs and technology

August 16, 2011

Lynne Kiesling

Thanks to Tim Haab for pointing us to this excellent observation from Bjorn Lomborg about innovation, regulation, and environmental quality:

Real reductions in carbon emissions will occur only when better technology makes it worthwhile for individuals and businesses to change their behavior. CFLs and other advances can take us part of the way, but there are massive technological hurdles to overcome before fossil fuels generally become less attractive than greener alternatives. …

Limiting access to the ‘wrong’ light bulbs or patio heaters, ultimately, is not the right path. We will only solve global warming by ensuring that alternative technologies are better than our current options. Then, people the world over will choose to use them.

Hear, hear.

Posted in Economics | Tagged , , | 1 Comment »

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Electricity restructuring and the failure to quarantine the monopoly

August 11, 2011

Lynne Kiesling

In 2011, roughly fifteen years after the passage of the first state-level electricity regulation restructuring legislation (in states like California, Pennsylvania, Maine, …), retail competition for residential customers remains anemic in most of the 15 states + DC that have implemented restructuring and allow retail choice.

Lots of possible theories exist for such weak competition — high customer acquisition costs, incumbent default service contracts as an entry barrier, regulation-mandated full depreciation of long-lived incumbent assets as a barrier to innovation, customer indifference, to name a few. Out of this set, the state where retail rivalry for residential customers has been most robust is Texas, with multiple retail firms offering a variety of traditional and green electricity products. At this point they are still competing primarily on price, not on product differentiation (such as dynamic pricing) other than green power, and not through bundling with other services to the home. If consumers value those products I expect them to develop as the distribution wires companies implement their digital meter installations, which will enable more variety and better information flow and customer engagement.

Based on my previous Texas work and on some reading I’ve been doing on the history of telephone regulation for a paper I’m working on, I want to explore another hypothesis: Texas has done a better job than the other 14 states + DC of quarantining the monopoly.

What does “quarantine the monopoly” mean? The phrase arises from the work of William Baxter, now a law professor at Stanford, who in his position as Assistant Attorney General in the U.S. Department of Justice in the 1980s was the primary architect of the settlement of the U.S. vs. AT&T case that led to AT&T’s divestiture in 1982. One of Baxter’s principal concerns regarding the welfare effects of the AT&T monopoly was what came to be known as Baxter’s Law, or the Bell Doctrine — “regulated monopolies have the incentive and opportunity to monopolize related markets in which their monopolized service is an input”, to quote Joskow and Noll’s outstanding 1999 paper on the Bell Doctrine. If there is sufficient rivalry or potential rivalry in that related market, then allowing monopolist participation in that market could reduce or stifle competition, enabling the monopolist to extend its monopoly into the related market, one result of which would be reduced output, higher prices, and deadweight loss arising in that related market.

Baxter’s argument was that the best feasible approach to such a situation, in which a regulated monopolist sits in the middle of a vertical supply chain with competitive or potentially competitive markets on either or both sides, is to quarantine the monopoly by restricting its market participation to its regulated functions. The best way to do this is to separate the ownership and control of the regulated functions from the other vertically-related functions.

Most of the restructured states in the US have failed to quarantine the monopoly in electricity. Regulated wires companies continue to participate in retail markets in states that have granted the default residential service contract to the incumbent, perpetuating the monopolist’s presence in the retail market. While they cannot use that contract to raise retail prices and hence raise their profits, their incumbency still provides an entry barrier in the retail market for residential customers, a market that already has substantial customer acquisition costs and a customer culture that is not yet accustomed to or aware of the potential value creation arising from novel energy-related services and bundles.

Texas, however, quarantined the wires monopoly very clearly in its implementation of restructuring. Incumbents were not permitted to provide default service in their native regulated territories, and they are only permitted to provide wires-related services, which includes metering. Texas has done a better job than the other states of applying the Bell Doctrine in electricity.

 

Posted in Economics, Regulation | Tagged , , , | 2 Comments »

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Risks and regulation

July 15, 2011

Lynne Kiesling

I’ve just returned from a conference on regulation in Bulgaria organized by the Istituto Bruno Leoni, a classical liberal think tank in Italy that does a lot of extremely good work developing and applying classical liberal principles and ideas to public policy issues in Italy and Europe. The topics included financial markets regulation, energy, and telecom/internet.

The organizers asked me to comment on risks and regulation with respect to energy and the environment. The topic prompted me to ask: risk to whom, and risk of what? The parties whose risks I analyze are consumers, the end users.

Risk of what? Historically, at least in the US, risks related to reliability of service and bankruptcy of firms have been the primary focus of regulatory policy. Keep the lights on, no matter the cost, and treat that as a uniform standard (by technological necessity, until the invention of good switches). Use economic regulation (rate of return + monopoly service territory for the vertically integrated firm) to ensure the firm’s financial stability. These two objectives have had the consequence of significant infrastructure redundancy at a substantial cost, and increased incentives to firms to build those redundant electro-mechanical infrastructure systems.

More recently, environmental risk has become more prominent, and increased the combined economic and environmental regulatory policy focus on electricity generation. Initially the concern was the “criteria pollutants” such as SO2, NOx, etc., but the focus has shifted in the past two decades to greenhouse gases and carbon policy. The emission policy options range from

  1. Do nothing while we do more scientific research into the complex and little-understood climate system
  2. Price carbon with a tax … but with this policy one cannot control emission quantity
  3. Constrain GHG emission quantities with emission permit markets … but with this policy one cannot control emission price
  4. Traditional command-and-control regulation: emission quotas, renewable portfolio standards … but this approach has high enforcement costs, with centralized decision-making that’s likely to be inefficient because it cannot reflect, as Hayek said “individual knowledge of time and place”

Other important economic risks to consumers include the effects of wholesale and retail price volatility as fuel prices fluctuate, and the mounting effects of the lack of innovation and new technology adoption in the customer-facing portion of the value chain.

That was the setup part of my remarks, and I’ll post the rest in a follow-up … but for now, tell me: what are some other ways to think about the risks associated with regulation, and the attempts of regulation to mitigate certain risks, that face electricity consumers?

Posted in Economics, Energy markets, Environmental policy, Regulation | Tagged , , | 4 Comments »

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