Richard Epstein’s Financial Times article on Wednesday lays out some problems that arise when you try to change the regulatory approach in a network industry in which technological change happens. He’s discussing telecom and the “deregulation” in the 1996 legislation, but as Keith at Liberty Lover points out, Epstein’s analysis has important insights for electricity deregulation as well. As Epstein says in his opening paragraph:
The world is always in flux, and nowhere is this more evident than in high technology, where innovation almost always counts as improvement. The legal arrangements that surround such technical advances are a quite different matter. It is tempting to think that the regulatory framework must always be adjusted to keep up, but the transition from one set of institutions to another is fraught with hidden perils that all too often undermine the success of the overall operation.
One of these hidden perils is the all-too-real fact that regulatory agencies, which are supposed to have specialized knowledge that better enables them to implement beneficial institutional change, also have their own interests and preferences to satisfy. Satisfying their own interests can, and usually does, create institutional change that does not map onto the institutional change that best serves other interests, such as “consumer welfare”, dynamic competition, or the ability to adapt to unknown and unanticipated changes.
The column concludes with
The overall lessons from this debacle are two: first, regulatory transitions are always perilous because there are too many points of slippage between the design of a new scheme and its implementation; and second, systems that rely on forced purchases are especially dangerous, because the choice of price is not likely to be made correctly in face of the multitude of political pressures and agendas that exist.
There are many reasons to dislike the status quo ante. But one reason to like it is that it avoids a set of transition costs whose magnitude is discovered only when it is too late.
As the electricity industry continues its regulatory evolution we should certainly bear these lessons in mind. We should not, however, give in to status quo inertia because of these transition costs. We are trying to move away from the regulatory status quo because it is inefficient, and does not respond well to dynamic market processes and technological change. In the transition we have to be conscious of, and try to minimize, the likelihood that these costs can nullify all of the benefits from deregulation.