Difficult Thinking About Institutional Change Ii: Organic Or Ordered Competition?

Lynne Kiesling

My first stab at answering the question at the end of my previous post starts with what I think is a basic claim, but one that does not get discussed much, or well, in electricity policy debates:

All other things equal, organic competition outperforms ordered/managed competition in delivering long-run dynamic benefits to both consumers and producers and in increasing total surplus.

By organic competition I mean the development of institutions supporting exchange (i.e., markets and the rules that govern them) through the interaction and mutual interest of potential buyers and sellers. Organic competition “arises spontaneously from human action and economic evolution based on choices and change over time” as Adrian Moore and I wrote in a Reason Public Policy Institute study from 2003 about competition in electricity transmission. As my great friend and co-author Dean Williamson puts it, this is the process by which markets do that voodoo they do so well, and this idea is precisely what is at the foundation of the long-standing notion of spontaneous order and the “invisible hand”. Millennia of human history suggest that organic competition can be very robust, and that the co-evolution of market processes and the institutions governing those processes is an important part of that robustness. It leads to robustness through decentralized mutual benefit.

By ordered competition, I mean competition engineered, controlled and managed to approximate some idealized notion of competition.

My interest here is not just in articulating the general distinction between organic competition and ordered competition, but is primarily in trying to articulate and understand an organic process of institutional change versus a more typical “control and manage” process of institutional change.

Note here a couple of things. First, I am not using any idea of efficiency or so-called “perfect competition” as a benchmark. Such benchmarks only exist on the blackboard or in the laboratory, and while they are useful in those contexts they are nonexistent in the real economy. The language of economic efficiency and perfect competition has sidetracked electricity policy debates for a decade, and has given political opponents to market liberalization a useful weapon — “If you don’t achieve perfection, your markets have failed, right? Well, isn’t that what we told you market fundamentalist types was going to happen?” Perfection is consuming, costly, and unattainable, so let’s recognize that and move on. As a related aside, I think this point is one reason why FERC Chairman Pat Wood III goes to such great lengths to point out that he views the objective as “workably competitive” markets. While I’m not enamored of the phrase, I think the concept is the same.

Second, note that the concept of markets that I use here is one in which markets are primarily human institutions of trial-and-error learning processes, not one in which markets are mechanisms for the allocation of resources. This idea is basically a corollary to the “perfect competition” point made above. While obviously one of the consequences of market processes and prices as transmittors of information is that resources get allocated to their highest-value uses, I do not start from the claim that market processes are designed specifically as resource allocation mechanisms. The idea of markets as resource allocation mechanisms is a very constructivist one.

That distinction may be part of the problem, and here’s why. This is an industry and a set of regulatory institutions that have become enmeshed over 85 years. It is very much governed by, as my colleague Vernon Smith would put it, constructivist rationality and a constructivist approach to policy, meaning that in a Cartesian sense we derive conclusions/theories via logical deduction from theoretical postulates. Natural monopoly theory is pretty high up on my Most Wanted List of Criminals of Constructivist Rationality. But we have to take the historical hand that is dealt us (as Marx poignantly reminded us over and over and over …), and the historical hand we are dealt in electricity policy in 2005 is a constructivist one. Given the very constructed, consciously-designed-by-human-intention place where we are, how do we get from here to that desired outcome of organic competition?

To put it another way: institutional change is in many ways itself a constructivist exercise. Is there a way to make the process of institutional change more organic, and thus more likely to lead to “valuable, meaningful, forward-looking, robust, evolutionarily adaptive institutional change”?

2 thoughts on “Difficult Thinking About Institutional Change Ii: Organic Or Ordered Competition?

  1. Lynne,

    Step 1 almost has to be “terms and conditions of service”, which include price and reliability. Without the signals provided by price, there is little or no incentive for customers to alter behaviors in ways which would affect capacity and reliability requirements throughout the system; that is, there is little opportunity for “dynamic benefits” because there is little dynamism in the system.

    As you stated, there is no requirement under regulation for cross-subsidization. However, there is a deeply embedded cultural preference for stability. There is also the “State Consumer Advocate” infrastructure which works to hold small consumer rates low and stable; and, the large corporation law departments (and their consultants) which work to minimize large customer energy costs. Between these opposing “jaws of the regulatory vise (sp?)” live the commercial and small industrial customers, unrepresented, over-“rated” and thus much “loved” by both suppliers and regulators.

    Many industrial customers could easily adopt peak-management approaches, if price signals made it economical to do so. Many more small customers would alter their consumption patterns if the benefits they received for doing so more nearly reflected the benefits to the overall system from their actions. The decision by many Pacific Northwest aluminum smelters to shut down and sell their electricity in the market several years ago is an extreme example with regard to price. The decisions by major credit card processors to install elaborate on-site generating and UPS systems is an extreme example with regard to reliability.

    “(M)arkets are primarily human institutions of trial-and-error learning processes” only when trial is possible and feedback identifies errors and facilitates learning. In the current regulatory environment, trial is almost impossible and feedback is inadequate or non-existent for most customers.

    We certainly do not proceed toward organic competition with average rates based on average costs, with “renewable portfolio standards”, with excessively high reliability standards for all service, or with large capacity reserve margins embedded in ratebase.

    We also do not proceed toward organic competition with a mix of aged, “grandfathered” generation and requirements for BACT or LAER for new generation, especially if LAER continues to be a moving target for covered facilities. The existing economic and regulatory barriers to entry are sufficient, without adding the additional barriers of an “initiation fee” (overcompensating for your competitors emissions) and “hazing” (running the gauntlet of federal, state and local luddites).

  2. The development of institutions supporting exchange through the interaction and mutual mutual interset of potential buyers and sellers, along with the topics ofspontaneous order and the “invisible hand” is one of the most interesting and under appreciated phenomena of human and cultural evolution. I recently finished a book by Robert Wright, “Nonzero” that I would recommend to anyone with an interest in cultural evolution and spontaneous order of society. While Wright claims he is not a supporter of laissez-faire policies he presents compelling evidence and explanation for the repeated evolution of increasing complexity and cooperation through virtually all successful societies and cultures over time. The positive sum relationships and intitutions that facilitated ever widening cooperation of people are powerful forces in cultural change. All very applicable to the problems of markets and network effects, especially when examining arrangements for less than perfect competition.

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