DIFFICULT THINKING ABOUT INSTITUTIONAL CHANGE IV: USE RIGHTS, RULES, AND CHANGE PROCESSES

Lynne Kiesling

In my previous post about organic institutional change, I pondered Ostrom’s eight institutional design principles. She applies her analyses to common pool resources (CPRs). Are they also applicable to changing electricity regulation institutions?

Obviously I suspect that the answer is “yes” or I wouldn’t be putting us all through this. One of the defining features of electric power networks, as with CPRs, is interdependence of individual actions. Going point by point through the first three of the eight design principles, I’m going to elaborate on how I think we can apply them in electric power.

1. Clearly defined boundaries. Ostrom considers specifying boundaries and use rights as “a first step in organizing for collective action.” (p. 91) The ability to define boundaries in an electric power network depends on some of the physical features of electric power networks. When we take into account two aspects of transmitting power on a network – Kirchoff’s Law and the interdependent nature of reliability, voltage, and power quality across agents – we get a clearer idea of the parameters of boundary definition here and its limitations. Electrons following the path of least resistance (Kirchoff’s Law) mean that a contract path and the physical path of the power are unlikely to match; the interconnections of agents on the network mean that all interconnected agents will experience some common features of the network. Physically excluding agents is difficult, which means that the ability to define “rules limiting appropriation and/or mandating provision” (p. 92) will be really important in electric power networks.

Use rights in electric power networks are more complex than for Ostrom’s irrigators. In that case there are n agents with rights to use a resource of uncertain and changing size, and those agents use by appropriating or extracting. In electric power, there are k sellers of power, m buyers of power, and n owners of the CPR that the (k+m) buyers and sellers are using. n can vary from 1 upward depending on the region and the distance covered in the transactions. The size of the CPR is more or less known, depending on the timeframe – future use and investment are uncertain.

The past decade has seen the development of transmission rights (FTRs) and efforts to work through the definition of use rights on the electric power network. But FTRs are but one part of defining use rights on the network. There is another use right that is implicit and not clearly defined – the use rights of the m buyers. In the FTR designs and transactions, the participants are the (k+n) sellers of power + owners of the network. But treating the m buyers of power as “load” implicitly gives them unrestricted use rights. Is it any wonder, then, that we see use patterns on the grid that look like overuse of a CPR?

Perhaps underinvestment in the network is not as much of a problem. Perhaps the primary problem is that the m buyers have unrestricted use rights, and our regulatory institutions do not allow the (k+m+n) full set of agents to devise appropriate rules to govern the use of all of the agents, not just the supply-side ones.

2. Congruence between rules and local conditions. In the US the electric power network comprises “broadly similar, but distinctly different, systems.” (p. 92) Contrary to common belief, local physical conditions do vary on the grid (which has implications for the degree of interdependence of agents). Also, local conditions vary across the country according to geography, economic activity, and political environment. Crafting well-tailored rules that reduce transaction costs across an entire network but still incorporates and respects local conditions is a daunting challenge in any CPR environment, and has been one of the struggles in the Standard Market Design debates in electric power in the past three years. I think a lot of the hard thinking and heavy lifting has to happen on this principle.

3. Agents can participate in modifying the rules. Allowing a process for agent modification is a powerful tool for exploiting local knowledge and forward-looking entrepreneurship. Being able to change the rules as agents observe whether ex ante commitments to abide by them are borne out ex post contributes to crafting rules that are more robust. This tool increases the use of local knowledge, decreases monitoring and enforcement costs, and increases the probability of compliance, which increases certainty and stability for all agents. It does come at a cost though; there will certainly be transaction costs to modifying rules. But the net effects of these costs and benefits have to be weighed against the net effect of the substantial and varied costs that we bear under the current set of rigid, inflexible institutions.