(Somewhat Technical) Perils of Regulation: The Shrinking Proxy Group

19 Comments / Economics, Energy markets, Politics / By

Michael Giberson

One of the difficulties that beset planned economies is that without good prices for retail goods, it becomes difficult to price capital goods well. Of course, without good prices for capital goods, it become hard to allocate capital goods to their best use, and resources become wasted. (I think we can credit Ludwig von Mises as the first to formulate this criticism of socialism.)

Note that it is easier to operate a planned economy in a world containing many capitalist economies, because the capitalist economies will generate useful prices for capital goods which economic planners can copy. The prices won’t quite reflect local conditions, but they are likely better than anything that a committee of planners or a bureau of economists could come up with on their own.

Pricing capital and intermediate goods is a problem in the economic regulation of industries. Regulators often seek to design rates so as to allow the regulated firm to attain a reasonable return on equity, but what return on equity is reasonable? At the Federal Energy Regulatory Commission, when setting rates for natural gas pipelines and oil pipelines, the practice has been to refer to a “proxy group” — essentially a handful of similarly situated companies — to construct a reasonable range to bound the target return on equity.

Of course, not just any firm can be in the proxy group; the proxy group companies have to meet certain standards. In the case of FERC’s pipeline rate regulations, those standards have become a bit of a problem: fewer and fewer companies were of the requisite size and corporate form, and so arises the “mystery of the disappearing proxy group.” Chairman Joseph Kelliher suggested the “mystery” title in his comments at yesterday’s FERC meeting (but not in his official statement) at which the Commission proposed a change in policy to adapt to changing conditions in the industry.

The proposed policy statement doesn’t resolve the mystery, it just provides a way to adapt to the changes. (I believe Commissioner Marc Spitzer points an accusing finger in the direction of tax law.) The resulting rates may not be perfect, of course, but they likely will be better than anything a bureau of economists would come up with on their own.

19 thoughts on “(Somewhat Technical) Perils of Regulation: The Shrinking Proxy Group”

  1. Carl Marks

    Just thought you would like to know that Mises proof of the impossibility of socialism did not rely on retail prices at all. In fact he contends that in a socialist society having retail prices is fairly simple, since the price can be adjusted to clear existing inventory at an acceptable rate.

  2. Carl Marks

    Just thought you would like to know that Mises proof of the impossibility of socialism did not rely on retail prices at all. In fact he contends that in a socialist society having retail prices is fairly simple, since the price can be adjusted to clear existing inventory at an acceptable rate.

  3. Ed Reid

    All that is required to achieve an optimal “managed market” is a market manager who is smarter than the market; that is, smarter than the aggregate of the collective inteligence of all of the market participants. What’s the problem?

  4. Boonton

    This reminds me of a story I read somewhere, maybe it was in one of Krugman’s books. Communist bloc nations had a serious problem in trade. Without prices from markets how could communist nations trade? If Poland ‘sold’ a million tons of wheat to the USSR how many tractors should the USSR ‘pay’ in return?

    The answer was to use the market prices from capitalist countries as a proxy. An American economist asked a Soviet one what they would do when the grand world revolution was achieved and the entire world was communist. He smiles and said that one little country would have to be kept capitalist for that purpose.

  5. Boonton

    This reminds me of a story I read somewhere, maybe it was in one of Krugman’s books. Communist bloc nations had a serious problem in trade. Without prices from markets how could communist nations trade? If Poland ‘sold’ a million tons of wheat to the USSR how many tractors should the USSR ‘pay’ in return?

    The answer was to use the market prices from capitalist countries as a proxy. An American economist asked a Soviet one what they would do when the grand world revolution was achieved and the entire world was communist. He smiles and said that one little country would have to be kept capitalist for that purpose.

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