Origins of state electric utility regulation: Was it protection of quasi-rents not creation of monopoly rents?

Michael Giberson

There is by now a fairly established body of economic history work that challenges what might be called the mainstream view of the origins of state regulation of electric utilities and offers as an alternative a nakedly public choice view that state regulation was all about creation of monopoly rents. The mainstream view asserts that electric utilities were natural monopolies – therefore competition was wasteful – and state-level rate regulation was desirable to limit the economic harms that would otherwise accompany monopolization.

A contrary view drawing on public choice and new institutional economics asserts that state utility regulation was a special interest effort in the creation of monopoly rents. This line of thinking may start with Stigler and Friedlander and Demsetz and culminate in the work of Jarrell, who found that the advent of regulation in states was associated with higher electric power prices and slower growth compared to the periods before state regulation. A central implication of this line of work is that state regulation is a negative-sum game in which powerful concentrated interests are able to capture political benefits through regulatory processes at the expense of dispersed, unorganized consumer interests.

In the December 2008 Journal of Economic History, John Neufeld presents an alternative explanation for the emergence of state regulation, which also draws on insights from public choice and new institutional economics. A key point of his article is that state regulation can be seen as a positive sum activity instead of a purely negative-sum rent-seeking exercise. (You might say that the earlier line of thinking emphasizes public choice concerns, while Neufeld’s alternative emphasizes new institutional issues.) In the abstract for “Corruption, Quasi-Rents, and the Regulation of Electric Utilities,” he says:

Was the adoption of state utility regulation the result of a negative-sum competition among special interest groups vying for the monopoly rents created by regulation or a positive-sum elimination of corruption arising from appropriable quasi-rents? Previous empirical studies of the adoption of regulation have assumed the former. Using discrete hazard analysis, this study considers the latter and finds the data more consistent with the positive-sum protection of quasi-rents than the negative-sum creation and appropriation of monopoly rents.

In Neufeld’s telling, the problem with municipal franchising with private utilities – the dominant practice prior to state utility regulation – was that post-contractual investments by the utility created appropriable quasi-rents, and it was difficult to prevent the municipality from reneging on contractual commitments in pursuit of those rents. In this environment, utilities preferred the relatively stability promised by state regulation.

I like Neufeld’s view, but it doesn’t seem to address one very important issue: Why did state regulation seem to necessarily entail imposition of a state-enforced monopoly? Couldn’t the state offer effective protection from municipal predation to competing electric utilities? Also, what features of state-level regulation protected utilities from state government appropriation of the quasi-rents?

Maybe Neufeld addressed these points and I just missed them.* In any case, he presents a good case for considering the role of appropriable quasi-rents in the story of electric utility regulation.

CITATION: John L. Neufeld (2008). Corruption, Quasi-Rents, and the Regulation of Electric Utilities. The Journal of Economic History, 68, pp 1059-1097. doi:10.1017/S0022050708000818

*I don’t have an electronic version of the document handy for reference, the article is only available online to subscribers. I’m working from memory from yesterday’s trip to the library. (Yes, I actually had to bike over to the library to read a journal article! It felt so old fashioned.)