Does Bad Regulatory Policy Sow the Seeds of Better Regulatory Policy?

Severin Borenstein asks whether growth of distributed energy is mostly an uneconomic response to regulatory dysfunction, and raises the question of whether uneconomic responses might lead to regulatory improvements. He doesn’t quite frame the issues quite like that, his post is somewhat exploratory in form, but I think this is the question he is aiming at. The questions point to some pretty interesting political-economy-of-regulation stuff, so let’s join Borenstein on the exploration.

In a post at the Energy Institute at Haas blog, Borenstein notes a conversation he had with a former student. The student, who he calls “Pat” in the post, agreed with Borenstein’s overall perspective that grid-scale generation is likely overall more efficient than distributed generation, even for renewable power, and that distribution generation only makes some sense in California because electric rates are so high for so many customers in the state. (Customers of the major regulated investor-owned utilities in California might pay rates above 30 cents a kwh at the margin, while the national average is nearer 11 cents a kwh.)

[Pat said] “ever since I took your class many years ago you’ve been saying that California has high electricity rates in part to pay for the mistakes of the past.  But those ‘mistakes’ keep happening and keep driving up our rates.  At some point, aren’t those ongoing mistakes just part of a broken regulatory process? DG is the competition that will either force repairs in the process or will replace it.”

Borenstein explores ideas of regulatory dysfunction and regulatory arbitrage. He seems to present them as alternative interpretations of what is going on in California (“is DG the answer to regulatory dysfunction, or is it just regulatory arbitrage?”), but it is pretty clear to me he sees both regulatory arbitrage and regulatory dysfunction in operation. His real question is whether regulatory arbitrage can help limit regulatory dysfunction.

I would define regulatory arbitrage differently than Borenstein does. He wrote, “By regulatory arbitrage, I mean taking advantage of the structure of pricing or other utility obligations by pursuing strategies that reap private rewards through cost shifts to other ratepayers.” His definition of regulatory arbitrage makes it a kind of rent seeking. I would define regulatory arbitrage as positioning oneself to benefit from differences in regulatory policies, which may or may not constitute rent seeking.

Moving corporate headquarters to a state without a corporate income tax may promote overall efficiency whereas moving headquarters into a state to cash in on over-generous economic development subsidies is rent seeking. Both are examples of regulatory arbitrage.

My initial response to the political economy questions raised is to say, “sure, responses to incentives created by regulation do feedback through economic and political systems and affect future regulation, but the feedback is weak and the political system is dysfunctional for good political reasons, so it is not a feedback system that naturally drives improvements in regulatory policy.” Take, for example, California: It has plenty of energy policy forums – overlapping commissions and agencies and boards, each with some job to do and a bit of authority to do it with. The result of energy policy Californication is not, however, polycentric governance and rapid experimentation that fosters fast adaptation. Instead, we have new mistakes ladled on top of old mistakes, little ability to coordinate or simplify, and policy dysfunction on a large scale.

State energy policy seems like fertile grounds for research. Are there good political economy of regulation studies that look into state-level energy regulatory dynamics?