Cato “Neutered” on Electricity Deregulation?

Last week, Peter Van Doren and I had an op-ed in The Wall Street Journal that reflected on the record of electric utility restructuring in light of the recent rate hikes experienced in the “deregulated” states. Libertarian energy consultant Mike Giberson over at The Knowledge Problem, however, was unimpressed.

Giberson offers only two substantive criticisms. First, he takes issue with our claim that the case for vertical integration was scarcely heard during the debate over restructuring:

It isn’t clear from the article where Taylor and Van Doren were during the debates over unbundling, but delving into the voluminous public records of both federal and state regulators of the electric power industry would reveal that vertical integration has been among the matters discussed at length. Earlier in the article they quote MIT economist Paul Joskow, but if they were at all familiar with his work they would not make such “unfortunate” claims.

Vertical integration was in fact a big part of the policy conversation in the state legislatures and regulatory hearing rooms during the course of restructuring. But as Economist Robert Michaels at U. Cal., Fullerton argues, those discussions were superficial, uninformed, and politically charged conversations primarily concerning utility market power and the need to corral it. Paul Joskow’s work on this matter (which we are indeed well acquainted with) along with that of other academics who’ve investigated vertical integration in the electricity sector from an I/O perspective was given little serious attention by policymakers. That was our point.

Second, Giberson seems to take issue with our contention that vertical integration is an efficient means of remedying hold-up problems between generators and power distributors, facilitating efficient investment in transmission, and maintaining system reliability. Giberson finds it “curious that Cato Institute writers are so skeptical about the ability of decentralized arrangements (like prices and contracts) to lead to efficient results.”

Market arrangements indeed have their place, but if they were always preferable to alternative arrangements, then the firm as we know it would not exist – a point well made by Ronald Coase (no enemy of markets he) in his classic essay “The Nature of the Firm” back in 1937. Just because one has great faith in the power of markets does not necessarily mean that one should enter a daily spot market in the search for secretarial help or, alternatively, daily spot markets for electric power. For a longer discussion on why “decentralized arrangements (like prices and contracts)” are problematic in the electricity business, see this Cato study from the aforementioned Robert Michaels.

With the substance now put aside, let’s examine the kicker:

And it dawns on me that through it all, the Cato authors don’t advocate anything at all, not even the “true deregulation” that they describe in the final paragraph. They discuss history, explain some economics, call the loss of vertical integration unfortunate, speculate on preferences for contracts, and suggest that a totally unregulated world might turn out to be like the old regulated world.

We are to some extent guilty as charged. We did indeed spend a lot of our available word count explaining how electricity markets work. But it seemed to us that this was necessary in order to fully explain why the current emphasis on recent price increases in deregulated electricity regimes is misleading. Consumers seem advantaged by regulation during fuel-price upswings and disadvantaged by regulation during fuel-price declines. But over a longer time frame (1990-2006), the average price increases in regulated and deregulated regimes are not statistically different. Thus the differences between the old and new regimes are more apparent than real.

We go on to argue (as we did more robustly in this study published a few years ago) that a totally deregulated world of independent generators, transmitters, and distributors and consumers buying spot would not be efficient or stable because of the hold-up problem. We speculate that the arrangements to which firms and consumers would agree would resemble vertical integration which returns certainty for firms and price limits for consumers. Giberson might not like that argument, but it’s hard to miss.

Often Cato is bold, or insightful, or both, and sometimes it is over-dramatic in asserting the costs of this-or-that government program or the benefits of some tax cut or another, but almost always Cato offers clear advocacy for liberty. Taylor and Van Doren don’t give us that Cato in their rambling Wall Street Journal essay. Instead we get what amounts to an implicit defense of the old status quo.

While we do criticize the regimes produced by “restructuring,” we do not defend the old regime. In fact we do not defend any particular substantive market outcome at all. Instead, we defend an idea – that business owners – not politicians – should decide how market enterprises are organized and operated. If there is a more libertarian argument, then I have not heard it.