Just Say No To “Managed Competition”

By Jerry Taylor
April 2, 1997

Before the 105th Congress begins to hammer out the interest-group compromises that typically constitute “deregulation,” it would be wise to profit from the political and economic lessons of the past 20 years. To wit,

  • Trusting the regulators to redesign the regulatory apparatus will probably perpetuate past regulatory errors and sabotage competition.
  • “Deregulation” often serves as legislative cover under which new political coalitions seize regulatory control of an industry once it becomes clear that the old coalition of special interests can no longer sustain itself.
  • Efficient market structures cannot be ascertained ahead of time by legislators or bureaucrats: only by letting markets spontaneously develop can we know the “best” industrial arrangements.

Unfortunately, the early debate over whether and how Congress should deregulate the electricity industry has been almost completely uninformed by the above observations. A classic example is Congressman Shaefer’s “Electricity Consumers’ Power to Choose Act.”

Although economists once thought that the electricity business was a “natural monopoly,” the fact that power “regulated in the public interest” is more expensive than power sold largely outside of the regulatory reach of government has disabused most economists of that notion. Mr. Shaefer thus proposes that states be ordered to adopt mandatory retail wheeling, which means requiring electric utilities to turn their private transmission and distribution systems into public highways. Consumers would have the right to choose the company from which he or she would like to purchase power and the electricity company would be forced to deliver it to them.

His bill would also dictate the manner in which companies can legally sell their services; maintain price controls on the rates power companies can charge for access to their wires; and perhaps most startling of all, order Americans to consume 5 times more renewable energy than they currently do. But since renewable energy is presently about three times more expensive than electricity sold on the spot market, economists expect that this order alone would cost consumers somewhere around $52 billion.

But if electricity markets are competitive, why not just decriminalize competition and let markets have at it? Why do we need Congressman Shaefer to tell us how the electricity industry should be structured, how consumers are to be charged for power, or what sources of electricity the power industry should turn to? Because absent regulation, Mr. Shaefer believes, utilities would either close their transmission or distribution lines to competitors or use their monopoly status to “gouge” consumers who would have no option but to buy power services from the incumbent monopoly. But this isn’t simply nonsense; it is nonsense on stilts.

First, the possible emergence of alternative power grids is not at all far-fetched. Investigations by economists have found little evidence of electricity businesses ever having “naturally” achieved monopoly status before the advent of public utility commissions, which implies that the “monopoly” grid is more an artificial product of regulation than of economic efficiency or market inevitability.

The concern that local zoning and land-use regulations would block the construction of alternative grids ignores the fact that multiple “rights-of-way” (telephone and cable lines, natural gas pipelines, and sewage lines, for example) already connect both retail and commercial establishments to outside service providers. Those providers could conceivably piggyback power lines on their current rights-of-way and directly enter the electricity distribution business with a minimum of local disruption.

Alternative grids, however, are not necessary prerequisites to competition. First, electric utilities already “compete” with other utility companies (who threaten to lure away industrial consumers and, ultimately, residential consumers), self-generation (an option that is gaining popularity with industrial consumers and is increasingly affordable even for homeowners), and energy-efficient technologies (which become more attractive as rates rise).

Second, deregulation of transmission and distribution might well lead, not to alternative grids, but to user-owned grids. Jointly owned transmission and distribution lines are already common in the electricity business and numerous other businesses. Taxi dispatch services, natural gas pipelines, and large freight vessels, for instance, turn to user-owned arrangements as a market response to services where significant economies of scale exist.

Third, the electricity transmission and distribution network affords many paths around any bottlenecks that a monopolist might seek to exploit. As long as entry is not blocked, expansions or loops can be readily constructed and tied into the grid. Given the interconnectedness of the grid, no monopolist could survive under a system of transmission and distribution property rights.

Finally, the mere threat of competition typically forces monopolies to act as if they were in competitive markets. The relevant concern is not whether competitors do or do not exist in a given market. The relevant concern is whether entry to the market is open or closed. As long as entry is possible, there is little to fear from aspiring monopolists.

The most important reason, however, to discount the fear of price gouging on the grid is the inability of rate regulation—the remedy presupposed by mandatory retail wheeling—to make any difference in the price of services delivered to the consumer. Empirical studies by such noted economists as Thomas Gale Moore, Walter Mead, and the late Nobel laureate George Stigler find that rate regulators are incapable of forcing utilities to operate at a specified combination of output, price, and cost. Thus, regulators are unable (self-serving mythology to the contrary) to control rates. The price an electric utility monopolist would charge for power absent governmental oversight is, according to their empirical studies, the current price.

Congressman Shaefer’s bill would lessen the incentives to form alternative networks or various user-owned arrangements. The market experiments necessary to discover more efficient institutional arrangements for the grid will proceed far slower and more haltingly under a regime of mandatory retail wheeling. It would needlessly socialize the transmission and distribution business and continue the politicization of power consumption.

True reform should be directed, not at reinventing regulation, but actually eliminating it: not at managing competition, but at freeing it from political control. Mr. Shaefer, step aside.

Jerry Taylor is director of natural resource studies at the Cato Institute and is senior editor of Regulation magazine.