News Analysis
Electricity is among the most-regulated sectors of the U.S. economy. A century of public-utility regulation of entry and rates has given way to new suites of government intervention. Wholesale electricity is centrally planned in most states, creating a contrived retail market. At the same time, government policies have increasingly displaced thermal generation (natural gas, oil, coal, and nuclear) with intermittent wind and solar power, requiring costly battery storage.
Today, a growing number of regions are subject to rising power rates, conservation appeals, and service interruptions. The Great Texas Blackout of February 2021 caused hundreds of deaths from a lack of heating and other services, not to mention a hundred billion dollars in damages. California, which in 2000–2001 suffered shortages that closed businesses and schools, endures “green” electricity rates at double the national average. Other states and regions are pursuing policies that portend similar results.
Economic discoordination can inconvenience, disrupt, and even kill. But this threat to reliable, affordable electricity is not the result of market failure but government failure, abetted by expert error from the knowledge problem and by politicization.
Regulated Electricity
For more than a century, electricity has been regulated as a “natural monopoly.” In recent decades, the interconnected network for delivering electricity (“the grid”) has been regulated as a “commons.”1 A forced transition to wind and solar, driven by Big Green, has created a perfect storm of cost increases and service instability. This statist tsunami begs for a nongovernmental alternative.
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Natural monopoly theory postulates situations where one firm exhausts economies of scale, buying competitors to achieve a dominant, least-cost position. The natural progression from inefficient duplication to singular control leaves one firm able to “exploit” consumers.
“It is everywhere acknowledged that the multiplication of wires overhead is a crying evil and danger,” one reformer wrote in 1889. “Can there be any doubt that it is the height of folly to continue, and that the only rational way of entrusting electric service to incorporated companies is to permit but a single company to operate in a district and control prices by some other means than competition?”2
Some 80 years later, economist Alfred Kahn described “acceptable performance” for the “regulated monopoly” as entailing “control of entry, price fixing, prescription of quality and conditions of service, and the imposition of an obligation to serve all applicants under reasonable conditions.”3 The quid pro quo of franchise protection for the firm in return for rate maxima authorized by a central authority became known as the regulatory compact.
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Traditional public-utility regulation of electricity has been joined in recent decades by a more comprehensive regulatory regime: a centrally planned wholesale power market predicated on mandatory open access (MOA) in transmission, from which “competition” in both generation and distribution could emerge. To get the power to homes and businesses, interstate regulation by the Federal Energy Regulatory Commission (FERC) in the mid-1990s has been joined by intrastate MOA, beginning in California (1996) and Texas (1999).4
Under so-called retail wheeling, the franchised utility retained its transmission monopoly with “unbundled” rates capped at cost plus a reasonable return (per public utility regulation). But the utility has had to allow outside generators and retailers access to its wires, creating rivalry to the (former) vertically integrated, franchised utility.
This regime is neither deregulation nor a waystation to deregulation. Mandatory access violates private property rights by taking away control from (utility) owners. “What’s Yours is Mine,” two free market critics of this “infrastructure socialism” wrote.5
The solar boom originated from the EPAct of 1992, which increased the Investment Tax Credit (ITC) to 30 percent of solar installation costs. Grid control by ISO/RTOs has made it easier for wind and solar energy to enter large regions. Tax preferences, federal must-take provisions, and low marginal costs have facilitated the rapid growth of these energy sources. The climate politics of decarbonization is a key factor in seven control regions.
A free market in electricity is characterized by the absence of government ownership, control, or regulation. Private ownership and control dictate each phase of the industry, from generation to usage. Industrial organization, entry, exit, pricing, and other terms of service are not dictated by the state in a free-market setting. The market discovery process determines industry specifics.
History shows the benefits of free markets over governmental control of electricity. The market era saw declining rates, expanding usage, and reliable service. The concept of regulation by competition lasted for decades in various states. Insull’s policies and strategies in the market era led to increased efficiency and reliability in electricity services.
Utility-led regulation created unnatural monopolies, diminishing firm-on-firm rivalry. The transition to public-utility regulation was driven by the desire for exclusive franchises and rate regulation. Rates were declining and services expanding without regulation, indicating no market failure. Industry leaders pushed for regulation to block new entrants and increase profits. However, a key concern was avoiding potential punitive local regulations and the looming threat of municipalization. The political economy showed a pattern of previous regulation leading to the implementation of new regulations.
Statewide commissions regulating electricity as a public utility began in Massachusetts (1887), New York (1905), and Wisconsin (1907). This trend continued with 35 more states joining by the early 1920s. The push for control by experts resulted in the utilities finding ways to manipulate cost-of-service regulation and evade state commission oversight through various transactions.
Despite the initial belief that state regulation would benefit the public, it proved to be ineffective and even allowed for mismanagement within the electric power industry. This led to increased government intervention, culminating in the enactment of major New Deal laws in 1935.
The failure of regulation prompted a reevaluation of utility regulation in the 1960s by free-market economists. They argued for less government intervention and more reliance on competition to drive efficiency and protect consumers. This perspective challenged the notion of natural monopolies and proposed alternative models for utility regulation.
The push for deregulation gained traction in the 1980s, with advocates highlighting the inefficiencies and obstacles created by overregulation. The concept of mandatory open access emerged as a solution to encourage competition and lower costs for consumers.
Overall, the history of utility regulation reflects a shift from heavy government intervention to a more market-oriented approach, with a focus on promoting competition and efficiency in the industry. The Energy Policy Act of 1992 and subsequent state-level initiatives allowed for interstate “wheeling” and retail access to power. This shift demoted utility planning and service to government control, creating centralized power pools that enabled new firms to buy and sell electricity. However, economic calculation challenges arose, leading to different pricing strategies and regulatory approaches.
The transition to central planning and government-mandated decarbonization has diminished consumer welfare and the “obligation to serve.” Sovereign immunity has protected agency errors, such as Texas’s energy pricing issues in 2021. A call for free-market reform suggests repealing landmark federal and state regulations to allow profit-seeking entrepreneurs, not regulators, to drive electricity production, transmission, and distribution.
A free-market approach would eliminate franchise protection, rate regulation, and industry-structure limitations, among other restrictions. By empowering firms and consumers through private property rights, a competitive market would drive down rates and enhance service quality. This reform agenda would reorganize or dissolve regulatory bodies and promote voluntary agreements between firms.
In conclusion, a return to free-market principles in the electricity sector holds promise for reducing costs, improving reliability, and fostering economic growth. The historical shift towards public utility regulation was a political, not economic, decision that created new problems rather than solutions. Embracing market forces and entrepreneurship can lead to a more efficient and consumer-oriented electricity industry.
Bradley (Edison to Enron, pp. 86-88), Bauer and Costello (Public Organization of Electric Power, pp. 37-38), Hawes (Utility Holding Companies, 2-18), Friedman (Capitalism and Freedom, p. 155), Stigler (“Monopoly” in The Fortune Encyclopedia of Economics, p. 409), and Primeaux (Direct Electric Utility Competition, p. ix) offer valuable insights on the topic.
In the 1950s, commercial nuclear plants faced challenges and required various forms of support to operate successfully. The transition to competitive electricity markets in the United States also presented difficulties and complexities (Joskow, 2005).
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