[BETA] Fortnightly

An oft-heard argument these days says that states with low-cost power should refrain from restructuring their electric utilities. This argument has gained credence in some states, where protectionists have used it to slow down the liberalization of electricity markets. The rationale is simple: Because the state would export its low-cost power, local consumers would lose. They would face higher electric prices than if their state had somehow confined its low-cost resources within its boundaries. Some regulators voice the same opinion: "Why should we share our low-cost resources with other states when it would only drive up prices in our own state?"

This prediction of higher electric prices in low-cost states comports with a "regional averages" hypothesis. To say it differently, interstate trading yields a zero-sum game; out-of-state consumers would benefit, but at the expense of in-state consumers. Some economists color this outcome as an "exploitation" transaction, suggesting that free-market trading produces gains for some but losses for others.

On the other hand, restricting power exports implies that the current beneficiaries of low-cost electricity are entitled to some special right to it.

The protectionist argument rests on an key premise (em that increasing the demand for low-cost electricity would drive up the price, forcing current users to pay more. In the short run this assumption may be true, but only if, say, a state holds an abundance of hydroelectric power that is being sold at production cost. In that case, consumers would pay less than a market-determined price, defined as the cost of the highest-cost electricity source in the region. The savings would reflect the fact that the owners of the hydroelectric resources (e.g., U.S. taxpayers) were being "short changed" in not collecting a higher return. But a higher return would reflect economic scarcity (em not market power. Apparently, proponents of a protectionist policy disregard or heavily discount the revenues and profits that would flow into a state selling low-cost electricity. They focus on short-term consequences.

The protectionist argument also discounts the effect of interstate trading on lowering the cost of electricity in all states. Even though such trading would induce competitive pressures, the protectionists assume that utilities in low-cost states (and others too) would somehow remain untouched in their operation, planning, and pricing activities.

What's Wrong with Protectionism

I am hard-pressed to find a case where government policy attempts directly to restrict demand for a highly valuable product or service to protect consumers. The one example I can think of comes from developing countries that impose an export tax on certain agricultural products. Economists have generally criticized such a tax as discriminatory against farmers and a deterrent to domestic production (the government takes away some of the revenues that would otherwise be allocated to farmers). Of course, some governments have tried to protect consumers by setting price ceilings that ostensibly fall below market-determined levels (e.g., the old natural gas wellhead price controls). But even there, the direct intent was not to restrict the flow of the product or service, but to limit the prices that consumers had to pay.

Here lies the