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Deregulation, Phase II

Recent electricity pricing argues for faster, more extensive deregulation.

Fortnightly Magazine - November 2007

sufficient revenue to finance their operations, but don’t abuse their monopoly position to earn unfair profits. In a competitive market, this need for oversight goes away, as long as no single firm can dominate the market.

When all companies are equal, each must strive to produce more value per dollar of cost than the others do, or risk losing market share. The quest for profits at the expense of one’s competitor ultimately drives prices down, and customers win. But Adam Smith’s invisible hand is shackled when one firm can control the market and use this control to gain monopoly rents at the expense of competitors and customers.

By contrast, in a regulated market the regulator focuses on cost-recovery and protecting the utility monopoly. Kahn is the rare regulator who understood this transition from both perspectives. Virtually none of the restructured states have effected this transition in regulatory oversight. No regulated utilities now find themselves subject to antitrust enforcement, and no commissions have volunteered to cede their oversight of consumer protection to antitrust authorities. Neither regulated entities nor regulators have any economic or political incentive to make this transition—and California illustrates the result.

On the one hand, companies such as Enron manipulated the market, using their market clout to withhold electricity and drive up the price. An antitrust enforcer should have—per Kahn—been on the watch for precisely such behavior, and yet such a regulatory body did not exist. When Enron later claimed it hadn’t really broken any laws, it was not entirely wrong. Its behaviors may have been unethical, but some degree of culpability must lie at the doorstep of regulators who failed to establish the necessary antitrust oversight.

However, the other side of this flawed deregulation—over-emphasis on consumer protection—is less visible, and perhaps more damaging. A pair of well-known industry bankruptcies illustrates this.

When (unregulated) Calpine filed for bankruptcy, the company was weighed down by $17 billion in debt. Popular media touted the resulting loss in shareholder value as an example of why deregulation failed. Conversely, when (regulated) PG&E declared bankruptcy, its costs (now approaching $16 billion) were borne by California’s ratepayers in the name of the public interest—and the popular media cited the need for a public bailout as an example of why deregulation didn’t work.

Clearly, both assertions cannot be correct. A hallmark of a functioning market is not only the ability to succeed, but also the transfer of the risk of failure to shareholders. In the case of Calpine, this exposure was clear—but in the case of PG&E, regulators imposed that risk on the public rather than jeopardize the utility’s shareholders. California’s experience might be extreme, but it isn’t unique. All restructured states have limited the scope of deregulation and largely left their weakened utility commissions responsible for market oversight, in spite of their reduced span of control. Both serve to confuse the distinction between antitrust enforcement and consumer protection, and therefore limit the ability of markets to reduce consumer prices.

Restructuring Misdirected

The final consideration is most important, both to recognize the limits of past deregulatory processes and