Bottling the Genie

Deck: 

Why deregulation is easy and reregulation is hard.

Fortnightly Magazine - April 2013

The now-familiar paradigm shift from traditional regulation of public utilities—and for that matter of financial institutions—to relaxed regulation was fairly easy to come by. But reverting to more stringent social oversight of these sectors when need has arisen—from failed policies, promises unfulfilled, or outright scandal—is very difficult.

The twin notions of “technical feasibility” and “value acceptability” together allow or hinder these opposite courses of policy action. In this context technical feasibility has to do with the capacity in place to handle a particular policy step, e.g., available technology or an existing market or institution. Value acceptability has to do with the readiness of the public or decision elites to welcome—or at least acquiesce to—the step. Both elements combined in the mid-1980s onward to allow the aggressive deregulatory movements in transportation and public utilities—and more recently in the banking and investment sectors. The resulting retrenchment of social regulation was wide and deep.

By contrast, in instances where relaxed regulation has either failed or fallen well short of the claims of its proponents, reregulation toward more traditional comprehensive and sustained oversight has been extremely hard to attain. While technical feasibility could be reconstructed, value acceptability is absent and unlikely to appear in any near term.

Deregulation Case

The deregulatory movement from the mid-1970s onward has been amply chronicled.1 In the course of little more than a couple decades the federal government had fully or substantially deregulated trucking, intercity busing, the airlines and railroads, natural gas, telecommunications, and cable TV, as well as various financial markets. Concurrently, states followed suit by enacting so-called “restructuring” initiatives for their jurisdictional utilities, first in telecommunications and then in the energy sectors. These changes largely mirrored the federal efforts and were either nationally mandated, encouraged, or proscribed.2 While not a smooth unbroken line of regulatory retrenchment in each industry, the overall thrust was one of dramatically diminished social oversight of these sectors. In the policy arena, the neoclassical economists had triumphed over the institutionalists in a near rout.

A number of forces came together to make this grand reform both feasible and acceptable.3 Of course the term “regulatory reform” itself should be a neutral one, denoting change in either direction, i.e., more stringent regulation or less. But from the beginning it became a euphemism for aggressive dismantling of traditional regulation at every opportunity, real or imagined. Successive presidents made it part of their domestic agendas; members of Congress from left to right embraced it as political symbol, liberals seeing it as a way of breaking monopolies, and conservatives imagining the paradise of free market competition. Proponents glibly argued that antitrust would protect us if any unexpected bad happenings ensued—a dubious proposition since antitrust action is a very poor substitute in this case; Labor unions and other constituencies that might have been expected to push back were surprisingly silent, perhaps not understanding the full impact of the movement or deciding the struggle couldn’t be won. Zealous advocates of deregulation were ubiquitous and effective, fostering a pervasive belief system that Judge Richard Cudahy has called “a folklore of deregulation—a sort of mythology of the market.”4

The utilities themselves were somewhat ambivalent at the outset, but a combination of: 1) the prospect of “finally getting out from under” comprehensive governmental oversight; 2) the realization that increasing returns through general rate cases before regulatory commissions was less and less likely, and; 3) the presumption that “the big dogs” likely would do quite well in a competitive circumstance overcame their residual worry about leaving the comfortable environment of territorial exclusivity and virtually assured earnings. Finally, while probably not rising to the level of a litmus test, the appointment of commissioners—and sometimes staff—who were congenial to relaxing utility regulation became the common course for these quasi-judicial independent agencies.

In addition to the inclinations of those several players, the state of the national economy at the time was a factor of considerable importance. A period of stagflation was the context. High prices might yield to a good dose of competition, it was thought; regulatory agencies, in the populist view, seemed captive of the industries they were designed to regulate; and there was a general disaffection with government, and a perception it couldn’t do much right in terms of problem solving—a big switch from the public’s very positive view of government in the aftermath of WW II. Fortuitously, a major sector, transportation, appeared to be particularly appropriate to a deregulatory incision.5

From Roads to Wires

Transportation seemed a good place to start with a high chance of success. Considerable benefits could in fact be claimed, though problems would remain, e.g., market concentration in transcontinental motor freight carriage and concerns about highway safety; successive bankruptcies together with major consolidation in the case of the airlines; and the nearly universal view among the public that air travel is a frustrating experience and surely no longer fun.

Similarly, deregulation in the natural gas industry according to some economists has failed in its objectives of lowering consumer prices, constraining market power, and promoting greater real consumer choice.6 Instead, it’s argued, industry concentration has grown, market power hasn’t been controlled, and gas markets are particularly vulnerable to manipulation, fraud, and collusive behavior, with companies sometimes submitting false data to distort natural gas price indices.7

Telecommunications came next. In terms of the number of consumers affected, the deregulation of telecommunications during the period was probably the most significant policy shift. With broad support, both the FCC and the courts adopted a pro-competitive stance for this field—importantly including the 1984 breakup of AT&T as a national regulated monopoly. Congressional participation to this endeavor came with the passage of the Telecommunications Act of 1996. Thus encouraged and directed, most states joined the deregulatory parade.

Perhaps counting on fadism to help carry the day and buttressed by enough claimed success for these initiatives aggressive advocates for deregulation turned to the last remaining network utility, electricity. Congress obliged by producing the Public Utility Regulatory Policy Act of 1978 and the Energy Policy Act of 1992; the FERC promulgated a raft of deregulatory implementing orders; and about half the states chose to restructure electricity regulation in their jurisdictions. There were, of course, some cautionary voices along the way in the case of this sector. But these warnings were effectively dismissed as clinging to old ways and being out of touch with the new; being obstructionist and just not getting it; and raising inconsequential downsides that would be far outweighed by the benefits—and which, if having any validity at all, would soon be fixed by self-correcting markets. What did give some pause to the movement, however, was the California debacle with the crash of retail deregulation there in 2002.

Thus within the frame of technical feasibility and value acceptability, the progression of liberalization in the transport and utility sectors demonstrates the breadth and depth of the public’s willingness to support, or at least acquiesce to, a major policy shift in its social oversight—trusting to market solutions in place of comprehensive regulation.8 Value acceptability was thus achieved for these industries, and, combined with the demonstrated technical feasibility of deregulation—through 1) operating advances of an engineering kind in each sector, and 2) the issuance of court decrees, legislation, and commission rulings—the ingredients of major change were assured.

Unfortunately, the electric sector is the least well suited to deregulation, and it exemplifies the asymmetry of ease and difficulty between deregulation and reregulation. However, the same thesis applies with general force to natural gas and telecommunications, when reforms are needed to fix the excesses of deregulation.9

Reregulation Case

Turn now to the challenge of accomplishing reregulation of utility sectors in these same terms. The story is very different, especially in achieving value acceptability. The technical feasibility of reregulation is well within the grasp of policymakers, though not without some obstacles. For example, restructuring de-integrated electric companies into their formerly vertically integrated selves involves issues of changes in value, in ownership, and legal status. Also, there’s some worry that the loss of institutional memory at public utility commissions through natural attrition and the absence of general rate cases, cost-of-service studies, and other paraphernalia of traditional regulation would require considerable retooling of staff skills.10 Still, as with deregulation, what’s mostly involved is the promulgation of legislation, commission rulings, and favorable court decisions pointed toward the goal. But while the way might be fairly straightforward, the will required to reach value acceptability of a broad reregulatory policy is weak at best. Here’s why.

Not surprisingly, constituencies that have a stake in maintaining status quo promptly grow up around a deregulatory environment. Relief from price and profit constraints, relaxation of the obligation to serve, and avoidance of serious cost-of-service defenses and certain other reporting requirements were viewed as hard-fought gains not to be lightly given back.11 Further, an army of consultants, marketers, and middlemen of various kinds appears and somehow gives legitimacy to the deregulatory posture, presenting another path of resistance.

Legislatures, national and state, that authorized deregulation of the energy and telecommunications sectors in the first place are reluctant to admit policy error, even when events point that way, or are so wedded to blind belief in market competition that they see no need. Moreover, legislatures understandably have little appetite or time for reopening so arcane and complex a matter as utility regulation. In the case of Congress, this might be no more often than every couple decades or so.

The role of public utility commissions in any movements toward reregulation is mixed at best. Commission technical staff, knowing where all the bodies are buried, often more quickly and more candidly recognize the downsides of past restructuring, but have sometimes been viewed as part of the problem when taking such a stance. Commissioners who were appointed to implement deregulation not surprisingly are slow to change course. Perhaps more fundamentally, as commissions moved from being quasi-judicial bodies to quasi-legislative ones, it followed that focus on traditional elements of utility regulation—measurable performance like rates-of return, tests like “used and useful” and “prudent investment,” and engineering standards like service reliability—was supplanted by dependence on more ephemeral notions like consumer sovereignty, workable competition, contestable markets, and accelerated innovation. Still, when effective competition failed to appear and when faced with the expiration of price freezes and caps on utility rates—originally included to secure consumer support for deregulatory restructuring—most commissions have acted to avoid the steep price run-ups that would have occurred if promised market pricing had been allowed to go into effect. Note, however, that this intervention merely provided a pause in the deregulatory journey and not a real reversion to more thorough oversight.

Finally, in explaining the lack of value acceptability for serious reregulation of utility sectors where arguably warranted, the broad public itself bears considerable responsibility for inaction. Its engrained attitudinal preference for free market solutions over governmental ones is a major hindrance. Concurrent to this is its willingness to cut a lot of slack for corporate misbehavior, even when victimized in one way or another. Also, the citizenry is typically unorganized so that even good governance or populist forces that might be counted on for affecting change are muted or ineffective. And if economic times are pretty good, there’s still less an impetus for correcting policy failures.

For all of this, what might the reregulation of public utilities look like? While a complete return to traditional utility regulation would be both unrealistic and undesirable in many cases, the elements of enlightened reregulation would include some of the following: Price and profit control to guard against excessive earnings (an excess profits tax might be considered if limits on returns aren’t otherwise imposed); occasional, but regular, cost-of service studies to periodically align prices with the costs incurred; a presumption in favor of service obligations and meaningful penalties for non-compliance; narrowing the scope of utility claims of proprietary information; insistence on integrated resource planning methodology in investment decisions; merger guidelines requiring demonstration of net efficiency gains that otherwise couldn’t be achieved; permitting or requiring use of long-term contracts in energy procurement and the acquisition of generating plants to accomplish vertical re-integration; and limiting retail choice to only large customers when promised competition has worked only for them and not residential and small business customer classes.12

Unhappily, the outlook for value acceptability on the part of the citizenry or decision elites to rise to the level that, together with technical feasibility, allows for corrective policy action toward reregulation continues to be unpromising. It seems that the answer to Cudahy’s 1998 musing13 about whether deregulation was “a sea change or only a nudge of right rudder” is now abundantly clear—and with little chance of actually righting the ship.

Endnotes:

1. For example, Sam Peltzman and Clifford Winston, editors, Deregulation of Network Industries, AEI-Brookings Center, Washington, D.C., 2000; Susan J. Tolchin and Martin Tolchin, Dismantling America: The Rush To Deregulate, New York, Oxford University Press, 1983; Phillip J. Cooper, The War Against Regulation: From Jimmy Carter to George W. Bush, University Press of Kansas, 2009; Alfred E. Kahn, “The Political Feasibility of Regulatory Reform: How Did We Do It?”; Chapter 12 in Reforming Social Regulation: Alternative Public Policy Strategies, L. Graymer and F. Thompson, editors, Sage Publications, 1982; and Martha Derthick and Paul J. Quirk, The Politics of Deregulation, Brookings Institution, Washington, D.C., 1985; Paul L. Joskow, “Regulation and Deregulation after 25 Years: Lessons Learned in Industrial Organization,” Review of Industrial Organization, Vol. 26, Springer, 2005.

2. The PURPA legislation of 1978 mandated that the states consider various pro-competitive provisions of the act; the Telecommunications Act of 1996 prescribed fairly detailed competitive initiatives to the states; federal deregulation of the transport sector prohibited states from reregulating what had just been abandoned.

3. Derthick & Quirk, op. cit., Chapter 2, The Reform Idea.

4. Richard D. Cudahy, “The Folklore of Deregulation,” Yale Journal of Regulation, Summer 1998.

5. Economists and others had long argued that the transportation sectors, with the possible exception of railroads, never fit the monopoly model for comprehensive financial regulation.

6. Harry M. Trebing, “A Critical Assessment of Electricity and Natural Gas Deregulation,” Journal of Economic Issues, June 2008.

7. A recent anecdotal example is found in a Columbus Dispatch newspaper item (“ Ohioans burned by gas choice,” Nov. 11, 2012) reporting that “customers on unregulated gas contracts have paid $885 million more for gas since 1997 than they would have at the regulated price.”

8. For a persuasive discussion of this see, for example, Robert Kuttner, Everything For Sail: The Virtues and Limits of Markets, 20th Century Fund, Alfred A. Knoph, New York, 1997.

9. While not the focus of this article, the difficulty currently being experienced in reregulating the financial services industry—banks and investment firms—in a serious way, first in getting legislation through and now in devising implementing rules, provides a counterpart example to the topic here.

10. Greg Aliff and Branko Terzic, “A Lost Art,” Electric Perspectives, November/December 2004; Douglas N. Jones, “Agency Transformation and State Public Utility Commissions,” Utilities Policy, Elsevier, March 2006.

11. Douglas N. Jones, “Regulatory Resurgence?” Public Power, June 2009.

12. A number of states authorized or considered authorizing some of these actions. See “ Delaware’s Electricity Future: Re-regulation Options and Impacts,” A Report for the General Assembly, by Nancy Brockway, May 2007.

13. Cudahy, op. cit.