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Market Economics: The Push for Deregulation
Deregulation and Use of Market-Based Principles in
Other Industries
Deregulation of Airlines
While the electric utility industry was being questioned about its status
as a natural monopoly, other industries had begun to be stripped of their
protective cloak of regulation. Under President Carter, for example, the
commercial airline industry lost regulatory oversight of fares, cities
served, and the ease of entry and exit from markets. Though some airline
companies went bankrupt in the new environment, other air transportation
companies emerged, and the flying public generally obtained good service
at lower prices than under regulation.
Challenges to Price and Service
Regulation
In general, economists, politicians, government officials, and much
of the public began wondering about the value of regulation. In some industries,
regulation had been imposed to prevent abuses that had previously been
endured and to ensure that all parties had equal access to information
and services (as was the case with the creation of the Securities and Exchange
Commission in1935). Other regulation ensured that safety and health (in
the food, drug, and aircraft industries, for example) would be maintained.
Such regulation attracted little criticism, since it clearly appeared in
the public interest.
But in other areas, such as in determining prices and business practices,
regulation came under fire. Why not depend on the discipline of the marketplace,
with numerous sellers and service providers competing against each other,
to determine prices? In other industries, such competition delivered an
abundance of new products and services, often at declining prices.
Deregulation of Other Industries
As this attitude became more prevalent in the 1980s, price and service
regulation was removed in several industries. While maintaining some governmental
oversight over safety and trying to prevent business abuses, price regulation
was lifted in the securities and banking businesses, trucking, natural
gas, and telecommunications industries. In most cases, customers watched
as the competitive industries introduced new services and lower prices
to gain market share. In a startling example of the natural gas industry,
regulation had previously hindered exploration of new gas supplies, since
prices were capped to protect customers. As soon as price regulation ended,
companies actively sought new supplies. Successful in their pursuit, natural
gas became abundant, and priced dropped precipitously. This and similar
experiences in other countries, such as Great Britain, led politicians
and policy analysts to suggest that the competitive market could discipline
industries better than could the regulatory apparatus. Almost naturally,
many people wondered why the electric utility industry should remain regulated?
Special Nature of Electric Utility
Business?
Of course, utility spokesmen and others pointed out that the electricity
business was different from other industries that had recently been deregulated.
It produced a product that was vital to 20th century life, for example.
If a electricity provider went bankrupt and could no longer provide service,
as would be expected in a competitive business, or if a firm simply decided
to leave a market, then customers would be deprived of a necessity. Such
an outcome would be untenable in modern American society, a society that
had worked so hard, especially during the 1930s, to ensure universal electrical
service. Electricity was simply a "special" commodity, affected
with the public interest as was no other product, and the industry that
produced it required special considerations, or so this line of reasoning
went.
Introduction of Some Competitive Principles into the
Utility Business
Problems with Traditional Regulation
As much as utility executives may have protested deregulation of prices,
many parties agreed that traditional regulation appeared flawed. In the
golden years, when new construction of power plants reduced the average
cost of electricity, regulation that set rates based on the value of the
new equipment worked fine, since rates generally decreased. But in the
1970s and later, utility construction became increasingly costly, and rates
reflected those higher costs. Moreover, regulatory rules encouraged utilities
to complete long-delayed power plants even if the demand for power was
not likely to warrant such a big plants or because poor management caused
costs to escalate.
New Approaches
Energy Efficiency
Regulators in many states, however, tried to address this and other
problems in creative fashions. Invigorated by greater public awareness
of their activities and better funding from state legislatures, regulatory
commissions in several states became more activist--in great contrast to
their passive nature before the energy crisis. In several cases, regulators
required utilities to sponsor energy efficiency programs that helped customers
reduce their demand for electricity. In such a way, the growth rate of
power use would slow or even decline, thus paring the need for new construction
of power plants. With fewer generation plants being built, rates could
stabilize rather than go up.
Competitive Auctions
In another approach, regulators came up with a competitive auction to
determine the rates that utilities had to pay PURPA QFs. Originally, commissions
determined the "avoided cost" of utilities--the cost that regulated
utilities faced when generating new power and the price paid to QFs--using
an administratively determined formula. But in California and elsewhere,
assumptions about the future price of fuel and other factors that entered
into the calculations proved false, thus making payments to PURPA producers
too high in some cases. To alleviate the problem, regulators (or utilities
themselves) sometimes determined only the amount of power that would be
needed in the future, and QFs offered price bids and other terms in a competitive
arena. In most cases, the unregulated generators bid lower prices than
had been previously approved by regulators--a victory for the free market.
Pay for Performance
Regulators in California and elsewhere also introduced the market-place
principle of "pay for performance." In unregulated markets, customers
only paid for services actually received. But in the regulated electricity
business, customers paid for the cost of power plants, even when they may
not have been needed (due to slower demand growth) or when they performed
poorly and had to be repaired and retrofitted frequently. However, in California
and elsewhere, regulators tried to insulate customers from poorly performing
power plants by allowing utility companies to charge customers only when
the generators performed properly. If plants operated poorly, the companies'
stockholders would pay the cost, not customers. In this way, regulators
gave utilities a tremendous incentive to operate efficiently--an incentive
that did not exist under traditional regulation, in which all costs were
passed on to customers. It was the same incentive that unregulated companies
faced daily: improved economic and operational efficiency meant they could
lower their costs and compete better with other companies offering similar
products and services.
Another energy crisis?
Gulf War
As the utility industry slowly underwent examination and alteration
of its activities in the 1980s, new concerns intervened to speed adoption
of competitive principles. After a near-absence of energy initiatives during
the eight years of the Reagan administration (except for the dismantlement
of many energy agencies created during the Carter presidency), President
Bush in 1989 inaugurated a new policy review. He found that the United
States had become more dependent on foreign oil producers than during the
1973 energy crisis, though oil now arrived from a greater variety of countries
than earlier. While working groups studied the energy situation, Saddam
Hussein's Iraqi army invaded Kuwait in August 1990, raising the dictator's
control of world petroleum supplies to 20%. Shortages pushed the price
of a barrel of oil to about $30--$10 more than before the invasion--costing
the American economy about $21 billion over the next few months.
A Free Competitive Market
Within this environment, the President proposed a new energy policy
that depended on the use of market-based principles when possible to encourage
greater production of domestic energy resources and for more efficient
use of existing resources. In classical economic theory, competition among
many participants yielded lower prices to customers and a flurry of innovation
among sellers to provide new services and goods. Overall, society benefited
from a free competitive market as resources were used and allocated efficiently.
In the energy realm, advocates of the free market expected economic efficiency
to yield energy efficiency as well.
A Free Market for Electricity?
Amending PUHCA
Electric utility use of petroleum had already dropped dramatically since
the 1970s, as the industry converted to coal use. But President Bush's
energy strategy still envisioned free-market approaches by which electricity
could be produced and used more efficiently. For example, the plan called
for amending the Public Utility Holding Company Act of 1935, which required
companies producing electricity to register with the Securities and Exchange
Commission and conform to numerous standards. While preventing a repeat
of utility abuses rampant in the 1920s, the law also inhibited independent
power producers--those working under the guidelines of PURPA and other
non-utility producers using efficient gas turbine-generators, for example--from
competing effectively with other producers, yielding lower prices.
As part of the plan to increase competition, the plan would make available
transmission facilities, owned by individual utility companies, so the
independents and other utilities could sell power across the country in
a process called "wheeling." The plan differed from the arrangement
made under PURPA, by which QFs sold power to a local utility for transmission
over the utility's transmission lines. Under the new approach, independents
could contract to sell power to distant purchasers and use the transmission
lines of several utilities (for a reasonable fee) to get the power to them.
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