Posted 11:02 AM by Robert

Herr Doktorprofessor In Spite Of Himself II

Kiesling and Vernon Smith point out that price and contracts could be used to ration power through new technology and simple regulatory reform, and describe what releasing a fuller measure of the free market might include:

Many technologies are available that provide a dual benefit -- empowering consumers to control both energy costs and usage while also stabilizing the national energy system. The simplest and cheapest is a signal controlled switch installed on an electrical appliance, such as an air conditioner, coupled with a contract that pays the customer for the right to cut off the appliance for specified limited periods during peak consumption times of the day. Another relatively inexpensive option is to install a second, watt-hour meter that measures nighttime consumption, when energy usage is low, coupled with a day rate and a cheaper night rate. More costly is a time-of-use meter that measures consumption in intervals over all hours of the day, and the price is varied with delivery cost throughout the day. Finally, a load management system unit can be installed in your house or business that programs appliances on or off depending on price, according to consumer preferences.

More important, better and cheaper technologies will be invented once retail energy is subject to free entry and exit. No one knows what combination of technology, cost and consumer preferences will be selected. And that is why the process must be exposed to the trial-and-error experiment called free entry, exit and pricing. As in other industries, investors will risk their own capital -- not your tax dollars or a charge on your utility bill -- for investments that fail. Also, as in other industries with dynamically changing product demand, competition will force prices to be slashed off-peak, and increased on-peak to better utilize capacity.

Together with demand response technologies, a simple regulatory fix can give new entrants the incentive to provide customers with attractive retail demand options. Local regulated distribution utilities have always had the legally and jealously protected right to tie in the rental of the wires with the sale of the energy delivered over those wires. But these are distinctly separable activities.

Such Smith/Kiesling technologies, regulatory reforms and the contracts through which they might operate are intriguing. Of course, there is no guaranty they will work as planned the first time out without refinements - and their imperfections might be revealed only in spectacular fashion, such as a blackout or other power crisis. We don't know. But what they suggest is surely worth the risk.

To Herr Doktorprofessor, it is likely that even modest problems with such Smith/Kiesling technologies and regulatory reforms would be deemed a "failure" of the experiment - in the same way he has recently railed against privatization of some military functions with little basis. In this respect, Herr Doktorprofessor has become quite the reactionary - and seems to be getting worse.

But many of the biggest obstacles to Smith/Kiesling reforms can be seen by understanding that these reforms essentially propose a program of congestion pricing - similar to proposals that would charge drivers more to use highways during congested periods. Congestion pricing has been resisted - and has terrified even the brightest politicians. For example, former Los Angeles mayor Richard Riordan was said by some of his closest aids (in private conversation) to be a big fan of congestion pricing as a method of relieving Los Angeles freeways. But he never even dared to publicly endorse an experimental program for fear of the political repercussions.

Consider the effects of a Los Angeles traffic jam on two drivers. Suppose driver A earns $10 per hour and driver B earns $1,000 per hour. Suppose further (for simplicity - the analysis does not depend on this point) than time in traffic is income completely lost to both driver - that is, no cell phone or lap top use, and no profitable thinking about business on the road. Then the cost of an hour delay in traffic to drivers A and B will be $10 and $1,000 respectively. In other words, the less economically productive a driver is, the less that driver is disadvantaged by congestion - at least in terms of gross dollars of income lost. Of course, as the roads approach totally impassability, driver A could not earn a living at all. But within wide parameters short of total impassability, the present structure in which road use is paid for only through gas taxes (which correspond only crudely to congestion) results in roads used increasingly by ever-less-productive drivers, just as present electricity pricing results in too many porch lights burning all night.

Economic rationalists argue that if drivers A and B could dicker, driver B might pay a lot of drivers like driver A to stay off the road - and that it only makes sense to let drivers bid to use the road through some congestion pricing mechanism. So why doesn't that fly politically - especially in congested California, which is desperate for new sources of revenue? The failure of California to consider congestion pricing on highways is all the more striking because it is a case in which an additional levy would actually increase overall economic efficiency and wealth while directly increasing state revenues. Why has no major politician even suggested such a source of revenue - even as the state has raised the odious car registration tax and worthies such as Warren Buffett walk into buzz saws by suggesting increased real property taxes? Why is congestion pricing resisted to the point of not even being brought up seriously in political campaigns in times of financial crisis even in places like New York and Boston - where there is supposedly no love affair with the automobile?

The details of the answers to such questions are complex, but the larger conclusion that follows from those answers is not hard to understand:

The current pricing of electricity and roads uses the political/regulatory mechanism to subsidize some people by allowing them to use resources that they would not be able to use if those resources had free market prices.

That means that receptivity to congestion pricing schemes is likely to increase only when the system - electrical or roadway - approaches total impassability. The Eastern blackout and the California power crisis are evidence that we are approaching that point.

UPDATE: Mark Byron remembers California in 2000 without Krugmanian revisionism:

First of all, environmental issues did contribute to the crisis, for a combination of regulations and nimbyitis led to few, if any, plants build in the southern half of California in the last two decades. ... Secondly, the electrical grid had a limited capacity to bring juice from the north ... Thirdly, the half-aseled deregulation plan that was put in place allowed wholesale prices to float while fixing retail prices via state utility regulators. When demand spiked and costs went up due to high natural gas and oil prices, you quickly saw the cost of energy get higher than the price they were earning. [Part] of the market manipulation was likely the fear that power suppliers would be selling to soon-to-be-bankrupt firms that might not pay for their power for a long time, if ever.

All very true. But, I'm still in the dark as to what role Herr Doktorprofessor's California detour is suppose to play in his analysis of the Eastern blackout - except as an attempt to distract his readers and himself from the incoherency of the column and generally smear power companies.

MORE: Excellent item by Luskin. Interesting reader comments on Kiesling's blog.

STILL MORE: Thoughtful musings from Ben Muse.

AND STILL MORE: Samuelson and Miller.