Robert P. Murphy – November 12, 2019
Although the roughly two million affected residents of Northern California are recovering from the rolling blackouts imposed by utility PG&E, the company has warned that these “fire safety outages” may be periodically required for another decade. Naturally, California Governor Gavin Newsom decried the debacle as yet another example of “greed and neglect.” Yet as IER analyst Jordan McGillis explained in a previous article, the episode actually showcases the dangers of a government-imposed monopoly in electricity provision. In this article, I’ll elaborate on McGillis’ insights and show why the conventional economic rationale for government regulation of electric utilities is fundamentally flawed.
PG&E’s Rolling Blackouts Not a Free-Market Outcome
When a company screws up so horribly, letting down literally millions of its customers and moreover promising to continue doing so for another decade (!), the obvious question is: Why don’t they go out of business? Why doesn’t a competitor grab their market share?
The answer, of course, is that the California government forbids PG&E’s customers from switching to a competitor. Let me quote directly from McGillis who gets to the heart of the matter:
PG&E does not function as would a company in a competitive marketplace. As a regulated monopoly, it has been granted status as the sole provider of electricity to a swath of the state stretching more than 500 miles from Eureka, north of the Bay Area, to Bakersfield, in the San Joaquin Valley. The company operates in tandem with the California Public Utilities Commission (CPUC), a panel of regulators appointed by the governor. Unlike in a competitive marketplace, PG&E does not need to compete for customers by offering more value dollar-for-dollar than other companies. Instead PG&E is guaranteed a rate of return on its investments and establishes with the CPUC the corresponding rates that customers will pay.
So we’ve solved the most immediate puzzle: The reason PG&E can get away with such outrageous mismanagement and shoddy customer service, is that the California government literally guarantees them their business. It is illegal for another company to try to entice PG&E’s disgruntled customers to switch their patronage.
Companies in an Open Market Love Periods of “High Demand”
Although the outrageous episode of PG&E is fresh in our minds, this is nothing unusual. Every summer, it is commonplace for utilities to urge their customers to “conserve power” by keeping their air conditioners at an uncomfortable setting, and they often impose rolling blackouts or “brownouts” in order to maintain the integrity of the grid.
Notice that you never see this type of behavior from genuinely private sector companies? Even though people greatly increase their consumption of beer and hot dogs during July, you never see Budweiser or Oscar Mayer imposing temporary outages on their customers.
On the contrary, companies in an open market love it when the public suddenly wants to buy more of their product or service. It’s only in the realm of government-regulated utilities (or services directly provided by a government agency) where the customers are viewed as annoying nuisances, who need to be scolded to stop consuming so much.
Different Incentives, Different Results
Any adult American reading my article surely can agree—regardless of your politics—that I am speaking the truth. To repeat, you simply do not see private companies in (relatively) open markets operating the way PG&E and other “public utilities” do. So the mismanagement and shoddy service of PG&E can’t possibly be the fault merely of corporate greed and neglect. Rather, the difference is due to the institutional structure and incentives that the government sets up.
As McGillis explained in the block quotation above, a regulated public utility is typically given a monopoly for a certain region. It’s not allowed to charge “whatever the market will bear,” but instead must have its retail prices approved by government regulators. After showing the regulators the official cost of providing the service—whether electricity, natural gas, land phone lines, water, etc.—the utility is then allowed to charge enough to cover its costs and earn a reasonable rate of return for the investors.
The problem with this approach should be all too obvious, in light of PG&E’s debacle and the similar episodes we see all the time with other government-regulated monopolies—the residential drinking water crisis in Flint, MI comes to mind. Once a company is guaranteed its customers, with competition expressly outlawed, there is little reason for it to maintain quality.
Furthermore, because the retail price to the final consumer is regulated, whenever the quantity demanded exceeds the supply, the only solution is to artificially restrict the ability of customers to use the product. In a normal, relatively unregulated market, the price rapidly adjusts to balance the quantity demanded and supplied. In extreme situations—such as the immediate aftermath of a hurricane—this can lead to “outrageous” prices for bottled water and batteries, but such “price gouging” is exactly what we want to ration the available supply and motivate outsiders to bring in new supplies.
The Conceptual Flaw With Mainstream Models of Regulation
The textbook rationale for regulating certain services—such as residential electricity and water—is that they constitute “natural monopolies.” The idea is that a certain level of infrastructure spending is necessary to even have the ability to offer these services to a particular region, and so in an unregulated open market you would either have unnecessary duplication—with a given street having numerous pipes and power lines from different companies—or you would have one company that had captured the market and could charge outrageously high prices for such essentials. In order to combat these undesirable outcomes, the model of a publicly regulated monopolist with cost-plus pricing was developed.
Yet as I’ve argued above, there is something terribly wrong with this approach. It simply takes it as a given that a regulated monopoly will provide the same quality of service as one facing open competition, which we see in practice is simply not true. Furthermore, as those in the Austrian tradition of economics stress, there is no such thing as an objectively given “cost of production.” Firms need to discover cheaper methods of producing electricity, water, etc., and we would expect them to look more diligently when they have profits as a reward. In other words, once your firm is allowed to charge its “cost” plus a markup for profit, you have no reason to weed out inefficiencies—the regulators will simply make you cut your retail price.
The PG&E debacle showcases the flaws of government-regulated monopolies. This is not an isolated incident, but is typical of the entire model. Yes, there are practical reasons that free and open competition might not work as smoothly with services requiring large infrastructure spending, but these complications pale in comparison to the dangers of having government outlaw competition. If we see the benefits of competition in trivial goods like soda and cereal, we should all the more so insist on competition for essentials like electricity and drinking water.
Originally published at Mises.org. Robert P. Murphy is a Senior Fellow with the Mises Institute. He is the author of many books. His latest is Contra Krugman: Smashing the Errors of America’s Most Famous Keynesian. His other works include Chaos Theory, Lessons for the Young Economist, and Choice: Cooperation, Enterprise, and Human Action (Independent Institute, 2015) which is a modern distillation of the essentials of Mises’s thought for the layperson. Murphy is co-host, with Tom Woods, of the popular podcast Contra Krugman, which is a weekly refutation of Paul Krugman’s New York Times column. He is also host of The Bob Murphy Show.
Image source: Flickr: David Prasad (no changes made)