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Bradley’s Political Capitalism Project (Part III: The Place for Government Intervention)

Act I finds the protagonist boldly proclaiming an original and bold explication of the economics and history of the gas and electric industries. In Act II, we use the weapons developed by our protagonist to render much that passes for sound energy policy both tragic and comedic.

In Act III, we search deeply within ourselves to discern if the protagonist provides answers to the modern vexations that ail us. Come let us listen to Friedman Milton as he disarms the protagonist.

Black and White–or Gray?

The Bradley Project seems to dichotomize the world into free market capitalism and political capitalism. To paraphrase George Orwell, free markets good; political markets bad.

I have no quarrel with Bradley’s conclusion that both energy generally and natural gas and electricity in particular have been victims of political capitalism in all its hoary forms. I disagree, however, with the Bradley Project’s hostility to addressing market failures.

The energy industry, more than any other industry I can think of, has some serious market failures in the classic sense defined by economists. For example:

· Market power problems in gas and electric transportation and distribution;

· Externalities in every supply option, including renewables;

· Public goods issues in basic research and some free rider problems;

· Information asymmetries in various industry segments (let a marketer try to get customer load information from a regulated utility).

Finding the right policy in light of these market failures, while not compromising market forces, is what makes energy policy so treacherous and complex.

Frankly, the economics profession has been asleep at the switch on this one. Electric and gas transportation has more similarities to highways, airports, movie theatres, the stock market, MF Global, and Microsoft Windows than it does to traditional commodities such as hamburgers, shirts, or cars.

Economic academic literature is replete with silo-based analysis on each of these network or coordination industries (I call them Plexus Functions) but completely fails to observe and thus offer a unifying theory of public policy on these types of assets and functions, which does exist, and will be the subject of a future article. But this is about the Bradley Project.

Bradley only minimally acknowledges these types of problems and offers little advice as to addressing them. The overwhelming impression one gets from his first two books is that any form of government intervention is adverse to capitalism, competition, and efficiency.

But sometimes a cigar is just a cigar, to quote Sigmund Freud. There is nothing wrong with a company pursuing profit by making rational adjustments to new government policies that promote efficiency.

Yes, Bradley will rebut that the U.S. has done a generally miserable job of implementing sound economic policy to efficiently address these failures. Rather, the result has been compounded government failures that dwarf the costs of the market failures. And he is right.

Good Middle-Way Government

But there is a third model between laissez-faire capitalism and political capitalism: sound implementation of coherent public policies to address market failures, with a strong recognition of the Public Choice-Government Failure implications of many interventions.

I will suggest two examples supporting this third model: natural gas reforms and clean air regulations.

The Reagan and Bush I Administrations did a terrific job between 1983 and 1992 of reforming natural gas regulation by putting in place sound, market-based policies that have resulted in tremendous benefits to America (truth-in-advertising: I worked on these reforms as an official in both Administrations).

We don’t have time to dwell on detail, but Bradley calls much of this reform “infrastructure socialism.” By that he means that we used very heavy-handed government power to force gas transmission systems and to some extent local distribution companies to adopt a common carriage obligation so that producers and customers could deal directly with each other rather than use these natural monopolists as intermediaries. This was called open access, or, more precisely, mandatory open access.

Chaos in natural gas markets would be an understatement as to the period from the winter of 1972/73 to around 1985. Yet radical, market-oriented reforms were implemented that promoted natural gas competition on both ends of the pipeline. These reforms have stood the test of time and natural gas has made an enormous contribution to energy, the environment, and the economy. It is today the one sharp arrow in our energy quiver.

Enron Reconsidered

Enron at its birth made responsible adjustments to the new regime and built a great natural gas company. There is nothing wrong with a business taking advantage of changes in government rules promoting competition and efficiency for its own profit, and that’s what Enron did in natural gas.

Paradoxically, Enron jumped the shark after its natural gas successes, ultimately leading to the debacle of bankruptcy. It did not have to end this way and would not have if Richard Kinder had replaced Ken Lay as chairman in 1997 as both men originally planned. (Bradley will undoubtedly cover this in his trilogy finale.)

Those of you who have grey hair remember the smog problems of the early 1970s. While it got off to a rocky start, amendments to the Clean Air Act now allow for SOx and NOx trading that promotes efficient internalization of an environmental externality. One might quibble, but it seems undeniable that we have made massive progress on air pollution in a cost-effective manner.

Power Crisis Ahead?

So what does government need to do? While very often in the news headlines, we will not have an oil crisis, a natural gas crisis, or a climate change crisis any time soon. So government need not focus action on any of these. Rather, to quote John Galt in Ayn Rand’s Atlas Shrugged, government should “get the hell out of my way.”

The electricity industry, however, is far more likely to be in crisis over the next decade, largely from six phenomena.

· First, generation options are being taken off the table at both the state and federal level. Try to build a coal or nuclear plant.

· Second, promotion of renewables and electric cars, not to mention increasing reliance on digital technology impose increased demand for electricity infrastructure.

· Third, much of this new demand exposes the reality that the function and technology of electric transmission has changed radically, but we still have a set of policies intended for the 19th century. If Edison were to come back, he would recognize today’s electric industry. Radical reform of electric transmission policy is needed.

· Fourth, one aspect of this transmission policy is to significantly preempt much of current state jurisdiction over electricity. We did it in trucks, planes, railroads, and phones. While electricity may have been intrastate commerce in the 1920s, no one can deny that it is today interstate commerce.

· Fifth, at both the wholesale and retail levels we have an incomplete transition from a highly regulated model to a competitive model. This can only be fixed by national policy.

· Sixth, seriously distorted prices set by regulation. The best analogy I ever heard to promote an understanding of utility pricing related to beef (I heard it from former FERC Commissioner Nora Brownell, herself a former state regulator). Suppose the government dictated that filet mignon and ground beef be sold for the same price. Now think about the implications for supply of both beef products. That’s a near perfect explanation of paying the same for a kWh of electricity on the hottest day of the year and at 2 am in the fall or spring.

Electricity is ever more increasingly the central nervous system of the US economy. While it gets far less press, these challenges will prove intractable over the next decade.

California

In electricity, Enron was fully in the grip of self-interested political capitalism for most of its ventures from about 1990 on. My favorite example of this is the California electric reform legislation that almost cratered California’s economy and gave us Governor Schwarzenegger. It passed the California legislature unanimously by a vote of 114 to 0 and was signed by a Republican Governor.

Yet it was a disaster, and capitalism got much of the blame. So, in general, I agree with the Bradley Project’s point about the fall of Enron, not only the rise, being a result of the perils of political capitalism.

Conclusion

Why is it important to articulate the legitimacy of some intervention when there are serious market failures? Why not just argue that all such interventions always lead to inefficiency and calamity? Legitimacy. It is the calling card to be part of the debate. The economic theory on these issues is too sound to be ignored.

I have been vilified on many occasions by those with a more libertarian streak for my advocacy to adopt the framework of economists, rather than anti-government ideologues. Many may actually be correct that there are very few market failures worth correcting.

But their failure to admit that some might and have been successful often relegates them to academic theorists rather than advocates relevant to the real world market practicalities of the debate. Frankly, market advocates need all the help we can get.

In Act IV, we will conclude with the search for a hero.

8 comments

1 Lionell Griffith { 02.04.12 at 8:55 am }

There is no such thing as market failure. A market is only and exactly free individuals trading the products of their lives VOLUNTARILY according to their INDIVIDUAL view of VALUES. Someone who doesn’t like the outcome of individuals exercising their natural right of freedom of association and trade thinks what he doesn’t like is a market failure. NO. It is simply the market working as the market must and should. The ONLY right that individual has is to present a better product and a better price to the market. He does NOT have the right to go to government and use its force to change the voluntary association and trade.

It is the fundamental right of each individual to HIS live and HIS products that make ANY intervention by the government into the mutually voluntary association and trades in a market wrong. There is NO such thing as a right to violate rights.

2 kmalloy { 02.04.12 at 11:44 am }

Does a coal plant have the right to belch out Nox and Sox and impose costs on others? Does a factory have the right to dump toxic chemicals in a river and ruin the rights of landowners along the river?

3 Lionell Griffith { 02.04.12 at 2:35 pm }

Kmalloy,

Stay in context of my full statement.

The coal plant or factory have a full right to do so only if the toxic substance say within their property bounds. Otherwise they would be using other people’s property in violation of the other people’s rights. Remember, I said that there is no such thing as a right to violate rights. That includes private, corporate, public, or governmental agencies.

One does not correct a violation of rights by further violating rights but THAT is exactly what the top down regulation of VOLUNTARY association and trade is including before, during, and after the fact.

Please understand that a person’s rights are absolute. You have them no matter what. One of those rights is the right of self defense. If your rights, not your feelings or tender sensibilities, have been violated, you have the right of redress of grievances. It is the proper function of government to intervene in only the cases where individual rights have been violated. Rights are violated when physical force, extortion, or fraud is initiated by a person or persons upon another. Such is properly countered by force from the government who is acting as your agent of self defense. There is no other proper use of force no matter how great the perceived need, desire, urgency, nor head count of the group demanding it be used.

It is the recognition of individual rights and especially economic and property rights that sets the foundation and continuation of conditions fit for man living as man on earth.

4 Jon Boone { 02.04.12 at 4:00 pm }

This invites discussion that moves beyond the usual ideological balustrades. In reality, government intrudes because people aren’t angels. Beyond this, there are commonweal reasons for government agency–the courts, the police/military functions, and, in complex societies, standards for commerce and infrastructure. As Mr. Malloy suggests, the ideal situation is one where less government is more: but the less/more calculation depends upon many factors in time and place. And of course, all individual “rights” are ultimately privileges given sanction by government to move civil society along. Government expands when rights collide at scale, since such occasions demand a formidable referee, one able to enforce adjudication.

History has demonstrated that, on balance, government action has resulted in more problems than would have been the case without that action. However, there are instances where the converse obtains, not least the result of World War II. Mr. Malloy’s short list also has merit.

I’ll await Part IV to evaluate what is being recommended for energy/electricity markets, expecting the writer to craft ideas around providing footholds to navigate the very slippery slope that characterizes any landscape where government holds forth. Too often, the slippery slope produces the camel’s nose….

5 rbradley { 02.04.12 at 11:14 pm }

Libertarianism might be defined as trying to find voluntary, non-coersive solutions to social problems. Negative externalities need careful scrutiny to see if, indeed, a better definition or allocation of property rights (even to air or water pollution) can address the problem better than a generic regulation. AND the regulation should not introduce government failure in ways that work against the gains in eliminating or reducing market failure.

Finally, keep in mind that there are positive externalities associated with self-interested behavior, not only negative ones. The undesigned order of markets is the biggest positive externality of all!

6 Lionell Griffith { 02.05.12 at 9:42 am }

“In reality, government intrudes because people aren’t angels.”

Government is simply some men taking action to use force to control the behavior of others . If men are not angels, what makes men in government angels? Nothing. They are like everyone else – not angels. This makes the power of use of force by government extremely dangerous and in need of very tight control. The only thing constraining that force is respect for the rights of the individual by all. As such rights are prior to government not a gift of government.

7 Jon Boone { 02.06.12 at 12:26 am }

“As such rights are prior to government not a gift of government.”

Please…!

Jefferson’s lovely Declaration required a government army to validate his poetic words. Lincoln’s exquisite Address, along with his Emancipation Proclamation, needed a Union Army to make them stick. And Roosevelt’s vaunted Four Freedoms were given wing when the Allied government forces shackled Hitler’s “right” to lebensraum.

Madison’s notion about angels, or the lack of them, and government is a cautionary one, recognizing that, since government is both crucial and problematic, the people who make it happen must have substantial checks–and balances–while keeping as low a profile as circumstance allows.

8 Tom Stacy { 04.27.13 at 7:46 am }

I have to have a little fuel to the fire here. I am really wrestling with the supposedly free-market mechanisms employed by PJM and other regional transmission organizations. These mechanisms do not–absolutely do not–account for the enormous inbalances in the electricity supply and demand: those of scale and product lifespan.

Scale: Electricity is sold in small units–megawatt hours–while the facilities that produce it cost billions. MWH value is typically between $25 And $50. Wholesale auctions held by regional transmission organizations work well to create a chronological dispatch order at each auction.

However there is no free-market mechanism to determine who spends billions of dollars to build the next large baseload power plant, And worse, no check and balance to ensure the investment in same can be recovered. This is important because the cost recovery for such capital-intensive and long design life projects is ultimately borne by society itself. That premise will require a lengthy defense, which I am prepared to offer. Perhaps a topic for another post?

Time: mismatch between lifespan of large power plants and the instantaneous perishability of electricity.

PJM’s capacity auctions are three year forward looking events intended to signal any potential shortage of capacity in any LMP region. I must argue that these capacity auctions are powerless as free-market mechanisms in the generation investment sphere.

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