Postrel vs. Free Market Electricity: Exchange and Comment

“Underlying most arguments against the free market is a lack of belief in freedom itself.” – Milton Friedman

Even since the Great Texas Blackout of February 2021, I have tried to engage classical liberal scholars with the lost tradition of free market electricity in theory, practice, and public policy. An interesting exchange with economist Steve Postrel on social media some months ago is worth preserving, in this regard.

Postrel is very critical of Lynne Kiesling’s uber technical optimism with governmental chess pieces (wind, solar, batteries, another story). But he rejects a free market in electricity.

I reproduce the exchange and then offer a critical comment. It began with my reference to my AIER primer: Free Market Electricity.

Postrel to Bradley: I am familiar with the old Primeaux and Demsetz [free market] arguments, but they have little concordance with each other or with the pre-regulation utopia you try to resurrect in your article. Simply reverting to common law and property and contract law while removing all electricity-specific regulations would not be in line with franchise bidding, etc.

My approach to the question of generation portfolios and transmission/distribution investment is Coasean and empirical: It turns out electricity is an area where there is sufficient homogeneity and predictability of demand and sufficient technological/engineering information that managerial planning rather than market discovery processes are the best way to exploit economies of scale, scope, synchronization, etc. Some public authorities seem to be pretty good at this, e.g. in France (where, not coincidentally, some of the first papers on optimal electrical capacity and peak-load pricing were written).

The outstanding problem with the current system in the U.S. that I see is that economies of scope in generating power-when-the-sun-is-shining and power-when-the-sun-isn’t-shining, which are two different products, are not internalized by any agent or pricing mechanism. A combined-cycle gas plant that provides power as needed all the time is more efficient than a combination of solar/wind plus backup/storage for the same demand for power of both types. That will continue to be the case for the foreseeable future (decades, I suspect). But the current dispensation effectively forces solar and wind onto the grid without anyone accounting for the increased overall cost occasioned by the need to also provide power in the no-sun/no-wind state of the world.”

Bradley to Postrel: First, what specifically is your criticism of “the pre-regulation utopia you try to resurrect in your article.” Where is the ‘utopia’ and the “market failure” that suggests government intervention? Second, your statement “managerial planning rather than market discovery processes are the best way to exploit economies of scale, scope, synchronization, etc.” is just an assertion. Managerial planning in a free market is not at all incompatible with “market discovery processes.”

Postrel to Bradley: First, duplicate transmission and distribution lines are generally a bad idea. So we can, I hope, remove that occasional aspect of the pre-regulation regime from our imagined future regime. Second, Demsetzian franchise bidding requires that the customers in a geographic area jointly pool together to purchase from the best option, without holdouts or free-riders interfering, and the lowest transaction cost way to organize that is through government action.

Bradley to Postrel: Duplicate lines are bad in the real world or in theory? Where was the market failure with duplication once Insull et al. took the industry into the mature phase? That consolidation took care of a lot of inefficiencies. And why in a true free market would there be a duplication problem today? I also disagree that organized monopsony would not be an option and practical with information/organization costs being so low. You vaguely speak of “government action” as if it was costless and did not result in what we have today with MOA/RTOs: the knowledge problem and politicization of central planning agencies.

Postrel to Bradley: You can see the same problem with services such as garbage pickup. There is a huge technical economy in having the same truck service every building on a street or neighborhood rather than driving greater distances between stops. (OTOH, there is probably an X-efficiency advantage to having each building be able to switch to a competitor at will.) But the first economy is very hard to achieve without government coercion to pool all the buildings into a single buying group.

Bradley to Postrel: I see the duplication problem with renewables, both in generation and in transmission, but why is this a ‘market failure’ that electricity entrepreneurs cannot handle via alertness and contracts? We are talking about lines and poles and not ‘tearing up the streets’ with natural gas or water or other services. Single provider service over a certain geographical area makes a lot of sense in electricity, and I await a ‘market failure’ argument in theory or history about why vertical and horizontal integration is not efficient and a great way to avoid all the problems of politics/intervention.

Comment

I am not at all convinced that Postrel is giving a true free market in electricity a fair hearing. I challenge his cavalier dismissal of pre-regulation history (in my paper) as being “utopian.” [1] The old duplication/market failure argument does not hold on close inspection, and I challenge him to empirically show otherwise.

He rejects the free market with this argument (emphasis added): “… electricity is an area where there is sufficient homogeneity and predictability of demand and sufficient technological/engineering information that managerial planning rather than market discovery processes are the best way to exploit economies of scale, scope, synchronization, etc.“

Electricity is a unique product, which free market entrepreneurs understood and tamed with vertical integration over some or several control areas. Franchise regulation then locked-in geographical regions, which a market discovery process without public-utility regulation would reveal. Economies of scale and the need for perfect reliability were conquered in a fascinating example of entrepreneurial alertness and necessity-is-the-mother-of-invention.

A market discovery process in a real free market would redefine the industry and the firms within it. Economies of scale and scope would determine vertical and horizontal integration. Utility management would be less political and more entrepreneurial. Investors would demand new things.

Finally, why would a free market provider not be consumer-oriented with politics demoted? Should consumers be dissatisfied, how would investors react? But yes, in our new age of low transaction costs, third party entrepreneurs could well step in to negotiate ‘global settlements’ for large groups of consumers (“ratepayers”). I disagree with Postrel; Demsetz’s bargaining could have more life today than when he wrote in the 1960s.

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[1] “Rob’s snide reference to my ‘chess pieces’ is a reference to my unwillingness to agree with his Utopian dismissal of ISO/RTO organized wholesale markets.” (- Kiesling to Vernon Smith, here)

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