Issue Paper

By Dennis Polhill

Although seldom a topic of conversation around Americas dinner tables, the generation and transmission of power is as ripe for privatization as the transportation industry. We must act quickly to assure that we do not lose the window of opportunity to do something significant in this area.

A brief background for the discussion of this issue is as follows. Infrastructure typically must be constructed to proved adequate capacity for peak demand. Thus, a great deal of capacity is simply wasted most of the time. This is true with highways, airports, water plants, telephone lines, power plants etc. When free market mechanisms can be injected, innovation ways to level demand emerge. Because capacity that was once wasted is now utilized, the product unit price is reduced both to the off-peak and peak users. Value is created, by using the facility more efficiently. Once pricing mechanisms are introduced to highway usage, at least twice as many vehicles can be carried on the same system with less congestion and virtually no increase in maintenance cost.

Technological and regulatory advances are beginning to allow for the rethinking of previous assumptions about the use of public and quasi-public monopolies in providing various utility services. Services that were once natural monopolies, justified on the basis of economic efficiency, may not be so justified in the presence of these innovations. Already deregulation has brought competition, greater efficiency and price reduction to consumers in natural gas and telephone serviced. Both of these were once widely considered to be natural monopolies. Electric power generation and transmission will soon be among the next major utilities to experience the benefit of competition.

In 1992, Congress passed the Energy Policy Act. This act required utilities to permit customer access to other suppliers and to the growing number of independent power producers. It set the stage for multilateral long distance competition among energy consumers and producers. Customers served by a local utility at high rates could buy power from other lower cost sources.

Already the California Public Utilities Commission has acted. Electricity users in California will soon be free to shop both inside and outside the state. Large industrial users may choose their supplier in January 1996. Subsequently, freedom will be expanded to small industrial users, then commercial, and finally to residential customers in the year 2002. Kiplinger Washington Letter predicts nationwide open competition within 10 to 15 years. The rates of Long Island Lighting are nearly double the national average. Competition will bring cheaper electricity to the consumer, will force Long Island Lighting to become more efficient, and will capture underutilized capacity in other parts of the country. Michigan is allowing a test of competition with bug users. Already the big three automakers made a deal with Detroit Edison to stay on as customers until 2004 in exchange for lower rates.

In the world of competition, the capture of efficiency results in dislocations. The industry has already reduced its force by 20,000 jobs. There will be mergers, takeovers and failures. Is it appropriate to have taxpayer subsidies to some but not all suppliers who are in competition with each other? Well, currently nearly 24% of American electricity customers are served by government-owned utilities and receive direct subsidies of over $2 billion per year. In addition, because their governments do not pay taxes they receive indirect subsidies of $4.8 billion per year. Under the old paradigm, these subsidies represent a transfer payment from taxpayers who do not live in subsidy areas to those that do. Under the emerging competitive paradigm subsidized electricity is free to go to another location. Thus, localized benefits of this subsidy will soon disappear. In t he future these subsidies will represent dislocations in the free market mechanisms that give unfair competitive advantage to some to producers. This is an inappropriate and dysfunctional roll of the government to play. The sooner these subsidies can be disengaged, then the sooner the benefits and efficiencies of free market competition will be realized by all. All of society benefits when economic efficiency is captured. All of society is injured when economic efficiency is lost or is stalled.

Most socialist state economies in the world have moved in the direction of free markets by divesting their electric power utilities. The U.S. has been slow to follow. In the free market model, financial risk is shouldered by the investor, not the rate-payer as with the American-style system or the taxpayer as with the foreign-style government ownership system. Both the rate-payer and the taxpayer risk models will quickly yield to investor risk as competition evolves. To facilitate the inevitable change, government should get out of the way as quickly as possible. Electric utility ownership and subsidy by the government must cease. Government can play an active roll by clearing away regulatory and property rights obstacles.