TCS Daily

Deregulation and Its Discontents

By Herbert Inhaber - February 12, 2002 12:00 AM

By pure coincidence, two major stories in the news - the collapse of Enron and the economic troubles of Argentina - have a similar nexus. Both are blamed, by at least some commentators, on deregulation. In an article titled "Laissez Not Fair," the New York Times' Paul Krugman used the two examples in an effort to discredit liberal market policies.

Argentina deregulated much of its industry over the past ten years, after undergoing hyperinflation for decades. It did this by pegging its currency to the U.S. dollar, which has inflated by only 2-3% annually for a number of years. Business boomed, and prosperity resulted.

But in the last few months, the economy took a nose-dive. Argentina had borrowed about $140 billion from banks around the world, and those banks wondered when they would get their money back. The nation ran through five presidents in a few weeks, all unable or unwilling to find a way to pay back creditors.

But if deregulation of the Argentine economy produced prosperity for years, how could it generate collapse within a few months? The answer is not deregulation but overdue loans. The situation is like a drunk who keeps putting drinks on his tab. Eventually the bartender asks for cash.

The Enron plunge has also been blamed by some on the deregulation of the electricity industry. It is true that Enron made much of its revenue from trading gas, oil and electricity futures. Some have charged that Enron was fleecing public utilities by selling them overpriced energy, as was claimed during the California deregulation fiasco. However, where are the billions that Enron and other wily Texans supposedly made from innocent Californians? Enron went bankrupt because of losses, not gains.

In any case, deregulation has affected only a few states so far, California being the most prominent one. The concept was a bit oversold, by Enron and others. The idea was that regulation had made public utilities fat, lazy and overcharging their customers. Competition in supplying electricity would lower prices.

Looking at prices helps us make sense of the claims and counterclaims. What follows is not a detailed economic analysis, but merely a look at some electricity prices from the Energy Information Administration, the main statistical body on energy. I considered only residential electricity prices, but the analysis can be extended to commercial and industrial users.

The price per kilowatt-hour in 1960 was 2.6¢; in 2000 it was 8.21¢. Pretty bad, right? Wrong. After taking inflation into account (using 1995-1996 as a baseline), the 1960 price was 11.7¢, and the 2000 price was 7.68¢. Prices, in real terms, have dropped by about 35 percent over four decades.

It is then no wonder that Americans now generally have whole-house air-conditioning and a host of other appliances that were rare in 1960. The steady decline in the real price of electricity -- as well as increases in real family income - helped make this possible.

So what role has deregulation played in affected prices? Many states have no or only partial electricity deregulation, so we can't estimate the overall effect exactly, but the price changes certainly suggest deregulation has been helpful.

In 1990, when deregulation was mostly a concept talked about in conservative circles, the real price was 9.05¢. By 1995, when deregulation plans were moving forward in many states, the real price was 8.56¢ This meant that the price had dropped by about 5.5% in five years, or about 1.1% a year.

By 2000, many states had adopted partial or full deregulation, and Enron and others had jumped into the market. Residential electricity rates fell to 7.68¢, an all-time low (real rates in the 1930s and 40s were on the order of 30¢). This marked a drop of about 10.3%, or about 2% per year.

So while deregulation marched forward, the rate of decrease about doubled over the previous five years.

We have here the familiar problem in economics - what is cause and what is effect? But at least a plausible case can be made that deregulation didn't cause electricity prices to skyrocket, as some had feared. Deregulation will continue, in spite of its unfortunate linking to the Argentina and Enron situations. Whether or not it is a good thing will be answered in the marketplace and in the dry tables of statistical agencies.

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