“Natural monopoly” in economics posits the “market failure” of one provider exploiting captive consumers, of which electric utilities serve as a prime example. The traditional narrative has been that the government must regulate rates and other terms of service to ensure that consumers have access to affordable and reliable electricity.
Although this has been an accepted doctrine for quite some time, a genuine free market for electricity is possible. In his recently published “Free Market Electricity: A Primer,” Robert Bradley Jr. looks at how a free market for electricity thrived in the past, how “infrastructure socialism” and government electricity management have led to bad outcomes, and how classical liberal ideas can serve as a guide for policy reform.
With free market roots, public-utility regulation crept in at the industry’s request. Then came federal regulation and what today is the Federal Energy Regulatory Commission (FERC), and central planning schemes like Mandatory Open Access (MOA). While some downplay the danger of government regulation and control of energy, Bradley writes, “economic discoordination [that] can inconvenience, disrupt, and even kill,” has been the outcome, and today, the threat to reliable affordable electricity, “is not the result of market failure but government failure.”
The current state of energy production, transportation, and distribution is wrought with government intervention and regulation. With MOA making the U.S. energy grid a de facto socialized entity, the current system is anything but free. Other interventions like the federal wind and solar subsidies have made the U.S. grid increasingly more reliant on far less reliable, “intermittent” energies in place of consumer-chosen alternatives.
The early history of electricity in the U.S. was “regulation by competition,” which lasted from the early 1880s to the mid-1910s, depending on the state. Bradley notes that during this era, “the market was characterized by declining rates, expanding usage, and reliable service.” Additionally, “grid electricity was never considered a common-pool resource at odds with definable private property rights and efficient operation.”
Early titans of the energy industry turned to regulation to limit new entry and therefore, competition. Bradley notes that “in a landmark 1898 address before the National Electric Light Association, Samuel Insull of Chicago Edison Company called for a middle way between municipal socialism’ and ‘acute competition.’” However, as Ludwig von Mises reminds us, it is the “middle-of-the-road that leads to socialism.” Beginning with Massachusetts (1887), New York (1906), and Wisconsin (1907), state commission regulation was joined by 35 more states by the early 1920s. While Progressive architects aspired to “scientific” regulation and impartial politics, subjectivity, and human bias produced different outcomes while utilities learned to “regulate regulation”.
This led to more regulation, once again proving the saying that “interventionism begets interventionism.” In 1935 public-utility regulation was expanded further into interstate commerce, banning energy companies from operating in multiple states with the enaction of two major New Deal laws: the Federal Power Act and the Public Utility Holding Company Act.
The status quo of utility regulation remained for decades, as it was not until the 1960s that leading economists such as Milton Friedman and George Stigler made a case for free-market electricity without rate and entry/exit regulation. Other economists also pointed out that regulated utility companies often artificially increased their rate base to get a larger rate of return in the process called “gold-plating.” Harold Demsetz argued that market self-regulation was better than the state because of potential competition, and Austrian economists stressed a “process” meaning of competition versus a static endpoint.
With the enactment of the Public Utility Regulatory Policies Act of 1978, independent power-producing firms gained preferential access to join the utility’s own generation. With academics and lobbying groups demanding cheaper electricity, a new regulatory regime, mandatory open access, was implemented “whereby utilities were mandated to open their (rate-regulated) wires to third parties between the generating plant and the consumer.” A de facto socialization of the grid was set in place when MOA became law in interstate commerce (wholesale level) and in key states at the retail level.
Like all central planning schemes, the new regime introduced incentive and economic calculation problems. Without true market price signals, energy bureaucrats have struggled with reliability incentives. For example, “some regions have implemented ‘capacity charges’ to reward generators for standby capacity. Others have banked on ‘energy only’ prices, betting that ample capacity would be incited by periodic price windfalls.” Mandatory open access has significantly diminished consumer welfare and violated the property rights of firms throughout the United States.
How does the U.S. electricity sector get from the status quo to economic rationality? For a truly free market in energy, numerous laws and regulations that have accumulated over decades, ranging from the Power Act of 1935 to the Inflation Reduction Act of 2022, would have to be repealed. In addition to federal laws, state and local public utility regulation would also need to end.
Bradley states that “a truly free market based on private property rights puts profit-seeking entrepreneurs, not regulators and planners, in charge of the production, transmission, and distribution of electricity.” In the world of private property, prices, profit, and loss, consumers benefit. In the world of central planning and regulation, consumers face more expensive and less reliable electricity. One only has to look across the pond to Europe to see these effects. In Western Europe, energy prices are often double, triple, or even quadruple the prices for the same amount of electricity in the USA, caused in large part due to Europe’s high regulations on the production of energy.
To find out more about how a free market for energy is possible, click here to read the full primer published by the American Institute for Economic Research.
