The Free Market 19, no. 3 (March 2001)
The state of California has experienced a meltdown in its electric power system. For months, the system has repeatedly run at or near the overload point, necessitating brownouts and even rolling blackouts. Incredibly, the fiasco has been blamed on deregulation and the free market. Economist Paul Krugman, for example, wrote a disgraceful article called “California Screaming” for the New York Times (December 10, 2000). The online lead-in to the article accurately conveyed its tenor: “California’s blind faith in markets has led to an electricity shortage so severe that the governor has turned off the lights on the official Christmas tree.”
Meanwhile, the governor of the state is proposing what amounts to a state takeover of the system. Instead of permitting private enterprise to build new plants, he proposes the government build them at taxpayer expense.
It is necessary to review the facts that have caused California s fiasco, in order to arrive at a rational judgment of its nature.
Destructionist government policy has increasingly restricted the supply of electric power in California and throughout the United States. For the last twenty years or more, there have been no new atomic power plants constructed and few or no new coal, oil, or hydroelectric power plants built.
Indeed, government policies have caused existing plants of these types to be dismantled. In California, in the last decade, only power plants using natural gas as their fuel have been allowed to be constructed, and such plants now account for most of the state s generating capacity. Such power plants are substantially more expensive to operate, and would quickly be plunged into unprofitability if exposed to the competition of other types of power plants.
Moreover, the government-caused dependence on natural gas as the source of fuel for power plants has contributed to the sharp rise in the price of natural gas to record levels. The rise in the price of natural gas has been especially great in California, where lack of adequate pipeline capacity has limited natural gas supplies more than in the rest of the United States.
Over the same period that the government has restricted the supply of electric power, there has been a substantial increase in the demand for electric power. The rise in demand has been brought about both by population growth and by the increase in power consumption per capita caused by economic progress.
When these facts are combined with government price controls on electric power (which have existed since the early years of the industry), shortages of electric power are an inevitable result. The government’s responsibility for shortages of electric power inescapably implies its responsibility for power brownouts and blackouts. Their immediate cause is a demand for power too great for the power system to supply, i.e., a power shortage.
When taken in conjunction with price controls on electric power, the government’s inflation of the money supply also contributes to power shortages. This is because inflation contributes both to the increase in the demand for power and to the restriction of its supply. The former results largely from the rise in money incomes that the spending of the additional quantity of money brings about, and which gives people the financial means to afford larger quantities of any given good at any given price. The latter results from the fact that inflation drives up the costs of constructing and operating power plants and thus correspondingly reduces their profitability in the face of controlled selling prices. The process does not have to go very far before it no longer pays to construct power plants-- assuming, of course, that the environmentalists did not prevent their construction in the first place.
Why are some people blaming deregulation for the crisis? The so-called free market in electric power in California consists of the fact that last summer, price controls were removed from the power supplies of San Diego County and the southern portion of adjacent Orange County, while remaining in force throughout the rest of the state.
Anyone familiar with economic theory could easily have predicted the result: skyrocketing power prices in the area. For the limited power supplies of this small area were being made to bear the burden of coping with the statewide and indeed, Western-states-regionwide power shortages caused by destructionist government policies.
An immediate, partial solution to the sharp rise in power prices in this limited area is the immediate decontrol of power prices throughout the rest of California and, indeed, throughout the whole Western-states region, which shares a more-or-less integrated power grid. The effect of such decontrol would be an immediate, substantial increase in the supply of electric power available for the decontrolled market and thus, probably within days, if not hours, a sharp drop in the price of electric power in the decontrolled market.
This increase in supply would not come from an increase in production, though very soon there would be such an increase and thus a further increase in supply and reduction in price in the decontrolled market. No, it would come from the more or less substantial portion of the already existing production of electric power that is presently consumed by submarginal buyers, i.e., by buyers unable or unwilling to pay the potential free-market price, which, of course, would be higher than the controlled price still in force over the far greater part of the state.
When the price control is removed, this substantial part of the supply, presently not available for the decontrolled market, is made available for the decontrolled market, where its effect is to enlarge the supply and thus correspondingly reduce the price.
Lifting price controls in the remainder of Orange County and in Los Angeles County, for example, would add supplies from these areas to the supplies presently available only from San Diego County and the southern portion of Orange County to meet urgent needs for power throughout the state and the Western-states region in general.
It should be clear that decontrol limited to the territory of just one or two counties is decontrol in a pressure cooker. It is decontrol in which all the pressure of the shortages of the whole rest of the state and surrounding states come to bear on the very limited supplies of power available just in this relatively small area. Decontrol over the whole state and region would serve to eliminate all of this pumping-up of the pressure that has propelled prices so high in San Diego County and south Orange County.
Retention of price controls, in contrast, is against the interest of all consumers of power=poor consumers no less than rich ones. It means that the wealthier, higher income buyer has no economic reason not to go on using power for a second or third refrigerator, or for his pool lights, which serves to deprive the poorer consumer of the power for his one refrigerator or the light in which to read.
When faced with the need to restrict consumption, a free market does so by eliminating the least important of the uses to which a good was previously devoted, i.e., its previously marginal uses. In the California case, such uses will probably turn out in large part to be power-intensive industrial uses in the production of products that are unable to bear substantially higher power costs.
To the extent that the free-market price were higher than the previously controlled price, it would operate to increase the profits of power producers and thereby provide both the incentive and the means (the latter through reinvestment of the profits) to increase investment in and thus production of power.
This, of course, is part of the more complete, longer-run solution to California’s power fiasco. Obviously, it requires the removal of obstacles to the construction of new and additional power plants, i.e., the environmentalists must get out of the way. The freedom to construct power plants fueled by atomic energy and by coal must be restored. In the meantime, let us hear no more assertions that California s “blind faith in markets” has led to an electricity shortage. This is the complete opposite of the truth. Presenting knowledge of the actual causes of California’s electric-power fiasco will prevent the enemies of the free market, such as the New York Times and its columnists, from getting away with blaming the free market for the consequences of the anti-free-market, destructionist policies they advocate.
George Reisman is professor of economics at Pepperdine University’s Graziadio School of Business and Management in Los Angeles and is the author of Capitalism: A Treatise on Economics (Ottawa, Ill.: Jameson Books, 1996), copyright c 2000 by George Reisman. He may be reached via email at Jefferson_School@compuserve.com.
