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The Privatization of Power
27/04/2003

Yesterday, James Bow wrote a lengthy, thoughtful article about The Privatization of Power. As James makes clear, this has been an important issue here in Ontario recently, and it likely will continue to be. The current system -- where the government makes up the difference between unregulated wholesale costs and capped consumer prices -- does not seem sustainable. Anyway, I've been thinking about it from time to time, so I'm glad James has opened the discussion and inspired me to write something.

If you're not interested in reading my lengthy amateur treatise about which goods should be public or private, please skip down past the following indented paragraphs.

As I've mentioned before, I feel that The Efficient Society, by University of Montreal professor Joseph Heath, is an excellent place to start understanding which goods should be public and which private. He frames his discussion around the idea of the prisoner's dilemma, but really the more applicable generalization is that of the problem of suboptimization. As defined on the Principia Cybernetica web site:

Optimizing the outcome for a subsystem will [in many cases] not optimize the outcome for the system as a whole. This intrinsic difficulty may degenerate into the "tragedy of the commons": the exhaustion of shared resources because of competition between the subsystems.

Cooperation is the method that allows people to break out of the problem of suboptimization. By cooperatively agreeing (explicitly or not) to not maximize our personal situation, we can avoid the suboptimal point and go on to the optimal level that rewards us all. Heath uses the problem of suboptimization to explain both why cooperation works, and why competition works.

We begin quite a ways back in our evolutionary history. Before cooperation there was only competition. And, as Hobbes said, this state of perpetual competition -- perpetual war, essentially -- resulted in a rather lousy existence:

In such condition there is no place for industry, because the fruit thereof is uncertain: and consequently no culture of the earth; no navigation, nor use of the commodities that may be imported by sea; no commodious building; no instruments of moving and removing such things as require much force; no knowledge of the face of the earth; no account of time; no arts; no letters; no society; and which is worst of all, continual fear, and danger of violent death; and the life of man, solitary, poor, nasty, brutish, and short.

Gradually, we began to learn cooperation. I don't claim to know how it came about (evolution, religion, intuition, insight, and negotiation probably all played their roles) but it has been cooperation that lead to our success. On the strength of cooperation, we found civilization and everything that has come along with it. Even today, in our "market economy", our society is primarily built on cooperation.

Honesty and the rule of law, are both forms of cooperation. Honest, law-abiding behaviour is not actually in one's self-interest -- as Heath writes, "Every exchange is facilitated by either an implicit or explicit promise to pay. And it is always in one's interest to make such a promise. At the same time, it is almost never in one's interest to actually keep such a promise." When looked at from both parties' points-of-view, it creates a prisoner's dilemma. The solution is the cooperation represented by honesty, and the result is a better world for everybody. Honesty is also one of our moral virtues, and I like to think that it is so because of how it fits into this universal principle. (In other words, our notions of right and wrong reflect something fundamentally and provably true about the universe.)

So, if cooperation is so great, where does market-based competition come in? Well, as it turns out, we've found that if we set up the right rules and limits, we can harness the principle of suboptimization and use it to our collective advantage. Consider cooperation between sellers. If all sellers of food cooperated, they'd be able to charge a high price, since we'd have no other choice. But sellers of food don't cooperate -- both because we don't let them, and also because of the principle of suboptimization. In the same way, the jeans industry would be in trouble if all buyers cooperated. We'd demand a very low price, and they'd have very little choice. They would have to sell cheap or get nothing. But, again, buyers don't cooperate, they compete because it is in their (suboptimized) interests to do so. This controlled competition helps force trade to happen at the right price -- the price that makes the most buyers and sellers happy.

Some people today tend to get a bit carried away with this idea, however. They forget about "the right rules and limits" and just think that market-based competition will work for everything and everybody. This is not even possible to achieve in many situations. Heath again:

Market failure is the baseline. It is the fundamental human condition. The Hobbesian state of nature is really just a state of total market failure. Out of this state of nature, we have been able to build up a set of institutions that promote co-operation and therefore improve efficiency. Markets are one institution of this type. But they are extremely limited in their range, since property rights apply only to a tiny fraction of the ingredients we require for successful living.

The best way to picture things is not to imagine a system of complete markets, with a few little failures here and there. It is better to start by imagining a state of nature in which there is total market failure. Imagine about ten billion prisoner's dilemmas. Each one that we resolve makes society just a little bit more efficient. The introduction of markets resolves perhaps one hundred million of them. The rest are not even touched.

Well, there's a lot more to it, but you should read the book. His big point, however, is that when it is possible to set up a functioning market that meets our goals, we are probably better off doing so. However, there are many other cases where a market-based approach doesn't deliver the goods we want in the most inefficent way. There are plenty of services that are more efficiently provided collectively... in other words, publicly, by the government. Interestingly, as our ability to make laws becomes more sophisticated, and as technology changes, our ability to design working markets also grows. So, what might be best provided publicly today might qualify for the private sector someday in the future.

So, to make a long story not quite so long, let's cut directly to the question of energy. I'd say that if a working market can be designed to deliver energy more effectively (on our terms*) than public delivery can, then I would be happy to see energy provided as a private good. Otherwise, I'd support collective, public, action to produce energy.

A working market for electricity would have to provide energy more cheaply than a crown corporation monopoly can. (I'm not talking about just rates, but the total cost, including subsidies.) This used to be entirely impossible because it would imply having several power companies running competing sets of wires through every neighbourhood, fighting it out for each individual's business. Now, however, it is claimed that sophisticated agreements allow power companies to share infrastructure, in a way similar to the way phone companies do. I don't know if this is sufficient, nor can I say whether or not this has been achieved, but it certainly has worked for our phone bills.

Another contributor to producing a cheaper free market for electricity is the set of laws that ensures business engages in fair competition. I'm not sure we're there based on the experiences of California. As Paul Krugman wrote:

In fact, the California energy crisis had nothing to do with environmental restrictions [as claimed by the White House], and a lot to do with market manipulation. In 2001 the evidence for manipulation was basically circumstantial. But now we have a new report from the Federal Energy Regulatory Commission, which until now has discounted claims of market manipulation. No more: the new report concludes that market manipulation was pervasive, and offers a mountain of direct evidence, including phone conversations, e-mail and memos. There's no longer any doubt: California's power shortages were largely artificial, created by energy companies to drive up prices and profits.

Now, this could just be an American problem, but I need to be convinced that Ontario would be safe from this sort of market-busting illegal cooperation. Especially given that we would be buying and selling power from an integrated North American market.

So, at present, I'm not convinced that we should open up Ontario's electricity market to competition. It's too bad, because there are benefits we're missing out on.

To James, energy is a public good because it benefits everyone -- even non-purchasers -- by improving the economy through cheaper electricity as an input to other products. This is where I disagree with him. You could say the same thing about lumber, concrete blocks, nails, and thousands of other things. Subsidizing them does make some downstream products cheaper (at the expense of taxpayers -- there's no free lunch), but this doesn't necessarily benefit anybody. In fact, cheap electricity has all sorts of negative effects, too. For example, today I purchased something at The Big Carrot and my bag listed the following as a reason to buy organic:

More energy is now used to produce synthetic fertilizers than to till, cultivate, and harvest all the crops in the US

In fact, it's easy to think of lots of ways that too-cheap energy subsidizes stupid things that we do. It's called waste, and it makes energy-wasting products cheaper than they ought to be, squeezing out better alternatives. So, to me, real-price electricity would be a good thing for Ontario. I'll be happy when it can made to work properly.

* -- when I say, "on our terms", I mean that I take it as a given in our society that everyone should be able to afford certain goods, like food, water, shelter, and electricity. This doesn't preclude a free market, but as I said when I wrote about rent control, it's a tricky problem, and subsidized electricity across the board is an easy solution.


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