Student Post: Deregulation: The Balancing Act

Economists have come full circle in the past few decades regarding “natural monopolies”, those utilities that were considered ‘natural monopolies’ as the economies of scale supposedly propelled this type of business as a natural monopoly.  As our textbook defines a natural monopoly on page 56, if one firm can more efficiently meet the total demand of a firm because of declining costs over the quantity demanded, then this is considered a natural monopoly.

The fact that electricity generation was considered a natural monopoly for decades in the early 1900’s was the impetus for the US policy of encouraging monopolies to take control of supplying utilities like electricity across the country.  It was thought that the only way, then, to control the natural monopoly was through regulation, where a Public Service Commission in each state would regulate how much a natural monopoly could charge for its services.  It was a sort of compromise that if society allowed a natural monopoly to exist and operate, then it had to agree to regulation of its rates.

But the history of natural monopolies was clouded at best in its ability to regulate rates efficiently.  The breakup of the telephone natural monopoly of AT&T and the astounding reduction in long distance telephone rates that occurred in the 1980’s and 90’s was a turning point in how we approached ‘natural monopolies’.  The magic of competition and its ability to generate efficiencies – even in the case of what was once considered a natural monopoly – re-emerged in economics circles. 

Once again, deregulation and creative ideas for introducing competition into the world of ‘natural monopolies’ was popular. As David Spence comments in our energy law textbook (Energy, Economics, and the Environment, third edition, Bosselman et el) on page 610, “The theoretical case for restructuring was and is simple, straightforward, and based on two related propositions.  First, the sale of electicity is not a “natural monopoly”’; rather, it can and should be an industry in which sellers compete for customers.  Second, and partly therefore, markets can set electricity prices better and more efficiently than governments can.”  He does on to describe how this differs from thought about natural monopolies in the first half of the twentieth century. 

However, because we are dealing with human beings, its likely that deregulation will go too far, just as it did in the case of California when deregulation of electricity and natural gas prices caused extreme shortages and extreme price fluctuations. Enron traders took advantage of that deregulation to abuse the energy markets, and exert market power to extract trading profits from those less capable of exerting market power.  These types of abuse always bring us back to a regulatory framework that involves some control over these behemouth industries, especially those that tend toward monopoly control of an industry.

It is providing and finding the proper balance between regulation and free markets that is always tricky!