Tuesday, 9 October 2007

Why "on average" in econspeak is bad policy

Even libertarians are sometimes right, well almost right at least. In an opinion piece on electricity deregulation in The Wall Street Journal (text available at the CATO institute). Peter van Doren and Jerry Taylor argue correctly that "regulation certainly delivers lower prices than the market during shortages. But regulation delivers higher prices during times of relative abundance".

Regulation delivers lower prices during shortages, because the end price is a weighed average of the cost of the different producers. So when for instance natural gas prices increase, the price increase is only based on the weight of natural gas in the total production chain. In a deregulated market, the price during shortages would be based on the price charged by the most expensive plant. This price would obviously be higher than the weighed price. During the times of abundance it's the opposite.

So should policy makers let markets dictate the price or not? Well, unsurprisingly, the guys from the CATO institute argue that we should because "in sum, allowing markets to dictate electricity prices is a good thing for consumers, even if they are sometimes higher than under regulation." So according to them consumers are on average better off, because times of abundance will outweigh the shortages and this will result in a net benefit for consumers.

I disagree, there are more convincing arguments for policy makers to be in favor of regulation (I'll ignore the obvious argument of a finite resources) :
  1. During market shortages the price increase under deregulation will make it impossible for people with low incomes to be able to pay for electricity (which is a basic necessity in modern day life). Besides this being bad in itself. This might result in negative publicity and a voter backlash against politicians who favored regulation.
  2. The sudden rise of prices during shortages (under deregulation) will be felt throughout the population, the negative impact of this on politicians is obvious. More stable prices under regulation are to be favored.
  3. Stable prises make longterm planning and investment easier for both business and private consumers. Sudden spikes in prices and an unstable energy market will put investors off.
The article further makes some interesting arguments in favor of bundling both production and transportation of electricity. Arguments I agree with. Too bad the EU has just favored unbundling and further deregulation. Why? Probably because deregulation and unbundling is a good job opportunity for consultants, free trade economists, lawyers and bankers.

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