No Good Answer on Utilities

A blog about business and economics.
March 22 2013 10:26 AM

Municipal Utilities Are About as Good (or Bad) as the Other Options

Several decades ago, jurisdictions across America got fed up with the waste and mismanagement of publicly owned utilities and there was a big fad for turning them into regulated private monopolies. More recently, jurisdictions across America have gotten fed up with the waste and mismanagement of private utility monopolies and there's a bit of momentum around returning to the public ownership model with Boulder, Co. perhaps leading the way.

Unfortunately, the problem here is that electricial utilities are simply one of these things for which there's no good solution.

What you would want is for private utilities to throw themselves a gigantic overinvestment party and build 10 reduntant electrical systems and then everyone would have fun and competition. But nobody's going to do that. It's what the textbooks call a "natural monopoly" with very large up-front costs to construct but relatively low marginal costs to operate. So there are essentially two options available to you. One is that you can operate the monopoly as a publicly owned monopoly so that instead of some private owner extracting monopoly rents from customers it's all in the public's hands. The other is that you can operate the monopoly as a regulated utility where you allow for enough profits to make it worthwhile to make capital investments but don't let the public get ripped off.

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Either of these could be great ideas or either of them could be terrible. At the end of the day, it all just comes down to the quality of the governance. With the regulated utility model, the problem you get is "regulatory capture." Joe Taxpayer has a lot of things to worry about and the governor's appointments to the regulatory commission are pretty far down the list. Johnny Utility CEO has a lot of things to worry about too, but the governor's appointments to the regulatory commission are pretty high up the list. So the commissioners end up getting systematically biased toward the interests of the regulated entity rather than the public. But with the publicly owned monopoly model the exact same governance issue arises again. Voters are not informed about or interested in electrical utility management. Management and appointments will be politicized and excess rents will be extracted from consumers. 

The difference is in where the rents go. In a public ownership model, typically management will team up with the rank-and-file workforce to divide the spoils. In a regulated monopoly model, management has more incentives to squeeze compensation and divide the spoils with shareholders instead. That is obvioulsy a very important difference to the specific people involved. But in terms of the public interest you are stuck with the problem of basic institutional quality and good governance. Here in the D.C. area, we run PEPCO as a regulated private and PEPCO has a ton of problems. We run WMATA as a publicly owned entity and WMATA has a ton of problems. In both cases, there appears to be systematic underinvestment in basic infrastructure and capacity. In WMATA's case the workforce benefits from that (see, e.g., the terrible escalator management system) while for PEPCO the gains accrue more to shareholders. That means that at any given time you could often see gains from arbitrary switching. Since PEPCO is private, taking it public would allow for a soaking of the shareholders. If it were public, selling it private shareholders could create a one-off infusion of private money. So the fact that the fads swing back and forth a bit is sensible, and I'm glad to see municipalities taking a look at their options in this regard.

But as with many things in life, there's no substitute for good governance and no easy way to know how to get it. Building a great public utility commission is hard, and building a great publicly owned utility is also hard and they're both hard for roughly the same reasons.

Matthew Yglesias is the executive editor of Vox and author of The Rent Is Too Damn High.

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