August 19, 2003

#115: We report, you decide ...

P. Krugman
KRUGMAN TRUTH SQUAD

We found three aspects of Paul Krugman's The Road to Ruin (08/19/03) of particular interest. 1) the column was NOT virulently partisan as some had expected, 2) it raised some legitimate issues about the consequences of partial de-regulation, BUT, 3) Krugman chickened out every time he got close to proposing possible solutions.

Let's start with some of the issues he raised. There is no doubt that partial de-regulation often has unintended consequences. In California a couple of years ago the consequences of a market design with free floating wholesale prices, but fixed consumer prices, contributed to a massive electricity crisis because the need for consumer rationing could not be signaled through this flawed pricing system. Krugman argues that in the case of the recent northeast blackout it was again partial de-regulation (this time of generation, but not of transmission) that was the culprit because generators were no longer tied to transmission facilites in a manner that gave them incentives to maintain and upgrade the systems. Here is how he put it:

"Under the old regulatory system, power companies had strong incentives to ensure the integrity of power transmission � they would catch the flak if something went wrong. But those incentives went away with deregulation: because effective competition in transmission wasn't possible, the companies providing transmission still had to be regulated. But because regulation limited their profits, they had little financial incentive to invest in maintaining and upgrading the system. And because of deregulation elsewhere, responsibility was diffused: nobody had a strong stake in keeping the system reliable. The result was a failure not just to add capacity, but to maintain and upgrade capacity that already existed."
Now this seems a little far fetched and convoluted to us, but we give Krugman credit for at least coming up with a plausible analysis. However, on the crucial question of how to solve the problem he is virtually silent. Would he restore the old regulations at the electricity generation level? Presumably not, but he never says why not. He is clearly against extending de-regulation to the transmission sector because of monopoly pricing issues. But if profits in transmission remain capped, as they are currently, where is the incentive to invest in grid facility upgrades? An obvious question, perhaps, but Krugman does not even touch it. Instead he ends the column with some anti-climactic posturing.
"This nation needs to invest billions in its power grid, yet given recent history, it's crucial that this investment not be simply another occasion for energy-industry profiteering. Somehow, I'm not optimistic".
Neither are we with this kind of lunacy! Where does he think the investment will come from in the absence of proper incentives? Until the Krugmans of the world make peace with "profiteering" vs. "return on investment" there is little room for optimism on issues such as these.

There is one howler today. Krugman notes that "Incidentally, there seems to be a weird reluctance to face up to what happened in California." This is so true�and especially by Krugman HIMSELF. Instead of engaging in a sensible discussion of regulatory issues, his California analysis continues to be hung up on market manipulation rather than de-regulatory design flaws. He makes this fallacious claim with regard to a FERC report on California:

"even the Federal Energy Regulatory Commission, which strongly backs deregulation, has concluded that market manipulation played a major role.
Here is what the FERC actually said:
"Staff concludes that supply-demand imbalance, flawed market design and inconsistent rules made possible significant market manipulations delineated in final investigation report. Without underlying market dysfunction, attempts to manipulate the market would not have been successful."
As the popular saying these days goes, "we report, you decide."

[The Truth Squad is a group of economists who have long marveled at the writings of Paul Krugman. The Squad Reports are synopses of their discussions. ]

Posted by John Weidner at August 19, 2003 8:54 AM
Weblog by John Weidner