You may remember the extremely cold winter of 2021. In Texas, the system of electricity collapsed; 4.5 million homes lost power—for days. More than 200 people died, half of them of hypothermia (cold). This wasn’t supposed to happen, of course. Texas’s electric utilities are regulated and the regulation had been modernized beginning in 1999.
Why wasn’t the public interest served?
The issue is so complicated that I can’t answer that question. But the ongoing debate over the Texas tragedy has plunged me into a new project: trying to understand why electric utilities are regulated in the first place. Why do state commissions control the activities of companies like Duke and PNG that produce and send electricity to our homes?
That effort sends us back to colonial days in America. [1]
The First Public Utilities
Colonists didn’t have electric power, but they had gristmills. “Gristmills were, in essence, the first public utilities,” writes David M. Gold.[2] These mills used water power to grind corn and wheat into flour.
Gristmills were so important that they were considered public services (a term familiar in colonial days). Farmers depended on them to transform their crops into food they could eat or sell. With muddy roads and trails limiting transportation, they needed mills nearby.
Water mills were built on waterways that had a substantial slope. A dam was built at the top, restraining the river or stream water. Pressure built up to the point where the water fell down a narrow millrace over a waterwheel that turned grindstones inside the mill.
Nearly all the colonies had Mill Acts. As early as 1669, Maryland enacted a law to make it easier to build mills. In the law’s preamble, the reason for the law was explained: Most suitable locations had been taken. They
“are already in the hands of persons under age or unable to be att the Charge of building a watermill or else of such as are wilfully obstinate in for bidding and hindring such persons as would purchase the said places fitt for building watermills . . . much to the Publick damage of the Province.”[3]
A typical Mill Act allowed a person who wanted to build a mill the right to damage or control other persons’ property.
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- If a person didn’t own the land on the other side of the waterway, he could take that land. (The dam had to hold back the entire river or stream.) Virginia authorized a taking of an acre for this purpose; Maryland, up to 10 acres.
- If water backed up onto a neighbor’s property, that, too, was allowed.
- Furthermore, someone who had a good mill site but didn’t use it could be required to do so (or lease or sell the land to someone who would).
- And the colony regulated the prices (“tolls”) for grinding grain.
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The owner of the submerged or taken land was compensated for the taking, but the price was determined by the courts—usually by a jury. Compensating for “market value” does not seem to have been a goal. [4]
What in the World?
Now, all of this may sound strange to you. It did to me.
I thought we had electric utility regulation because electricity is a “natural monopoly.” I used to think that means it’s impossible or difficult for two electricity lines to go, say, to my home. Two lines couldn’t reasonably be dug (or strung) in the same area.
However, the actual definition is this: If a producer requires substantial capital spending, and has large economies of scale, only one producer will be able to last and will become a natural monopoly. So, if there were two producers or transmitters of electricity, the one that could build the largest network would inevitably force the other out through lower prices. To use Milton Friedman’s phrasing, it would be the “natural outcome of competitive market forces.”[5]
Yet the concept of “natural monopoly” is pretty much dead now. It was undermined by economist Harold Demsetz, in 1968. [6] He argued persuasively that as long as the so-called monopolist faces different bidders or rivals or the potential for them, he or she will charge competitive prices. [Note: This may be overstated. See Daniel Klein’s comment below.]
Okay, no natural monopoly.
Second, evidence is strong that regulation doesn’t achieve all that much in public benefits:
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- Prices and profits are about the same whether a utility is regulated or not. [7]
- It wasn’t the public, but electric utilities themselves, that sought regulation. [8] In the early twentieth century, Samuel Insull, president of Chicago Edison, found Chicago’s municipal control troublesome (he had to get permission to dig up streets to put in his lines), and he feared a possible takeover by municipalities. He preferred state regulation.
- According to another study, utilities wanted regulation because it improved their ability to raise capital (a key part of their business).[9]
Hmm. Utility regulation may not be all it’s cracked up to be.
Conclusion
We don’t have regulation of gristmills anymore, although there may still be some acts on the books. Why?
The importance of water-powered mills declined, of course. Readily replaced by steam-driven mills, they became less of a public service. “Now that wheat was successful and more capital was available, entrepreneurs could be expected to build mills where most needed, without an artificial stimulus,” wrote John F. Hart. [10] The Maryland Mill Act was repealed as early as 1766.
Other repeals took longer. In fact, judges, more than legislatures, undermined the laws protecting “antiquated public utilities.” Citing cases in 1869 and 1871, Gold writes, “Some judges, although upholding the statutes, repeated the familiar refrain that if the question were new, the acts would fall.” [11] About the same time, judges in Georgia and Vermont struck down their laws as unconstitutional.
So now, why exactly do we still have electric utility regulation?
Image above of Yates Mill in North Carolina is by Scott on Pixabay.
Notes
[1] Thanks to Roger Donway for this suggestion.
[2 ] David M. Gold. “Eminent Domain and Economic Development: The Mill Acts and the Origins of Laissez-Faire Constitutionalism,” Journal of Libertarian Studies https://citeseerx.ist.psu.edu/document?epid=rep1&type=pdf&doi=37457d81ea36881b1007c196da24d3462dac2c84.
[3] John F. Hart. Colonial Land Use Law and Its Significance for Modern Takings Doctrine.” Harvard Law Review 109, no. 6 (1996): 1252–1300, at 1267, https://doi.org/10.2307/1342215.
[4] John F. Hart. “The Maryland Mill Act, 1669–1766: Economic Policy and the Confiscatory Redistribution of Private Property,” American Journal of Legal History 39, no. 1 (January 1995): 1–24, at 5.
[5] Quoted in Harold Demsetz, “Why Regulate Utilities? “ Journal of Law and Economics, 11, no. 1, (Apr. 1968): 55-65, at 57, http://www.jstor.org/stable/72497056.
[6] Ibid.
[7] George Stigler and Claire Friedland. “What Can Regulators Regulate? The Case of Electricity.” Journal of Law & Economics 5 (1962): 1–16, http://www.jstor.org/stable/725003.
[8] Gregg A. Jarrell, “The Demand for State Regulation of the Electric Utility Industry,” Journal of Law & Economics 21, no. 2 (Oct. 1978): 269–295.
[9] W. Hausman and J. Neufeld, “The Market for Capital and the Origins of State Regulation of Electric Utilities in the United States, Journal of Economic History 62, no.4 (2002): 1050-1073. doi:10.1017/S002205070200164X.
[10] Hart, Maryland Mill Act, 21.
[11] Gold, 118, 117.
Stigler and Friedland looked at the early history of the industry as state regulation of industry began. A number of recent studies have looked at the effects of market-oriented regulatory reforms of the electric power industry, most of which find no lasting effect of reform on retail prices (I.e., industry restructuring appears to not have lowered–or increased–retail prices as compared to what regulation would have delivered in those same areas.)
Leung et al “What can deregulators deregulate? The case of electricity” in the J. Regulatory Economics (2016) https://rdcu.be/dn8TW
Rose et al “Retail Electricity Market Restructuring and Retail Rates,” in the Energy Journal (2023)
https://www.iaee.org/en/publications/ejarticle.aspx?id=4100
The “no noticeable effect” of rate regulation does indeed raise the “why exactly do we still have electric utility regulation?” question. Although note that recent reforms are not from “regulation” to “deregulation” but better described as a move from regulated monopoly to regulated markets.
One thing that caught me is these are really two different economic problems with different incentive structures. With the gristmills, you have 4 parties. One is the original gristmill owner, who invested the capital to dam the river and hopes for a local monopoly for his investment. The second is the newcomer, who seeks to enter the industry and end the monopoly. The third party is the government, which wishes to promote economic development by increasing milling capacities. The last is the uninvolved landowner who can have his land taken or flooded by the building of the mill. Regulating the waterway in the manner you describe gives both the government and the newcomer what they want at some cost to the original millowner and any uninvolved landowners who are also affected by the new mill. It also has pluses and minuses for the free market; if it offends the principle of private property rights, it also ends monopolies and spurs competition.
In the case of modern power companies, the incentives and outcomes go the other way. Newcomers are relatively rare, since there is such a high cost to entry. Instead, it is the larger power companies that want regulation, since that is seen as the best way to avoid onerous government actions, such as obstructions or actual takeover. Plus, they know they can write many of the regulations through regulatory capture and possibly do so in a way that eliminates competition. The government likes to be in control for planning, it likes the physical efficiency of a single power grid, and through close contact with utilities there are ample opportunities for “honest graft” (which occur when political insiders buy up the land along newly proposed infrastructure projects like rail or power lines before the public knows about them and can sell the land for a big profit when the projects are completed. See “Plunkitt of Tammany Hall.”) Through regulation, the large companies and the government both get what they want.
So, for the 18th-century gristmills, the regulation is pushed by the newcomers and promotes competition. For the late 19th-20th century power companies, the regulation is pushed by the existing firms and eliminates competition.
https://www.amazon.com/Plunkitt-Tammany-Hall-Practical-Politics/dp/0451474139
Jay, this is an interesting analysis. I’m still trying to figure electricity regulation out and your comparison is valuable.
Are you familiar with the [James] Johnston test for whether an industry would be regulated? Joseph Bast updated it, here: https://heartland.org/publications/why-regulate-new-applications-of-the-johnston-test/
Diane, thank you for this link. It’s a beautiful article, just as I would expect from Joe, with your help, and it’s a great memorial to Jim Johnston. Excellent ideas there.
Great piece. I love the ending. Why?, indeed!
One comment: You treat Demsetz’s idea as too dispositive. Victor Goldberg (1976) and Oliver Williamson (1979) argued that Demsetz’s clean idea depends on knowledge and commitment abilities, both for private parties in their private affairs and for legal forces and factors, that are far-fetched. Their point doesn’t undermine the case for liberalization, in my view. But it does suggest that we oughtn’t make the case for liberalization on Demsetz’s point.