When Using Less Costs You More

Soon Missourians will enjoy the unique privilege of paying more for reducing their electricity usage. The way it works is as follows:

1. As electricity use rises, utilities have to build additional plants
2. Building additional plants is expensive
3. That cost gets passed on to rate payers
4. When consumers use less power, it reduces the need to build expensive new plants
5. When consumers use less power, utilities revenue falls
6. No business will promote something which leads to a reduction in its own revenue
7. If we allow utilities to pass along the cost of power-saving programs, they will promote them

Let’s take as a given for a moment the notion that power conservation is a social good. This situation illustrates how government’s first, second, and last instinct in solving a problem is by using more government, no matter how many levels of inefficiency have to be folded in on themselves to do so. Consider:

1. Even after “deregulation,” utilities still operate as regulated monopolies, particularly with regard to rates for individual consumers. Pro-government-action types (let’s call them liberals for shorthand) favor this because it prevents things like ‘predatory pricing’ and balances the power between Big Business and The Little Guy. However, this also prevents businesses from charging people what the product they are using actually costs. This means they have to make it up somewhere else.
2. In a free market such as, say, delivery pizza, prices are not set by producers, but by consumers. The Upper Crust on Beacon Hill charges about $15 for a large pie, while Dough in East Boston charges $10. Now I think Dough’s pizza is just as good, but if they tried charging $15, a lot of people might order from Domino’s ($12.50) instead.
3. Every time I call Dough, I’m told I have to wait an hour or more for my pie. The bottleneck in pizza production is usually the oven, and Dough might want to invest in a fancy new one that can handle more, but ovens are expensive. Since Dough can’t raise its prices, they would have to finance this themselves, e.g. by taking out a loan in expectation of increased profits from selling more pies. In the end, I the consumer get my pie in 45 minutes for $10. This is what economists refer to as Consumer Surplus.
4. In a regulated industry, however, this picture becomes much more complicated. The short version is that the regulated industry representatives meet with the regulators and explain that the demand for pizza continues to grow, and in order to accommodate it they need bigger ovens, and since that will cost money, they need to be allowed to increase the price of a pie from $1o to $12. The pizza regulators know that running out of pizza would mean big trouble, so they nod and raise the price.
5. As government realizes that obesity is becoming a problem, they decide it would be good for people to eat more salad and less pizza. But because salad is a lot cheaper, every pizza buyer who switches to salad represents lost revenue for the pizza industry, which was counting on having a customer for decades to come. So when the government asks them to promote salad, they are understandably reluctant.
6. The pizza regulators, half of whom are former or future pizzeria owners, nod and pass a rule that requires consumers to buy one salad for every two pizzas, and by law fixes the price of salad at $12 a bowl. Consumers who may have substituted salad for pizza to save money eat just as much pizza as before and pizza producers’ profits go up thanks to high-margin salad sales.

A similar dynamic is at work in discussions now evolving with various states considering a move from gasoline taxes (priced per gallon) to road use taxes priced per mile. Consumers, it turns out, respond remarkably well to price signals–when gas prices go up, they use less, and when incomes are constrained, they do the same, all of which results in reduced revenue.

I offer all of this as a cautionary tale to my environmentalist friends, whose instincts usually lead them to favor expansion of government as the antidote to the perceived ills of “the free market.” Government in practice loves predictable and growing revenue streams just as much as business does, and when the pursuit of green goals and green dollars collide, it is a safe bet which will win.

Is there a solution? Consider the example of EnerNOC, which allows utilities and large consumers to dynamically negotiate consumption to balance supply and demand in real time. It works because large power consumers operate in an environment much closer to an ideal free market, which provides the incentives needed for both sides to find a better equilibrium.