The Political Economy of (De)Regulation: Theory and Evidence from the U.S. Electricity Market

Abstract:     
The choice of whether to regulate a market or let firms compete is a key issue in economics. If the demand is sufficiently inelastic, competition produces lower allocative distortions but also lower expected profits and, thus, weaker incentives to invest in cost-reduction than regulation does. Hence, the likelihood that a society will select competition is higher the less socially relevant cost-reduction is and the stronger the political power of consumers is. This prediction is consistent with U.S. power market data. During the 1990s, deregulation was implemented where generation costs and inefficiencies of input usages were historically lower and politicians were more pro-consumer. Also, GMM estimates show that restructuring made more likely that the firms with the lowest costs served the market to the detriment of cost-reducing investments. This evidence sheds new light on the slowdown of the deregulation wave.

Number of Pages in PDF File: 35

Keywords: Regulation, Competition, Electricity, Political Competition.

JEL Classification: L11, L51, L94, P16

working papers series