The Political Economy of (De)Regulation: Theory and Evidence from the US Electricity Industry.

IEFE Working Paper No. 39

45 Pages Posted: 27 Sep 2010 Last revised: 23 Sep 2019

See all articles by Carmine Guerriero

Carmine Guerriero

Department of Economics, University of Bologna

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Date Written: January 22, 2018

Abstract

The choice of whether to regulate firms or to allow them to compete is key. If the demand is sufficiently inelastic, competition entails narrower allocative inefficiencies but, also, smaller expected profits and, thus, weaker incentives to invest in cost reduction. Hence, deregulation should be found where cost reduction is less socially relevant and consumers are more politically powerful, and it should produce lower expected costs only when investment is not sufficiently effective. These predictions hold true under several alternative assumptions and are consistent with data on the deregulation initiatives implemented in 43 US state electricity markets between 1981 and 1999 and on the operating costs of the plants that served these markets. To illustrate, deregulation prevailed where the marginal fossil fuel cost and the inefficiency of fuel usage had been the lowest and politicians were the most pro-consumer. Moreover, GMM estimates imply that deregulation lowered labor and fossil fuel expenses by pushing the most efficient firms to serve the market, but it did not reduce the inefficiency of fuel usage. These results help rationalize the slowdown of the deregulation wave and are robust to considering the other key drivers of deregulation, i.e., costly long-term wholesale contracts and excessive capacity accumulation.

Keywords: Regulation; Competition; Electricity; Political Biases

JEL Classification: L11; L51; L94; H11

Suggested Citation

Guerriero, Carmine, The Political Economy of (De)Regulation: Theory and Evidence from the US Electricity Industry. (January 22, 2018). IEFE Working Paper No. 39, Available at SSRN: https://ssrn.com/abstract=1683251 or http://dx.doi.org/10.2139/ssrn.1683251

Carmine Guerriero (Contact Author)

Department of Economics, University of Bologna ( email )

Strada Maggiore 45
Bologna, 40125
Italy

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