Made in Sacramento: The political roots of the California power fiasco

By Lawrence W. Reed
web posted February 5, 2001

Years ago, California state senator Bill Richardson wrote an instructive little book about politicians with the charming title, "What Makes You Think We Read The Bills?" The electricity debacle in the Golden State makes me think there's a need for an updated version. The title could be, "What Makes You Think We Read Anything At All?"

It's customary in public policy discussion to treat the views of others with a certain dignity, as though they represent legitimate differences of opinion. But what happened in California was utterly, certifiably, and inexcusably stupid. Saying so is also completely bipartisan: Every single legislator of both parties voted for the imbecilic 1996 legislation that bore its fruit in recent months in the form of random blackouts and soaring prices. In his January confirmation hearings, Treasury Secretary Paul O'Neill termed the whole thing "lunacy."

The geographic boundaries of the crisis ought to tell us something right up front. Drive one mile across the California border in any direction and there's no power problem. This is not a crisis of the free market. It is a political crisis confined to the jurisdiction of which so-called public servants are in charge. It is a crisis made in Sacramento by consenting adults whose appalling ignorance of the most basic principles of economics will get them all fired if there's any justice in this world. Moreover, anybody who has the gall to call what they did "deregulation" is no better informed than the culprits themselves.

It is not "deregulation" when government fixes retail prices, forces companies to sell their power plants and bans them from buying power through long-term contracts, creates a state-run power broker, and stifles additional supply while demand soars. All this California did in the name of "deregulation"--and it did it in the form of a law the size of a city phone book. True deregulation would have actually freed markets to operate according to supply and demand. It would have removed rules and barriers instead of creating a mass of new ones. It would have granted government less control, not more.

California Gov. Gray Davis, center, defends how his state handled its energy crisis as Wyoming Gov. Jim Geringer, left, and Washington Gov. Gary Locke listen
California Gov. Gray Davis, center, defends how his state handled its energy crisis as Wyoming Gov. Jim Geringer, left, and Washington Gov. Gary Locke listen

We cannot overestimate the extent to which the assumptions built into California's botched "deregulation" attempt flouted long-settled and elementary principles of economics. This is the frustrating aspect of the whole mess, the reason it's hard for any market economist to write about it without grinding teeth. Didn't anybody in the California legislature ever read any economics?

Consider this: Prices are the signals of the marketplace. They tell us infinitely more than the most deluded central planner could ever dream of knowing--things like what people want, how badly they want it, where and when they want it, and what they're willing to pay for it. Prices also direct production-they tell suppliers to create more of something or create less and switch instead to other, more valued lines of work in concert with conditions of supply and demand. We know that when prices are fixed by government decree, they can't do any of these miraculous things effectively.

If mankind has learned anything from hundreds of years of research, study and exposition in economics, surely that's it. But not California legislators. They fixed retail prices of electrical power, perhaps because they thought they were immune to the laws of the marketplace or because they just didn't think at all. In any event, a funny thing happened on the way to electrical Nirvana in La-La Land.

Electricity demand rose twice as fast in California as in the nation as a whole. Stripped of the power plants the law required them to sell, Golden State utilities had to buy power in a government-managed wholesale market where prices were rising-rising in part because of a harsh winter, a strong economy and a regulatory environment that prevented any new power plants from being built over a decade.

In the last six months of 2000, the two largest utilities alone spent $11 billion more to purchase electricity from power producers than the state's price controls allowed them to recoup through sales to customers. At this writing (late January), the state's two largest utility companies are hemorrhaging cash and facing the real possibility of bankruptcy.

The 1996 law created something called the "Power Exchange," what Adrian Moore of the Reason Public Policy Institute describes as "a mandatory bidding pool where all sellers of electricity are paid the price of the last bidder needed to meet total demand, which is the highest bidder." A new state agency called the "Independent System Operator" took over operational control of California's electricity transmission grid. Only in bureaucratese could this painstaking, centralized micromanagement be termed "deregulation."

One of the effects of this Rube Goldberg contraption was to prevent utilities from making long-term contracts for power. All the electricity they purchased had to be bought in the spot market, where prices are agreed to according to conditions at the current moment and delivery is immediate.

Long-term contracts historically allowed utilities to lock in their power costs and thereby give them some protection against high and erratic spot market prices, but that market-hedging mechanism evaporated with the decrees of the 1996 law. Moreover, the "deregulation" scheme mandated that utilities cannot look outside the government's power exchange for cheaper sources of power.

With deregulation in other states looking much more like the real thing, new power plants are being constructed to meet growing demands. But not in California. Texas power companies have added 5,700 megawatts of generating capacity over the past five years-nine times what California has added. It's nearly impossible to build a new power plant anywhere in the Golden State because of the most cumbersome, time-consuming and costly regulations in the Union. No new plants have been built in 15 years in California. Indeed, according to Investor's Business Daily, California "produces less power per resident than any other state and imports one-quarter of its energy from places as far away as Quebec."

So add it up: Don't let anyone build a power plant. Slap on retail price controls that guarantee that utilities' costs will far exceed what they can get for the power they sell. Forbid companies from getting the best deals in an open marketplace. Force utilities to get rid of their power plants and buy power through a government bureaucracy. This is not rocket science. It is a surefire prescription for disaster that can't honestly be labeled deregulation.

Incredibly, "economist" Paul Krugman, formerly of MIT and now of Princeton, wrote this in the New York Times last December: "California's blind faith in markets has led to an electricity shortage so severe that the governor has turned off the lights on the official Christmas tree." Blind faith in what? And this guy's a professor?

The California power meltdown has one source and one source only: politicians. It has nothing to do with the free marketplace. The people who thought they knew more than the market and could "plan" the state's electrical future need to step up to the plate, take responsibility, apologize profusely, rid the books of their nightmarish schemes, and promptly find honest work.

Lawrence W. Reed is president of the Mackinac Center for Public Policy in Midland, Michigan, and chairman of the board of trustees of the Foundation for Economic Education (FEE) in New York. He writes a column for FEE's monthly journal, Ideas on Liberty, for which the above article is a forthcoming installment.

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