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Paul Romer and California’s electricity crisis

By Rachel Shey
web posted October 28, 2019

Over the past couple days in Northern California, there have been strategic power cuts by PG&E, purportedly to “prevent forest fires.”  The blackouts harken back to the past California energy crisis in the early 2000s, which brings me to my subject: Nobel-winning economist Paul Romer. Romer first entered my ‘economics radar’ when I read an article about his visit to Burning Man.  Romer won his Nobel Prize for his work in economic growth and development, or, as the article explains, “building cities from nothing.”  Hence, Burning Man is the perfect place for Romer to explore his concepts in action: every August, people flock to the Black Rock Desert in Nevada to erect a temporary city, create and share art, and, in short, do weird stuff; so, too, is the California energy crisis, which throws into high relief the roles of a free market and a government. 

Adam Smith’s invisible hand doesn’t quite work in the temporary Burning Man city.  First of all, the Burning Man ethos is somewhat “communist,” in a way, as among its guiding principles are devotion to “gift giving” and “decommodification.”  Such things don’t really have a presence in economics; transfer payments, which constitute a “gift” from the government to the people, don’t get counted in GDP, as they aren’t earned.  Thus, it’s also an examination of something that breaks the typical mold of economics that we’ve been studying in this class.  What is exchanged in the city of Burning Man, if not money and goods?  Romer argues that typical macroeconomics misses an important thing: ideas.  We are more efficient today than we were forty years ago, because of massive technological leaps.  Ideas are a real part of economic systems, being that they are frequently economically motivated, and they have economic value. 

According to Romer, cities are labor markets, which work because of infrastructure: “roads leading workers out of their favelas.”  He argues that infrastructure doesn’t come about organically on its own.  Burning Man is not the only example of this: the article also mentions Manhattan, whose roads were carefully planned back in 1811.  Changing the infrastructure now, that people have filled areas with houses, businesses, and the like, would be expensive and difficult, requiring eminent domain and government intervention.  However, once good infrastructure, or good rules, have been established, the city can offer a huge amount of “choice” to people; there’s much more diversity in the city.  This is again illustrated in Burning Man.  The festival was founded in a spirit of anarchy.  But the consequence of anarchy was that people got hurt; a man on a motorcycle was killed while playing chicken with a large vehicle, and people in tents were run over, etc.  That was when rules kicked in; the carefully measured street plans in the desert, plazas for people to mingle, all structures that people worked hard on, intended to facilitate the experience of anarchy.  Urban planners favor control, structure, and rules; economists favor anarchy and the free market, which rely on the structure to function, just like in Burning Man

Simply speaking, Romer is arguing more for the urban planner point of view on economics.  While he hasn’t swung all the way toward downright Communism, he has proposed the idea of charter cities, where some force (the government and other leaders) set up a framework for the free market to take effect.  It’s a slightly different argument from the typical “night-watchman state” that economists support, and perhaps more insightful to reality. 

Romer’s point is further illustrated by the California energy crisis.

The electricity crisis in 2001 was caused by partial deregulation.  The population of California increased by roughly 13% in the 1990s, yet no new power plants were built; the state came to rely heavily on excess hydroelectricity from the Pacific Northwest.  In 1992, the Energy Policy Act was passed, and in 1996 California started the process of deregulation in the hope of creating a freer energy market. In 2001, a drought in the Pacific Northwest lowered the supply of hydroelectricity. The demand for electricity never actually exceeded supply, but energy reserves were low enough that Enron could simulate a shortage (rolling blackouts) to force people to pay more money to get power. 

Electricity prices were capped at a certain ceiling, which was extremely low.  This caused several energy companies to go bankrupt as a result of the electricity wholesaler's (Enron) artificially high prices.  Enron employed multiple strategies to extract more money.  For instance, it would intentionally overbook the power lines, causing blackouts, and then charge the state a congestion fee to fix the shortage.  Because there was no actual shortage, this allowed Enron to collect more profit.  In addition, Enron exploited a loophole in the law that allowed companies to charge more for electricity that was generated out of state, so they would conceal the origins of the electricity and then pretend that it was produced out of state.  During a shortage, consumers were forced to purchase electricity more expensively from private sellers who marked up the price astronomically.  These prices were connected to the price of natural gas, which Enron also owned. 

Essentially, consumers had no substitute good for electricity.  It was either “buy from Enron” or “go without.”  Rather than having the intended effect (competing producers generate more energy and drive down prices), deregulation created more demand for electricity, which allowed companies to charge higher prices.  Energy producers started shutting down plants to create a bottleneck in the energy supply, simulating a shortage and allowing companies to charge higher prices.  Here, Adam Smith’s invisible hand didn’t work; greed led to chaos and suffering, rather than order as everyone expected. 

What Paul Romer said seems to be true.  Infrastructure can’t be established through the free market.  S. David Freeman, chair of California Power Authority during the crisis, said: “There is one fundamental lesson we must learn from this experience: electricity is really different from everything else. It cannot be stored, it cannot be seen, and we cannot do without it, which makes opportunities to take advantage of a deregulated market endless. It is a public good that must be protected from private abuse.”  Yet, Kenneth Lay, Enron CEO, contended in a letter to the editor that “the wealth of California was born of regulation by the few, not by markets of the many.”  Ultimately, before the free market can take hold, the proper foundation must be laid.  ESR

© 2019 Rachel Shey

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