California reportedly is faced with the prospect of thirty days of rolling blackouts this summer, along with all of the accompanying chaotic consequences. And yet, there is a very simple, free-market way to prevent these impending blackouts: namely, raise the price of electric power. As the price of power rises, the quantity demanded falls. All that need be done to avoid blackouts is to raise the price to the extent necessary to reduce the quantity of electric power demanded to the point that it will be within the limit of the ability to supply electric power. Then there will be no blackouts.
What prevents the public and politicians from supporting this very simple and straightforward free-market solution is their fear of how high the price of power would have to be before the necessary reduction in quantity demanded would be achieved. In particular, they look at the enormous prices of electric power that have existed in the wholesale market in California over the last six months or so and fear correspondingly high prices in the retail market. And, indeed, following the customary method of basing the retail price of power on its cost of delivery, the retail price would, for a very short time, be correspondingly high.
What hardly anyone realizes, however, is that the enormously high price of power in the wholesale market is a direct consequence of the retail price of power being set too low. The low retail price of power allows the quantity of power demanded to be large enough to require the use of extremely high-cost sources of supply to meet it. In fact, in such circumstances, the price may far exceed the costs of the very highest-cost producer able to be in the market. If, however, the retail price of power were higher—and, thus, the quantity of power demanded were lower—the resulting smaller supply of power that would need to be generated would be generated at a sharply lower cost and thus at a sharply lower wholesale price.
At the same time, in a free market, the supply of power generated at relatively reasonable wholesale prices, by power plants already in existence, would be substantially larger than it now is. In part, this would happen precisely as the result of the retail price of power being higher. This would give the power companies the means of paying various suppliers that they have ceased to be able to pay because retail price controls have served simultaneously to restrict their revenues while sharply increasing their costs, thus driving them toward insolvency. Suppliers who now do not provide power, out of fear of not being paid, would once again supply power, because they would be paid.
In addition, a relaxation of environmental controls would also significantly increase the supply of power available from existing power plants. At present, there are plants that do not operate as often as or to the extent that they might, and in some cases do not operate at all, because of such controls. Certainly, all but the most misanthropic environmentalists should agree that there is major room for relaxing such controls, at least for the duration of the looming summer power emergency.
The power crisis is not the result of “deregulation.” No one can really believe that the power companies were deregulated and then chose to impose price controls on the power they sold while paying higher and higher prices for the power they bought. The power crisis is the result of government controls—most obviously, its control over the retail price of power, but also its protracted refusal to allow the construction of sufficient new power plants.
The crisis has been worsened by the government’s refusal to allow retail power prices to rise immediately in conjunction with the rising wholesale price. This has allowed the quantity of power demanded to go on rising and thus to cause the wholesale price of power to go on rising. It has also driven electric utilities into bankruptcy or to the verge of bankruptcy and has impaired the State of California’s credit rating, as the result of its stepping in to buy power in the wholesale market once the utilities’ ability to go on doing so had been exhausted.
The solution to the power crisis is, not to expand the power of the government by having it take over the assets of the utilities it has almost destroyed, but to establish for the first time a free market in power.
The process should begin with an immediate sharp increase in retail power rates and relaxation of environmental controls. Because the government’s bungling has driven wholesale power prices far higher than they would have needed to go in a free market, it is probably not necessary to raise the price of all the power sold at retail to the point of corresponding to these higher wholesale prices.
Homeowners and apartment dwellers could be allowed to purchase some minimum of electricity at prices increased to a lesser, though still substantial, extent. But the price of all power beyond that minimum should reflect the higher wholesale prices. The result would be a significant drop in power consumption the following month and thus a lower level of wholesale power prices the month after that. The further result would be that retail power prices probably could start coming down after just this one month. And there would be no blackouts. The worst of the crisis would be over. (The increase in power rates imposed by the Public Utilities Commission last month works in this direction and represents a step forward.)
Longer term, with the government and misanthropic environmentalists out of the way of the construction of new power plants and of the production of the fuel and pipelines needed for their operation, the real price of electric power would be able to resume its historic decline.
In a free market, everyone involved in electric power production or energy production of any kind—indeed, in the production of goods and services of all descriptions—is motivated to find lower-cost methods of production as the means of increasing profits. Sooner or later, however, competition serves to eliminate such increased profits and thus to pass the lower costs on to the consumers in the form of lower prices. The continuing quest for premium profits then leads to the discovery and implementation of still lower-cost methods of production, with the same result. The consequence is progressively falling real prices of everything, including electric power.
In just this way, the average American of the year 2000 was able to obtain at least ten times the goods and services, and vastly more than ten times the electric power, as the average American of the year 1900, even though he worked perhaps only two-thirds as many hours per week. In other words, forty minutes of his labor in 2000 gave him wages sufficient to buy the equivalent of what in 1900 required ten hours of his labor. And a very few minutes of his labor was sufficient to give him the wages to buy electric power that would have required many, many hours of his labor in 1900.
Such wonderful progress in the ability to buy electricity and all other goods can continue in this new century—if only power-hungry government officials and misanthropic environmentalists will get out of the way.
To learn about every aspect of the case for capitalism, read my Capitalism: A Treatise on Economics. Originally published at the blog of George Reisman. Copyright 2019 George Reisman. All rights reserved.
