WAYS & MEANS

Deregulation Shorts Out

The hazards of putting too much faith in the market

From the time Ronald Reagan was elected president in 1980, his proclamation that "government is the problem, not the solution" has become part of the nation's conventional wisdom. "Just leave it to the marketplace" trumped every argument. The country complied by deregulating the airlines and telephone networks, and many states freed their electric-power systems as well. They rejected old-fashioned "command-and-control" anti-pollution measures in favor of supposedly nimble market-based methods. And extending this approach to the rest of the planet became the focus for our international negotiations on everything from world trade to global warming.

This secular faith found its apotheosis in George W. Bush's Texas, with its voluntary air-pollution controls, barely funded state parks, and rigorous nonenforcement of clean-water standards. But just as Bush brought his gospel to Washington, something odd began to happen: The lights in California were flickering out. To keep the power running, Californians were told they'd have to pay as much as $20 billion to utility holding companies for electricity from the same power plants that had always generated reliable electrons in the past, at predictable prices set by state regulators.

Other states like New York, which had followed California into the brave new world of utility deregulation, took cold comfort from the fact that while prices were doubling, at least they were not faced with blackouts. Even old- fashioned states like Idaho and Washington, which had declined to deregulate, faced blackouts and soaring prices because California's colossal failure had swamped the entire energy infrastructure of the American West.

Markets turned out to be as fallible as governments-and in ways that many people found truly terrifying. Government's failures are typically those of excess caution: Prices are somewhat higher and new services and technologies are not introduced as quickly as they might be. But market failures translated into chaos. People didn't know whether the lights would go on, or whether they could afford to both heat their houses and feed their families. High-tech industries threatened to leave California, thus jeopardizing the state's new economic prosperity.

Why did the market fail so dismally in California? Free-market ideologues, the Federal Energy Regulatory Commission (FERC), and power generators like Enron (one of W.'s biggest campaign supporters) claimed that the problem was that deregulation hadn't gone far enough. Since California had put a lid on consumer prices, the argument went, consumers lacked sufficient incentive to conserve electricity and balance supply and demand.

Of course, deregulation wasn't sold as a strategy that would work because prices would skyrocket and consumers could freeze in the dark to save money. It was sold as a way to bring supplies up and prices down. In fact, those who designed the California energy system had so much faith in the market that they simply assumed that once deregulation took place, prices would fall. They had such faith that they promised consumers (in exchange for bailing out the utilities' bad investments in nuclear power) that prices wouldn't go up. And when, in the waning days of the old regulated system, the state tried to ensure a sufficient supply of power by requiring the utilities to build enough new power plants to serve 1.2 million people, the utilities convinced FERC to block the state order (see "Snake Oil for Fossil Fools,").

The nation previously experienced the consequences of faith-based economics in the savings-and-loan debacle of the 1980s. Freed from government scrutiny but promised a government safety net, S&Ls took enormous risks-and left the public footing the bill when their gambles soured. This time, released from government regulation, California's utilities not only fought the building of new power plants, they sold off more of their old ones than required and shipped the profits to the safety of corporate holding companies. Big energy users ceased storing backup fuel, believing that the market would supply all. Everyone stopped investing in energy efficiency, because if energy was going to be so cheap, who needed to scrimp? Owners of dirty, inefficient power plants abandoned plans to install cleaner, more efficient turbines, promising instead that they would run the plants only a few hours a day. (They ended up running them flat-out, dramatically raising pollution and wasting natural gas, thus raising prices still higher.) Once again the public was left to write the check.

The faithful respond that markets work just fine elsewhere; it was California's particular deregulatory system that was flawed. But the idea that unsupervised markets can guarantee reliable supplies of essential commodities is simply wrong. Markets attract gamblers. That's fine if the commodity is dot-coms or Yen futures, but if they're gambling with our power supply or our environment, we need to protect ourselves. Markets have no reason to hedge against bad times, reckless decisions, or the unexpected-which always happens.

It is ironic that for many who call themselves "conservative," faith in the market outweighs prudence, thrift, and caution. Radical market advocates, says conservative British philosopher John Gray, fail to recognize "the institutions of the market as being as fallible, as frail and as obdurately imperfectible as any other human institution." As I was writing this column, on a night flight from Detroit to San Francisco, I looked down as we passed over Sacramento. Suddenly, a vast swath of the orange grid of light below vanished into blackness. The magic of the marketplace had struck again.