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"Politics": How Do Regulators Respond?
“The hardest part of my job is the politics.” - MARC Commissioner (June 2008)
In utility regulation, politics comes in two forms: public interest politics -- the regulator’s obligation to make tradeoffs among meritorious but conflicting goals; and private interest politics -- the pressures regulators receive from forces seeking benefits for themselves. One enhances, the other undermines regulation's public interest mission. Understanding the distinction is essential to effective regulation.
This June essay categorizes regulation's many political components, distinguishing between commission decisionmaking and legislative processes. The July essay will discuss how effective regulators make the best of regulation's increasingly political dimension.
Public interest politics
Commissions practice public interest politics when they exercise their broad statutory discretion: Regulatory statutes have broad phrases: "just and reasonable," "undue discrimination," "public interest." Verbal breadth means policy discretion. The exercise of policy discretion is a political act: the use of government powers to create rights and obligations, to allocate benefits and costs, to establish expectations and consequences. This discretion comes with constraints, namely facts and logic (without which, decisionmaking is "arbitrary and capricious" and thus unlawful). But within those constraints, consider the many political choices:
“Just and reasonable": For return on equity, upper or lower end of the "zone of reasonableness"? For rate design, average embedded cost or long run marginal cost? Scarcity prices to induce new supply and dampen load, or average prices to ensure simplicity and reduce volatility?
"Undue discrimination": For commercial and industrial customers, rate discounts below embedded costs (with the difference picked up by residential customers) to keep them on the system? Discounts for low income customers (paid for by more fortunate customers)? Energy efficiency programs, paid for by all to benefit some?
"Public interest": Rate adders to fund (a) environmental improvement, (b) work retraining necessitate by merger-related job loss, and (c) research investments in experimental technologies?
These choices are the meat and potatoes of utility regulation. They are all political choices, because they allocate among citizens their rights and responsibilities. They reflect the tensions inherent in any policymaking: tensions between the technical and equitable, short term and long term, rural and urban, large customer and small customer, legacy customer and new customer, investor and consumer, shareholder and lender.
Regulation's inherently political nature should cause no surprise, since commissions exercise legislative powers (although they sometimes use court-like procedures). (On regulation's legislative character, see the essays of February 2008 (Commissions are not Courts; Regulators are not Judges) and March 2008 (Legislatures and Commissions: How Well Do They Work Together?).
Legislatures practice public interest politics when they define a commission's powers and determine its resources. Regulation's central public interest question is: What performance should we require of regulated utilities -- what products and services, at what standard of excellence? Answering this question, the legislature first must decide which decisions to prescribe and which to delegate. Which decisions belong with the government body whose main tools are expertise, facts and procedural formality?
For those powers granted to the commission, the legislature then must address three more questions: How much and what type of commission intervention is necessary to ensure excellent industry performance? What should be the commission's reward and penalty powers? What resources, and what flexibility, must the commission have to build the expertise, fact-gathering capability and procedures necessary to carry out the commission's public interest duties?
A legislature's broadest public interest question is whether regulation should play any role. The legislature must ask, continuously: What industry structure most effectively will induce accountability in our infrastructural industries? Or, as Prof. Alfred Kahn most memorably wrote, in The Economics of Regulation, what is "the best possible mix of inevitably imperfect regulation and inevitably imperfect competition"? A principled selection of the "best possible mix" -- for example, a decision to calibrate a reduction in regulation to a growth in effective competition, or to restore regulation where competition is ineffective -- is "political" because it affects multiple stakeholders. But the stakeholders' avid interest in the outcome need not convert the legislature's motivation from public interest pursuit to private interest satisfaction.
Private interest politics
The commission's broad discretion attracts private interest pressures. Statutory breadth is a two-edged sword. While accommodating legitimate political judgments, breadth also invites stakeholders to cloak their private goals in public interest garb. I have seen companies insist that only a 14% ROE (a private interest desire) will prevent debilitating bond downgrades (a public interest concern); but then settle at 12.5% (exposing the public interest argument as a clothesless emperor). Some generators seek supramarket prices (a private interest desire), arguing that scarcity pricing induces efficient consumption (a public interest concern), while offering no facts on elasticities of demand (which facts might show the weakness of the public interest argument). Industrials often argue for discounts below fully allocated cost (a private interest desire), arguing that without rate reductions they will depart, shifting fixed costs to other ratepayers (a public interest argument), while offering no facts on their destination (which evidence would reveal the strength or weakness of their argument).
With these examples, I mean no broad-brush tarring of the many legitimate arguments of this type. But they are real-world examples.
In responding to private pressures, legislatures can make regulation more effective or less effective. With prescriptiveness, legislatures can shrink commission discretion. One state statute specifies the company-types regulators may use as "comparables" when setting the utility's authorized return on equity. Many state statutes single out specific costs for accelerated or guaranteed cost recovery. When advanced through private party pressure without public interest consideration (including the expertise and fact-gathering techniques used by commissions), these actions can make regulation less effective.
In diminishing commission discretion, legislation also can reduce the accountability of sellers. Awarding ratepayer-funded "incentives" without defining seller obligations makes ratepayers pay extra for performance already inherent in the obligation to serve. Reducing regulation in the name of "competition," without confirming the effectiveness of competition, does the double duty of increasing customer vulnerability while giving "competition" a bad name. These are not public interest results.
Conclusion
Private and public interests are like Boolean circles with blurry boundaries: they overlap but do not coincide, and there is risk of confusion. Relative to the industries they regulate, commissions and legislatures are overworked and informationally disadvantaged. Effectiveness requires continuous curiosity, alertness and skepticism. More on this subject next month.
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