The Knowledge Problem
Commentary on Economics, Information and Human Action

Friday, May 30, 2003  

California's electricity network reliability pales in comparison to competitive states

Yesterday California experienced a Stage 1 alert , indicating that electricity operating reserve margins had dipped to below 7 percent. Nothing compared to 2000-2001, but still a signal for some concern about electricity network reliability.

As we approach this summer air conditioning season, I wanted to bring a recently-released analysis of California’s electricity outlook to your attention. The Bay Area Economic Foundation (BAEF) has released a study entitled "California is Still Coming Up Short on Electricity”, in which they address the ability of California’s electricity network to meet anticipated demand in the short, medium, and long run. They are not sanguine, but rather foresee supply shortfalls as early as 2006.

The reliability of the network and the ability of supply and demand to meet at sufficiently low electricity prices continues to be a challenge in California, and the BAEF study summarizes the challenges facing policymakers as “inadequate infrastructure, an uncertain regulatory environment, a lack of incentives for consumers to conserve, and high retail electricity prices.” (p. 2) The report focuses on the importance of taking diverse approaches to improve network reliability, including infrastructure investment, generation investment, and integrated demand response to connect wholesale and retail markets with price signals. In fact, just last week the California PUC approved plans to upgrade Path 15, the notorious transmission bottleneck in the Bay Area, which is a good step.

The BAEF report emphasizes the role of regulatory uncertainty in reducing incentives for capital investment in California, a role that cannot be reiterated frequently enough. In analyzing the proposed additions to generation capacity (50 gigawatts proposed since 1998, with only 13 gigawatts likely to be built), the report indicates that California has a lower construction rate for proposed generation projects than other states that have implemented electricity restructuring. California’s recent construction rate has been 25 percent, while even in states that started with higher capacity relative to demand, such as Texas and New York, generation construction success rates are higher than California’s. Regulatory uncertainty in California has a variety of sources – the denouement of the 2000-2001 crisis and the shadow of expensive energy contracts to pay back, the introduction of legislative proposals to re-regulate the industry in California, the prolonged siting and permitting process that makes building baseload plants extremely difficult (leading to a shift toward construction of peaking plants), and the persistence of retail and wholesale price regulations that make it almost impossible to earn a return on your peaking plant investment.

Instead of focusing entirely on California, the BAEF report compares California’s reliability situation with other states that have restructured their electricity industries (an exercise similar to one that I did in early 2001), and they reach an important, but not surprising, conclusion:

California is the only major restructured power market that faces this problem.(p. 16)

In fact, the Ohio Public Utilities Commission just released a report to the Ohio state legislature on the effects of Ohio’s restructuring in 2001 and 2002. In his transmittal letter to the General Assembly, PUCO Chairman Alan Schriber states that

Of the twenty-four states in the United States that have adopted electric choice, Ohio’s experience has been among the best. While it is difficult to argue that electric choice has been pervasive anywhere, I believe that under the circumstances, Ohio’s program has so far been a success.

Ohio’s report is similar to the competition report cards that the Texas PUC provides, the most recent having been released in February 2003. Both the Ohio and the Texas experience indicate that California’s continuing reliability concerns are an anomaly in states that have adopted electricity restructuring. The BAEF report also compares California unfavorably to the mid-Atlantic and the New England experiences.

California’s investment predicament is exacerbated by the complete and utter lack of market price signals. The lack of price signals to retail customers breaks the link between energy costs and prices to consumers. How, in such a situation, will customers see any incentives to conserve in peak periods? Other than the usual imploring statements from policymakers, that is. Consumers can and should be responsible for making power use choices that meet their needs, and the integration of wholesale and retail market competition is the most effective way to do so. Innovative suppliers should be free to choose approaches that would appeal to their customers, from direct retail access to a menu of contracts that enables customers to take on as much or as little price risk as they choose, with the appropriate prices for each option.

If market signals in California were not so distorted, and the degree of regulatory uncertainty was not so high, then profit opportunities in California would attract investment, even without the mandatory capacity reserve requirements that the BAEF report advocates. Such mandatory requirements are simply band-aids to cover the lack of true information transmission through price signals in integrated markets.

The BAEF report closes with recommendations for policymakers in California:
-link retail electricity prices to wholesale costs
-permit full retail choice, including direct access
-increase attention to transmission infrastructure siting and investment
-remove obstacles to customer distributed generation
-issue clearer mandates to agencies and improve decision-making consistency
-promote energy efficiency and resource diversity responsibly

These actions would improve the uncertain investment climate in California, to the benefit of customers and suppliers alike. But as it now stands, California is the only state that has passed restructuring in which electricity markets are not win-win propositions, because they are not allowed to be.

posted by lkkinetic | 5/30/2003 12:06:00 PM

Electricity choice and competition a success in Ohio, according to a recent Ohio PUC report.

Funny how California is the only place where electricity competition is not a positive-sum game ...

posted by lkkinetic | 5/30/2003 11:36:00 AM

This clever little Alex Beam column from the Boston Globe highlights the hybrid car cult effect. I think this effect is critical in looking at how the demand for hybrids will grow, and the role of early adopters. Geek chic, indeed.

posted by lkkinetic | 5/30/2003 11:30:00 AM

So I am not at all surprised to learn that Virginia Postrel is a fellow ENTJ. In fact, I think that the Myers-Briggs Type Indicator is the most robust model I've ever encountered in my life. I have found it useful for understanding relationships, family interactions, my teaching style, my career choices, and I've also found it informative as a tool for improving all of the above.

Interestingly, a lot (most, actually) of the women who are my friends are ENTJs. Some versions of the MBTI refer to ENTJs as "The Field Marshal", which I think is a bit overstated, but still captures the essence of it. The link above does a nice job of summarizing, and a scary job of hitting the nail on the head regarding how I behave under stress! And most of my guy friends, including the Knowledge Spouse, are INTJs.

posted by lkkinetic | 5/30/2003 11:19:00 AM

Unintended hiatus ... the day jobs required a lot of my attention over the past few days.

posted by lkkinetic | 5/30/2003 11:09:00 AM

Monday, May 19, 2003  

Many thanks to William Sjostrom for posting the link to a short article on how to craft a successful paper presentation. I think it hits the nail squarely on the head:

Any effective talk must do three things: communicate your arguments and ideas, persuade your audience they are true, and be interesting and entertaining. In our obsession with persuasive argumentation, academics sometimes forget about the third item on the list. Some people feel it follows automatically from the first two (it doesn't). Some even scoff at the goal itself. Perversely, we seem to have come to believe that if a talk is entertaining, it's probably not very deep.

These attitudes are seriously mistaken. It is impossible to communicate and persuade effectively without entertaining as well. Keeping your audience interested and involved - entertaining them is essential because in order to communicate your work and its value, you need their full attention.

This paper is full of useful advice for those of us who make a living trying to persuade people of novel ideas.

posted by lkkinetic | 5/19/2003 09:40:00 AM

FCC Allows Spectrum License Trading

On Thursday the Federal Communications Commission voted to allow spectrum licensees to lease their licensed spectrum to third parties. This long-awaited result now frees spectrum licensees and interested parties to create a secondary market in spectrum licenses. As reported in the New York Times,

Officials and industry analysts say the hope is that by allowing license holders to lease slivers of the spectrum that are currently underused, consumers will benefit from reduced instances of cellphone calls being dropped. More efficient use of the spectrum would make it easier to connect to the Internet with hand-held computers in crowded areas where the spectrum available is inadequate to move data and it should help extend wireless services in rural areas that are underserved.

Other stories on the FCC’s decision are at, at Wired News, and at the Washington Post.

Not all observers are convinced that this move will deliver benefits. Those who are skeptical about the effects of the license trading (discussed in this Wireless Week article), argue that because of the economic doldrums, there is not excess demand for spectrum, so the economic effects of relaxing the constraints on license trading are small. While that is true in the short run, it’s a small point. The larger point is that removing this constraint will have both static and dynamic efficiency effects. Enabling secondary license markets to arise provides an opportunity for licensees to profit from reallocating spectrum to higher valued uses that other firms may be pursuing. One example of such reallocation, from the New York Times article is

An airport with congested airwaves from air-traffic transmissions and cellphone use would be able to lease a piece of the spectrum from other spectrum holders that are not using their space during peak hours.

That reallocation creates value, both for licensees and other firms, as well as for consumers who can avail themselves of the uses of the spectrum. Furthermore, removing this trading constraint may encourage technological change and innovation, an important dynamic efficiency consideration.

But is still not a full, true, alienable property right. The FCC still retains the ownership of the spectrum, so this license trading opportunity still does not convey a full property right to the spectrum.

For most of the past century the federal government, usually through the FCC, has retained ownership of rights to transmit in various parts of the radio spectrum. For most of the twentieth century the FCC allocated spectrum use through either an application procedure or through a lottery; both of these allocation methods allowed the FCC to choose the potential licensees, in keeping with the FCC remit to govern broadcasts based on a public interest objective (this public interest remit for the FCC is increasingly coming into question, too).

As early as 1958, economists Ronald Coase and Arthur DeVany recommended privatizing the radio spectrum, selling it through an auction process. Privatization would create well-defined property rights in specific locations on the spectrum, and would enable spectrum owners to transfer rights, and importantly, to determine how much value they place on having adjacent owners far enough away to remove some, most, or all likely interference. Privatization could also involve a judicial system of legal recourse in the event that some owners believed that interference from someone else’s spectrum property harmed their use of their spectrum.

Since 1994 the FCC has auctioned spectrum transmission rights. The FCC retains ownership of the spectrum itself, but has been auctioning ten-year licenses conveying the rights to use spectrum for specific purposes. These licenses have not been transferable between uses or between license holders. Retaining spectrum ownership enables the FCC to continue regulating broadcast, cable, telephone, wireless cable, and two-way analog and digital (such as analog and digital telephones and pagers) communication uses. However, a turgid system of enabling but regulating radio spectrum use, such as the FCC has been following since its inception, could slow or deter technological change itself, particularly in the burgeoning wireless technology industry. Still, the new license trading opportunity moves us toward the alienability, or tradeability, feature of ownership that best facilitates the reallocation of spectrum to higher valued uses.

Will it transmit information on actual opportunity costs to military and other incumbents? Government users of spectrum typically do not sit well with the licensing and trading of spectrum, and the military is a particularly substantial incumbent in several parts of the spectrum that could be put to good commercial use. If they are able to benefit financially from allowing others to lease part of their spectrum, that would force the military incumbents to compare the option value of holding onto all of it for their own future uses with the commercial value of the license to others. License trading potentially provides an alternative source of revenue for federal and military agencies that have looked at their spectrum as an entitlement rather than an asset. License trading will permit them to lease unused wavelengths without losing future rights to them. It will also allow commercial communications companies to have access to spectrum that would otherwise be off limits. In other words, free trade in spectrum rights creates opportunities for mutually beneficial exchange.

posted by lkkinetic | 5/19/2003 08:51:00 AM

My Reason colleague Michael DeAlessi has written the following regarding fisheries policy, which I feature here as a guest post:

Yesterday [Thursday] the New York Times published an article in response to a study in the journal Nature that details the decline of large fish in the world's oceans.

The article begins "In just 50 years, the global spread of industrial-scale commercial fishing has cut by 90 percent the oceans' population of large predatory fishes, from majestic giants like blue marlin to staples like cod, a new study has found."

Fisheries depletion is nothing new - just about everyone already knows that fisheries are generally in decline around the world. Unfortunately, as usual, activists and journalists don't seem to understand, or care, about _why_ this is the case. And heaven forbid anybody writes about solutions that are actually working.

But solutions are what it's all about, so I thought you might be interested in the response I sent in earlier today. Think the NYT will actually print it?

May 15, 2003
To the editor:

While it is undoubtedly true that “Commercial Fleets [have] Reduced Big Fish” (May 14) by tragic proportions, your article misses the most important question – why are some marine species depleted and others conserved?

Implicating clichéd, rapacious fishers and quotes like “With all this technology together, the fish hardly have a chance," point fingers in all the wrong places. Fish-finding sonar and wily fishermen could just as easily be the solution – as they are in places like New Zealand and Iceland where fishing rights are secure and so fishermen themselves press for conservation measures.

The article mentions the resurgence of buffalo, which were only saved because a small number of ranchers took them off the range where they were free for the taking and ‘privatized’ them. Until we allow some kind of privatization of ocean resources, the rules of the game will continue to be stacked against the fish.

Michael De Alessi
Director of Natural Resource Policy
Reason Foundation

posted by lkkinetic | 5/19/2003 08:41:00 AM

Sunday, May 18, 2003  

Will Wilkinson has written a really thoughtful essay on international relations among nation-states in which he critiques a recent essay by Martha Nussbaum that invokes the Dutch political theorist Grotius. I've been thinking about Grotius recently because I am reading Simon Schama's The Embarrassment of Riches: An Interpretation of Dutch Culture in the Golden Age. My knowledge of political theory is sufficiently superficial that I am ill-equipped to think carefully about Grotius, so Will's essay is incredibly helpful.

Schama's book is very interesting, and I am learning a lot about the central Dutch identity during their commercial heyday. I'm also learning that there was a lot more antipathy and aggression between the English and the Dutch than I realized. Much of that antipathy revolves around conflicting ideas of the extent to which each nation could use access to waterways to increase their commercial ventures. It's also interesting in the context of the subsequently rising commercial and financial star of the English and the waning star of the Dutch. One hypothesis is that English institutional change post-1688 (for which they really have to thank the Dutch, after all!) created a stable environment in which financial innovations could occur, such as new credit instruments and new financial relations that allow for risk spreading. Increased credit and its associated risk spreading enabled increased trade and interconnection of physically disparate markets, which harnesses the Smithian "division of labor is limited by the extent of the market" increased extent of market to increase specialization, thereby increasing efficiency and incomes. That dynamic had worked to a large extent for the Dutch in the 17th century, and it worked at an even larger order of magnitude for the English in the 18th century. And don't forget that this dynamic also occured in the context of, and further encouraged, technological change in shipping, navigation, road and carriage.

I think the decentralized dynamics of growth are truly beautiful.

posted by lkkinetic | 5/18/2003 10:23:00 AM

Reason Public Policy Institute has a new weblog on privatization and government reform called Out of Control. It provides useful details and commentary on government spending, services, and performance (or lack thereof).

posted by lkkinetic | 5/18/2003 09:50:00 AM

With thanks to Book Addict, I am thrilled to find The Republic of Pemberley, a site covering all things Jane Austen. My love of Jane Austen runs the gamut from her sharp, ironic wit, to her nuanced women characters, to her coverage of the troubling economics of personal relationships in a socially constrained society, to the fashion and interior design, to the elegance and graciousness of manners (especially when they veil that wit ever so thinly), to the opportunities to see lovelies like Colin Firth, Alan Rickman and Hugh Grant in period dress.

posted by lkkinetic | 5/18/2003 09:32:00 AM

Friday, May 16, 2003  

A CAUTIONARY NOTE ON ECONOMETRICS: This Daniel Davies post on econometrics is very worth a read (with thanks to Henry Farrell for the link, as well as the caveat that the permalink is not working, YMMV). In particular, I have just finished reading some senior honors theses, and have tried to impress upon my students how important it is to understand and think through what your canned software is doing to ensure that it's doing what you think you are telling it to.

I'm sufficiently curmudgeonly to be pleased that my econometrics professor in college made us all do our first regression by hand, before we were ever allowed to touch a computer. Much as I cursed him at the time, I remain convinced that doing it by hand gave me experience in thinking about what a regression does, and what it does not do, that doesn't stick in the brain if you're told it. Yet another application of the old Confucius saying:

I see and I forget
I hear and I remember
I do and I understand

posted by lkkinetic | 5/16/2003 11:06:00 AM

Sylvain Galineau posted recently on Chicagoboyz about the Seminary Co-Op Bookstore in Hyde Park. It is indeed a haven for bibliophiles, a warren of dim halls and little corners, stuffed to the gills with books. Sylvain excerpts a recent article on the Co-Op in the Financial Times weekend edition. It is one of the great distinctive things about living in Chicago.

posted by lkkinetic | 5/16/2003 10:59:00 AM

DID DUSTY LIGHT A FIRE UNDER THE CUBS? So Wednesday night after the Cubs beat Milwaukee, Steve and Chip pointed out that in 2002, the Cubs won their 23rd game of the season on June 5. So in terms of wins, we are three weeks ahead of last year. Wowie!

Is it Dusty? I did cartwheels when I found out he was coming here (I did! Ask the Knowledge Spouse, he'll tell ya), and it seems that his leadership is contributing to results, particularly for Moises Alou (who is, for the record, my favorite Cub). But it's not a controlled experiment, because the new GM, Jim Hendry, acquired several veterans with a lot of fire left in them to be good team leaders. Some of them play off the bench, and have performed well (Troy O'Leary, Eric Karros) on both offense and defense. Hendry has also acquired pitching depth on what I think of as a portfolio model -- a diversified range of ages, experience, handedness, best pitches, start/mid/close, etc. This is the first time that I can recall such depth in pitching; even in 1989 we weren't this deep.

Plus there's the youngsters, and that's where I think the coach and veteran player leadership is making a big difference. Example: last weekend Corey Patterson sucked it up base running on a steal attempt. In a similar play Wednesday night he corrected. Error correction rates are crucial, particularly in a sport with such a long season.

Of course, being a Cubs fan, I await the June swoon ... My ancestral team, the Pittsburgh Pirates (whom I also still follow), has already started their swoon, which is deeply disappointing.

posted by lkkinetic | 5/16/2003 10:55:00 AM

Thursday, May 15, 2003  

FERC delays SMD implementation until Congress passes an energy bill. I've got enough problems with the SMD as currently articulated that I think this is probably a good thing. I'm also firmly in the "given the proposed bills, having no energy bill is better than either" camp. But the bureaucratic rigamarole that stifles meaningful, dynamic change that lots of folks are interested in and willing to make is a true, real, painful cost.

Sometimes I think James Madison was a genius, and sometimes I really, really want to tell him off.

posted by lkkinetic | 5/15/2003 09:14:00 AM

PRODUCER PRICES AND ENERGY PRICES: Producer prices fell 1.9 percent in April, at least as a first estimate. Much of that fall is due to energy price declines, the biggest in 17 years. As Reuters reports it:

Excluding food and energy costs, the core PPI fell 0.9 percent in April, compared to a rise of 0.7 percent in March.

The fall in the April PPI, which is a measure of prices received by producers, is the largest one month decline on record.

The Reuters article then goes on to quote some bond and foreign exchange analysts on the importance of the report. Generally, they do not perceive this as a deflationary problem (thank goodness, because I remain unconvinced that deflation is a problem, largely with the skepticism that Kevin Brancato expresses.

This Smart Money article gives more in-depth details on the components of the PPI and their movements.

And if you want to read the report for yourself, it's here. Note, importantly, that these numbers are seasonally adjusted, which is really important when you're talking about things like energy.

Of course, I think we have to take all of this stuff with an enormous grain of salt. Such aggregation is, in many ways, meaningless (now I'm showing my Austrian microeconomist stripes!). I think a lot of these price indices are estimates with standard errors so big you can drive a truck through them, but, as with trade deficits (which are also both theoretically and substantially meaningless), people who like to get their hands in and mess with economic policy pay attention to them, certainly more than they should.

Other people who pay attention to such estimates, and who I argue give them more of their appropriate due, are investors. So how are capital markets responding to this report?

Stocks gain at open
Investors bid up shares early Thursday on comments from IBM, drop in jobless claims, PPI

So it's not a controlled experiment, where we can evaluate only the effect of the PPI report on Wall Street. But that's the whole point. Unemployment fell last week, IBM thinks that technology markets are going to stop roiling, and producer prices have fallen. Nothing in economics ever happens in isolation except on the blackboard.

posted by lkkinetic | 5/15/2003 08:46:00 AM

Monday, May 12, 2003  

YET AGAIN, SUPPLY CURVES SHIFT: Funny how high prices induce capacity expansion ... another in my periodic pointing out that oil and natural gas drilling activity in the US is endogenous, and responds to expectations of future prices. Right now natural gas prices are quite high, and are expected to stay that way for enough time to make it worth while to go drilling for more of it.

US drilling activity continued to climb, with 1,021 rotary rigs working this week, 20 more than the previous week and up from 812 during the same period a year ago, said officials Friday at Baker Hughes Inc.

Land operations added 19 rigs for a total 894 units working this week. Offshore drilling increased by 1 unit to 107 in the Gulf of Mexico and 112 for the US as a whole. Activity in inland waters was unchanged, with 15 units at work.

Canadian drilling continued its seasonal slide with the spring thaw, down 19 rigs with 91 still working. That's up from the 87 active rigs reported at this time in 2002, however.

In the US, all of the build this week was in natural gas drilling, up 23 rigs to 848. The number of rigs drilling for oil declined by 4 to 170.

posted by lkkinetic | 5/12/2003 05:26:00 PM

On Thursday Hal Varian had some suggestions on ways to use markets to improve politics. He cites a paper by Robin Hanson, an economist at George Mason.

Once you get the idea, the possibilities are endless. Suppose a company is trying to choose between ad agencies. The board can simply create an option that pays off in shares conditional on which one is chosen, along with the appropriate money options.

Given the increased liability corporate board members are facing, they should welcome ways to make sure their decisions are better aligned with shareholder views. Buying and selling shares is a lot easier than calling a proxy vote.

Mr. Hanson wants to go further and extend the idea to the political domain. Government agencies could define a measure of performance and let markets determine their actions.

Take central banks. Most economists think central banks should care about both the unemployment rate and the inflation rate. Market expectations about inflation can be estimated from existing financial securities, but what about unemployment?

Suppose the Fed creates a security that can be exchanged, at some specific time in the future, for the unemployment rate times $100. If the unemployment rate in December 2003 is 5 percent, then the "unemployment futures contract" would be worth $5.

Now the Fed could issue options on this security. One option would deliver one contract if the Fed sets a short-term rate of 2 percent, another delivers one contract if the Fed sets a short-term rate of 3 percent, along with the appropriate money options that pay off depending on the decision.

All the board of governors now has to do is to see how the market values these two options and carry out whichever action the market recommends. Maybe Alan Greenspan isn't so irreplaceable after all.

Mr. Hanson speculates that one might even make explicitly political decisions — like setting the tax rate on dividends — by using such a mechanism. Economists would no doubt be active participants in such markets.

This is a great tool to enable government to shift to thinking about performance and less about relying on measuring inputs. Technology, of course, has contributed to reducing the transaction costs that have up until now made such ideas pie-in-the-sky ivory tower fun over beers after work. But think about the potential of so many things that we had thought impossible even five years ago ...

posted by lkkinetic | 5/12/2003 05:18:00 PM

Found an interesting series of articles on Always On entitled "Practical Ecology." The first article in the series lists five "environmental myths":

-Being environmentally correct requires a lower standard of living
-Any good environmentalist is a socialist
-Hydrogen and other renewable energy are the answer to our energy needs
-We have to recycle everything
-New housing developments must be limited to within existing cities

and the second article in the series lists five more:

-Natural wilderness and biodiversity are sacred
-We must have mass transit
-There are going to be worldwide energy and water shortages.
-There is a population explosion.
-If we don't make drastic changes right now, the earth will become uninhabitable

The author, Ed Ring, edits EcoWorld. Very, very interesting site!

posted by lkkinetic | 5/12/2003 04:48:00 PM

Friday, May 09, 2003  

The good news about working at home today: reading Chapter 2 of Stoft's Power System Economics with the Cubs on in the background meant that I got to see Moises Alou hit his third home run of the year! Cubs 3, Cardinals 4. Go Cubs!

The bad news about working at home today: reading Chapter 2 of Stoft's Power System Economics with the Cubs on in the background means that I'm not as absorbed by my reading as I probably should be. Such is life on a sunny late Friday afternoon in May ...

posted by lkkinetic | 5/09/2003 03:25:00 PM

The best quote from President Bush's commencement address today at the University of South Carolina:

Do not bet against the success of freedom.

History certainly bears out that advice.

posted by lkkinetic | 5/09/2003 02:47:00 PM

FREE TRADE IS MUTUALLY BENEFICIAL, CREATES VALUE, AND RAISES LIVING STANDARDS: According to several news reports today, including this Bloomberg News article, this San Francisco Chronicle article, this BBC report, and this Financial Times article. The BBC article states:

US President George W Bush will on Friday call for a free trade area between the US and the Middle East within a decade, officials have said.

The proposed free trade area would build on existing US free trade agreements with Israel and Jordan, an unnamed senior administration official was quoted as saying.

Washington hopes Iraq and a new Palestinian state would be among countries that qualify for membership, the official said.

Since I quoted Adam Smith yesterday, I will follow with a relevant quote here about how trade enables people/countries to specialze according to comparative advantage, thus increasing total production, and most likely at lower cost. This quote is from David Ricardo's Principles of Political Economy and Taxation. Note that his examples illustrate comparative advantage as it was in 1817; due to technological change and other manifestations of human creativity and economic dynamism, comparative advantage is itself endogenous:

Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each. This pursuit of individual advantage is admirably connected with the universal good of the whole. By stimulating industry, by regarding ingenuity, and by using most efficaciously the peculiar powers bestowed by nature, it distributes labour most effectively and most economically: while, by increasing the general mass of productions, it diffuses general benefit, and binds together by one common tie of interest and intercourse, the universal society of nations throughout the civilized world. It is this principle which determines that wine shall be made in France and Portugal, that corn shall be grown in America and Poland, and that hardware and other goods shall be manufactured in England.

In one and the same country, profits are, generally speaking, always on the same level; or differ only as the employment of capital may be more or less secure and agreeable. It is not so between different countries. If the profits of capital employed in Yorkshire, should exceed those of capital employed in London, capital would speedily move from London to Yorkshire, and an equality of profits would be effected; but if in consequence of the diminished rate of production in the lands of England, from the increase of capital and population, wages should rise, and profits fall, it would not follow that capital and population would necessarily move from England to Holland, or Spain, or Russia, where profits might be higher. ... [Ricardo lays out the comparative advantage: Portugal can produce both wine and cloth with less labor than England, but she specializes in wine and buys cloth from England, and between the two of them they produce more wine and more cloth, to the benefit of each.]

It would undoubtedly be advantageous to the capitalists of England, and to the consumers in both countries, that under such circumstances, the wine and the cloth should both be made in Portugal, and therefore that the capital and labour of England employed in making cloth, should be removed to Portugal for that purpose. In that case, the relative value of these commodities would be regulated by the same principle, as if one were the produce of Yorkshire, and the other of London: and in every other case, if capital freely flowed towards those countries where it could be most profitably employed, there could be no difference in the rate of profit, and no other difference in the real or labour price of commodities, than the additional quantity of labour required to convey them to the various markets where they were to be sold.

Thus free trade is mutually beneficial, and creates value and growth. Seeing this value creation occur in the Middle East would be super.

posted by lkkinetic | 5/09/2003 11:37:00 AM

Thursday, May 08, 2003  

OMG, I absolutely love this!! Capitalist Chicks is a refreshing, fun website. Their statement in their about section is eloquent and powerful:

We believe that Capitalism is the only moral and practical economic system. Only Capitalism offers individuals the opportunity to create, produce and exchange freely with others. It is the only system that recognizes individualism and protects the freedom of independent minds. Capitalism bans the use of force in economic relationships and leaves people free to make transactions based solely on their own judgments and decisions. We have progressed by leaps and bounds under Capitalism. From longer life spans and better hygiene to increased food production and instant communication, Capitalism has enabled great minds to produce great things.

We have seen more women blazing into the business arena within the past twenty years. In a Capitalistic society where all minds are free to create and produce, women have been trail blazing in fields that were once male dominated. We are doctors, lawyers, astronauts, engineers, athletes, CEO's, and even geeks and gamers. Capitalist Chicks: we are the productive women of the up and coming generation. Capitalist Pigs make way, we may take over the farm!!!

posted by lkkinetic | 5/08/2003 07:23:00 PM

I can't believe it's taken me this long to find Kevin Brancato. Nice blog! Gotta love the name -- Truck and Barter. For those of you who never tire of hearing Adam Smith quotes for the nth time, even as n approaches infinity:

This division of labour, from which so many advantages are derived, is not originally the effect of any human wisdom, which foresees and intends that general opulence to which it gives occasion. It is the necessary, though very slow and gradual, consequence of a certain propensity in human nature which has in view no such extensive utility; the propensity to truck, barter, and exchange one thing for another. [emphasis added]

Whether this propensity be one of those original principles in human nature, of which no further account can be given; or whether, as seems more probable, it be the necessary consequence of the faculties of reason and speech, it belongs not to our present subject to enquire. It is common to all men, and to be found in no other race of animals, which seem to know neither this nor any other species of contracts.

With thanks to Liberty Fund and the Library of Economics and Liberty for having an online Wealth of Nations. My students thank you too.

posted by lkkinetic | 5/08/2003 07:05:00 PM

While I'm ranting about consumer respect and sovereignty, another area in which we get no respect is in our automobile choices. For instance, this CNN/Money article discusses how it's Detroit's fault that we consume so much oil, foreign or domestic:

Two environment groups -- the Natural Resources Defense Council and the Detroit Project -- argue that America needs an SUV that can get 40 miles per gallon, but say the problem is that "Detroit won't build it." ...

"Detroit is waving a white flag instead of an American flag. They have surrendered the battle for energy security," said NRDC attorney Robert F. Kennedy Jr. "It's time for sensible standards that put existing technology on the road in every car, truck and SUV."

How come it's always the fault of the suppliers? You know why Detroit won't build it? Because they can't sell it, yet, at a price that we are willing to pay! The eco-scolds (to steal Lileks' term) give no credence to the fact that when someone chooses a vehicle, we are choosing a bundle of attributes. One of those attributes is fuel efficiency, but we weigh that against storage and carrying capacity, high-end and low-end torque, acceleration, style, and comfort.

Give consumers our due, and respect the fact that our choices best suit our preferences. If these preferences change, as they have over the past three decades in many ways, you can be sure that Detroit will satisfy them. They may not be as expeditious about it as other auto producers, as we found in the 1970s with Toyota and Honda. But that's what competition is about. If they don't satisfy our wants at prices we're willing to pay, they will get bitten in the wallet.

posted by lkkinetic | 5/08/2003 08:43:00 AM

WHAT ABOUT THE CONSUMER? Whether it's electricity or automobiles, consumers get no respect. Electricity regulators and other policymakers condescend to them, essentially arguing that electricity is too complex for consumers to make smart choices. Thus, they argue, we need retail rate caps, because otherwise electric companies would take advantage of those poor dolts who just want to have the juice coming through the wall.

Ask yourself this: from a consumption perspective, is electricity really any more complicated than other things we consume? Cellphone service, internet service, natural gas? And don't ever, ever, give credence to the "electricity is different because it can't be stored" argument, such as CA Senator Dunn makes like a broken record. Many things we consume can't be stored but are parts of a capital-intensive network -- airline seats, cellphone calls, hotel room stays.

Plus electricity is not as un-storable as Dunn would have you believe; it's just that batteries and existing storage technologies are expensive for the amount of power you get from them. Smart entrepreneurs are working on that problem as we speak, and once we figure that one out, then the stasist control freaks will have to find some other rationale for controlling the economy. And I'm sure they will try.

But they will fail.

posted by lkkinetic | 5/08/2003 08:33:00 AM

Now this Oakland Tribune article does a nice job of contrasting the two bills currently in play in California, the Senate re-regulation bill and the Assembly direct access bill. For a more thorough explanation of the bills, see this April post, which I also mentioned earlier.

posted by lkkinetic | 5/08/2003 08:25:00 AM


posted by lkkinetic | 5/08/2003 08:22:00 AM

CALIFORNIA SENATE BILL WOULD RE-REGULATE ELECTRICITY: And send California back in time, just as the happy modern primitives who abhor dynamic change want. California Senate Bill 888, about which I posted back in April. This bill has been approved by a Senate panel.

The 1996 deregulation law [AB1890] was intended to foster competition to drive down electricity prices. Instead, wholesale electricity prices rose sharply in 2000, driving three utilities to the brink of bankruptcy when they couldn't pass on higher costs to customers.

Dunn's bill would phase out retail competition and let California regulators again set profit margins for utilities.

First, this article's headline, and the legislation, claims that this bill is about rolling back deregulation and retail competition. Neither of those concepts even come close to describing the morass of regulation that AB1890 represented. It was not deregulation. And while AB1890 did have provisions for retail competition, they were so ludicrous and uncompetitive that the utilities couldn't survive while abiding by them! Why, you ask? AB1890 allowed the California PUC to retain the retail price caps, so that customers would see stable rates (and in fact, the legislation mandated a discount from 1996 rates and capped them). You call that deregulation? Not in any understanding of the word that I accept.

At the same time, new suppliers couldn't make money serving the California retail market either, because AB1890 said that the utilities were allowed to charge their retail customers an energy price as low as the wholesale price, which left no margin room against which entrants could compete (i.e., no headroom). In essence, this provision reflected the policymakers' beliefs that retail service has no value added beyond the value of the energy that gets sold to the customer (or the utilities did a great job of lobbying to remove the real possibility of competition). No wonder that competing suppliers didn't do a Gold Rush stampede into the California market.

Furthermore, in October 2001 the California PUC abolished the one remaining shred of retail competition in California -- direct retail access. Some direct access customers (typically large industrial customers) were grandfathered into their existing direct access contracts, and the proposed re-regulation bill will nullify those contracts and force customers and energy companies who have entered into a mutually beneficial exchange back into regulated utility service.

Second, this article and many others, such as this Desert Sun article and this LA Daily News article, fail to make the crucial distinction between the wholesale market and the retail market. AB1890 was much more about freeing up restrictions on trade in wholesale electricity markets, although it did a pathetic job of that, requiring buyers and sellers to use the government-created faux market that was the Power Exchange, mandating that they engage only in day-ahead and day-of trades, and maintaining the retail rate caps that stifled the transmission of accurate price signals from the retail market into the wholesale market.

How can anyone call this deregulation? It wasn't, and stop calling it such. Continuing to call California's restructuring "deregulation" does nothing except play into the hands of policymakers who think that central planning and control is necessary for the existence of electricity service, notwithstanding the mountains of international evidence to the contrary. To borrow Virginia Postrel's taxonomy, this plays into the hands of stasists who do not acknowledge the benefits possible through dynamic change.

That said, though, Dunn's proposed bill would lead to an even more stagnant and backward-looking electricity industry in California. Its return to cost allocation as the basis for pricing and for utility profits will provide stability and certainty in the short run, and a lack of innovation and investment from outside of the utilities in the longer run. If other states have regulations that support electricity entrepreneurs finding and redefining the value propositions that they can bring to consumers, then business will choose to locate elsewhere, not in California. Some will even leave California. That will make the job of the utilities easier, because they'll have fewer customers to serve. But wait, in a cost-based regulated environment with regulated rates, hasn't it always been the case that the way you make higher profits as a utility is to serve more load? Hmmmm. But if costs are the basis of the rates that the PUC allows, and businesses leave the state (thereby decreasing industrial and residential demand, and probably commercial too), won't that mean spreading those costs (which have already been incurred, because of the timeframe in this capital-intensive industry) over fewer ratepayers? So ... regulation will mean a decrease in demand would lead to higher rates!

That is the illogic of a regulated system. It's absurd, it's uneconomic, it's inefficient. And it's California's future if they return to cost-based regulation of wholesale and retail supply.

posted by lkkinetic | 5/08/2003 08:17:00 AM

Monday, May 05, 2003  

Chicagoboyz also has a post on the TotalFinaElf/Iraq oil connection, featuring the NY Times article that shows some even deeper connections than previously known.

posted by lkkinetic | 5/05/2003 08:55:00 AM

THE LUNAR MEN: FIVE FRIENDS WHOSE CURIOSITY CHANGED THE WORLD: Tomorrow I start the section of my economic history class that covers the industrial revolution, so this Chicago Boyz post is exceedingly timely. They recommend Jane Uglow's book, The Lunar Men: Five Friends Whose Curiosity Changed the World, in which she analyzes the intellectually fertile friendship of Erasmus Darwin, Joseph Priestley, James Watt, Matthew Boulton, and Josiah Wedgwood. I focus quite strongly on Watt, Boulton and Wedgwood in my class, so I am thrilled to hear of this book. And this comment from one of the Amazon reviewers:

Uglow gives wonderful personal details about these men and a multitude of minor characters. The amazing detail here represents a triumph of careful scholarship and digging into letters, chapbooks, and forgotten volumes. The Lunar Men helped form their society in significant ways; Uglow is very good, however, in showing historic influences on them, and a reader will learn plenty here about the American and French Revolutions, as well as the Industrial one, and in science, the revolutionary schemes of Linnaeus and Lavoisier. Best of all, this is a preservation of remarkable friendships cemented by the happy communal activity of learning things and experimenting.

makes me want to read it as soon as possible! Note especially that last bit, "the happy communal activity of learning things and experimenting". Even though James Watt was a pioneer in patenting his inventions, and following up on potential patent violations, he also recognized the complementarity of "learning things and experimenting" to his desires to commercialize his inventions. It's a great example of the magnitude of the positive spillovers from sharing knowledge, and using shared knowledge to create new knowledge.

posted by lkkinetic | 5/05/2003 08:44:00 AM

THE SENATE ENERGY BILL: Tom Lenard at the Progress and Freedom Foundation has analyzed the proposed Senate energy bill, S.14, and he has found it wanting. In the title he calls it a disappointment, which I consider an understatement. It's full of money for all sorts of research, including the kind of technology commercialization research that should not be the purview of government, and devoid of any meaningful actions that would reduce government control and regulation in energy industries (except, as Tom notes, its repeal of PURPA).


posted by lkkinetic | 5/05/2003 08:34:00 AM

Friday, May 02, 2003  

HOW TO PRIVATIZE IRAQ'S OIL ASSETS: Well, if I'm going to get beaten to the punch on an essay I've been incubating for a couple of weeks, at least it's by Susan Lee. Her Wall Street Journal editorial from Wednesday (subscription required) does a superb job of addressing the "how and why" of Iraqi oil privatization. She also does a great service (and, again, beats me to it!) by pointing readers to this 1999 Cato Policy Analysis by Terry Anderson, Vernon Smith, and Emily Simmons on privatizing federal land.

The actual mechanism would look something like this: As the oil land is surveyed and divided into discrete units, an open auction for the deeds of each unit would be held. The deeds won by auction would be paid for in certificates. Buyers of the deeds -- anyone from an Iraqi citizen to a giant oil company -- must pay with certificates purchased on the market either before or right after the auction. (The existence of a futures or option market would allow potential buyers to hedge their purchases.) Holding a rolling auction -- probably over several decades -- has several virtues. The economy avoids the inflationary impact of a huge, sudden capital inflow; certificate holders can time their cash flow by deciding whether to sell early in the process or at the end of the auction period; and prices for individual certificates could be kept low by declaring "stock splits."

And I wholeheartedly endorse her conclusions advocating their approach (you're shocked, shocked to hear that, I'm sure!).

UPDATE: Liberty Lover Keith has a link to this article on the Cato website that does not require a subscription. So go read it!

posted by lkkinetic | 5/02/2003 03:14:00 PM

The US Department of Energy has released projections of energy use through 2025. Take these projections with a grain of salt, knowing that they do not, and cannot, incorporate the dynamic changes and adaptations that are likely to occur as prices and technologies (for both production and consumption) change over the next 20 years. Still, interesting to see what they anticipate. I'm not persuaded, though.

posted by lkkinetic | 5/02/2003 11:28:00 AM

SEN'S PARETIAN LIBERAL PARADOX: I was absolutely tickled to find a discussion on Brad DeLong's site and Robert Waldman's site about Sen's seminal article on the impossibility of a Paretian liberal (that's small-l classical liberal). Takes me back to my undergraduate days, when I had a superb economics honors seminar with the irrepresible and ever-stimulating Dennis Sullivan, one of the primary people who encouraged me to go to graduate school in economics.

posted by lkkinetic | 5/02/2003 11:20:00 AM

THE STATE OF AIR QUALITY: Reason Senior Fellow Joel Schwartz and Stephen Hayward have analyzed the American Lung Association's annual "State of the Air" report, and have some comments on the science and advocacy therein. Stephen Hayward and Ryan Stowers of the Pacific Research Institute have published their eighth annual Index of Environmental Indicators, and Joel Schwartz has a forthcoming AEI study entitled "No Way Back: Why Air Pollution Will Continue to Decline". Joel and Stephen has also put together some suggested questions for reporters to ask the Lung Association's authors.

Clearly “State of the Air” is designed to generate alarming headlines—and aid fundraising for the American Lung Association—rather than provide the media and the public with accurate information on air pollution. Last August Andrew Goldstein of Time magazine wrote: “Fuzzy math and scare tactics might help green groups raise money, but when they, abetted by an environmentally friendly media, overplay their hand, it invites scathing critiques. . .” (From “Too Green for Their Own Good?” Time magazine, August 26, 2002.)

posted by lkkinetic | 5/02/2003 11:09:00 AM

REASON RELEASES A CITIZENS BUDGET FOR CALIFORNIA: As the state budget deficit grows daily and lawmakers struggle to find common ground on a solution, a new budget plan demonstrates how California's $26 billion budget deficit can be turned into a surplus by 2005 without raising taxes or cutting vital services.

On Wednesday 30 April, Reason Foundation released "Citizens' Budget," a plan that calls for the permanent adoption of a two-year state budget process, currently used by 23 states, and includes a line-by-line analysis of the state budget that reveals nearly $16 billion in potential cost savings in state programs. Another $1.1 billion could be saved with a 5 percent reduction in state personnel costs through attrition, renegotiation of employee contracts, limits on overtime, and reduction in staff levels to compensate for excessive growth in recent years. The report uses cost and savings benchmarks from other states and the federal government to offer a total of more than $18 billion in possible savings. But, by balancing the budget over two years, the plan requires that only $11.7 billion in spending reductions be made.

The full report, Citizens' Budget 2003-2005: A 10-Point Plan to Balance the California Budget, a summary, and related documents are available online at

Reason's plan rejects the false notion that the only way to balance the budget is through massive tax increases or draconian cuts in education and state services to those who need them the most. The real challenge is how to provide the same or better services at a lower cost to the state.

Our plan offers a menu of more than $18 billion in spending reductions that state lawmakers can pick and choose from to balance the budget. Californians pay more in taxes, but get less services than taxpayers in other states. We have to confront the state's inefficiency and prevent a crisis like this from happening again.

Instead of implementing across-the-board budget cuts, the plan advocates evaluating the importance and effectiveness of each state program and then consolidating and streamlining state agencies accordingly. To aid in that process, a California Sunset Commission would be created to review 20 percent of the state's agencies each year. Since its inception, a similar program in Texas has abolished 44 agencies and consolidated another 11.

To avoid comparable shortfalls in the future, the report proposes several constitutional reforms, including: a Taxpayer Bill of Rights, limiting increases in state revenue growth to population and inflation increases; a modified version of the Gann Spending Limit; and an automatic balanced budget adjustment trigger that would make proportional spending reductions to discretionary programs when revenues fall short of expectations.

We hope this helps move both sides of the debate towards a realistic budget deal.

posted by lkkinetic | 5/02/2003 10:43:00 AM

Thursday, May 01, 2003  

Henry Farrell has a nice post that picks up on my earlier post on the evolution of slugging in DC. Henry disagrees with me that it's a market process, but I think it is. I define "market process" as involving the consideration of opportunity cost and enabling parties to engage in mutually beneficial exchange. In this case slugging is the informal institution that arises out of that process. I grant that I probably have a broad definition of "market process", but I think it's the right way to conceptualize such situations. Sometimes the institutions that make market processes more likely, and more available as a tool for value creation, are formal (like patent law) and sometimes they are informal (like slugging).

It's interesting that Henry picked up on that point, because I was going to finish the post by pointing out that this is a market process because it is the creation of value through mutually beneficial exchange in a voluntary context. I didn't because I was worried about being too pedantic, of which I am often accused. Now I shall be more pedantic!!

Thank you, Henry, for your careful and insightful reading. And all y'all should read Jack Knight's book that he recommends in his post. I read it in the course of doing my dissertation and found it incredibly insightful. And I'll put their co-authored paper on my to-read list!

posted by lkkinetic | 5/01/2003 12:25:00 PM
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