6 Jan 2009

Fixing Monopolistic Utilities

[This is an important post. Please read the bit after my comment and please do respond/critique in the comments.]

Angrybear has a post on the TVA fuckup (a retaining wall collapsed, letting loose a huge flood of flyash -- the stuff left after burning coal -- that buried houses, killed people AND left a huge environmental mess).

I left this comment:
TVA, like most utilities (public and private), has low incentives to maintain capital stock. Spending leads to hearings over rate increases, lowers cash flow that bond buyers like to see (as noted), and reduces "performance"-related bonuses.

Ex-post clean up and rate increases are always easier to justify (they MUST occur), and they are counted as special items -- accidents that are not the CEO's fault.

The most important factor is that TVA, like other monopolistic utilities, will not go out of business for making such a stupid move (compare that to how asbestos companies got treated).

I am betting that TVA will also get gov't aid since it, like Fannie Mae, has a "privatize profits, socialize losses" incentive structure.

The only One way to prevent a future occurrence is to put people in jail since fines would be paid by rateholders anyway. The problem with that is that future execs -- everywhere -- would gold-plate everything [i.e., build capital stock to such a high (and expensive) standard that nothing would ever fail].

Another way to do that is to prohibit self-insurance against environmental damage. Instead have independent companies insure against risk, which will mean that they will also monitor the monopoly. (Insurance against water shortages would make it more likely that water rates would stay in the "right" range. Hmmm..)
So that last comment got me to thinking.

The problem with monopolies is that they don't face competition. On way to make them compete is by rewarding/punishing those that preform better/worse than a benchmark.

Another way is to chip away at the monopoly by subjecting "business lines" to competition (as the USPS was forced to do with packages and water utilities are involuntarily experiencing with bottled water).

A third way would force the monopoly to purchase from a competitive market at prices that would fall if they were well-run and rise if their operations were shoddy (e.g., TVA). So my new idea is this: Require that water monopolies (private and public) purchase insurance against outages, shortages, toxic spills, etc. Such a requirement would produce two good results:
  1. Current practices would immediately improve with oversight -- solving the free-rider/coordination problem (in principal-agent jargon) of monitoring utilities.
  2. Insurance companies would pay for future problems, which reduces the problem with ex-post rate increases to fix them.
Current water rates would rise, but future rates would not spike, so rates would be actuarially identical over the long run.

Bottom Line: Sometimes we must have monopolies; that doesn't mean they should be badly-run.

Addendum: Kevin Dick had a great idea (use prediction markets) in the comments. I had assumed that monopolies' insurance rates would be made public, but prediction markets would allow outsiders to bet if the rates were right or wrong. SUPER!

Addendum 2: It would cost $1-5 billion/year to bring coal waste sites (ponds and landfills) up to EPA specs. That's disaster (or profit!) waiting to happen.

4 comments:

  1. This is an interesting idea. I have a twist.

    Have the insurance companies use a prediction market to set the insurance rate. Then the whole community can have their information about operational risk taken into account.

    Then the utility would be even less cavalier because everyone would be watching.

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  2. Kevin -- good idea. I imagined that monopolies would have to disclose their insurance rates. It would be natural to aggregate these rates in one place. The prediction market would allow outsiders to bet if the rates were right or wrong. Wait, that's a GREAT idea :)

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  3. {"Require that water monopolies (private and public) purchase insurance... Insurance companies would pay for future problems.."}

    :::

    And just who would you 'require' to 'sell' this insurance... and what would you permit them to charge in your dictatorial economic scheme ??

    And what if those insurance-companies failed in your envisioned 'oversight' & financial reparations mission (?) Would you then require still another layer of outside oversight & insurance ?

    Exactly what punishments would you levy against people who did not comply with your economic dictates ?

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  4. Anon -- why the hostility?

    And just who would you 'require' to 'sell' this insurance... and what would you permit them to charge in your dictatorial economic scheme ??

    All water utilities (private and public). Which "them"? Insurance companies? Premia would be established in a competitive market.

    And what if those insurance-companies failed in your envisioned 'oversight' & financial reparations mission (?) Would you then require still another layer of outside oversight & insurance ?

    They would lose money. They may go out of business, but most insurance companies carry re-insurance.

    Exactly what punishments would you levy against people who did not comply with your economic dictates ?

    It's a regulation, and regulations must be obeyed at the risk of receiving fines.

    ReplyDelete

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