SYNOPSIS: If there was ever a time for temporary price controls, it's now. I once had a math teacher who responded to student errors by saying "Save that answer — I may ask that question someday." I thought of him after George W. Bush's apparently pointless trip to California.
During that trip, Gov. Gray Davis asked for a temporary cap on wholesale electricity prices — a request that gained extra force because it was backed by economists with strong pro- market credentials, including Alfred Kahn, who oversaw the deregulation of airlines, trucking and other industries in the 1970's. Mr. Bush, however, was unmoved. Again and again he declared that a price cap would do nothing either to increase supply or to reduce demand.
Save that answer, Mr. Bush. We might ask that question someday.
Actually, Mr. Bush's assertion may have been wrong even on its own terms. I'll come back to that in a minute. But the most striking thing about his declaration was that it had nothing to do with the actual problem.
For the issue facing California right now is not how to increase supply and reduce demand. It's too late for that; summer is almost upon us, and it is simply a fact of life that there will be power shortages in the months ahead. It is important that the state build power plants as quickly as possible, so that this shortage is only temporary. But not to worry: power plants are being built at a furious rate, in California and in the nation at large. Indeed, last week the credit agency Standard & Poor's expressed concern that electric generating capacity is being added so quickly that the industry will soon face a glut.
Meanwhile, however, the temporary lack of capacity has led to incredibly high wholesale electricity prices, which are a huge financial burden on the state, over and above any disruption that may be caused by physical shortages of power. Nobody knows exactly how much California will pay for power this year, but reasonable estimates suggest that it will pay at least $50 billion more than two years ago — an increase of more than $1,500 for every resident. The great bulk of that represents not an increased cost of production but windfall profits for a handful of generating companies.
The main purpose of a temporary price cap would be to reduce — though by no means eliminate — this transfer of wealth away from California residents. That is, we're talking about dollars, not megawatts. And Mr. Bush's response is therefore almost surrealistically beside the point.
You could argue that any financial benefit from price caps would be more than offset by a worsened physical shortage. But that's a hard case to make. Nobody has proposed capping prices at a level that would prevent power producers from making extraordinarily high profits; why should this reduce the supply of power?
It's true that Econ 101 teaches that price controls tend to produce shortages. But this would be a minor effect in this case, since neither production nor consumption would be much affected. And anyway, students who go beyond Econ 101 learn that strictly speaking the standard argument against price controls applies only to a competitive industry. A price ceiling imposed on a monopolist need not cause a shortage, if it is set high enough; indeed, price controls on a monopolist can actually lead to higher output. That's not an argument you want to use too often, but given the extraordinary prices now being charged for electricity, and the considerable evidence that producers are exercising monopoly power, if ever there was a case for a temporary price ceiling, California's electricity market is the place.
I am actually somewhat surprised by Mr. Bush's obtuseness on this whole subject. No doubt his determination to answer the wrong question is deliberate: misrepresenting policy issues is, after all, standard operating procedure for this administration. But even on a cynical political calculation, Mr. Bush's remarks seem to be foolish, only reinforcing the sense that he neither understands nor cares about California's problems.
Maybe Mr. Bush's advisers are knee-jerk ideologues who believe that the market is always right, even when textbook economics says it is wrong. Or maybe they are so close personally to energy industry executives that they believe that whatever is good for Enron is good for America.
Whatever the real story, it's clear that this administration not only has no answers for California, it won't even listen to the question.
Originally published in The New York Times, 6.3.01