Tuesday, August 10, 2010

Adam Smith and the Smart Grid

Jumping off of my last post on Portugal I'd like to explore the subject of institutional barriers to investment and progress.  This is a subject that deserves a much more detailed treatment than I can give it on this blog, still I can give enough space to give an outline of the subject without making this post a prime example soporific writing.

To start this off, the relevant paragraphs from the NY Times article on Portugal's energy transformation.

"But a decade ago in Portugal, as in many places in the United States today, power companies owned not only power generating plants, but also transmission lines. Those companies have little incentive to welcome new sources of renewable energy, which compete with their investment in fossil fuels. So in 2000, Portugal’s first step was to separate making electricity from transporting it, through a mandatory purchase by the government of all transmission lines for electricity and gas at what were deemed fair market prices..."

"Such a drastic reorganization might be extremely difficult in the United States, where power companies have strong political sway and states decide whether to promote renewable energy. Colorado recently legislated that 30 percent of its energy must come from renewable sources by 2020, but neighboring Utah has only weak voluntary goals. Coal states, like Kentucky and West Virginia, have relatively few policies to encourage alternative energies..."

"Last year, President Obama offered billions of dollars in grants to modernize the grid in the United States, but it is not clear that such a piecemeal effort will be adequate for renewable power. Widely diverse permitting procedures in different states and the fact that many private companies control local fragments of the grid make it hard to move power over long distances, for example, from windy Iowa to users in Atlanta. The American Society of Civil Engineers gave the United States’ grid a 'D+,' commenting that it is 'in urgent need of modernization.' "

So, the first thing that is apparent from this is that the fragmented ownership of transmission lines is one of the biggest barriers towards a modernized grid and a significant bottleneck in making renewable energy viable.  This is an institutional barrier and one that is unlikely to go away through private negotiation (though I guess it would be possible for a large well financed company, or on an even more fantastical level a giant non-profit, to try to buy up the entire grid, I find this highly unlikely however).  The alternative is state intervention to do as Portugal did and take control of the grid away from smaller groups so that modernization can proceed. 

Personally, I don't view this problem as one of state vs. private; there wouldn't have been a problem if the institutionalized system of power transmission had been set up differently with a private central authority.  This wasn't how history happened in the U.S. however.  State intervention becomes necessary only because the way institutions developed make it impossible to modernize within the current system and provide no clear pathway to a new institutional framework.  In other words, the market system largely acts by maximizing efficiency given an existing institutional framework; it has little ability to change the institutional structure that it is functioning within.  So, to break this path dependency state intervention becomes necessary to create a new set of institutions to manage the grid, once this is done the system can either be re-privatized ) under the new institutional framework or remain within state power (or, if we want to get innovative, spun off under a type of non-government organization devoted to the grid's maintenance.

So what does this have to do with Adam Smith?  Mostly that much of the anti-government rhetoric claims a vague relationship to his thinking.  The problem with this is that it's an anachronistic reading of Smith.  Smith claimed (to paraphrase loosely) that barriers to trade, largely created by government, interfered with the development of markets that would efficiently allocate resources.  This worked pretty well for England but from a comparative contemporary perspective this contention needs a few caveats.  England was unusually highly centralized at the time Smith was writing, private enterprise had little ability to erect strong barriers to trade and innovation in England so Smith's opposition to government interferences was plausible enough and a correct analysis of the problems within the institutional structure that was England.  Of course, even then, a careful reading of Smith reveals that his attitude towards the state was much more complicated than those claiming to be his modern adherents.  Throughout the work Smith favors rationalization of necessary state institutions, such as poor houses, rationalization that would only be possible through a central authority.  He also writes favorably about the navigation acts, which displays the nuance Smith meant to convey but that isn't terribly relevant to the immediate topic.

So, why the confusion?  At the time centralization was largely seen as how concentrated power was at the top, England was less centralized because power was shared between institutions at the highest levels while in France and other countries more power was concentrated in the singular person of the monarch.  This is far different from the modern conception of centralization that understands it in terms of how power is distributed at different levels.  This becomes very clear when comparing France and England in the 18th century.  In France, private individuals (though there is some necessary confusion of definitions here, duties that were later centralized within the state were privatized in this period making the distinction between private economic and political power even more complicated than it is today) retained rights over many institutions necessary for the easy transportation of goods, they had rights to rivers that could block commerce, corporate groups could resist taxation, and other local bodies could restrict the flow of goods and labor in and out of the areas that possessed contractual rights over.

England was far different.  It had destroyed many of these traditional rights and restrictions long before the 18th century.  The state had much more sway over how goods moved within the country and could promote the formation of a truly national market, something that the King of France had great difficulty in doing, no matter how hard he tried.

Back to US policy, I'm becoming afraid that we're beginning to look more like France than England.  The state has ceded so many powers to private institutions that it is losing the ability to impose a truly common market across the country in critical areas such as energy transmission.  Indivdiual firms and local political institutions are winning the battle to fracture the national market and to instead create limited markets subject to private control.  As long as the rhetoric continues to embrace the simple distinction of private ownership = free market rather than the more complicated relationship between different levels of authority and the continued strength of the institution of the national free market (international markets aren't truly free yet) there exists a very real threat to the practice of free market capitalism within our country.  Restricted markets simply aren't free markets, even if restricted markets are controlled by powerful private individuals or incorporated entitites instead of political institutions.

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