How not to reform an electricity sector

Some weeks ago, the Spanish government unveiled its package to reform the electricity sector with the main objective of ending the tariff deficit. This arises as the difference between the regulated costs of the electricity firms and the revenues obtained through regulated tariffs paid by consumers. Its volume, 28 billion euros by the end of 2012, highlights the main regulatory problems of the Spanish electricity sector. The tariff deficit is the result of bad past regulation (controlling the prices without reflecting underlying costs) and constitutes an enormous distributive problem. According to experts Natalia Fabra and Jordi Ortega, the remuneration of renewal energies has been the scapegoat of the tariff deficit. Fabra argues that “the reform places the burden of the cost of adjustment mainly on renewal energies and consumers, and leaves untouched conventional energy despite the fact that its over-remuneration is in the origin of the tariff deficit. The new legislation does not define a regulatory framework that is able to face the challenges of the electricity sector.” The new regulation alters the remuneration of investments in renewals that have already been made. The reform leaves intact the current electricity market and the remuneration of conventional energies (nuclear, hydro, coal and natural gas).  Truly reforming the electricity sector amounts to solving together efficiency issues (allocative efficiency and energy efficiency), income distribution and environmental challenges. Europe has given too much discretion to member states, as argued by another expert, Juan Delgado, and Spain keeps using this discretion in a way that is inefficient, distributionaly regressive and environmentally reckless. Final prices should be related to real costs by introducing capacity markets and incentive regulation of the network elements. A reasonable reform should favour the entry of new competitors and the integration of European markets and commit to objectives of financial and environmental sustainability and energy efficiency. The process of reform has been characterized by debates behind close doors and ministerial disputes. Transparency has been absent, as opposed to what happens in countries with better regulatory systems, where a a white paper, stakeholder participation, and input from an independent regulator (for example evaluating the alternatives) would have been conventional. However, at the same time, the Spanish government is abolishing the independent energy regulatory agency. 

Too much collusion between business and politics

The Economist had a few issues ago a revealing piece on the excessive influence of business people into politics. Starting with the takeover of Italian politics by Berlusconi (and its disastrous effects), it goes on to survey the many ways in which large corporations influence the political arena. The conclusion of a pro-free market magazine as The Economist is clear: there is too much influence of large business on politics. Big firms are obviously necessary in a developed economy, especially when they perform in competitive and well regulated markets. However, their excessive influence in the political process is a corruption of democracy. One way they try to do so is by appointing former politicians, to try to gain access to policy decisions that impact their bottom line. Of course, former politicians have a right to be hired by large corporations, but these appointments should be subject to strict codes of conduct that are nowadays absent. However, some former politicians (such as two former prime ministers and several former economics ministers in Spain, who are in the boards of energy firms which they used to regulate) should reflect about the embarrassment they inflict in their political parties and former voters. And some companies should think twice about some of the low quality politicians they appoint. Although firms not always succeed to influence policy fully in the direction they desire, it is obviously not surprising that it is difficult from local media to follow the responsibilities that business people have of many bad social and economic outcomes, and it is not surprising that in many developed economies large firms pay a very low effective corporation tax. Large corporations are one of the great institutions of modern economies, but societies at large should reflect more about what is their role in bringing about good societal outcomes. If a business friendly magazine as The Economist says that business has too much influence on politics, the truth is probably even more serious.

Re-reading Bowles and Aoki

Although it has become fashionable to quote “Why Nations Fail” by Acemoglu and Robinson, as the standard explanation of why institutions matter in economic development, there are better sources in my view to understand the role of institutional factors and its interaction with preferences and economic behavior. That is why I am re-reading the books by Masahiko Aoki ("Toward a Comparative Institutional Analysis") and by Samuel Bowles ("Microeconomics") and finding that they mention authors that I have been reading for other reasons between my first reading and the current one, such as Basu and Allen. Bowles and Aoki have in common that they offer a game theoretic view of institutions, which is presented as a critique of, and in dialogue with, standard economic theory. Both of these authors present their view of institutions as a platform to initiate the reader in the foundations of evolutionary economics. They also show interdisciplinary science at its best, namely not as an excuse to reduce rigour, but as an encouragement to find better mathematical models and other scientific techniques, such as evolutionary and agent-based modelling. A common theme is that economic outcomes are not necessarily the result of human design, but often they are the unintended consequences of human behavior, which does not exclude the role of collective action. Aoki is especially illuminating when he presents his view of social reality as a set of domain games (commons, social networks, exchange, organizations and polity) and how the linkages between these domains create complementarities. For example, the free rider problem in the contribution to public goods may be alleviated by the threat of social ostracism in a game of social interaction. All of this is better grounded in social (and other) sciences than “Why Nations Fail”, but it is slightly more complex, which is why you will not see it mentioned in the popular media. But I plan to teach it in my courses (more than I have done so far).

Update about Italy

I like to follow events in those countries where I have lived for a while or to which I feel attached. One of them is Italy (the others are the UK, Chile and the US). I try to keep updated reading everything on Italy in the Spanish media, and also in The Economist. But my preferred method is to read every Sunday the column by Eugenio Scalfari in La Repubblica, the newspaper that he founded some time ago. I like many things from Scalfari, like his attention to economic details, must most of all I admire his firm commitment against populism and corruption, and in favour of a federal Europe (the state should be Europe and national governments should sooner rather than later evaporate in a borderless Europe). The good news from recent columns is that Berlusconi has very difficult his return to politics, and that finally it seems that the forces of democracy and justice are prevailing and it is very unlikely that the blackmail of Berlusconi has any chance of having any real bite. Is democracy finally defeating populism and corruption? That is what Scalfari seems to imply. He believes that the Partito Democratico, in spite of his divisions, still has enough human assets to sustain a solid government under prime minister Letta, and that the centre right will have to realize that its future lies in reforming itself to become a respectable European centre-right instead of a clan under the ownership of a corrupt tycoon who once decided to vertically integrate into politics instead of contracting out favours from corrupt politicians.

"Freedom," by Jonathan Franzen

If you have a few days to read a substantial novel, “Freedom” by Jonathan Franzen is a rewarding experience. The story of the Bergklund family is a portrait of the USA in the George W. Bush years and the beginning of the Obama administration. This matters, because the story of the relationships between husbands and wives, between parents and children, is set against the background of a political landscape where the relationship between money and politics is bitterly criticized. The power of the wealthy families is shown in the well connected Jewish family that is “explored” by Joey Bergklund, or the failure of the grandparents of the family  to support her daughter (Joey’s mother later in time) because the rapist was the son of a family that funded liberal causes. The use individuals that have everything material make of freedom and the competition between them to have fulfilling lives is the topic of the book. Being a portrait of contemporary America, depression is perhaps in too many places, and perhaps there is also too much demonstration of the author being well versed in things such as mobile messages, social networks and e-mails. But it is a page turner. And take your time to read the final pages until the end: it is a nice ending.

Towards a federal Europe

There is no doubt that the economic, financial and monetary crisis that Europe has suffered in the last few years has exacerbated inequalities and calls for a reaction that facilitates a return to equitable growth. A European federal state, rather than a European inter-governmental Union, is necessary to achieve the triple objective of: 1) coordinating progress towards economic growth and prosperity in the context of more democratic and transparent politics, 2) making a European-wide effort to achieve higher levels of income equality through high taxation and a modernized welfare state, and 3) contributing to protecting the environment and tackling climate change by putting a price on emissions, and promoting under the leadership of a coordinated public sector at European level a new industrial revolution based on green energy.

Statist solutions are no longer sufficient to solve the problems of a monetary Union, and risk making Europe irrelevant relative to the other international and emerging powers.

As Olaf Cramme argues in the book “After the third way. The future of social democracy in Europe”, “social democracy must not underestimate the power of European integration at a time where the phenomenal pressures of globalization and far-reaching societal transformations are asking profound questions of all traditional political ideologies. At some point, a movement, initiative or policy idea will capture the attention of the wider European public. The center-left ought to make sure that it is part of it.”

Mostly good news from Baumol

Baumol and his co-authors explain that the cost disease takes place because “progressive industries” experience above average productivity growth, and “stagnant sectors” experience below average productivity growth due to the irreducible amount of labour they require. The amount of labour in personal services is constant, but the workers cannot earn much less than workers in "progressive industries" (otherwise they would not accept working there). Many stagnant sectors, for technological reasons, are in the public sector, which is one reason why the costs of public sector activities keep increasing. The good news is that because on average the economy’s productivity increases, we have more resources to afford a more expensive public sector. The products and services from progressive industries become cheaper (think of computers, mobile phones, electronic appliances, but also agricultural products, which in this sense are “progressive”), so that societies tend to spend more on stagnant sectors (health, education) than on progressive ones. Unfortunately, that this cost structure is affordable for society overall does not mean that it is affordable for everybody, and there are distributive consequences of some groups not being able to afford cost increases. These distributive implications are most worrying. Another caveat is that activities with negative externalities also belong to the progressive industries, like weapons construction and distribution or polluting activities that produce climate change. Therefore, it is cheaper now to produce bad things. The condition for the affordability in general of a more expensive public sector is that the economy’s productivity keeps increasing at the rate of the last century. Baumol thinks that this is most likely. Let’s hope that he is right.