Naive energy markets.

• Author: Spence, David B.

Centrifugal forces dominate the twenty-first century American policy process. Ideologically, the two major political parties are more homogenous and further apart than at any time since the advent of the modern regulatory state. (1) Political scientists ascribe polarization in Congress to any number of factors, most of which fall within either of two categories: one focusing on the increasing ideological homogeneity in congressional districts, (2) and a second focusing on various kinds of institutional factors that affect how parties manage congressional business. (3) Legal scholars, for their part, have begun to explore the implications of this ideological split for our understandings of American federalism, (4) modern American administrative law, (5) and more. (6) At the center of these ideological differences lies the fundamental dilemma of the regulatory state: namely, the question of when it is advisable for the state to intervene in the market. (7) Recent debates over the Affordable Care Act, (8) financial regulation, (9) antitrust regulation, (10) and net neutrality, (11) for example, divide the parties along this fault line. This "market versus regulation" divide has riven the American polity since Ronald Reagan first began to challenge the New Deal consensus (12) and the cross-party acceptance of the modern regulatory state. (13)

Nowhere is that divide more prominent today than within the field of energy law, a body of regulation that encompasses two basic challenges: (1) the problem of ensuring well-functioning energy markets, and fair energy prices, (14) and (2) the problem of managing the many and varied externalities associated with the production and delivery of energy. American policy has traditionally addressed the former objective through public utility and antitrust law, and the latter objective through environmental health and safety regulation. Both challenges pose the question of how best to allocate the costs and benefits of energy services: that is, when to rely on the market to allocate those costs and benefits, and when to use law to change that allocation. (15) Congressional gridlock over the last twenty years has shifted the battle over these questions from Congress to states, regulatory agencies, the courts, and quasi-governmental and private governance institutions. (16) The push to deregulate price and competition in energy markets has proven particularly successful at the federal level and in some states; the push to deregulate the externalities of energy production, much less so. (17)

Each of these competing visions of our energy future--one seeking ever-freer energy markets, and another seeking ever-cleaner energy markets--represents an ideologically coherent ideal that stands in contrast to a more complex and messy reality. The trend toward competition, market pricing, and less regulation in the energy industry embraces the logic and elegance of markets. It means that participants are exposed to more price risk than in the past; (18) and as William Boyd has illustrated with respect to public utilities, it represents a narrowing of both the notion of the public interest and the government's role in protecting that interest. (19) The vision of greener energy markets, on the other hand, is mostly a top-down vision pushed along by policy, mostly at the state level. California and New York, for example, are among those states using policy to drive reductions in the use of fossil fuels in their energy sectors, while other states are more or less content with the environmental status quo. (20) As political polarization worsens, energy policy seems to be approaching a kind of stalemate, as federal agencies and states try to address new energy policy problems without the help (and sometimes over the objections) of a gridlocked Congress. (21) Thus, in the last few decades, when Republicans have controlled the executive branch, states and regional entities have pursued their own clean energy and pollution control policies; (22) when Democrats have controlled the executive branch, federal agencies pursue those same policies, often with active resistance from Republican states. (23)

Furthermore, political polarization exacerbates the tendency of each side to caricature the other, and to frame problems in starkly ideological terms, or as either/or choices. Proponents of regulation charge their adversaries with failure to understand environmental science, (24) and with lack of compassion for consumers. (25) Proponents of market solutions charge their adversaries with a failure to understand markets, and decry regulation as "central planning" or "socialism," (26) sometimes employing the now ubiquitous "war on" language, as illustrated by the phrase "EPA's war on coal." (27) While neither caricature is fair, this Article addresses the impact of the latter caricature on our understanding of contemporary energy policy problems. (28) Specifically, the focus here is on how two interrelated trends--the growing popularity within the GOP of the conservative intellectual challenge to the New Deal consensus, (29) and the rise to dominance of economic theory within regulatory and energy policy debates (30)--have obscured the importance of regulation to well-functioning energy markets. This happens in part because conservative politicians increasingly embrace neoclassical economic views of regulation that are in turn the product of economists' scientific aspirations. Those aspirations lead the discipline to turn a blind eye to the social and emotional drivers of individual preferences that once sat at the center of classical political economy, and that bear directly on the question of when governments should intervene in markets. While many institutional economists, behavioral economists, and scholars in other disciplines seem to understand the blind spot, mainstream economics has not fully embraced its importance. This issue seems particularly lost on political decision makers, who use economic models selectively and instrumentally in the "government versus markets" debate. This, in turn, contributes to a misunderstanding of the role of regulation and government institutions in markets.

This Article uses contemporary energy policy disputes to illustrate how and why energy markets can never resemble the idealized markets of economic theory that have become so popular in conservative policy discourse. Part I of this Article examines the ideological conflict at the root of the energy policy debate. That discussion traces the struggle between those who would tame price volatility in energy markets and those who would embrace freely floating prices as the agents of "creative destruction." (31) This examination includes a review of how the thinking of Adam Smith and Friedrich Hayek has come to shape the conservative challenge to the New Deal consensus, and how modern proponents of that challenge see the history of energy markets as a march toward less regulation and more competition and market pricing. Part II looks more closely at the fundamental precepts of the neoclassical model of competition, and how it can miss important considerations in the policy process, in at least two ways. First, it examines how the economist's goal of allocative efficiency does not necessarily subsume notions of fairness and risk management that are important to voters and policymakers.

Second, economic models continue to have trouble incorporating important lessons from behavioral research, lessons that are important to understanding the operation of energy markets. Part III examines how these shortcomings implicate the problem of ensuring a reliable, reasonably priced energy supply, given markets' inability to fully capture risk, uncertainty, and externalities in energy prices. Specifically, this Part explores how the discrepancy between real and idealized markets explains why regulators continue to intervene in American energy markets in ways disfavored by economic theory and contemporary conservative doctrine. (32) Part IV concludes with some observations about the inevitability of regulation in energy markets (something both Smith and Hayek probably would have accepted), and some further observations about how ideological polarization shapes policymaking in the modern regulatory state.

1. THE ECONOMICS OF ENERGY REGULATION

   Debates over the proper role of government in energy markets are almost as old as energy markets themselves. Section I.A briefly traces the regulation of modern energy markets since their inception in the nineteenth century, documenting the recent trends toward competition, market pricing, and greener energy supply; Section I.B examines the case for continuing and expanding the deregulatory trend, as advanced by political conservatives and some economists.

   1. The Energy Policy Debate

      In the nineteenth century John D. Rockefeller lamented the destructive effects of competition and boom-bust cycles in the oil industry, (33) recommending that the government leave his Standard Oil monopoly unregulated so that it might bring price stability to the industry. (34) The unpopularity of this stance led to the breakup of his company, (35) and to state regulation of oil and gas production aimed in part at stabilizing prices. (36) Rockefeller's contemporary, electricity titan Samuel Insull, by contrast, sought that same price stability through government regulation of the electricity industry, and is credited with creating the first modern electric utility, Commonwealth Edison. (37) Insull's views enjoyed more sway than Rockefeller's, and since at least the early twentieth century governments have used ex post regulation (antitrust suits) to try to tame price volatility and unfair competition in the oil industry, (38) and ex ante price regulation (public utility law) to achieve the same objectives in the natural gas and electricity industries. (39) For example, the Federal Power Act (40) and the Natural...