Saturday, 23 June 2012

Economic experimentation and regulation

Obviously experimentation is important in the economy. Consumers experiment with new goods and services, they do a bit of 'learning by doing' to see if they prefer the new things compared to what they have been buying in the past. Firms experiment on many dimensions, they try out new business models, they introduce new products and services, change their organisational structures etc. This experimentation is a normal part of the 'creative destruction' that we see around us all the time.

Over at the Knowledge Problem blog Lynne Kiesling has been writing on the effects of regulation on economic experimentation.
In all industries and markets, regulatory policy affects the extent to which such economic experimentation can occur. Some regulations restrict the nature of new technologies, products, or services that can be offered to consumers (think, for example, of all of the debate over the past three years about retail financial services and the new CFPB). Some regulations either directly or indirectly affect the scale and scope of the organizational structure that firms can have. Some regulations restrict entry into the provision of specific technologies, products, or services (one example here is occupational licensing, which erects entry barriers). And some regulations do all three of these things, stifling economic experimentation in multiple dimensions.

Traditional electricity regulation restricts product and service characteristics and restricts entry, thereby reinforcing the old vertically-integrated monopoly utility organizational structure (three for three in my above taxonomy). Not surprisingly, then, this is an industry in which exogenous technological change and pervasive economic dynamism in the rest of the economy has been so slow to penetrate, because traditional cost-based regulation of vertically-integrated monopolists presents sizable barriers to economic experimentation. If Rosenberg and Greenstein and Shane and others are correct that the freedom to engage in economic experiments is one of the most significant causal factors in economic growth, the limit on economic experimentation in an industry that is so intimately connected to innovation and well-being and thriving in so many dimensions of our lives is an exceedingly costly limit that electricity regulation imposes on all of us.
The comments on the electricity market are interesting give the debate here over the partial sell-off of SOEs in that industry. Something I have heard nothing about is whether a partial change in ownership for the SOEs will be accompanied by changes to the regulatory environment. If one of the hoped for changes to be bought about by the partial sell-off of shares in the SOEs is greater innovation and experimentation then we have to ask the question, How much of the lack of experimentation and innovation now is due not to ownership but due to regulation? The partial sell-off of shares is unlikely to do much to increase experimentation since 51% of the firms will still be in government hands. May be looking at the regulatory structure the industry works under would do more to invigorate innovation than a partial ownership change.