Incentive Regulation for Public Utilities.
Atkinson, Scott E.
This book, which is a compilation of papers presented at two seminars
at Rutgers University, presents a wide range of generally high quality
papers on the subject of incentive regulation for public utilities. In
general, the papers are not highly theoretical, and some focus almost
exclusively on policy issues. While a few of the contributions do not
appear to fit the general topic very well, most of the papers will be
found informative by economists who are new to the field of incentive
regulation. This is even true for the last article, which presents much
useful policy information, but adopts a controversial definition of
total factor productivity growth. However, those with extensive
backgrounds may not find enough to justify the relatively high price of
this book.
The first chapter presents a useful overview of the basic elements
and alternative forms of incentive regulation. The summary of
implementation, though sparse, is encouraging for incentive regulation
as an alternative to rate of return regulation.
Chapter two then logically attempts to explain why only two states
have utilized incentive regulation in the form of price caps in the
telecommunications industry. The fundamental reasons presented are the
inherent weaknesses in the application of price cap formulas, structural
differences in relevant markets, and political advantages associated
with social contracts. Typically, price caps equal the rate of inflation
net of economy-wide productivity growth estimates. However, these
estimates may inaccurately reflect performance in specific industries.
Instead, social contracts, in the form of rate freezes and network
modernization may be more politically palatable.
Chapter three addresses the problem that while price cap and
rate-of-return regulation may be optimal in static settings, they may be
inappropriate in dynamic environments, where differential rates of
growth across products may cause pricing distortions. This chapter is
more innovative than the previous two and shows that while usage-based
pricing schemes cannot easily be revenue neutral in a static
environment, they can be profitable in a dynamic one.
The fourth chapter is the most mathematically intensive contribution
of the collection. The authors address the topic of regulators imputing
prices for a vertically integrated firm which provides inputs to itself
for the production of a downstream product. The authors show that the
use of an externally determined price for the internal imputed price is
frequently incorrect. Then the authors compare profit-maximizing and
welfare-maximizing prices for this model. The shadow price of the input
is shown to equal its marginal opportunity cost in both the
welfare-maximizing and profit-maximizing models.
Chapter five examines the expectations and realizations of the
long-distance telecommunications industry in the post-divestiture
period. Analysis proceeds along the structure-conduct-performance lines,
but admittedly presents little empirical evidence to support the
theoretical result that price caps lead to greater efficiency and
productivity growth.
The sixth chapter does not really fit in with the general theme of
the book. This paper addresses the role of privacy of information for
regulated utilities.
Chapter seven examines the pricing of priority service. In one of the
more creative papers, the authors establish that priority service has a
limited role to play as a competitive tool, due particularly to adverse
selection. Real-time pricing can remedy these inefficiencies under
priority service.
The eighth chapter, on integrated resource planning, offers few
analytical insights, while chapter nine investigates incentives in
pipeline pricing. The authors present a nice overview of the history of
pipeline regulation and then apply admittedly standard models to derive
socially optimal prices for the peak and off-peak periods.
The final chapter examines the measurement of total factor
productivity, in theory and in practice, in relation to price caps,
where prices are allowed to increase at a rate no greater than the
growth rate of inflation minus the firm's expected rate of
productivity growth. The authors define the "true" measure of
total factor productivity growth as a Divisia index of the percent
change in output minus a Divisia index of the percent change in inputs.
While this is a distance measure, the author's exclude a
firm's movement to the frontier. This is at odds with currently
accepted definitions of distance measures of total factor productivity
growth, as implemented by Roll Fare and others, which include such
movement. See for example, Multi-Output Production and Duality: Theory
and Application by Rolf Fare and Dan Primont and references cited
therein. In addition, the authors fail to present a general definition
of input and output distance measures of productivity growth. This would
allow the reader to understand that there are other ways of computing distance measures of growth in total factor productivity which avoid the
strong assumptions of the Divisia index. The remainder of this chapter,
however, provides a useful discussion of other problems in the
calculation of total factor productivity growth and the determination of
price caps by subtracting target levels of productivity growth from the
percent increase in inflation. An alarmingly wide range of productivity
target levels or offsets are employed by different states.
Scott E. Atkinson University of Georgia
