Heskett Column - Have We Overdone Deregulation and Privatization?

During the Jimmy Carter administration, Congress enacted legislation that had become known as "the Federal Express bill." It was designed to test the idea of deregulation by allowing air freight carriers to fly planes of any size on any routes, without federal price controls.

The bill accommodated the persistent lobbying activities of one Fred Smith, the young CEO of Federal Express, who had been required under previous regulation to use small, inefficient aircraft to transport freight or else submit to stringent government regulation. It was regarded by Congress as an experiment carried out in a small, obscure industry which, if unsuccessful, would have little economic impact.

Little did Congress realize that true believers in deregulation, like Alfred Kahn, a Cornell economics professor whom Carter had appointed as chairman of the Civil Aeronautics Board, would champion the extension of the idea to the entire airline industry, and then into areas such as brokerage fees and other professional services.

In recent years, the deregulation movement has spread to industries with which consumers interact daily, such as electric power and telephone service, whose dependability and equitable pricing were generally left to government and not thought much about.

There seems to be an increasing feeling among consumers that much of this ended with the deregulation and privatization of these industries. According to neocritics of deregulation, for example, we are confronted with a melange of telephone and electric service "deals" with a confusing array of prices. We are confronted with the possibility that those doing their homework are receiving better service and lower prices than we are, that equitable pricing may no longer exist. We can't even make sense of the bills we receive for such services. We are forced to think about something that we used to take for granted.

A recent study by the research firm Yankelovich Partners suggests that, while consumers generally want more control over their lives and purchasing decisions, there are some things (electric power and telephone service among them) that they just don't want to have to study or worry about. Life is already complex enough.

Willis Emmons of the Georgetown University faculty and author of a new book, The Evolving Bargain (HBS Press), has spent several years studying the implications for managers of deregulation and privatization. He maintains that the impact on consumers is complex. Sometimes consumers are winners and sometimes losers. And sometimes they're both, as in the case of lower prices for air travel of inferior quality "on many dimensions."

In spite of the facts, can we expect mischievous consumer-driven backlash for any idea that rewards those who take initiative? Is deregulated service really inferior? If so, by what measures? Have we such short memories that we have forgotten what it was like before deregulation? Or have we gone too far, requiring consumers to spend far too much time trying to figure out the system, let alone obtaining services that best meet their needs?

As a consultant to the utility industry, I believe in the long-term advantages of deregulation. However, the economists and regulators seem to ignore the short-term dislocations, which can/will occur in industries with daily service obligations that also have long response-time requirements to add new capacity. Electric service in particular is being deregulated, with poor attention to potential disruptions in service and dislocations in price; witness the California experience. Other jurisdictions that deregulated electric service, such as Australia and England, have seen significant drops in prices. That will be the case in some states in the U.S., but not so in others where prices may actually increase. Your note that some consumers want choice for utility service, while many do not care at all, is confirmed by our experience.

It is true that from the consumer's perspective, the benefits of deregulation may not be intuitively obvious, especially with the hassle factor of making sense of various offers and confusing bill formats. However, deregulation of the electric industry has yielded some tangible indirect benefits to consumers. Deregulation agreements in opening markets came with rate reductions, an indication that there was fat to be drummed out of a cost-based regulated system. The opening of both wholesale and retail markets has led to increased merger and acquisition activity. With that activity comes substantial synergy savings, much of which has come from improved business processes and consolidation of information technology systems. Some regions of the country, Illinois and New England in particular, have experienced an increase in capacity, with new, more efficient, and less polluting power generation. Finally, as large consumers of electricity are faced with pricing that moves with the market, there is a greater emphasis on new approaches to managing consumption, such as distributed generation and price responsive load. The technology infrastructure to support these approaches is beginning to gel. This can only make for more efficient management of demand, which benefits all consumers.

Residential and small commercial customers will only save money in the deregulated market if they can change their behavior in response to hourly changes in the price of energy. It's unlikely in the near future that technology will be in place for most people to do this, nor will they want to spend the time in front of a computer screen looking at their consumption patterns. Instead, the mass market customers will most likely sign on with suppliers that will be able to follow the market and get the best prices for their customers.

As a consultant to the deregulating energy industries as well as a consumer of many of the offerings of deregulating industries, I believe that properly implemented deregulation is beneficial to consumers. That, however, is a very loaded statement, because proper implementation is potentially difficult and costly. Moreover, the people responsible for setting deregulation policy — including many on the leading edge of its implementation — lack experience in the dynamics of a deregulating industry. Looking with the benefit of hindsight at deregulation in the electric industry, for example, I have to question why the wholesale markets were deregulated before the retail markets. My only answer is that it was considered easier to implement. The experience in California suggests to me that, by deregulating wholesale markets first, the policy makers and the resulting rules lost sight of the fundamental purpose of deregulation. The result: a few big companies that figured out how to game the rules profited enormously, while everyone else suffers.

On the whole, deregulation has not gone far enough. The recent electrical shortage in California demonstrates some of the liabilities of a half-hearted approach. On the other hand, while the tremendous benefits of deregulation are not often obvious, the confusion among consumers is.

The government could play a much more valuable role in providing information to consumers. A centralized location that provided meaningful comparison information in a deregulated industry would bridge that gap.

By deregulating these industries, you set them upon the free market, the original idea behind capitalism and this country.

The free market, under pure capitalism (with no regulation), is self-correcting. (The transition period may be a bumpy road, however.) If the consumers feel they are not being treated fairly or think they can get a better deal elsewhere, they will go to that company. The businesses that overcharge, produce inferior quality, and altogether have bad value will be forced out of business in a short time by the free market. People will take their dollars elsewhere. Only those companies that treat the public with fairness, honesty, and offer a good overall value will survive. No regulation or government oversight is needed at all.

Please tell me if I am wrong here, and why.

The issue of confusing bills in utilities has been solved in other countries by a simple regulation: utilities and telcos have to submit the average rate charged per kWh, cubic foot, impulse, etc., in each bill. This makes comparison easy, even for customers whose mathematics skills aren't honed.

Quality has been taken care of via fines for downtime and reflect mostly on the asset management services of the value chain [sic].

However, it's clear that services such as airlines, which have many more dimensions than utilities, are much more difficult to compare.

I'd specifically like to respond to Dr. Emmons's observations on the airline industry.

The quality of service in the airline industry (or any privatized industry, for that matter) is caused by the wants and needs of consumers. The main variable driving consumers' decisions when choosing an airline is price. If consumers were willing to pay for higher airline quality, we would most likely see the airline industry structured like other industries, with some airlines providing better quality (more space, etc.) to consumers who are willing to pay for it, and other airlines operating like the industry does today (less quality, lower prices). The fact that the industry is not structured like this is evidence that consumers, despite their complaints, really aren't willing to pay for better quality.

The fact that airports have not been privatized is what causes most of the delays and inconveniences that consumers experience. There is obviously an imbalance in the supply and demand forces with regard to our airports. The market forces that cause a normal industry to expand its capacity are not at work in our airports. Private industry tends to correct such imbalances (because there is money to be made), whereas publicly owned or heavily regulated industries do not.