The Political Economy of (De)Regulation: Theory and Evidence from the U.S. Electricity Market

by Carmine Guerriero

The decision to introduce competition into regulated industries is a key issue in economics. Provided that demand is sufficiently inelastic, competition assures lower allocative distortions at the cost of weaker cost-reducing investment incentives via lower profits. Hence, deregulation is more likely where the extent of asymmetric information under regulation is more limited, cost reduction less socially salient and the political power of consumers stronger. This prediction is consistent with U.S. electricity market data. During the 1990s, restructuring was enacted where generation costs were historically lower and politicians had weaker pro-shareholder attitudes. Also, instrumental variables estimates show that restructuring has delivered a medium-term cost-reduction greater than that documented by previous analyses.