Theory and Practice of Deregulation: the Prevalence of Free Markets - Research Paper Example

The shift of the world economy to the free-market philosophy of economics saw the deregulation of many industries in the past three to four decades. Many public sector firms were bought by private firms and this increased fair competition in the market with prices being decided on the basis of supply and demand of goods rather than government intervention and capping. The utilities sector – which includes natural gas, oil, electricity, water and sewerage – also underwent deregulation in the past few years. The deregulation of utilities refers to those monopolies that were formed in the post-World-War era, which had been granted the ownership and management of some of the largest and most prolific utilities in the country, including electricity, telephone and natural gas. These monopolies, through the deregulation, are to be broken and will be responsible only for the distribution systems and logistical support, going forward (Energyshop.com). The role of deregulation of utilities is to encourage fair competition in the market for the setting of prices, based on the market forces of supply and demand. Competitors do not face barriers to entry and can come and sell their own product bundles based on their pricing models. This is meant to allow consumers more choices of service and product options. Many states have deregulated their utilities sector in the hopes of materializing these very aspirations for their residents. Benefits of Deregulation Available Choices In essence, deregulation breaks monopolies and allows free competition to flourish in the economy. With no over and above checks and balances over the operations of the industry, market forces will take over automatically. This will be fostered by the entrance of new competitors in the industry who will also be able to make justifiable profits. Consumers will also have more options to choose from, suiting their needs and preferences. More choices will also bring prices down. Free Market Economics The preferred way to do business in the democratic, capitalist world is the free market economic model. According to this, the market prices are set by consumers on the basis of their demand, matched with the supply of the producers; this market determined price is supposed to be to the satisfaction of the buyers and the producers. This is characteristic of an unregulated, market-driven economy. In regulated markets, this does not happen as price controls are set by the government or monopolistic competition. To subdue the potential risk of higher prices charged by the company due to less competition and more demand, governments encourage cost-base pricing in such a scenario (Warwick 2002). Having deregulation will allow the setting of price to be on a fairer basis which will lead to happy consumers, lesser inflation and fair competition. New Product, Same Channel Deregulation was intended to provide a better priced product from, in all probability, a new company; however, it was supposed to make use of the same distribution channel (Energyshop.com), the same network of lines and pipes that were used previously. So, in fact, the deregulated market was supposed to provide more options to the consumer, with no inconvenience caused to him at all. Concerns Over Deregulation Stranded Costs With government regulation, the utilities sector had financial support and assistance in the form of subsidies and grants; furthermore, the setting of prices based on needs of the utilities companies allowed them to cover their huge costs of operations. With deregulation of the industry, these companies have been forced to lower their prices for the consumers, which have rendered them incapable of covering their costs. This has led to huge stranded costs for the utilities sector. Stranded costs are defined by the Congressional Budget Office (Cbo.gov 1998) as “the decline in the value of electricity-generating assets due to restructuring of the industry”. The current moot point is whether the utilities companies should be compensated for their stranded costs. Proponents of this view, which make up the utilities companies mostly, say that these are necessary for the very survival of the companies, which would cease to exist if burdened by these astronomical costs. Opponents, contrarily, which are the consumers and rights groups, argue that these companies have enjoyed benefits (cbo.gov) in the regulated market for so many years that they have already be recompensed. This argument has not reached any conclusion yet. Price Instability One of the benefits expected from the deregulation of the utilities industry was cheaper prices for consumers as a result of more competition and more supply. In reality though, the opposite happened. Utility bills for many residents have risen, despite the same level of usage. This is due to the price hikes after the removal of price capping. To curtail this unexpected turn of events, many states are considering reinstating some form of regulation (Davidson 2007). The government is the only entity powerful enough to absorb the extra costs in the provision of utilities; without it, prices can skyrocket without much effort on the part of the suppliers. Fuel Cost Fluctuations The prices of natural fuels including natural gas and oil are extremely unpredictable. They can reach highs and lows depending on the fluctuations in the international commodities market. This has the direct impact on the prices of utilities locally. With government capping, these can be prevented from trickling down to the general public and be absorbed by the government beforehand. Rate of Return on Investment In regulated markets, utilities companies are given the leeway to earn a rate of return on their investment which allows the company to make a profit, given the price of the utility. Through this, the company may also cover its operating expenses and labor costs (Warwick). This also allows retained earnings for the company which is invested back into the company. Inefficient Competition Noticing the benefits that can be achieved by limiting supply and having market-led high prices, many utilities companies have paralyzed effective competition. Davidson writes that wholesale power suppliers have been unable to obtain sufficient financing of late, and have built very few plants. Furthermore, big utilities and their subsidiaries have not invested in the building of transmission lines for acquiring power from other states – this keeps supply tight and prices high. Conclusion Deregulation has worked very well in other industries such a telecommunication and air travel. It has successfully managed to create more competition, better price offerings to consumers and allow the prevalence of free markets. That it hasn’t worked in the utilities sector has more to do with the roadblocks in the industry per se, rather than loopholes in the theory and practice of deregulation. To successfully deregulate the utilities sector, states must aggressively implement strategies for short run price competition. Failure to do this will allow interstate competition to take over the local market as in the long run utilities prices are not as price inelastic as in the short run (Macfie 2008). This will allow competition to be generated locally and more control over prices. Financing options should be easily available to companies and entities interested in investing in the utilities sector. One of the biggest reasons for limited competition creation has been little access to funds; these should be accessible and the capital structures should also be simple enough to leave no room to be misconstrued by the taker (Feldman 2002). These checks will hopefully enable smoother deregulation of the market. Works Cited “About Deregulation & Energyshop.com”. Energyshop.com. n.d. Web 30 April 2011. Davidson, P. “Shocking electricity prices follow deregulation”. USA Today. (2007). 10 Aug 2007. Web. 30 April 2011 “ELECTRIC UTILITIES: DEREGULATION AND STRANDED COSTS”. Congressional Budget Office. 1998. Web. 30 April 2011. Feldman, Roger D. "Doing deals in disheveled deregulating markets." Journal of Structured and Project Finance 8.2 (2002): 13+. General OneFile. Web. 10 Apr. 2011. Macfie, B.. "The Impact of Utility Deregulation in Arizona”. Contemporary Economic Policy. 26.2 (2008): 335-350.  Research Library, ProQuest. Web.  10 Apr. 2011. Warwick, WM. “A Primer on Electric Utilities, Deregulation and Restructuring of U.S. Electricity Markets”. United States Department of Energy. 2002. Web. 30 April 2011. Read More