“The Knowledge Problem, Learning, and Regulation: How Regulation Affects Technological Change in the Electric Power Industry”
Studies in Emergent Order, Vol. 3 (2010)
The economic regulation of the electricity industry, grounded in neoclassical natural monopoly theory, adapts slowly to exogenous technological change, and creates incentives that stifle endogenous innovation. This maladaptive character of regulatory institutions harms consumers, despite the good intentions of their designers. By erecting entry barriers, by focusing the regulated firm‟s incentives on cost recovery subject to regulatory prudence review, and by specifying the definition and quality of products and services, our existing regulatory institutions stifle the experimentation and social learning that are the outcomes of market processes. This paper focuses on the current smart grid technology investment debates to argue that transactive digital technologies and institutional and market design enable consumers and producers to engage in experimentation and social learning in this industry in ways that were heretofore not feasible, and that such experimentation is welfare enhancing. The case study of the GridWise Olympic Peninsula project illustrates the types of potential benefits that can arise from regulatory change that enables such experimentation.