Interview with the famous Economist

*BIG DOGS EAT FIRST: THE FALSE ECONOMICS OF ELECTRICITY DEREGULATION—AN INTERVIEW WITH DR. EUGENE P. COYLE, ENERGY ECONOMIST*
An Interview with Dr. Eugene P. Coyle, Energy Economist,

Interviewed by Dan Berman, Ph.D., November 28, 2001.

Copyright © 2001 by Dan Berman & Eugene P. Coyle.
San Francisco, October 20, 2001

DB: How did you get interested in public power? It is not a common interest among economists.

EPC: As a young man I was a member – and still am, technically -- a member of the International Brotherhood of Boilermakers, the union that builds power plants. I worked on a couple of power plants being built in New Jersey.

I studied economics in college and then went into the USAF. First as an Aviation Cadet, going through flight school. I went through jet fighter school and later helicopter school.

After the service, and some commercial flying, I worked on Wall Street, picking stocks of utility companies to buy. I worked for Brown Brothers Harriman & Company, a powerful private bank. Prescott Bush, the father of George Bush the First was a partner and a US Senator at the same time. Averill Harriman, Special Ambassador under Kennedy and Johnson, was a partner.

Clients of Brown Brothers owned a lot of stock in utility companies, so I could easily call on the CEOs of utility companies I was considering for investment. Later I went to grad school in economics.

DB: So you talked with the CEOs of utility companies around the United States?

EPC: Yes, and because our clients owned a lot of stock, the officers were quite frank with me. I learned a lot about their strategic thinking at that time. I wrote articles for the bank's investment letters on investment prospects and on the bond market.

The insights I got led me to write my dissertation entitled /THE THEORY OF INVESTMENT OF THE REGULATED* */FIRM*/./* I think it is still the best theoretical work on how regulated utilities behave.

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*/*/*/Interviewed by Dan Berman, Ph. D., co-author (with John T. O’Connor) of WHO OWNS THE SUN? PEOPLE, POLITICS, AND THE STRUGGLE FOR A SOLAR ECONOMY*. *This interview will be posted under “Coyle” at www.publicpowernow.org <http://www.publicpowernow.org/>, an on-line magazine, along with other recent writings and testimony./

DB: Were you always going to pursue the subject of utilities?

EPC: No. My dissertation was really in economic theory -- in the context of electric power. I guess I thought of myself as a micro-economic theorist. But when the first oil crisis hit I called up Sylvia Siegel, to ask her to help me with a project in Berkeley.

DB: Who is Sylvia Siegel?

EPC: Sylvia is the woman who founded TURN, the California group still representing consumers in utility matters. Very witty and a lot of fun. She had great strategic insights and understood the issues at a deep level. She's a genius at media and communications. She's retired now.

DB: Did she help you with your project?

EPC: Anybody who knows Sylvia knows I ended up helping her, rather than the other way around. I worked with her at TURN, which at that time was really just Sylvia and a post office box.

I knew as much about utilities as anybody in the country outside of the utilities themselves at that time, and of course the energy crisis made that a hot area. My work on the first California rate case of that era, in 1974, was the economic piece of getting the CPUC to adopt what are now called "Baseline rates." I quickly became well known around the US and that launched my consulting career.

DB: When you finished your Ph.D. at Boston College, where did you go to work?

EPC: What I learned at my first teaching job is really an important part of my education. I taught at a Catholic women's college in Boston, Emmanuel College. I had just learned all the elegant theory that every other micro-econ student learns. I was a little older than the typical new Ph.D. because I'd worked on Wall Street, been in the service, and flown as a commercial pilot for a couple of years.

I loved the elegance of the theory, but because I'd seen a lot of the world, working with the Boilermakers, in the Air Force in Asia and flying in South America, I knew the theory didn't have much relevance to the economy. But that kind of economics was all I had been taught, all I knew.

I started teaching these very bright women what I had been taught. I was drawing the curves on the blackboard like every other economist is still doing, After a few weeks of class the students -- this was at the time of the Vietnam War and the Civil Rights struggles -- the students said "We are not willing to listen to this stuff. We want to learn about the economy." Students were very militant around Boston in those days and I was in big trouble. I said, "Well, gee, this is all I know." Me with a Ph.D.! And the students very generously said, "Well, if that's all you know, you can do that; but let's see if we can learn something about the economy too." And so I embarked on learning economics. My dissertation was an attempt to move in the right direction, but without those women I might never have broken away from the economics with no content still taught in every economics department.

DB: You just wrote a fascinating study called /PRICE DISCRIMINATION, ELECTRONIC REDLINING AND PRICE FIXING IN DERGEULATION ELECTRIC POWER/. You say that electric deregulation can't work for small businesses and residential consumers. Can you explain why?

EPC: Electric power has a cost structure that makes it different from some other industries. There is a huge upfront cost to building a power plant. A large new power plant is hundreds of millions of dollars. Once you've laid out that kind of money, you have to run that plant full time and sell as much as you can. You sell as much as possible at a high price and then to keep the plant running full tilt you sell at a lower price to everyone else. By selling all the output possible -- we call it running at a high capacity factor -- you can spread the fixed costs of the plant over the maximum number of kilowatt -hours.

It is what the airlines do -- sell the business customers high-priced tickets and then fill the plane with leisure travellers for whatever they will pay. Even a few dollars is better than getting nothing from an empty seat. It is the cost structure that makes them do that. If the plane leaves the gate with an empty seat they'll get nothing. They are better off selling a vacationer a cheap ticket -- as long as they can keep the business flyer from getting the cheap ticket too.

You see the pharmaceutical companies doing the same thing right now. They spend a lot on research but actually manufacturing the pill costs almost nothing. They sell AIDS drugs here for $10,000 per patient per year. It only costs them maybe 50 cents to make that pill. So the cost of a daily pill, is 365 times 50 cents, or $182.50, rather than $10,000.00.

But in Brazil and South Africa the governments said "Wait a minute. People are dying. We can make the stuff ourselves for 50 cents per day per patient, the formula is in the literature." The drug companies were under heavy pressure, both political and moral. They agreed to sell at a lower price as long as the governments didn't break their patents. The only thing they wanted to be sure of was that the low-priced AIDS drugs from Brazil didn't get back here to undercut their market.

And the anthrax scare brings out another example. Bayer, the manufacturer of Cipro, was charging a high price. Canada said "Ok, we'll ignore the patent and let a generic company supply us." Then the U.S. made similar threats and Bayer cut the price almost in half. It was better for Bayer to do that then have the whole patent system go down. Now the rest of the world is asking the United States why it was so tough in helping the drug companies against Brazil and South Africa and quickly changed positions when it needed cheap Cipro.

DB: I want to be sure to understand you. Tie this back to electricity for me.

EPC: Well, an unregulated power plant has to find enough of a market in order to run at a high capacity factor. Let's say it spreads the total costs equally over each unit of sales -- selling at what we call the average cost of production. It might not get enough sales at that price to run at full capacity. If it fell short, then each unit would have to be priced even higher, to spread the overhead costs. The better way is what the airlines have been doing. Find some customers to pay more than the average price, and then fill out the sales to somebody else who will fly only if the price is low.

DB Ok, but with the airlines the small customer gets the breaks. Why won't that happen in electricity?

EPC With the airlines the business customer has to make the trip and doesn't want to be on the road over the weekend. That's why the airlines required a Saturday night stay. Leisure travelers will fly if the price is attractive, but can always choose to drive or stay home if the price seems too high.

In electricity it’s the other way around. Electricity is a necessity for the small business and residential customers; and they have limited options to generate their own power, to switch fuels, and so on. They are captive customers. The big customers have some options such as switching fuels, or building their own power plant. So the small customers will be gouged and the big customers will get the low prices.

It isn't that the airlines like small customers better and give them a break. And it isn't that power plant owners are just out to gouge small customers. Each of them is driven by cost structure and by what economists call the customer's elasticity of demand.

DB So you are saying that no matter what else restructuring does, small business and residential customers are going to be hurt.

EPC Yes, there is no way around it. To be profitable they will have to discriminate, and the target of the price discrimination will be customers who don't have alternatives.

DB The experience of California in the last year and a half seems to indicate that there is something dreadfully wrong with restructuring. I mean besides discrimination against small customers. How would you fix that?

EPC Electricity is an industry which has to be regulated in some way. Besides the cost structure problem, which itself is a major one for an industry providing an essential service, there are the issues of reliability and safety. The market doesn't ensure that there will be enough generating capacity to serve the public. The market doesn't do what the public wants with respect to clean energy. For both reliability and green or clean power this industry has to be planned. For safety they can't be allowed to keep cutting jobs.

DB Don't unregulated businesses plan?

EPC They plan, but in the interest of the owners, not the public interest. In terms of electric reliability it is in the owner's interest to be short of capacity, to keep the price high, so reliability is threatened.

We are not going to get reliable power, we're not going to get clean power, we're not going to get green power unless it's through public ownership or strong regulation.

DB Most economists seemed to me to be in favor of deregulation. They believe in the market and think it will fix everything, not just electricity. Isn't that the conventional wisdom among the big name economists? Are they paid off by people who hope to make a fortune from deregulated electricity?

EPC It is actually much worse than that. Of course there is a lot of money to be made by consulting for companies pushing deregulation but the problem is much more serious than that. Economists are trained to believe only one thing, which is that if you let the market set the price everybody will be better off.

The problem is deep in the universities, where the belief in the market is passed on in spite of the obvious flaws that we see everyday. Poverty, pollution, homelessness, racial discrimination, lower pay for women. Economists are trained to say, and worse, to believe, that you can assume that those problems aren't related to the economy.

This summer there was a paper given at Jackson Hole, Wyoming, where all the highest muck-a-mucks of finance and economics gather every year to discuss the world's problems. Two of the biggest names in economics wrote a paper together where they said the market does a magnificent job of producing economic welfare. They put in parenthesis "(if the initial distribution of wealth is satisfactory)". That is a mighty big "if." We know most of the wealth in this country is concentrated in very few hands, and that many have little or nothing in terms of assets. Many families have negative net worth, and even people who own their homes might owe more on credit cards than the equity in the house. But economists assume that we all are on a par. Then they can show, with equations and graphs, that the market works.

That Jackson Hole paper is just a handy example. It is more than you usually get in plain language from an economist. But economists make many more assumptions that also fly in the face of reality. And those assumptions are key to their beliefs.

DB I hear rumors about some of the stars getting $5,000 for a speech at a luncheon. Don't you think that influences them?

EPC Well, all the big consulting money comes from the big players. But I think there is a more important problem with economists. Most of them will say the market works better than public regulation, public planning, public control. And they are taught that, and in turn teach the next generation.

DB If the economics is so wrong, why aren't they challenged?

EPC They are. Some really big names have come out with serious challenges over the years -- John Maynard Keynes, John Maurice Clark, some real purists out of the University of Chicago. It doesn't make a dent. It is partly the same problem that I had when my students challenged me -- I didn't know what else to say. But the biggest thing is that the economics departments in our leading universities -- and all the ones with less prestige that follow along -- the departments drive out dissent. They only teach one school of economics, what is called "marginalism" or "neo-classical" economics.

There is currently a big student revolt in France which has the government looking at what is taught in economics. Now it is spreading to other countries. 27 Ph.D. candidates at Cambridge University in England wrote a letter demanding a wider view of the world. I think the fact that the 27 students put their letter out anonymously says a lot about the state of things. This student revolt is spreading world wide. They are demanding a new economics which they very descriptively call "Post-Autistic Economics."

DB Well, if big name economists point out the flaws, as you are claiming, why don't the flaws get corrected? Why do we have to have_ One Market Under God_, to use the title of the recent book by Thomas Frank?

EPC I read a very clear explanation of that recently, I think it was in the latest "Post-Autistic Economics" newsletter. Someone was quoted as saying that economists keep two sets of books. One set is for students, journalists and legislators where the economists talk about perfect competition and the glories of the market. The other set is used when they are challenged, and they say, "Yes, we know there isn't perfect competition, we know the wealth isn't distributed fairly, there are flaws in the analysis, but we are writing articles about all that." They are always giving bad advice but then claim that in "rigorous scholarship" they get it right.

It leads to bad policy and provides cover for politicians intent on doing the wrong thing. But that's what’s going on in the leading universities. And almost all the rest.

Let me just add one thing. The effect of this sort of economics in our graduate schools drives out the best students. The best students think "This isn't about the economy, this isn't why I wanted to learn economics." And they leave economics. The students who get caught up in the elegance of the theory, no matter how irrelevant to people and the economy -- they stay and become professors. So it gets perpetuated, generation after generation. I got caught up in that elegance myself but luckily got free of it, as I talked about earlier.

DB So you are thanking those brilliant young Catholic women at Emmanuel College in Boston for helping you break out of that strait-jacket?

EPC Yes, they straightened me out.

DB It seems to me that the question of cost structure of electric power is the key to how your analysis differs from a lot of the economists who extol the market, who pray to the God of the market. Is that right?

EPC Yes, it is a key part of it. I think on Wall Street people look at actual industries and how they operate. Economists look at curves and think about how companies would operate if the companies conformed to the curves.

DB Are you the first person to see the importance of cost structure?

EPC Wow! No, I'm just copying a century of famous economists who have understood this.

DB Well who are these, and if they are so famous why doesn't that get taught in the universities?

EPC You went to Yale University didn't you? We can go back to an economist who became the president of Yale University in the early part of the 20^th Century, A. T. Hadley. There were others before him, but he was a prominent American. In the 1920s John Maurice Clark of Columbia University, and a leading economist, wrote a very well known book, _Studies in the Economics of Overhead Costs_. I mentioned Keynes earlier. In my own monograph I cited Lester Telser of the University of Chicago and a bunch of economists following him who are active right now. And then I mentioned before a paper given at Jackson Hole this year. That was by Larry Summers, former Secretary of the Treasury and now the President of Harvard and Brad DeLong of UC Berkeley. It's amusing that the President of Yale discovered this in 1896 and the President of Harvard re-discovered it in 2001.

DB OK, so there's a long list, a long history of economists that you've learned from. But why isn't this taught in the universities?

EPC Well, that's a very complex question in the history of economics. But I think the main reason is that it cuts the legs right out from under worship of the market. It smashes the idol in the temple.

DB Go back to that Jackson Hole paper you've mentioned a couple of times. Was that about electric power?

EPC Summers and DeLong, the authors, described in the paper what people are calling "the _new_ natural monopolies." Stress on the word "new." They want to talk about how industries like pharmaceuticals and software have to have a monopoly to be profitable. It is the cost structure of drug and software companies that they rely on for the conclusion. Those industries have large costs up front -- overhead costs, or fixed costs --- which put them in the category of "new natural monopolies." But that's the same cost structure that is the reason for the old natural monopolies -- like electric power. But to answer your question, they never mention electric power.

DB So your argument is that electric generation is still a natural monopoly because of its cost structure, and because of that it needs to be publicly controlled, either through public ownership or regulation. Have I got that right?

EPC Yes.

DB Let's talk about public ownership for a minute. I happened to have a discussion on KPFA with Severin Borenstein of the University of California Energy Institute. And I brought up the fact that in 1998 the 18 public power entities in Northern California sold $1.5 billion worth of electricity for an average price of 7.64 cents per kilowatt-hour. PG&E sold $7.0 billion worth of electricity at 9.29 cents per kilowatt-hour. I ran this number by professor Borenstein and asked him "Do you study this phenomenon? Do you study the fact that public power entities, which are democratically governed, actually deliver power for a lower price? And do you work that into your theoretical model?

And he replied "We don't study that."

A month or two later, in the spring of 2001, he gave a talk at the California Public Utilities Commission. He was asked the same questions and once again he said it wasn't something his Institute studied, and that perhaps this was a discussion for another time.

I'm wondering how we break into this closed system with what we are calling our "new" paradigm, which is really as old as the hills? Do you have any suggestions?

EPC I think the solution is political. Electric power, because it is a necessity for modern life, is a political problem for the public. Bills are going up, service is getting poorer, reliability is down. People have to run grassroots campaigns, all over the country, to either get regulation back in place or form new public power utilities. To do both really. We can't expect economists and the universities to lay out an analysis to get there. It is time for people to express what they want -- cheap, clean, reliable electricity.