Deregulation Is Not the Enemy

By the late 20th century, the book on the regulatory state seemed to have been closed. On the economic side, it was deemed to be inefficient, prone to regulatory capture. To further economic growth, neoliberal politicians agreed, it was time to deregulate.

On the environmental side, meanwhile, nearly the opposite held true. Advocates accused deregulatory processes of leading to vast environmental destruction. And so, they maintained, more regulation would be good. With strong rules usually come more stringent enforcement of controls on emissions, pollution, and resource usage, at least in advanced economies where the implementation gaps are relatively small.

Those ideas are evident in President Joe Biden’s approach to environmental protection; on taking office, he ordered a review of more than 100 environmental regulations that his predecessor, Donald Trump, had ended. The new administration’s progress in reinstating these protections has been closely tracked by environmental analysts and criticized by pro-business ones.

But that is not always how the trade-off works. To see why, it is worth comparing deregulation of the power sectors in the United States and China—the two largest carbon-emitting countries in the world, with power sectors that are each country’s second-largest overall source of emissions. Both countries’ experiences show that to reach a net zero-carbon world, deregulation, if steered in the right direction, can be good for the economy and the environment, too.

What Deregulation Is For

In general terms, deregulation refers to the reduction or elimination of government regulations in a particular industry. The process is thought to be good for the economy in several ways. First, it is believed to reduce inefficiencies associated with coercive government policy instruments. For example, in 1978, the US Airline Deregulation Act phased out government control over prices and entry to the air travel market. In a market with price competition, consumers are estimated to have saved over $19 billion dollars per year on airfares ever since.

Second, deregulation is also thought by some to prevent the regulated from manipulating policy to advance their own interests at the expense of consumers. For example, the Trump administration alleged that regulations requiring occupational licenses for hairdressers and interior designers merely served to increase professionals’ wages without providing commensurate health, safety, or quality benefits to consumers.

Third, deregulation is meant to directly lead to greater competition. For the power industry, for example, deregulation typically allows retail customers to receive their electricity from the supplier of their choice, which leads electric utilities to set their prices in competition with rival utilities.

At least that was the stated goal of attempts at deregulation in the United States in the 1990s. As in most Western countries, the US electricity sector has long been a monopoly owned by investors and regulated by state-level public utilities commissions. Those state commissions have made pricing decisions and approved new facilities, among other actions. Over them, the Federal Energy Regulatory Commission (FERC) has dealt with interstate issues. While FERC regulations have been aimed at ensuring fairness, they have also, if misapplied, enabled rent-seeking behavior by utilities, as when the commission based price controls for California utilities on the least-efficient producers’ costs in 2001.

To help reduce US dependence on imported oil, the 1992 federal Energy Policy Act ended many regulations that had prevented open market competition in transmission lines. The measure invited into the energy mix previously excluded suppliers, especially clean energy suppliers, and opened up the possibility for a restructuring of the power sector. Many states responded to this possibility by passing their own legislation aimed at providing consumers with more choice in electricity provider. For example, Texas began to seriously assess the possibility of restructuring its electricity generation and consumption patterns for the long term, which ultimately culminated in a deregulation program launched in 1999 that included goals for steadily increasing the amount of electricity from renewable sources in the state’s energy basket.

In China, the electricity sector has always been owned and operated by the government, with little independent regulatory oversight. What is commonly considered the deregulation of the national grid took place around 2000. The existing centralized power system had proved unable to weather market volatility in the late 1990s, when state-owned enterprises, including those in the power sector, began to incur mounting losses and show greater inefficiencies. As a result, the central government corporatized the power sector. Beijing created the State Power Corporation and a national regulator known as the State Electricity Regulatory Commission. The regulatory commission was never granted the authority to approve, plan, or set rates, however. And key strategic decisions for the electricity sector, including electricity pricing, still rest in the hands of the National Development and Reform Commission (NDRC), China’s main policy planning agency.

Significant subsequent reforms took place in 2002 and 2015. In 2002, the power corporation was split into several generation, grid, and service companies with the aim of further improving efficiency through competition. And the 2015 reforms provided guidelines for enhancing market-based competition, improving regulation of monopolies, and decreasing retail electricity prices while stressing the importance of environmental protection.

Over the past decade, according to the BP Statistical Review of World Energy, an increasing percentage of China’s electricity has been generated from renewable sources such as hydro, wind, nuclear, and solar. Between 2010 and 2020, renewables’ contribution to electricity generation increased from about 20 percent to about 27 percent. Wind saw the most significant increase among renewables.

Texas’s Boom; California’s Bust

Despite the differences in structure and oversight, deregulation of the power sectors in the United States and China achieved many similar goals. Namely, by opening the sectors to some competition, the processes laid the foundation for the integration of renewables into electricity generation. Meanwhile, they made adoption of previously untenable renewable-friendly policies much more possible.

For example, studies have shown that US state governments saw bundling environmental and renewable policy with power sector deregulation as an effective way to pass legislation. The linking of two related issues allowed state legislators to cater to a wider set of constituencies, including pro-market groups and environmental groups pushing for greater adoption of renewables into the grid.

One need look no further than Texas to see how deregulation of the power industry went hand in hand with uplifting renewables—in this case, explicitly, as a way to secure political support from environmentally minded constituencies. The “Restructuring of Electric Utility Industry” Chapter of the 1999 Public Utility Regulatory Act in Texas included provisions for a renewable portfolio standard (RPS)—requirements for a certain percentage of electricity sold by utilities to be generated from renewable sources—and emissions reductions for pollutants such as sulfur dioxide and nitrogen oxides, while also promoting competition and low consumer prices.

To many observers, Texas’s apparent yearning for renewables and environmental improvement came as a surprise. It stood in stark contrast to the state’s long-standing image as big oil country, with a “captured” public utility commission that had shown minimal concern for input from citizens and environmental groups. Yet environmental organizations and citizen groups, with support from some utilities that were already using renewable sources, were able to bundle RPS provisions with deregulatory legislation more popular on the right.

Since the legislation’s passage, Texas has grown to be a national leader in wind energy: in 2020, the state produced 28 percent of all US wind power electricity. According to the US Energy Information Administration, electricity prices across the residential, commercial, and industrial sectors in Texas rose above the national average from 2003 to 2009; but from 2010 to 2020, rates in Texas have been consistently below the national average.

The question remains, though, whether deregulation is anything more than a one-time opportunity for promoting better climate policies. On the one hand, as one study documents, while only 17 US states (34 percent) have pursued deregulation, those states accounted for 61 percent of states that would later adopt an RPS and 89 percent of states that would later adopt cap-and-trade carbon schemes. On the other hand, another study found US states that deregulated their electricity sectors were no more likely than others to adopt a number of other renewable-friendly policies later on.

More well studied is the direct link between energy market deregulation and greater adoption of renewable energy into the grid. One common feature of deregulatory policy packages in the United States is the introduction of retail electricity choice, which allows end-use consumers greater freedom to choose among competing power suppliers. And as energy consumers, including households and corporate clients, have become more attuned to the reality of climate change—be it through personal experience with extreme weather events or education—consumer demand for renewables-based retail electricity has grown.

In fact, in a 2018 Deloitte survey of businesses in the United States, seven out of ten reported that their customers had started demanding greater adoption of renewables in business operations. The same survey also found that only 14 percent of households said they had been offered the option of purchasing renewable energy, meaning there is room for the sector to grow. In an open retail electricity market, power suppliers can take advantage of rising demand by adjusting their portfolios accordingly. Such actions add up. In 2015, out of the 77.9 terawatt-hours (TWh) of renewable power sold to consumers, 15.4 was purchased directly through retail electricity choice.

To be sure, deregulation can go terribly wrong, too. A chilling example is California’s 2000–01 energy crisis when supply and market disruptions caused prolonged rolling blackouts, including the state’s largest planned blackout since World War II. In June 2000, over 100,000 Bay Area commercial and residential customers were left in the dark, and offices of businesses were forced to close. An even larger blackout was ordered months later, affecting 1.5 million consumers across the state. By conservative estimate, the crisis cost California around $40–45 billion, or 3.5 percent of its total annual economic output.

Frank Wolak at Stanford is one of the scholars who diagnosed California’s misadventure as a failure of deregulation without backstops. Factors such as FERC’s ex ante evaluation of whether producers possessed unacceptable market power, an overreliance on short- and medium-term contracts that prohibited stable long-term planning, and a lack of coordination between state and federal regulators led to a prolonged crisis featuring widespread blackouts and collapse of the energy market.

Large energy companies—including, infamously, Enron—took advantage of the weak regulatory environment to engage in market manipulation to the detriment of the state and retail consumers. Several Enron employees were convicted for their activities in California, and Enron collapsed several years later, but not before California paid dearly.

To avoid similar crises in future deregulated markets, policy makers should institutionalize and empower independent regulators to proactively investigate and sanction providers who attempt to “game the system” for their own benefit; they should also conduct thorough reviews to prevent setting rates in excess of established market caps. More broadly, California’s example shows that even if deregulated markets hold the promise of greater efficiency and stronger adoption of renewables into the grid, new guardrails are still needed to ensure that bad actors cannot exploit weaknesses in the system.

Initiatives In China

China’s experience with power sector regulation in the past several decades is distinct from the American approach in several ways, but it offers useful lessons as well. Crucially, rather than the subnational initiatives seen in the United States, where individual states took leading roles in regulating the power sector within their jurisdictions, China has followed a top-down approach. The late 1990s–early 2000s market-based power sector reforms, for example, were spearheaded by central government agencies such as the State Council and the NDRC.

Deregulation facilitated entry into the electricity generation and transmission industries of multiple firms, especially producers overseen by provincial governments, opening up greater opportunities for experimentation and innovation. From 2002 to 2006, the national government pursued the development of regional electricity generation markets. And beginning in 2004, China reformed its retail electricity market, implementing direct transactions between customers and power companies. Arguably, this and other adjustments to the rules opened political room for later reforms in support of market mechanisms for pollution abatement and the deployment of renewable energy.

Thanks to a more deregulated electricity sector, Beijing has also made extensive use of cap-and-trade, a form of regulation relatively new to China, to help steer carbon control in the right direction. In principle, this market-based emissions control mechanism—less coercive than a blanket emissions standard—allows firms to more efficiently distribute the costs of carbon abatement. The current cap-and-trade scheme began as an initiative promoted by the NDRC, which selected several cities and provinces—Beijing, Chongqing, Guangdong, Hubei, Shanghai, Shenzhen, and Tianjin—as sites for pilot carbon markets in 2011. Building upon experience accumulated in those areas, China’s national government then expanded the scope of the carbon market. Today, the country is the world’s largest national carbon market. This approach would likely not have been possible without the space opened by prior deregulatory efforts.

Another new scheme is the adoption of RPS on a national scale, beginning with the 2005 enactment of China’s Renewable Energy Law. While the initial law lacked details, later amendments definitively granted the State Council the authority to devise and implement renewable energy minimums for power-generating entities, with penalties for noncompliance.

Over time, China raised its RPS standards: in 2019, it set a goal to have renewables account for 20 percent of total energy consumption by 2030. In late 2020, President Xi Jinping further raised the bar, pledging to have non-fossil fuel energy sources make up 25 percent of China’s total consumption by 2030. Earlier this year, government documents seen by Reuters indicated that the National Energy Administration plans to increase renewables to 40 percent by 2030, mandating that local grid firms increase their renewable uptake. Arguably, without the reform spirit engendered by the initial wave of power sector deregulation, which disrupted the long-standing status quo in China’s energy sector, the political will to pursue further reforms and regulations to encourage greater adoption of renewables would never have solidified.

Just as in the United States, while deregulation and related new guidance in China can lead to good, they may also lead to undesirable and unintended consequences if implemented without sufficient oversight. Take carbon cap-and-trade as an example. Ahead of the launch of China’s nationwide emissions trading scheme in July 2021, a local environmental protection bureau in Erdos, Inner Mongolia, disclosed a case of false reporting of carbon emissions data. The offending company, Inner Mongolia High-Tech Materials Co., is a power plant and aluminum maker that reportedly tampered with its emissions data for 2019. Upon further disclosure of information related to the case, while the company did not doctor reporting of the carbon content of coal it used, it did change the testing, verification, and reporting dates, possibly to avoid hitting the upper limit of carbon emissions for accounting.

What’s needed, indeed, is institutionalized procedures and standards, so that policy instruments aimed at decarbonization can have their intended consequences. According to Xiao Jianping, the head of the carbon management department at the China Energy Investment Group Co., standards in carbon accounting have been neither precise nor fixed. For instance, the official carbon oxidation rate—the rate at which carbon gets oxidized into carbon dioxide during combustion—has been adjusted three times in just the past three years. That’s a problem. As a reporter summarized Xiao’s explanation, “if the length of the ruler is constantly changing then it is not worth talking about the accuracy of the measurement. If the length of the ruler is fixed and the procedure and standard of measurement are set, then data discrepancy can be minimized.”

China’s experience suggests that earlier deregulatory efforts opened up the political space for reform, too, including adoption of innovative new regulations to more efficiently bring down carbon emissions and encourage more renewable energy within the power grid. The similarity with the American experience, where politicians combined strong renewable incentives with power sector deregulation, suggests that the world’s two largest emitters of carbon dioxide may have far more in common than many realize. While each nation has worked through its own policy making context, their common goal of gaining efficiency through deregulation while simultaneously mitigating climate change through renewables suggests that deregulation can go hand in hand with a net zero-carbon world.

Old Laws Out, New Ones In

To be sure, regulations are still necessary for environmental protection. Their existence and enforcement serve to restrain exploitative behavior and help guard against the worst harm to the commons in a race to the bottom.

But it is also true that deregulation should not always be seen as the enemy. The cases of China and the United States shine a light on the conditions under which deregulation can open the space for environmental progress. When deregulation is coupled with smart new regulations and adequate oversight, it can be a boon to these efforts. Indeed, it appears that deregulation may help clear out unhelpful rules to make room for new ones. As the world comes together to consider new approaches to tackling climate change, then, those most concerned shouldn’t dismiss deregulation out of hand.

Acknowledgments: The author thanks Rand Perry for his outstanding research assistance.