Price Controls Spark Deja Vu

A debate now rages in California over whether price controls should be adopted to stem the state’s soaring power costs and help consumers who are bracing for huge spikes in their electric bills.

But price controls are one of the most controversial actions in economics--and in politics, for that matter. And now the caps are more in dispute than ever because they run counter to the nation’s move over the last two decades to deregulate more and more industries, from airlines to railroads to energy.

Yet California is a good example of deregulation gone haywire, so controls are again being demanded by lawmakers, consumer advocates and others as a way to check surging prices. On the other side is a chorus of critics who ridicule price caps as being ineffective and, at times, making matters worse for consumers.

Case in point: the Golden State itself, which tried last summer to use temporary price caps to keep a lid on skyrocketing wholesale electricity prices.

Critics claim that the caps drove power sales out of state, thus widening the imbalance between supply and demand, reinforcing the existing shortages and contributing to this winter’s rolling blackouts.

But defenders of the caps note that the dysfunctional California market had no way to self-correct. The utilities couldn’t simply refuse to buy electricity in the face of higher prices, and with no price ceiling in sight, something had to be done.

And now Gov. Gray Davis and others are again calling for temporary controls until more electricity supplies can be added, especially as the state enters the peak-power summer season. On Tuesday, Sens. Dianne Feinstein (D-Calif.) and Gordon Smith (R-Ore.) introduced legislation that would impose price controls on wholesale energy throughout 11 Western states.

Mindful of the controversial history of controls, Feinstein and Smith stressed that the caps would last only through March 1, 2003. But they also argued that the economic damage to industries and consumers from escalating power costs would exceed any harm caused by price controls.

“I have a strong preference for markets, but it’s a mistake to believe that we have a free market when it comes to energy,” said Smith, the only GOP co-sponsor of the legislation.

Their bill would require the Federal Energy Regulatory Commission, which regulates U.S. wholesale electricity prices, either to impose a regional price cap or institute a rate schedule for each power generator, tying the price of electricity to the cost of producing it.

Coincidentally, FERC today is expected to decide on various other proposals to again limit California’s power costs--but without explicitly stating that the plans include price controls. Why? Because the Bush administration and FERC Chairman Curt Hebert Jr., among others, are on the record as adamantly opposing price caps.

That’s not surprising. Price controls often are tagged as a liberal maneuver that flies in the face of conservatives’ free-market ideology. Yet, ironically, hanging over the California debate is the legacy of a Republican president who was the last one to mandate price controls on a nationwide level: Richard M. Nixon.

The late president took that rare step 30 years ago this August to try to quell inflation and spark an economic rebound. His actions were so dramatic that they are still invoked by those wanting to criticize or, in some cases, endorse setting limits on prices.

“What he did is almost larger than life now,” said Shannon Burchett, chief executive of RiskLimited Corp., a strategic consulting firm in Dallas.

Nixon’s controls were the most far-reaching since World War II, when prices were capped so that profiteers couldn’t reap huge sums for scarce commodities being used for the war and simultaneously rationed at home.

In most cases, price controls have been much less sweeping and targeted at specific products or services. They don’t always involve changing the law, either. In 1962, President Kennedy publicly rebuked the then-U.S. Steel Corp. and its chairman, Roger Blough, for starting an industrywide move to raise steel prices. The price hikes were rolled back a few days later.

Since Nixon, price controls have become rarer as industries that were once regulated--which means their prices were government-controlled--have been deregulated.

So it is in California, where electric utilities’ prices were controlled for decades until the state’s deregulation law in 1996. But now that the law has been blamed for the soaring wholesale prices, power shortages, crippled utilities and the need for a huge jump in ratepayers’ costs, some again want price controls on electricity until the crisis eases.

Which brings everyone back to Nixon.

Some Nixon Controls Were Lifted by Reagan

“I’ve heard people make the analogy to what happened . . . when Nixon put on controls,” but in California “this is fundamentally different,” said Mike Florio, a board member of the California Independent System Operator, which oversees most of the state’s electricity grid.

“When you get into a situation of shortage [of supplies], there is really no restraint at all on prices,” said Florio, who said he normally prefers unfettered markets but also defended the state’s caps last summer. Such government intervention “on a temporary basis is better than nothing, but I don’t think it’s ideal.”

The reverberations from Nixon’s fiat aren’t just felt in California either. When New York Mayor Rudolph Giuliani recently proposed more stringent controls on wholesale electricity costs in New York state, critics promptly pointed to Nixon’s controls. “They were a disaster,” one columnist wrote.

Even Federal Reserve Chairman Alan Greenspan, who was in the private sector in the early 1970s, turned down several requests to take high-level White House jobs in part because he was disgusted with Nixon’s price controls.

Many economists and historians also judge Nixon’s controls as a mistake. But some maintain that his decision--which began with a 90-day freeze on prices, wages and rents--wasn’t entirely a failure and even provided “shock value” that, for a while at least, arrested higher inflation.

In addition, part of Nixon’s move involved taking the dollar off the gold standard--which in effect meant its price was controlled--and letting it float in value against other major currencies. And that, many believe, is the base upon which today’s global financial markets operate.

Others disagree.

“There really isn’t an example of where they’ve [price controls] worked,” said Robert Goldberg, a senior fellow at the National Center for Policy Analysis, a nonpartisan think tank in New York.

“Controls always lead to an underproduction” of the commodity involved because producers don’t have any incentive to spend more on additional output, he said. When the caps ultimately are lifted, prices typically soar anyway as producers move to quickly recoup the profit they lost when the controls were in place, Goldberg added.

Others note that although most of Nixon’s price controls lasted only a couple of years, various forms of controls over crude oil and natural gas lasted for another decade until they were removed by President Ronald Reagan.

In the meantime, the controls--aggravated by embargoes and other supply cuts by the Organization of Petroleum Exporting Countries--distorted the free market for energy, critics say. The controls kept U.S. oil prices artificially low, which in turn kept demand for oil high, giving OPEC more power over world production and prices in the 1970s, they contend.

Nonetheless, proponents keep calling for controls when prices for certain items seem to be spiraling out of control.

Critics Say Controls Worsen the Problems

President Clinton’s massive health-reform proposal in the early 1990s included price controls on drugs. But the idea set off howls of protest from the pharmaceutical and biotechnology industries, and ultimately the entire proposal was shelved. Consumer advocates and others also demanded federal controls on rising cable TV rates in 1997 and 1998, again contending that the cable operators were hiking prices at a much faster rate than inflation. Cable firms were allowed to keep passing certain costs on to their subscribers, but specific price caps weren’t enacted.

But proponents of temporary price controls on California power emphasize that electricity isn’t in the same category as an airplane seat, steel or other commodities that don’t have to be bought if the price soars too high.

“In soybeans maybe the market can adjust quickly” to changes in supply and demand, “but in electric generation in California it can’t,” said Florio, who also serves as an attorney for the Utility Reform Network, a consumer group. “For most products, one of the ways prices get determined is if buyers refuse to buy when the price gets too high. But that’s generally not an option for people when it comes to electricity.”

Critics of California’s attempt to cap prices last summer said the controls instead prompted many power suppliers to sell their electricity to other states. That “actually made the tight-supply problem worse [in California] by driving imports out of the state,” the Bay Area Economic Forum, a research group funded by regional business and government agencies, said in a report last week.

Indeed, the temporary caps were basically abandoned by year’s end to keep enough electricity in the state.

Frank Wolak, a Stanford University economics professor who heads the Independent System Operator’s market surveillance committee, said there are ways to mitigate the state’s power prices without having to set rigid controls. One proposal: Have FERC require that generators supply 75% of their expected future sales to California under long-term contracts at “just and reasonable” prices set by the federal agency, he said.

That would “send the right [price] signal to suppliers to come into the state,” Wolak said.

And because it will take time for California to get more of its own power-generating plants up and running, the state’s electricity crisis isn’t unlike a natural disaster in which “normal public service is disrupted” and short-term controls serve a purpose, Florio said.

“Over time, market forces will work” and controls shouldn’t be need, he said. “But does that mean we’re supposed to pay $10,000 per kilowatt-hour until something gets done?”

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Times staff writer Ricardo Alonso-Zaldivar in Washington contributed to this report.

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* RATING DOWNGRADED

Citing California’s power crisis, Standard & Poor’s cut the state’s bond rating by two notches. A1