Electricity Restructuring,
Innovation, and Efficiency

by Julie Fox Gorte and Tina Kaarsberg

Efforts to deregulate this nation's electric power generation and to restructure its utility sector almost certainly will spark significant changes in the technologies used for electricity generation. Today's dominant generation technology is based on the steam turbine, which is no more efficient today than it was in the early 1960s. (See Figure 1.) Early deregulation efforts already are advancing a wave of innovative technologies that boost efficiency, increase productivity, and reduce pollution. Yet deregulation is a necessary but insufficient step for achieving ongoing innovation in the electricity industry. Policies that remove other barriers to competition are needed too.

Monopoly regulation of electric utilities -- like regulation in a host of other industries, including air travel, surface freight, and telecommunications -- stifled innovation. Yet other factors also played a role, including an oversupply of electric generation capacity in the 1980s and 1990s, and the Clean Air Act's failure to have the oldest and dirtiest electric generating plants comply with new source performance standards for air pollution. Innovation also has been stifled by restrictive interconnection standards, environmental permitting procedures, and equipment depreciation schedules.

Much of the motivation behind recent efforts to deregulate or restructure U.S. utilities is to permit competition from innovative and efficient technologies. For example, gas turbine efficiency exceeded the steam turbine's average in the 1980s and has continued to improve. These advanced turbines -- which are available and economically competitive -- also lower greenhouse gas emissions by 40-80 percent. It is widely expected that deregulation will spark a significant expansion in U.S. electric generating capacity based on advanced gas turbines -- both simple cycle and combined cycle. According to the Energy Information Administration, 70-90+ percent of power plant capacity planned between now and 2006 is gas fired. (See Figure 2.)

Yet restructuring electric utilities will not necessarily create a competitive landscape that rewards continued innovation. Although most analysts expect a deregulation-inspired wave of new gas capacity, based on a host of turbine technologies developed over the last few decades, the electricity industry's continuing capacity to innovate is not clear. Experience from deregulating other regulated industries, as well as from privatizing and restructuring British utilities, suggests that the capacity for sustained innovation actually may be impaired if R&D is cut in response to restructuring -- unless steps are explicitly taken to remove other barriers to technological progress.

Sustained innovation is critical if the U.S. is to achieve economic growth and raise its standard of living. Technological advancements in electricity production also are essential to reduce emissions of air pollutants and carbon dioxide emissions, the primary contributor to climate change.

Introduction

U.S. electric utilities, under monopoly regulation, have had little incentive to take advantage of technological advances, and their fuel efficiency has remained at about 30 percent, meaning that U.S. electric generators throw away more energy than Japan consumes. In contrast, new commercial electric generating systems achieve efficiencies approaching 70 percent (or more than 90 percent when waste heat also is recovered).

New technologies also reduce pollution. The production of electricity and thermal energy, using primarily fossil fuels, accounts for one-third of U.S. carbon dioxide emissions. Another third comes from production of thermal energy, and roughly half of that amount could be supplied by heat discarded by the electric industry. Unlike the regulated pollutants that can be scrubbed from power plant smokestacks, the only known way to reduce net carbon dioxide emissions from electricity production is to burn less fossil fuel, which more efficient generation technologies can accomplish.

At the dawn of 20^th century, a new filament constructed of tungsten produced an incandescent lamp preferable to a flame, and the dramatic growth of the U.S. electric industry began. The cost of a kilowatt-hour from a central power station dropped from 22 cents in 1892 to only 7 cents by 1922. Today, the electricity sector is one of the nation's largest industries, accounting in 1997 for nearly $170 billion of gross domestic product.

Early competition in the electric industry sparked a technological and business revolution. But the unregulated electricity market began to show strains. A customer moving across the street often found that his electrical appliances no longer worked. Electricity entrepreneurs eventually began to merge and consolidate, as well as develop questionable relationships with local officials. Georgia, New York, and Wisconsin responded to these concerns in 1907 by establishing state public service commissions that began to regulate electric utilities. Twenty more states followed quickly, and electric companies became integrated monopolies -- generating, transmitting, and distributing electricity to consumers in their exclusive service territories. For some 60 years, these utilities provided reliable power in exchange for guaranteed returns on their investments.

Competition began to reemerge with the passage of the Public Utilities Regulatory Policy Act of 1978 (PURPA) which enabled cogenerators and renewable electricity generators to sell electricity to regulated utilities. In the mid-1980s, deregulation of the natural gas market lowered the price and increased the availability of that relatively clean fuel. Finally, the Energy Policy Act of 1992 (EPACT) and subsequent rulings by the Federal Energy Regulatory Commission allowed unregulated independent power producers and wholesale customers to obtain electricity from distant utilities. Non-utility production almost doubled from 1990 to 1996, and it now contributes some 7 percent of U.S. electricity.

Within the last few years, 16 states have enacted restructuring legislation to advance retail competition, and almost all states are considering the issue; as of April 1999, only two states have taken no significant action on restructuring. Several lawmakers have introduced federal legislation to advance retail competition and to assure reciprocity among the states. In April 1999, the Clinton Administration unveiled its own federal restructuring plan which it estimated would save American consumers $232 per household each year.

Most of the debate about utility restructuring has focused on two issues: when to impose retail competition, and whom to charge for the "stranded costs" of utility investments, such as expensive nuclear power plants, that will not be recoverable in a competitive market. The strategies proposed for dealing with these issues vary dramatically. Utilities argue that current customers no longer wanting to buy electricity from them should pay an exit fee in order to help the power companies recover their stranded costs. Independent power producers and others, in contrast, maintain that utilities could pay for stranded costs by improving the efficiency of their operations.

How stranded costs are recovered has a great deal to do with how innovative a restructured electric utility sector will be. High exit fees to those wanting to switch utility services will discourage competition and inhibit introduction of new technologies, since many of the more revolutionary advances in technology are likely to come from enterprises that are not now electric generators. Yet there are numerous other issues in the restructuring debate that will affect the industry's capacity to use new technologies and achieve lower emissions, including interconnections with the grid, utilities' dealings with affiliates, cumbersome permitting processes, lengthy depreciation schedules, and consumer disclosure. If not resolved, such issues threaten to create substantial barriers to the deployment of innovative and efficient electric generating equipment, which will inhibit the nation's ability to cut energy costs and utility-related emissions.

Surprisingly little of the policy discussion -- either in the states or Washington -- has focused on how to restructure this giant and critical industry in ways that spur technological innovation.

Innovation in America

Innovation defines America. It is difficult to name a major technological advancement made over the past half-century that hasn't been shaped in some significant way by a U.S. inventor, enterprise, or corporation. Our nation's system of innovation--its entrepreneurial traditions, scientific prowess, well-developed angel and venture capital sectors, and market system--is more conducive to innovation than any other national system in the world. American universities provide technical and scientific education that draw students from all over the globe, especially in science and engineering, and they grant nearly half of all doctorates in mathematics, computer science, and engineering. The United States accounts for almost half of all research and development done in OECD nations. It long has been a net exporter of scientific knowledge, engineering know-how, and information.

Innovation is quite difficult to measure, but by using proxies, economists have estimated that technological innovation has very high rates of return -- on the order of 20 to 30 percent for firms, and 50 to 100 percent for the nation as a whole. Such statistics might inspire the belief that investments in innovation are even more robust than they are, however. For any individual or single enterprise, innovation can be a precarious investment, carrying both technical and financial risks. While the rewards of successful innovations often are quite generous, it is also true that most innovations never reach the market, and the majority of those that do wither before achieving financial success. Competition is a harsh taskmaster for inventions, but it has been proven repeatedly to be superior to command-and-control economic regimes at rewarding innovation and encouraging entrepreneurship.

Changing technology is widely regarded as one of the principal factors behind utility restructuring, or deregulation, in the United States. The U.S. Energy Information Administration, in a summary of issues involved in restructuring, states, "[A]dvances in power generation technology, perceived inefficiencies in the industry, large variations in regional electricity prices, and the trend to competitive markets in other regulated industries have all contributed to the transition." As of April 1999, 16 states have enacted restructuring legislation, four have issued comprehensive regulatory orders, four have legislation or regulatory orders pending, and 24 are investigating the issue, as is the District of Columbia. Only two states (Florida and South Dakota) have no current activity in electricity restructuring. So far, however, few states have addressed how to assure that new, more efficient technologies can compete fairly with established technologies and companies.

Of course, the fundamental reason for deregulation (at least in the United States) is to reduce costs and prices. Improved thermodynamic efficiency is only one way to get there; improved business efficiency is another. But technological innovation in the business of producing electricity is one of the most effective means to keeping costs low in the long run, and deregulation efforts in other industries have proven it. Since the late 1970s, several industries have been substantially deregulated: surface freight (rail and trucks), airlines, natural gas, cable TV, and long distance telecommunications. In some cases, deregulation has been episodic (cable was reregulated in the early 1990s, and then again deregulated in 1999) or partial (local telecommunications remains regulated), but deregulatory efforts are proceeding, and deregulated industries are adjusting to the new landscape of competition. Although the process of adjustment can take a decade or more, in nearly every case prices and costs have come down and efficiency has gone up.

Another hallmark, often quite a spectacular one, has been the adoption (and in some cases, development) of new, more efficient, multifunctional technology. The explosion of technological choices in telecommunications, which has been only partially opened to competition, is perhaps the best example. Yet there also have been revolutionary changes in the airline and surface freight industries, such as the adoption of hub-and-spoke traffic routing. Similarly, electric utility restructuring could be accompanied by substantially increased productivity, lower prices, and deployment of efficient new technologies -- at least initially.

The environmental consequences of electricity production will depend heavily on policies and rules that have yet to be implemented (or, in some cases, written). Predictions of outcomes differ widely in both magnitude and direction. No doubt the widespread adoption of new electric generating technologies will improve the efficiency of production, measured by electrical output per unit of fuel input. Since fuel is the largest single cost component in electricity production, this change alone ought to reduce production costs, and probably lower emissions per unit of electricity generated. Whether this adoption results in lower emissions in general, or in the areas with the worst air pollution problems, depends greatly on how rapidly new technologies are adopted, how much electricity prices change, and how companies position themselves in the restructured market. Some environmentalists worry that a significant drop in prices could result in a rebound of electricity demand, which could end up raising, rather than lowering, emissions.

Such increased demand could be met by today's least expensive generators, which often are older coal-fired plants. Their high emissions of air pollution were exempted from provisions of the Clean Air Act of 1970 that required all new power plants to meet strict control regulations. Seventy-seven percent of U.S. fossil-fuel-powered plants are "grandfathered." Today's average fossil fuel plant began operation in 1964, and one-fifth are more than 50 years old. New plants are much more efficient and cleaner, but capacity additions have not come rapidly. Planned new capacity -- about 40 gigawatts -- amounts to only about 6 percent of existing capacity in the decade between 1998 and 2007 (or 0.6 percent per year).

Achieving the goals set by the Kyoto Convention will require the development and adoption of innovations across all sectors of the economy. Still, more efficient electricity production has a substantial contribution to make -- and without it, the burden of reducing emissions will fall much more heavily everywhere else. The rules of restructuring will have a great deal to do with the incentives for more efficient, cleaner production of electricity.

Innovation and the State of U.S. Electric Utilities

We have no good measures of innovativeness. Instead, we employ proxies -- productivity growth, capital investment rates, research and development intensity, patenting and patent citations -- that, in combination with more qualitative information, can give a fair picture of the relative competence of any sector in developing and deploying new technology.

The most common measures of innovation are research and development expenditure and R&D intensity (research and development expenditures as a percentage of net sales). R&D, it should be noted, is a much better proxy for the ability to deploy new innovations in the future -- five to 50 years from now -- than for the likelihood that today's new technologies will be diffused. Using this measure, however, shows that electric utilities and gas companies are not very innovative. Among companies performing research and development, the utility industry's R&D intensity also was meager -- 0.2 percent, and declining. This rate compares with an all-industry average of 3.4 percent, and 3.6 percent in R&D-performing manufacturing industries. (It should be noted that this is not a completely fair comparison since electric and gas utilities are reported in a category that also includes sanitary services, which may be even less R&D-intensive.) Moreover, much of the R&D that contributes to the efficiency of electricity production is done by manufacturers -- for instance, work on combined-cycle gas turbines and microturbines is done in the machinery industry, which has an R&D intensity of over 5 percent.

Other measures, however, confirm that utilities suffer a slow pace of technological change. One is the stagnation of efficiency in electricity production. (See Figure 1.) For the first half of the 20th century, the efficiency of electricity generation technology improved steadily, from below 10 percent at the turn of the century for small units (5 megawatts) to about 35 percent in the mid-1950s for 300-megawatt units. Since then, however, there has been very little improvement in fuel efficiency, although the industry's productivity continued to grow in the mid-1970s as the size of state-of-the-art steam units increased to over 1,000 megawatts.

Although more efficient technologies began to appear in the 1970s, the energy shocks, and the resulting demand-side energy efficiency measures that the nation undertook, led to a large bubble of overcapacity in electric generation in the early 1980s. Finally, the Clean Air Act's grandfathering clause allowed a generation of relatively dirty coal-fired power plants to continue operating, while new plants were subject to more stringent performance regulations. The result of all these factors was very little investment in new technologies throughout the 1980s and 1990s.

Productivity growth is another poor proxy for innovation, though it is related. Gas and electric utilities compare fairly well to all private business in multifactor productivity growth (see Figure 3), but utility productivity has leveled off after 1974. Productivity slowed down throughout the U.S. economy in the 1970s and 1980s, but it plateaued more emphatically for utilities than for most other private businesses, and certainly for manufacturers.

No good statistical series measures effectively the utility industry's output of innovations, or the pace of innovation. However, it is almost axiomatic that there is little incentive for innovation in the absence of significant competition. Large firms with stable shares of mature markets, moreover, rarely initiate radical technological development, or provide incentives for their employees to undertake such development.

Two researchers, Philip Israilevich and K.J. Kowalewski, tested the hypothesis that regulation of utility monopolies retarded the rate of technical change over the period from 1965 to 1983. By focusing on electric utilities in Ohio, these researchers found that regulation curtailed implementation of efficient capital and production systems, and that the impact on technical change was greatest when regulation was most constraining, during the energy shocks of the 1970s. Though this study has limited geographic scope and is somewhat dated, it is consistent with both other evidence and the judgement of informed observers as to how utilities have lacked the incentives and propensity to expand the technological envelope.

Investment analyst Hugh Holman characterized the electric utility industry's technical nimbleness in considerably less complimentary terms. Holman concluded:

After decades of regulatory protection, the utility industry operates from a moribund technology base; competition will create incentives for innovation, leading potentially to a total reshaping of the industry's technology base.

Changes are coming. Deregulation -- or more precisely, restructuring -- of the electric utility sector likely will be accompanied by a wave of new technology. Yet the policies associated with restructuring will have a great deal to do with how much, and how rapidly, and what kinds of new technologies are deployed. A key question is whether the ability and will to develop and deploy new technologies becomes a characteristic of the electricity production sector, or whether we simply lock in on a new generation of technology that, in 30 or 40 years, will be just as difficult to displace as coal-fired steam turbines are now. Lessons can be obtained by reviewing other deregulation experiences.

Deregulation in Other Industries and Nations

Certain sectors of the economy were once considered natural monopolies because the economic scale of production was so large that having more than a single supplier would presumably raise costs. Yet recognizing the ability and tendency of monopolies to manipulate prices, governments regulated these entities in order, at least in theory, to capture the low costs available only to the monopolist but also to control unfair pricing behavior.

Regulated monopolies, however, turned out to be inefficient. The lack of competition, according to one analyst, "causes an industry to accumulate substantial managerial slack or 'X-inefficiency' -- that is, firms do not minimize the cost of producing a given level of output."

Regulated firms, moreover, are somewhat cushioned from external shocks, and they tend to react less effectively than firms facing competition. When oil prices rose during the energy shocks of the 1970s, for instance, regulated utilities simply imposed higher electricity prices.

Some industries -- airlines and freight are good examples -- never fit with the concept of a natural monopoly. They simply were deemed too important to be left to the vicissitudes of competition, which might mean that some customers could receive no or inadequate service. In other sectors, such as telecommunications and electric utilities, the transmission system represents an enormous capital investment that would be expensive and redundant to duplicate. But other parts of the entire system -- customer premises equipment (phones, handsets, PBXs) in telecommunications, and electric generation in utilities -- are not characteristically natural monopolies. Similarly, parts of electricity service may be logical candidates for continued monopoly status; most electric restructuring schemes leave transmission and distribution lines as regulated monopolies, while they introduce competition and deregulation into the business of electricity generation.

What can we expect from utility restructuring? Recent efforts in other industries--including airlines and motor carriers (freight), railroads, banking, natural gas, long-distance telecommunications, and cable -- can serve as analogues.

In all cases where significant deregulation was undertaken, efficiency has improved significantly. Effects on externalities -- e.g. quality of services, universal service, environmental effects -- have been less consistent. Effects on technology development and adoption have been positive in the immediate term, but much harder to forecast after the first wave of adaptation passes.

In general, deregulation reduces costs and prices. That certainly happened in trucking, rail, air travel, long-distance telecommunications, and British electricity. Estimates of savings in these industries are shown in Table 1.

Prices and costs, of course, are not the only measure of an industry's performance, nor are they the only way to measure the results of deregulation. During air, truck, and rail deregulation, for example, many analysts raised concerns about safety. Although projected safety problems never materialized, some analysts feel that the quality of service in air travel declined after deregulation. For this study, however, the most important dimension is innovative capacity.

No doubt deregulated (or restructured) industries experienced rapid diffusion of new technologies. However, in most cases, deregulation resulted in cuts in R&D spending sustained innovation, or changed the focus of R&D in ways that may mean less capacity for new innovations in future decades.

Innovative Capacity in Deregulated Industries

As mentioned earlier, innovative capacity is not something that can be measured easily. Research and development expenditure is the most widely used proxy, yet it is quite possible for an industry to be innovative without investing heavily in R&D. The software industry, for instance, has supported a stream of new products without a great deal of R&D investment (though much research has been supported at universities and in public agencies). Still, for the most part, R&D intensity (defined as R&D investment per dollar of net sales) tallies fairly closely over the long run with other measures of innovativeness (e.g., patenting activity, publications and citations, patent citations).

Evidence shows that many industries respond to deregulation by curtailing R&D, or emphasizing development and curtailing research. In air transport, for instance, innovative aeronautics for many decades led to declining air transport costs. The introduction of the jet engine in the 1950s and 1960s, the increase in aircraft sizes and loads made possible by the turbofan engine and wide-body aircraft, improved fuel efficiency of aircraft engines, and improved airframe design to permit laminar flow all helped to reduce aircraft operating costs. Yet, according to Hanlon, the leaner environment resulting from deregulation meant that airlines couldn't afford to continue their support of aeronautical innovation. While the military cutbacks that accompanied the end of the Cold War have nothing to do with deregulation, their combination with the airlines' withdrawal of support for aeronautics R&D has slowed the pace of technology advance. The most eagerly awaited innovations in aeronautics -- economical supersonic transport at Mach 1.2, or Mach 2-5 passenger transport, or even hypersonic air travel -- now are probably decades away from commercial reality.

In telecommunications, the story is somewhat different. Research and development nearly doubled between the late 1970s and late 1980s, with much of the gain coming after the 1984 consent decree that restructured the industry. But telecommunications R&D plummeted rapidly in the late 1980s and early 1990s. According to the most recently available statistics, R&D expenditures in communication equipment dropped from over $10 billion in 1987 to less than $5 billion in 1991, and the drop was steady, not just induced by the recession of 1991. Unfortunately, there are no statistics on total communications industry R&D after 1991 due to nondisclosures. In the narrower data series that excludes federal funds, however, the picture is not so dramatic. These data suggest that R&D expenditures in the industry held fairly steady through the mid-1980s, then dropped after 1988 to a low of $3.3 billion in 1992. There was some recovery after the recession, though not to the levels of the mid 1980s. (See Figure 4.)

R&D intensity in the communications equipment industry, on the other hand, has held up better than total R&D expenditures. According to the National Science Foundation, R&D intensity increased from 5.4 percent in 1985 to a high of 10.3 percent in 1994, and then fell to 8 percent in 1995.

In the case of British utilities, research and development spending fell dramatically after restructuring and privatization. R&D expenditures dropped from over $300 million (converted to dollars) to $144 million in just five years, and the R&D intensity of British electric generators dropped from over 2 percent to less than 1 percent.

Innovation, Deregulation, and Productivity

Deregulation has had different results for each industry, but there are some common elements. Strong evidence suggests that introducing competition will greatly increase incentives to improve efficiency, which will lead to cost-cutting measures. Some of the cost-cutting is quite likely to be passed on to consumers, though not all of it; profitability often improves. When an industry is truly opened to competition a wave of new entrants will arrive, possibly followed by a period of consolidation. It also is likely that restructuring will reduce the industry's interest in pursuing research and development, at least for a few years while initial adjustments to a new, competitive landscape are made.

The relationship between deregulation and technology is not simple. One fairly reliable result of even partial deregulation is an explosion in the availability of new technologies, in both hardware and business management. This initial flood is often a pent-up wave and does not necessarily portend a continuing surge of accelerated technological progress.

In fact, deregulation can be hard on technology development, especially over the long term. Airline industry support for aeronautical technology development declined as pressures for efficiency and cost containment grew. British utilities, even with relatively little new competition, slashed research and development funding. The telecommunications industry is still quite innovative, though there has been a slight decline in the amount of R&D funding in communications equipment.

It would be inappropriate to draw strong conclusions from these few examples, but it seems that deregulation does not alter an industry dramatically in terms of innovation. High-tech industries with rapidly advancing technologies and rapidly growing markets tend to remain innovative after deregulation, while industries whose markets are saturated with long-established technologies are unlikely to become greatly innovative solely as a result of deregulation.

The long-term outlook for R&D in the electric utilities, therefore, ranges between indeterminate and grim. Dr. John Maulbetsch, a former director of exploratory, long-term research for the Electric Power Research Institute, observed that when serious restructuring began, the utilities' interest in exploratory research plummeted. This observation is unwelcome to some industry participants, and some discount the importance of R&D as a measure of anything meaningful. However, there's a strong correlation between industries with high R&D intensity and sectors that are considered innovative by other measures, qualitative and quantitative.

During the wave of corporate restructuring (including mergers, hostile takeovers, acquisitions, and leveraged buyouts) during the 1980s, a spirited debate raged on the effect of such restructuring on R&D. Some analysts maintained that certain types of restructuring, including hostile takeovers (or attempts) and leveraged buyouts that resulted in heavy debt, did affect R&D spending negatively; even when funding was not cut, the focus of R&D became more myopic. These analysts argued that the pressure on corporations to be more responsive to stockholders meant less control over retained earnings, which had been a primary source of corporate financing for research and development. R&D, in addition, usually takes years to pay off, and short-term cuts in R&D funding do not hurt companies in the short run; the piper is paid five, ten, or more years in the future. Therefore, instituting competition in electricity generation, which would place much more pressure on generating companies to show profits, could lead to similar reductions in R&D spending, and probably would affect the development and deployment of new electricity technologies.

The short-term outlook for new electricity technologies is far brighter. Most analysts expect a wave of new generation equipment over the next few years, led by gas turbines. The use of these highly-efficient gas technologies undoubtedly will improve the emissions picture for electricity production. The Energy Information Administration's latest published forecast is for 4.5 percent per annum growth in natural gas electric generation, far higher than the 0.9 percent per annum growth in total electric generation. Because gas-fired generation is relatively clean, emissions of CO₂ from gas-fired electric generation are projected to increase only 1.1 percent per year during 1996-2010.

Many other new technologies, according to some analysts, could reshape the electric power industry. These include solid-state electronics to control the flow of power to end-use devices; advanced sensor, communication, and computation technologies that allow greater flexibility in control and metering; high-temperature superconductivity that enables "lossless" transmission; higher-efficiency generators and motors; short-term storage capacity to avoid surges; fuel cells that convert hydrogen to electricity with no CO₂ emissions; efficient long-term storage technologies; low-cost renewable electricity; and gasification. Some of these technologies allow for much more efficient and accurate use of the grid, some offer greatly improved ability to reduce the emissions of air pollutants and greenhouse gases associated with electricity production, and some promise greater systemwide efficiency. These technologies could change the electricity industry from a system of giant generating plants linked to customers by a vast transmission and distribution network to a system that permits distributed generation, or small-scale power generation, based on small turbines, fuel cells, or renewable technologies. Distributed generation also could enable greatly increased use of combined heat and power (CHP), or cogeneration, which captures and uses the heat that is inevitably a by-product of electricity generation. CHP can improve dramatically the fuel efficiency of electricity generation.

Whether restructuring will boost distributed generation and storage technologies depends a great deal on how it is done. For example, policies that impose heavy transition charges (e.g., exit fees) or backup power rates will tilt the playing field against new entrants.

The greater the advantage that established utilities have in a restructured electricity market, the dimmer the prospects for continued innovation. Electric utilities already have cut back substantially on research and development, and are likely to trim still more as deregulation puts downward pressure on prices and costs. The utilities also have no tradition of technological dynamism, as did the aircraft and telecommunications industries. It is possible that utilities could become much more innovative after restructuring, due to the pressure of competition, but such a development is unlikely without a critical mass of new competitors with new technologies.

If restructuring opens the market to new competitors, however, the prospects both for immediate application of more efficient technologies (e.g., gas combined cycle) and for continued innovation are brighter. Net positive entry of firms was heavily associated with radical innovations in one study of several industries. For example, the researchers point out that the greatest wave of entry into the automobile industry, which began in 1894 and ended in 1950, corresponds to when approximately three-quarters of the major product innovations were made.

Summary

Both state and federal governments are rewriting the regulatory framework for electric utilities. Some states, usually those with the highest electricity prices, already have passed restructuring legislation, and others are studying the issue. More attention is needed to removing barriers to new market entrants in order to help create true competition in electric power generation. Rules that allow existing utilities to erect significant barriers to new competitors -- high competition transition charges or high rates for backup power -- will delay or dampen the benefits in production efficiency, sustained innovation, and reduced air emissions that new electric generation technologies are capable of achieving.

Julie Fox Gorte and Tina Kaarsberg are senior policy analysts at the Northeast-Midwest
Institute. This article is excerpted from an upcoming three-part study on electricity restructuring.