Do Markets Reduce Costs? Assessing the Impact of Regulatory Restructuring on U.S. Electric Generation Efficiency, by Kira

While neoclassical models of profit-maximization assume static cost-minimizing behavior, agency models of managerial behavior, particularly under regulation, suggest that managers may not minimize costs in less-competitive environments. We test whether the transition from cost-of-service regulation to more marketoriented environments affected input demand at U.S. electric generating plants. We find that municipally-owned plants, whose owners were largely unaffected by the reforms, experienced the smallest efficiency gains. Investor-owned utility plants in states that restructured their wholesale electricity markets had the largest gains, while investor-owned plants in nonrestructuring states fell between these extremes. The results suggest modest medium-term efficiency improvements associated with replacing regulated monopoly with a market-based industry structure. Economists have long maintained that markets generate important efficiency benefits for an economy. These arguments usually focus on allocative efficiency; the implications of competition for technical efficiency are less clear. Neoclassical models of profit-maximization assume static cost-minimizing behavior by all firms, regardless of market competitiveness. Agency models, however, in recognizing the interplay of asymmetric information with the separation of management and control, suggest possible deviations from cost-minimization by effort-averse managers. These distortions may be