Regulation and technological change, in theory and in practice

In the 20th century, the electricity industry in the United States developed as a set of local monopolies due to the natural monopoly characteristics of large-scale electricity generation, transmission, and distribution. With high fixed costs and declining average costs, one firm serving the entire market was considered more efficient than competition. To prevent these monopolies from abusing market power, regulatory institutions were created, notably state public utility commissions, which established rules for pricing and returns on capital. The regulatory framework centered on pricing electricity at average cost, allowing firms to recover costs without profit-maximizing behavior, while ensuring stability in a system characterized by homogeneous technologies and economies of scale.

However, by the late 20th century, this regulatory model began to fray under technological innovation. The development of combined cycle gas turbines made small-scale generation more cost-effective, breaking the scale-dependent structure of the industry. This shift reduced transaction costs and paved the way for a move from vertical integration to market-based coordination, in line with Coasean and transaction cost theories. Wholesale power markets emerged, prompting regulatory restructuring and asset divestment among utilities.

In the 21st century, digital communication technologies—grouped under the term “smart grid”—are again transforming the sector. Digital sensors, meters, and communication infrastructure enable real-time monitoring and consumption feedback, allowing for dynamic pricing and more decentralized decision-making. These innovations not only improve grid efficiency but also further reduce transaction costs, potentially reshaping organizational structures and regulatory models in the electricity industry. The industry's evolution thus illustrates how technological change continuously challenges and redefines the alignment between economic theory, institutional design, and organizational form.

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