Take Heed of the Law of Unintended Consequences

Sponsored and Written by: Ross Hemphill, President, RCHemphill Solutions, FRI Advisory Board Chair

Ross Hemphill

One of my stops on a vacation drive this past summer was to Flathead Lake, about 100 miles due north of Missoula, Montana.  This is the largest freshwater lake in the contiguous U.S. west of the Mississippi River – and it is gorgeous.  The water is deep, crystal clear and surrounded by beautiful scenery.  As we floated around the lake with an entertaining and informative guide, I could not help but start thinking about the challenges in the utility industry and the difficult decisions ahead.  “Whoa,” you say, “what is it about Flathead Lake that would make you start thinking about utility issues?”  Well, even this beautiful piece of nature has its challenges.  And there are similarities with the utility industry in terms of how they developed.

The guide told us that Lake Trout (a non-native species) is crowding out native species of fish like the Westslope Trout and the Bull Trout.  From what I heard and read, this didn’t happen naturally.  Way back in 1905 someone (or some agency) decided it would be a good idea to introduce Lake Trout into Flathead.  Several decades later, Possum Shrimp (also non-native) was introduced to help feed all the fish.  It turns out that the native fish don’t much like Possum Shrimp, which, by the way, started devouring organisms that the native fish like to eat.  Thus, the population of Lake Trout exploded because they love to eat Possum Shrimp.  And the fish native to Flathead are sparse.

There are many, many stories around the world like the one above where challenges to the ecosystem are created by some type of human action.  They are all examples of the law of unintended consequences, which states that actions frequently lead to one or more outcomes that were not intended.  This law is ever present in all types of actions, not just with the ecosystem.  It is particularly relevant in our economic systems where there are ample opportunities to make decisions that create far-reaching repercussions.

In doing a little research on unintended consequences, I was amazed to learn how much has been written about it with even scholarly interest.  It was eighty years ago that Robert Merton published a systematic treatment of this phenomenon.[1]  In this article, Merton discusses five reasons why it occurs: (1) limitations of knowledge, (2) unforeseen changes in technology or the environment, (3) errors in evaluating the situation, (4) imperious immediacy of interest, and (5) basic values.  Every one of the reasons cited by Merton deserve strong consideration; however, it’s the fourth one that I will call out as being particularly relevant to utility regulation.  In Merton’s words, “the ‘imperious immediacy of interest’ refers to instances when the actor’s paramount concern with the foreseen immediate consequences excludes the consideration of further or other consequences of the same act.”  In my words, sometimes a policy decision is made with a sole purpose in mind that is viewed to be of such high importance that other potential outcomes are not considered.

This can and does happen in the regulatory arena from time to time.  When I first started my career, some 37 years ago, an issue upon us in several jurisdictions was that residential customers were not paying full cost of service and commercial/industrial customers were paying more than costs (known as a subsidy).  This happened over a number of years when costs were rising and C&I customers saw a larger than share increase in rates to mitigate the rate impacts on residential customers.  But ultimately the utilities and regulators realized that placing more burden on the job-creating C&I sector was not in the best long-term interest of households.

Lately, there is a lot of attention regarding transformation in the electric utility industry, with growth in distributed resources and such.  This has put the spotlight on net metering rules and residential rate design.  There are many facets to these issues with stakeholders from all sides providing reasoned arguments worthy of consideration.  My point here is that policy-makers should step back and carefully consider not only the intended outcomes but potential unintended consequences of any action or, for that matter, inaction.

There are many recent writings on these issues, of which I will mention only two.  There is a recent article in Public Utilities Fortnightly by three experts representing historically diverse perspectives in the regulatory forum discussing unintended consequences of net metering. The authors point out that net metering was originally designed to encourage alternative forms of energy for residential customers, which provides an opportunity for those participating to lower their bills.  But the combination of growth in distributed generation with highly volumetric rates has led them to conclude that net metering is regressive in nature.  “The subsidy, in the aggregate, constitutes a regressive wealth transfer from lower-income customers to high-income customers.  Solar power is typically installed by higher-income customers.” [2]  I also encourage you to read a report released earlier this year by Lawrence Berkeley National Laboratory (LBNL) that provides a balanced presentation of the issues by authors representing a broad range of perspectives. [3]

Finally, I will use this opportunity to plug the value that the Financial Research Institute adds to critical debates in our industry such as this.  You can see from the make-up of the advisory board that all perspectives are sought in their agenda for Hot Topics, Points of View and the annual symposium.  FRI provides a very valuable platform for sharing information, ideas and alternative approaches to addressing pressing issues in utility regulation so that we can make decisions that minimize the unintended consequences.

[1] Robert K. Merton, “The Unanticipated Consequences of Purposive Social Action,” American Sociological Review, Volume 1, No. 6 (December 1936).

[2] Barbara Alexander, Ashley Brown and Ahmad Faruqui, “Rethinking Rationale for Net Metering,” Public Utilities Fortnightly, Volume 154, No. 10 (October 2016), pp 28-33.

[3] “Recovery of Utility Fixed Costs:  Utility, Consumer, Environmental and Economist Perspectives,” LBNL-1005742, Report No. 5 (June 2016).  You can access this report at https://emp.lbl.gov/sites/all/files/lbnl-1005742_1.pdf.