Abstract
This paper examines the decomposition of total factor productivity growth for firms subject to regulation, given the production of a bad output. The production of good and bad outputs provides benefits and costs to society. Corporate socially responsible firms recognize the cost to society of producing the bad output. The paper separates the production technology and regulation effects from both the scale and technical change components. The paper also examines the measurement and decomposition of productivity growth when not accounting for production of the bad output. Using a 1992–2000 panel of 34 U.S. investor-owned electric utilities, results indicate that improvements in the scale, efficiency change, and technical change components contributed to positive growth. Not accounting for production of the bad output led to, on average, an overestimation of both the rate of productivity growth, and the contributions of scale economies and technical change to changes in productivity growth.
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Notes
The author is very grateful to the referee for bringing forth this hypothesis.
Total combined emissions of carbon dioxide, nitrogen oxide, and sulfur dioxide, measured in thousands of metric tons, steadily increased from 1,886,734 in 1992 to 2,327,915 in 2002.
There were approximately 179 major U.S. investor-owned electric utilities over the sample period. Several electric utilities are privately traded, making it difficult to compute a similar measure of the cost of capital. Many electric utilities were involved in mergers in the 1990s. The study excluded such firms (involved in mergers) due to the difficulty in trying to determine how mergers may impact the decomposition of TFP.
Several state governments and public utility commissions enacted legislation giving end users more choices in selecting which firms to purchase electric power. Such legislation could provide for more competition among electric power producers at the retail level, not necessarily at the wholesale level. A dummy variable is included in the regression analysis to determine if such legislation affected the generation of electric power by electric utilities. It is possible that such legislation affected the cost of producing electric power.
The Federal Energy Regulatory Commission regulates the sale and transmission of electric power in interstate commerce. Firms are required to meet various FERC requirements in order to obtain EWG status.
Data on non-utility power producers comes from the Electric Power Annual 2002.
The input quantities of quantities of coal, oil, and natural gas are converted into one measure of fuel.
The quantities of carbon dioxide, nitrogen oxide, and sulfur dioxide emissions (each measured in tons) are aggregated into one measure of total emissions.
The paper uses a translog specification in estimating a cost function/input share equation system. Having separate input prices of coal, natural gas, and oil, as well as separate output measures of carbon dioxide, nitrogen oxide, and sulfur dioxide, may contribute to multicollinearity problems within input prices and outputs.
Regulators also determine the firm’s allowed expenditures on capital. In determining the allowed rate of return and the allowed expenditures on capital, regulators determine the allowed user cost of capital. The variable θ can be thought of as the difference between the allowed and actual user costs of capital.
The output price is not included in the regulated cost function because the regulated firm only observes a point on the demand curve (the price established by the regulator).
The paper uses the Tornqvist index in part because information from the decomposition of the regulated cost efficiency, and the regulated cost function, help to show how the Tornqvist index can be decomposed for regulated firms. Plus, the author is more familiar with the Tornqvist index, compared to the Malmquist–Luenberger index. Use of the Malmquist–Luenberger index would require the development of such an index for firms subject to rate regulation.
With no information on the price of the bad output, and the regulated firm not observing its entire product demand curve, output prices could not be used as weights to compute aggregate output.
Data on the quantities and average costs of coal and natural gas come from the 2003 Edition of the Electric Power Annual.
Under the Averch–Johnson hypothesis, a firm subject to rate regulation has an incentive to use more than the cost minimizing amount of capital to produce its selected output level.
The translog cost function was developed by Christensen et al. (1971).
The output price does not appear in the regulated cost function because the regulated firm only observes a point on the demand curve (the price determined by the regulator).
The following steps are implemented to impose concavity of the unregulated cost function in input prices. First, select an observation to normalize the independent variables: let y′′, w i ′′, θ′′, and t′′ denote the value of the variables at the selected observation. Now, the independent variables used in estimating the cost function and the input share equation are y′ = y/y′′, w i' = w i /w i ′′, θ′ = θ/θ′′, and t′ = t − t′′. Second, denote γij′ the parameters on the interaction terms of the input prices in the unregulated cost function. Concavity of the unregulated cost function in input prices involves equations for γij′. These equations in turn impose restrictions on γij. Finally, estimating the regulated cost function with these parameter restrictions on γ ij imposes concavity of the unregulated cost function in input prices.
Net steam generation is total generation minus the electric energy used for station use.
The investment tax credit is zero over the sample period. The depreciation rate of 4% is based on the class life of the electric utility steam production plant, as determined by the modified accelerated cost recovery system. Data on the class life of the plant is obtained from the U.S. Master Depreciation Guide.
It was very difficult to obtain convergence for the system of equations when adding a non-capital input share equation, since the labor and fuel input share equations are highly nonlinear in the parameters.
As correctly stated by an anonymous referee, a formal hypothesis test is needed to determine whether the estimates of the proportional shifts in the regulated and unregulated cost functions are statistically different from each other. A similar test is needed to examine whether differences in the scale components of the regulated and unregulated cost functions are statistically different from each other. The difficulty in performing such tests is that the parameters from the unregulated cost function that are involved in such tests contain ratios of the parameters on the variables containing θ from the regulated cost function.
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Acknowledgements
I am grateful to Jennifer Shand and Sean Delehunt for their assistance in compiling the data sample, and to George Davis, Bill Even, Knox Lovell, Diego Prior, and Robin Sickles, and an anonymous referee for their comments and suggestions. I would like to thank Elizabeth O’Reggio, Catherine J. Morrison Paul, and Donald Siegel for their helpful comments and suggestions regarding corporate social responsibility. I am also grateful to Professors Paul and Siegel for providing me with the opportunity to contribute to this journal issue regarding corporate social responsibility.
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Granderson, G. Externalities, efficiency, regulation, and productivity growth in the U.S. electric utility industry. J Prod Anal 26, 269–287 (2006). https://doi.org/10.1007/s11123-006-0019-1
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DOI: https://doi.org/10.1007/s11123-006-0019-1