Technology and Culture

Engineers and Economists: Historical Perspectives on the Pricing of Electricity WILLIAM J. HAUSMAN AND JOHN L. NEUFELD The history of' the electric utility industry in the United States is in large part the story of how engineers and businessmen responded to the numerous organizational and technological problems associated with the generation and distribution of electricity.1 A particularly com­ plex problem faced by the industry was the seemingly prosaic com­ mercial issue of how to price the product. Although physical measures of electrical energy were developed quite early, the technological and economic characteristics of electricity generation and distribution were such that the establishment of a single, uniform price charged all customers under all conditions would have been disastrous for the utility. Electricity rate structures were important on a broader scale because they were a major factor influencing the diffusion of electric power, the pattern of electricity consumption, and the efficiency of energy use. As one contemporary engineer noted regarding the cost of power, “Some industries are absolutely dependent for their exis­ tence upon the possibility of obtaining cheap enough power to enable the product to compete with something else, which may possibly be a natural product (either the same or a substitute).”2 In the early days of electric power, firms in the industry faced severe competition both from other electric utilities and from alternatives to centrally generated electricity, including gas and, especially important, the generation of electricity by large consumers in “isolated plants.” By 1910 many electric companies had consolidated into local monop­ olies, although competition with gas utilities and isolated plants ofDr . Hausman is professor of economics at the College of William and Mary; Dr. Neufeld is associate professor of economics at the L’niversitv of North Carolina at Greensboro. 'They thank the Technology and Culture referees for their helpful comments. 'For an excellent discussion of this process, see Thomas P. Hughes, Networks of Power: Electrification in Western Society, 1880—1930 (Baltimore, 1983). ^Charles E. Lucke, “Power Costs,” Transactions of the American Electromechanical Society (1907), p. 339.©1989 by the Society for the History of Technology. All rights reserved. 0040-165X/89/3001 -0001 $01.00 83 84 WilliamJ. Hausman andJohn L. Neufeld fered a continuing challenge. Under these circumstances, the structure of rates was a major determinant of the profitability and ultimate success of an electric utility and of the industry as a whole. The po­ tential for abusive pricing practices, however, was one of the factors leading to demands for state regulation of electric utilities. The problem of devising actual rate structures fell initially to the engineers and businessmen in the forefront of the new industry. The discussion this problem stimulated is well recorded in the engineering and trade journals of the time.3 Its significance can be seen in part from the statements of Samuel Insull, the individual who was perhaps most responsible for developing the organizational and technological structure of the modern industry.4 In 1898 Insull remarked in a dis­ cussion about pricing, “I devote more of my time to it than to any other one subject connected with our business.”5 He noted in 1910 that the use of proper rate structures “may possibly have had as much to do with reducing operating costs and reducing interest and de­ preciation costs as have the wonderful work of the inventors and the marvelous skill of the engineers.”1’ Insull’s words fail to reflect the fact that it was engineers who were largely responsible for the pricing developments he lauded. It was not until the end of the first decade of the 20th century, when the electric power industry was being brought under the umbrella of state regulation, that economists began to focus their attention on the issue of electricity pricing. From the beginning, they tended to ap­ proach the industry as a case study for the application of theoretical pricing principles. Although substantial work had already been done on this problem by engineers, economists brought a new perspective to the issue. The relationship between economists and engineers on such commercial issues as pricing parallels the relationship between scientists and engineers on many scientific issues. Economists generally worked from an overall theoretical framework...