WSJ, January 21, 2001

Commentary

California: The Free-Lunch State

By Bradley R. Schiller, an economics professor at American University's School of Public Affairs and author of "The Economy Today" (McGraw-Hill, 2000).

Economists have long argued that "there's no such thing as a free lunch." Even if the lunch is on the house, somebody had to pay for the resources used to grow, prepare and serve the food.

But Californians have never fully embraced the "no free lunch" maxim. Although the Golden State's residents are among the richest inhabitants of this planet, among the many things they demand are free college, low rents and cheap electricity. To get them, they have elected politicians who defy the economic laws of supply and demand with regulations that keep prices low, below market-clearing levels. Now Californians are paying the price for that defiance. Rolling blackouts have darkened homes, shut down offices, and turned intersections into demolition derbies.

• Cheap Electricity. California's elected officials have tried to assure every voter access to cheap electricity by mandating price controls. Prior to so-called deregulation, the state explicitly regulated the prices charged by electric utilities, each of which had a monopoly in its service area. In 1996 the state legislature voted to partially deregulate the industry, permitting consumers to access electricity from out-of-area (and out-of-state) power suppliers. Local utilities would shed their own monopoly power plants and buy power from third-party sources. By breaking the monopoly franchise of local utilities, the legislature expected electricity prices to decline.

There was one fatal flaw in California's plan: Retail electricity prices remained under state control.

Alas, a resurgent economy and unseasonable weather increased the demand for electricity faster than supply could respond. At one point last summer spot wholesale electricity prices were 10 times higher than the year before. Suddenly, California's utility companies were in the position of having to buy power at very high prices, then sell it to consumers at state-controlled low prices.

California's power crisis is clearly a government failure, not a market failure. Without controls, electricity prices would rise until supply and demand came into balance and the crisis would pass quickly. Consumers and businesses would respond to the higher prices by shutting off lights, setting thermostats lower, and reorganizing production -- all voluntarily. The state's utilities would avert bankruptcy by closing the gap between wholesale and retail prices. And power plants would more readily divert electricity to the state once the prospects for getting paid improved. Power companies might even start building new plants in California again.

The downside of this market solution is that it violates the political promise of cheap electricity. So instead of stepping back from regulation, Gov. Gray Davis is pushing the state further into the regulatory morass.

• "Free" colleges. Californians, of course, should have learned the laws of supply and demand in college. After all, California is the only state in the nation to guarantee a "free" college education. The California legislature has always kept tuition low for the two million students attending the state's sprawling university and community college systems. But last September, the state went a step further: It guaranteed free tuition to college-bound students. Any high school senior with a B average and a family income under $64,000 is now eligible for free tuition at any public university in California. The state will also pay $9,700 a year toward tuition at any private college in the state for these B students. Less qualified students also get a tuition break under the new law.

As a result of the state's largess, nearly every California resident now gets free or nearly free college. The only high-school graduates who don't get a subsidy are the ones who are both rich and stupid.

Yet despite the intent of the state legislature, there's still no free college. The first hint of the cost of "free" tuition is the line item for higher education in the state's budget. Last year, the $9.4 billion the state spent on higher education absorbed 12% of the state's budget. That was before the new law took effect. Now the state is projecting a 30% increase in enrollments over the next eight years. The state expects the new tuition grant program alone to add at least $1 billion a year to the state's budget.

But budget outlays are only part of the tab for the state's "free" colleges. The state's campuses are already filled to capacity. Entering students are not assured access to their campus of choice. Once enrolled, they find it difficult to enroll in the classes they want. There simply isn't enough supply of college courses to satisfy the demand for a free education. Available classroom seats have to be rationed according to priorities established by individual departments. As a result, thousands of California students must stay in college longer, just to complete required courses. That additional time is a real cost, to both the students and the economy.

To relieve these bottlenecks, the state is building more campuses, hiring more faculty, and investing heavily in distant learning and other communications technology. These add further to the real cost of California's "free" education. Ultimately, these costs will be visible in the form of higher taxes or reductions in the state's non-college services like health care or freeway construction.

• Cheap rents. The voters living in rent-controlled apartments and houses in Berkeley, Santa Barbara, East Palo Alto and Santa Monica are probably the most fervent believers of this myth. After all, they've enjoyed cheap rent for years, thanks to legislated rent controls. But the price of that free lunch has become highly visible as well. Builders long ago decided that building or maintaining rental units in rent-controlled jurisdictions was bad business. So the supply of housing hasn't kept pace with its growing demand. In affluent Santa Barbara, police now have to keep tabs on the growing number of people living in vans, RVs and other vehicles. Those residences not subject to rent control command exorbitant rents and sale prices.

Californians have come to view free college, cheap electricity and cheap rents as birthrights. They are no more willing to give up the proverbial free lunch than to forsake beautiful Pacific Ocean sunsets. The state's current energy crisis is just one symptom of this intransigence. As college, electricity and housing crises multiply, however, more and more Californians may come to realize what all that education hasn't taught them: There really is no free lunch.