Hurricane Sandy: Debating Economics

Hurricane Sandy swept across the northeastern and midwestern regions of the United States last week, destroying thousands of homes and rendering more than eight million individuals without electrical power. The news might become even more grim this week, as a midweek storm threatens to dump several inches of snow on homes that still remain without any heat or light.

Although the immediate priority for government officials is the restoration of the existing power grid, long term planners are beginning to suggest innovative approaches to strengthen the region’s energy infrastructure. After all, such “storms of the century” are attacking the region with more regularity, with Hurricane Irene causing massive damage on August 27, 2011, and an unnamed nor’easter dumping over 21 inches of snow on New York State on Halloween Day, just two months later.

Some commentators attribute the recent onslaught of freakish weather to climate change that is caused by our own carbon omissions. Others believe that the region might be experiencing a naturally occurring shift in climate cycles. All would undoubtedly agree, though, that a new long term strategy may be needed to confront this meteorological threat.

Distributed Generation

During the past few years, government officials in Connecticut and New York State (as well as in California) have studied the possibility of developing innovative programs to address climate change. Connecticut, in particular, has aggressively launched a pilot program to develop clusters of microgrids at the local level.

Microgrids? What are microgrids? The term refers to relatively tiny power generation systems that serve very limited geographic areas. When a large region relies on many small microgrids instead of a single massive facility to produce power for its entire population, it is employing a strategy known as distributed generation to serve the needs of its citizens.

A few years ago, for instance, Toshiba developed a proposal to build and maintain a miniscule nuclear power plant for Galena, Alaska, a village with a population of 470 citizens. Although safety and other concerns led to the discontinuation of the project, such microgrids could nevertheless serve as back-up systems in the event of a massive regional power failure.

Economics: Theory Vs. Theory

Is this a good idea or a bad idea? Unfortunately, the discipline of economics does not offer us a clear answer to this question. Instead, it provides a pair of conflicting theories, one in support of each position.

On the one hand, the law of economies of scale would imply that a single large regional facility would be far more cost-efficient than a large number of tiny facilities. In other words, according to this law of economics, a widespread microgridding strategy might drive up the costs of generating power to unsustainable levels.

On the other hand, clusters of microgrid facilities would not necessarily focus exclusively on supporting the primary regional power grid during times of crisis. The small generation plants could produce power during times of normal operations as well. In fact, they could easily feed power into the primary grid on a continuous basis, and even compete with each other to sell energy to local customers.

A large number of small suppliers, competing on the basis of cost, service quality, reliability, and other factors? Classical economists would call such a model capitalism. Although each individual supplier may fail to achieve significant economies of scale within such a system, the “invisible hand” of market competition — as first described by Adam Smith in his classic text The Wealth of Nations — would nevertheless regulate the industry and produce optimal results.

From Banking To Health Care

In a sense, this “micro vs. macro” debate over energy production and distribution strategies is similar to policy disputes that are raging across many other industries. In the banking sector, for instance, many industry experts have noted that the Dodd Frank regulatory structures that were developed after the 2008 global financial crisis may have actu­ally punished relatively healthy regional banks, while the “too big to fail” institutions that precipitated the collapse have grown even larger in size.

Likewise, in the American health care sector, arguments continue to flare about whether the provisions of the Affordable Care Act (i.e. “Obama Care”) will save the system or destroy it. Whether or not the Act is implemented in its current form, hospital systems and insurance companies in the United States are likely to continue with their consolidation activities, hoping that the effects of economies of scale will outweigh the impact of diminished competition.

Regrettably, such economic debates will not benefit the victims of Hurricane Sandy, who are awaiting next week’s approaching snow storm with immense trepidation. Nevertheless, in consideration of their plight, our government officials may wish to consider a microgridding strategy as a means of building additional power capacity. After all, in this situation, the economic cost of service redundancy may be outweighed by the human (and humane) benefit of financing it.