There is a literature standing behind this essay, and then you take the argument somewhere it has not gone.
Coase asked why coordination happens inside a firm rather than across markets, and answered, transaction costs. The vertically integrated utility was Coase's firm at maximum scale, coordination internalized because coordinating a thousand independent resources by contract was impossibly expensive. Your observation that power electronics lowers the transaction costs of coordination, so it can happen through markets and contracts rather than inside the firm, is the Coasean boundary moving in real time. The grid is running the theorem.
Hayek asked how dispersed knowledge could be coordinated at all. Capability by time by location by system condition by alternative use is the knowledge of the particular circumstances of time and place, and your performance-specification principle is his answer stated for engineers. Specify the end, let resources compete to reveal the means, because nobody, including the planner, knows which combination wins.
Demsetz explains why the moment has arrived. New rights emerge when technology makes them worth defining, and power electronics is creating grid capabilities valuable enough that someone must finally own them, price them, and commit them. Lee Anne Fennell supplies the piece that comes next. Slices and Lumps treats configuration itself as an economic problem, when value comes from dividing a resource and when it comes from holding it together. The programmable battery is her problem electrified. The 100-megawatt battery is the lump; energy, reserves, regulation, reactive power, and grid-forming are the slices. But the same inverter and state of charge constrain them, so the slices are neither independent nor costless. That is your opportunity-cost argument viewed through property architecture. The question is not merely what each capability is worth, but which configuration of the underlying resource creates the most value. Unbundling itself has an opportunity cost.
Maskin's mechanism-design work takes the problem from there, and Hurwicz built its foundation. The message space, the very concept your co-optimization turns on, is Hurwicz's construction. Once the slices are defined, the rules determine whether self-interested participants reveal what they privately know, and the battery owner's knowledge, opportunity costs, state-dependent capabilities, degradation, alternative contractual uses, is a textbook mechanism-design problem. On this view the co-optimizer is not objectionable for being centralized. An auction is centralized too. If the information driving it is generated by decentralized bids under rules designed to elicit private information, the computer is not Hayek's planner. Vernon Smith spent a career testing exactly these designs in the laboratory, electricity markets included, and his career finding was your principle in experimental form. Institutions discover more than their designers understand.
But there is a question the mechanism cannot answer about itself. Co-optimization solves an allocation problem within a specified feasible set, and someone specifies the set. The optimizer can discover the best use among the capabilities its designers permitted it to see. It cannot discover the capability for which the mechanism has no message. Power electronics creates exactly this problem, and capability number seven is not merely a service the designer forgot to list. It may be a new way of slicing or recombining the resource that nobody had recognized as an economic object at all. Kirzner named the person who finds it, the entrepreneur, whose function is alertness to the opportunity no mechanism solicited. So the question underneath your essay is what disciplines the design of the mechanism itself, which is Buchanan's question, the choice among rules rather than within them. Your own principle points at the answer, and Ostrom gave the answer its name. Polycentricity. Make the institutional boundary contestable too. Let bilateral contracts, private networks, and microgrids compete with the organized market in discovering forms of coordination the optimizer did not anticipate. Performance specification, applied one level up.
Coase asked why the firm. Hayek asked how knowledge coordinates. Demsetz explained why new capabilities become property. Fennell explained how the slicing works and what it costs. Hurwicz and Maskin asked which rules make private knowledge reveal itself. Smith tested the rules and found them wiser than their authors. Kirzner named who finds the slice that is not in the message space. Buchanan and Ostrom asked who governs the governors. Your essay raises the question none of them quite answered: what happens when innovation changes the feasible set faster than any designer can specify it? That may be the most interesting question in the series.
Really enjoying this series, Lynne. What struck me here is the shift from getting more value by making individual resources larger to getting more value from coordinating many different resources more intelligently. The idea that the same battery, load, or generator can have different value depending on time, location, system conditions, and what else it could be doing makes the economics much more interesting.
One thing I’d be interested to hear more about is how that coordination value actually gets discovered and divided among the participants. If several independently owned resources become more valuable when they are coordinated, how do markets and contracts determine who gets paid for what—and provide enough incentive for everyone to participate in the combination?
You are right that the price is sotto voce, but price is always lurking in the background in everything I write! Here I wanted to focus on the system manifestation rather than the mechanism.
Lynne,
There is a literature standing behind this essay, and then you take the argument somewhere it has not gone.
Coase asked why coordination happens inside a firm rather than across markets, and answered, transaction costs. The vertically integrated utility was Coase's firm at maximum scale, coordination internalized because coordinating a thousand independent resources by contract was impossibly expensive. Your observation that power electronics lowers the transaction costs of coordination, so it can happen through markets and contracts rather than inside the firm, is the Coasean boundary moving in real time. The grid is running the theorem.
Hayek asked how dispersed knowledge could be coordinated at all. Capability by time by location by system condition by alternative use is the knowledge of the particular circumstances of time and place, and your performance-specification principle is his answer stated for engineers. Specify the end, let resources compete to reveal the means, because nobody, including the planner, knows which combination wins.
Demsetz explains why the moment has arrived. New rights emerge when technology makes them worth defining, and power electronics is creating grid capabilities valuable enough that someone must finally own them, price them, and commit them. Lee Anne Fennell supplies the piece that comes next. Slices and Lumps treats configuration itself as an economic problem, when value comes from dividing a resource and when it comes from holding it together. The programmable battery is her problem electrified. The 100-megawatt battery is the lump; energy, reserves, regulation, reactive power, and grid-forming are the slices. But the same inverter and state of charge constrain them, so the slices are neither independent nor costless. That is your opportunity-cost argument viewed through property architecture. The question is not merely what each capability is worth, but which configuration of the underlying resource creates the most value. Unbundling itself has an opportunity cost.
Maskin's mechanism-design work takes the problem from there, and Hurwicz built its foundation. The message space, the very concept your co-optimization turns on, is Hurwicz's construction. Once the slices are defined, the rules determine whether self-interested participants reveal what they privately know, and the battery owner's knowledge, opportunity costs, state-dependent capabilities, degradation, alternative contractual uses, is a textbook mechanism-design problem. On this view the co-optimizer is not objectionable for being centralized. An auction is centralized too. If the information driving it is generated by decentralized bids under rules designed to elicit private information, the computer is not Hayek's planner. Vernon Smith spent a career testing exactly these designs in the laboratory, electricity markets included, and his career finding was your principle in experimental form. Institutions discover more than their designers understand.
But there is a question the mechanism cannot answer about itself. Co-optimization solves an allocation problem within a specified feasible set, and someone specifies the set. The optimizer can discover the best use among the capabilities its designers permitted it to see. It cannot discover the capability for which the mechanism has no message. Power electronics creates exactly this problem, and capability number seven is not merely a service the designer forgot to list. It may be a new way of slicing or recombining the resource that nobody had recognized as an economic object at all. Kirzner named the person who finds it, the entrepreneur, whose function is alertness to the opportunity no mechanism solicited. So the question underneath your essay is what disciplines the design of the mechanism itself, which is Buchanan's question, the choice among rules rather than within them. Your own principle points at the answer, and Ostrom gave the answer its name. Polycentricity. Make the institutional boundary contestable too. Let bilateral contracts, private networks, and microgrids compete with the organized market in discovering forms of coordination the optimizer did not anticipate. Performance specification, applied one level up.
Coase asked why the firm. Hayek asked how knowledge coordinates. Demsetz explained why new capabilities become property. Fennell explained how the slicing works and what it costs. Hurwicz and Maskin asked which rules make private knowledge reveal itself. Smith tested the rules and found them wiser than their authors. Kirzner named who finds the slice that is not in the message space. Buchanan and Ostrom asked who governs the governors. Your essay raises the question none of them quite answered: what happens when innovation changes the feasible set faster than any designer can specify it? That may be the most interesting question in the series.
Really enjoying this series, Lynne. What struck me here is the shift from getting more value by making individual resources larger to getting more value from coordinating many different resources more intelligently. The idea that the same battery, load, or generator can have different value depending on time, location, system conditions, and what else it could be doing makes the economics much more interesting.
One thing I’d be interested to hear more about is how that coordination value actually gets discovered and divided among the participants. If several independently owned resources become more valuable when they are coordinated, how do markets and contracts determine who gets paid for what—and provide enough incentive for everyone to participate in the combination?
I did not read the prod "price" in this post. Is not price flexiaility the key to "co-optimization?"
You are right that the price is sotto voce, but price is always lurking in the background in everything I write! Here I wanted to focus on the system manifestation rather than the mechanism.
I was pretty sure it was tactical. :)