The Dynamic Impact of Market Integration

The paper presented in this Research Seminar studies the static and dynamic impacts of market integration on renewable energy expansion. The authors theory highlights that statically, market integration improves allocative efficiency by gains from trade, and dynamically, it incentivizes new entry of renewable power plants. Using two recent grid expansions in the Chilean electricity market, the authors empirically test their theoretical predictions and show that commonly-used event study estimation underestimates the dynamic benefits if renewable investments occur in anticipation of market integration. The authors build a structural model of power plant entry and show how to correct for such bias. They find that market integration resulted in price convergence across regions, increases in renewable generation, and decreases in generation cost and pollution emissions. Furthermore, a substantial amount of renewable entry would not have occurred in the absence of market integration. The paper shows that ignoring this dynamic effect would substantially understate the benefits of transmission investments.