Why Miliband is wrong on energy policy

This article was originally published in the Young Fabian’s quarterly magazine, Anticipations (Volume 18, Issue 1 | Autumn 2014).

On this we will agree: the corporate monopoly dominating the UK energy market needs to come to an end. Currently, British customers have a total of six firms to choose from in the energy market, all of which offer very limited price distinctions.

And those prices keep going up. Since 2010, gas and electricity rates have risen by three times the rate of inflation (10.2% between 2010-2013). Quite rightly, the Big Six are constantly under attack from very political party in the UK for over-charging customers and raising retail prices, even when wholesale costs fall. With such little competition in the energy market, mega-firms can charge extortionate prices, and customers have no choice but to pay the bill.

Another point of agreement: a change in government regulation is key to breaking up this monopoly. Both Labour and Conservatives acknowledge that government regulations, like Ofgem, aren’t holding the Big Six accountable for what they charge customers. Over the past few years, party leaders have come up with new variants of the Regulatory State to combat the problem. Most recently (and most misguidedly) Ed Miliband has advocated for a government-mandated freeze on energy prices, which would force firms to fix their prices for 20 months, regardless of future changes in market conditions.

Why is this misguided? Let’s put aside Miliband’s refusal to acknowledge the costs that are loaded on to energy companies by the state (ie: requirements to source energy from renewables), which in turn, gets pushed onto the customer and focus on a second, more important point: Miliband’s policy proposals reinforce the energy monopoly.

It’s near impossible to create a market monopoly without help from the ultimate monopoly; that is, competition in the market place is so often drowned out, not by competitors, but by the state.

The energy sector is a prime example of well-intentioned government regulation gone awry. The sector is regulated so heavily, through both onerous compliance requirements and heavy taxation, that it is near impossible for any budding energy firm to compete with the Big Six. In its effort to stop energy firms from over-charging customers, the state has effectively regulated all competitors out of the market, re-enforcing the monopoly it was trying to prevent.

The bureaucratic, slow-moving nature of government bodies means that they are not equipped to understand or anticipate the unpredictability of market prices on energy. The security of energy supplies, complexities of long-term contracts, and real commodity costs are often dismissed by politicians who have made unsustainable, politically motivated promises to voters. Whilst the Big Six have no incentive to bring energy prices down when they can, a Labour prime minister would have no incentive to bring the prices up even when he must.

Britain needs appropriate, scaled back monitoring of the energy market that removes ‘safeguards’ for the Big Six’s market share and introduces healthy competition in the market place. A less-regulated system where consumer choice dictates the real price of energy would see monthly bills drop. But piling price fixation on top of bad regulations will produce a lot of heat and very little light.

A bankers’ ethics oath risks being seen as empty posturing

The suggestion put forward yesterday by ResPublica think-tank that we can restore consumer trust and confidence in the financial system, or prevent the next crisis by requiring bankers to swear an oath seems excessively naïve.

Such a pledge trivializes the ethical issues that banks and their employees face in the real world.  It gives a false sense of confidence that implies that an expression of a few lines of moral platitudes will equip bankers to resist the temptations of short-term gain and rent-seeking behavior that are present in the financial services industry.

In fairness to ResPublica’s report on “Virtuous Baking” the bankers’ oath is just one of many otherwise quite reasonable proposals to address the moral decay that seems to be prevalent in some sections of the banking industry.

I don’t for a moment suggest that banking, or any other business for that matter, should not be governed by highest moral and ethical standards.  Indeed, the ResPublica report is written from Aristotelian ‘virtue theory’ perspective that could be applied as a resource for reforming the culture of the banking industry.  ‘Virtue theory’ recognizes that people’s needs are different and virtue in banking would be about meeting the diverse needs of all, not just the needs of the few.

The main contribution of the “Virtuous Banking” report is to bring the concepts of morality and ethical frameworks into public discourse.  Such discourse is laudable but we should be under no illusion that changing the culture of the financial services industry will be a long process. Taking an oath will not change an individual’s moral and ethical worldview or behaviour.  The only way ethical and moral conduct can be reintroduced back into the banking sector is if the people who work in the industry were to hold themselves intrinsically to the highest ethical and moral standards.

Bankers operate within tight regulatory frameworks; the quickest way to drive behavioural change is therefore through regulatory interventions.  However, banking is already the most regulated industry known to man and regulation has not produced any sustainable change in the banks’ conduct.  One of the key problems with prevailing regulatory paradigms is that regulation limits managerial choice to reduce risk in the banking system, rather than focuses on regulating the drivers for managerial decision-making.

Market-based regulations that do not punish excellence but incentivize bankers to seriously think through the risk-return implications of their business decisions, will be good for the financial services industry and the economy as a whole.  A regulatory approach that makes banks and bankers liable for their decisions and actions through mechanisms such as bonus claw-back clauses will be more effective in reducing moral hazard at the systemic level and improving individual accountability at the micro level than taking a “Hippocratic” bankers’ oath.

Voxplainer on Scott Sumner & market monetarism

I have to admit that I usually dislike Vox. The twitter parody account Vaux News gets it kinda right in my opinion—they manage to turn anything into a centre-left talking point—and from the very beginning traded on their supposedly neutral image to write unbelievably loaded “explainer” articles in many areas. They have also written complete nonsense.

But they have some really smart and talented authors, and one of those is Timothy B. Lee, who has just written an explainer of all things market monetarism, Prof. Scott Sumner, and nominal GDP targeting. Blog readers may remember that only a few weeks ago Scott gave a barnstorming Adam Smith Lecture (see it on youtube here). Readers may also know that I am rather obsessed with this particular issue myself.*

So I’m extremely happy to say that the article is great. Some excerpts:

Market monetarism builds on monetarism, a school of thought that emerged in the 20th century. Its most famous advocate was Nobel prize winner Milton Friedman. Market monetarists and classic monetarists agree that monetary policy is extremely powerful. Friedman famously argued that excessively tight monetary policy caused the Great Depression. Sumner makes the same argument about the Great Recession. Market monetarists have borrowed many monetarist ideas and see themselves as heirs to the monetarist tradition.

But Sumner placed a much greater emphasis than Friedman on the importance of market expectations — the “market” part of market monetarism. Friedman thought central banks should expand the money supply at a pre-determined rate and do little else. In contrast, Sumner and other market monetarists argue that the Fed should set a target for long-term growth of national output and commit to do whatever it takes to keep the economy on that trajectory. In Sumner’s view, what a central bank says about its future actions is just as important as what it does.


In 2011, the concept of nominal GDP targeting attracted a wave of influential endorsements:

Michael Woodford, a widely respected monetary economist who wrote a leading monetary economics textbook, endorsed NGDP targeting at a monetary policy conference in September.

The next month, Christina Romer wrote a New York Times op-ed calling for the Fed to “begin targeting the path of nominal gross domestic product.” Romer is widely respected in the economics profession and chaired President Obama’s Council of Economic Advisors during the first two years of his administration.

Also in October, Jan Hatzius, the chief economist of Goldman Sachs, endorsed NGDP targeting. He wrote that the effectiveness of the policy “depends critically on the credibility of the Fed’s commitment” — a key part of Sumner’s argument.

But read the whole thing, as they say.

*[1] [2] [3] [4] [5] [6] [7] [8] [9] [10] [11] [12] [13] [14] [15] [16]

An unpublished letter to the LRB on high frequency trading

Lanchester, John. “Scalpers Inc.” Review of Flash Boys: Cracking the Money Code, by Michael Lewis. London Review of Books 36 no. 11 (2014): 7-9, http://www.lrb.co.uk/v36/n11/john-lanchester/scalpers-inc

Dear Sir,

It is striking for John Lanchester to claim that those who believe high-frequency trading is a net benefit to finance (and by extension, society) “offer no data to support” their views. Aside from the fact that he presents such views in the line of climate-change deniers, rather than a perfectly respectable mainstream view in financial economics, it doesn’t really seem like he has gone out looking for any data himself!

In fact there is a wide literature on the costs and benefits of HFT, much of it very recent. While Lanchester (apparently following Lewis) dismisses the claim that HFT provides liquidity as essentially apologia, a 2014 paper in The Financial Review finds that “HFT continuously provides liquidity in most situations” and “resolves temporal imbalances in order flow by providing liquidity where the public supply is insufficient, and provide a valuable service during periods of market uncertainty”. [1]

And looking more broadly, a widely-cited 2013 review paper, which looks at studies that isolate and analyse the impacts of adding more HFT to markets, found that “virtually every time a market structure change results in more HFT, liquidity and market quality have improved because liquidity suppliers are better able to adjust their quotes in response to new information.” [2]

There is nary a mention of price discovery in Lanchester’s piece—yet economists consider this basically the whole point of markets. And many high quality studies, including a 2013 European Central Bank paper [3], find that “HFTs facilitate price efficiency by trading in the direction of permanent price changes and in the opposite direction of transitory pricing errors, both on average and on the highest volatility days”.

Of course, we should all know that HFT narrows spreads. For example, a 2013 paper found that the introduction of an algorithmic-trade-limiting regulation in Canada in April 2012 drove the bid-ask spread up by 9%. [4] This, the authors say, mainly harms retail investors.

The evidence is out there, and easy to find—but not always easy to fit into the narrative of a financial thriller.

Ben Southwood

[1] http://student.bus.olemiss.edu/files/VanNessR/Financial%20Review/Issues/May%202014%20special%20issue/Jarnecic/HFT-LSE-liquidity-provision-2014-01-09-final.docx
[2] http://pages.stern.nyu.edu/~jhasbrou/Teaching/2014%20Winter%20Markets/Readings/HFT0324.pdf
[3] http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1602.pdf
[4] http://qed.econ.queensu.ca/pub/faculty/milne/322/IIROC_FeeChange_submission_KM_AP3.pdf