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.

Increasing access to private education will add billions to growth

  • The UK’s average annual growth rate between 1960 and 2007 would have been almost 1 percentage point higher had it matched the Netherlands’ long-term level of independent school enrolment since 1960. This in turn means that UK GDP per capita would have been over £5,800 higher in 2007 than it was.
  • Better education boosts economic growth; improving students’ international test scores by 10% raises a country’s average annual growth rate by 0.85 percentage points.
  • UK GDP per capita would have been almost £5,300 higher in 2007 had it performed as well as Taiwan since the mid-twentieth century.

Britain could add billions of pounds to long-term economic growth if it increased access to private education, a new report released today (Tuesday July 29th) by the free-market Adam Smith Institute has found.

The report, “Incentive to Invest: How education affects economic growth”, illustrates how higher educational achievement boosts long-term economic growth, and the important role of private schooling in this process.

Through the use of existing research and new quantitative evidence, the author of the report, Gabriel Heller Sahlgren, establishes that test scores are closely related to growth. Lifting achievement by 10% hikes a country’s average annual growth by 0.85 percentage points.

Furthermore, the report illustrates how competition from independent schools has proven successful in generating higher international test scores, while also driving costs down. Sending 20 percentage points more 15 year olds to independent schools would raise growth by 0.4pp—or about a sixth—via its positive effect on educational achievement.

Based on his findings, Heller Sahlgren calls for the government to radically reform education policy by encouraging more privatisation and competition in the education sector.

Had the UK matched the Netherlands’ long-term level of independent school enrolment since 1960, its GDP per capita would be over £5,800 higher today, the report argues. At a time when policymakers are trying to cement and broaden the economic recovery, the report suggests that expansion of access to private schooling would be an attractive component of a long-term growth strategy.

Commenting on the report, its author Gabriel Heller Sahlgren said:

My research shows that a focus on increasing the number of pupils taking higher qualifications is misguided. There’s in fact no robust impact of average schooling years in the population on economic growth on average.

On the other hand, education quality, proxied by international test scores, has a consistent and strong effect on growth. According to my calculations, the UK’s real GDP per capita in 2007 would have been over £5,000 higher had we performed on par with Taiwan since the mid-20th century. So the dividend of improving children’s attainment is large indeed.

Yet there are different ways to do achieve this. Unlike expensive resource-driven education reforms, which are rarely cost effective, a good option is to raise the level of independent school competition, which other research shows both increases international test scores as well as decreases costs.

According to my calculations, the indirect economic benefit, via higher achievement, of increasing the number of pupils in independent schools to the Netherlands’ level would be a 0.92 percentage point higher long run GDP per capita growth rate. The government should therefore continue their market-based reforms on education and expand choice as widely as possible.

Sam Bowman, Research Director of the Institute, said:

This report shows that we need greater access to private schooling for all pupils regardless of background, not just to improve the welfare of the children themselves but to boost the UK’s overall standard of living and long-term economic growth.

Expanded access to private education through school vouchers and a revival of the assisted places scheme may be an easy, low cost way for the government to boost growth by improving the human capital of British workers. The results may take some time to materialize but studies like this show just how valuable a long-term strategy for expanding access to private schools could be.

Click here to read “Incentive to Invest: How education affects economic growth”.

For further comments or to arrange an interview, contact Kate Andrews, Communications Manager, at kate@adamsmith.org / 07584 778207.

Why get rich?

You might have seen this chart, which shows different professions’ household income during childhood vs their income now:

A lot of people have focused on the fact that artists’ incomes ‘fall’ more than any other group. It reminded me of this quote from the American Founding Father John Adams:

I must study politics and war that my sons may have liberty to study mathematics and philosophy. My sons ought to study mathematics and philosophy, geography, natural history, naval architecture, navigation, commerce, and agriculture, in order to give their children a right to study painting, poetry, music, architecture, statuary, tapestry, and porcelain.

Equality: as cheap as 50p?

Peter Oborne argues that Ed Balls’ pledge to raise the 45p top tax rate back up to 50p is a good idea. While the extremely high marginal rates (top main rate 83%, plus a 15% surcharge for “unearned income”) of the 1960s and ’70s might have been driven by “socialist envy”, George Osborne’s dropping the rate from 50p to 45p in was “profoundly shaming and offensive”, Oborne contends. This is because, echoing Stanley Baldwin and his brand of Toryism, the conservatives should represent the whole country, not the rich or any other factional interest.

Apparently the Coalition has “devoted a great deal of effort to lowering the living standards of the poor”, and this move to “make the rich richer” is inappropriate when the poor are getting poorer. I contend this by arguing that inequality is down to 90s levels under chancellor Osborne, while the worst-off in society are the only group to actually see their living standards improve the since the recession hit. And the (ugly, unpleasant, and regrettable) attitudes that have emerged towards benefits claimants are probably driving government rhetoric in that area, rather than vice versa.

In general, it annoys me when a columnist writes something apparently trading on what everyone just knows. Sometimes the common view is incorrect. Funnily enough, politics is the area where people err most profoundly and with the most regularity. And I would argue that Oborne is trading on falsehoods in his piece; would it still be a coherent argument if it started with the factual premise that inequality in the UK fell back below its 1997-8 low in 2011-12, 0.34 measured by the GINI coefficient? That the top 10% of earners endured the biggest blow to their incomes since the onset of the recession? And that the bottom 10% by income were the only one to see a rise in living standards taking inflation into account? I don’t think so.

The IFS reports I link above predict that by 2015-16 inequality will rise back to roughly its pre-recession level, so perhaps Oborne could refocus his attack on the future inequality Osborne possibly has a hand in. But in all likelihood there is probably little the government can do about inequality over the long-term, caused as it is by very fundamental trends and robust as it is to institutions even such as the USSR’s. Most of the extra inequality since the 60s and 70s has come from couples engaging in much more assortative mating. And very long-term trends are mainly dominated by heritability of social class—those with Norman surnames are 28% more likely than a random sample of similar others to get an Oxford place.

Bubbles and balloons

Quite a few people criticised the title of my last post — There was no British housing bubble — on the basis that, even if there was no overconstruction of housing (and thus no Austrian-style distortion in the structure of production), there was a bubble in the sense that prices rose rapidly, and so on.

But is this right? I suppose it depends on what you mean by a ‘bubble’. As far as I can tell, there are at least three different meanings of the word ‘bubble’:

  1. A speculative bubble, like the Beanie Baby craze. As Arnold Kling put it recently, “If investors who are buying the asset have estimates of the discounted present value of the income from that asset that imply a negative real return, then it is a bubble.”
  2. An Austrian-style bubble that distorts the real economy by incentivising production in an area where much of the demand is illusory (typically created by credit expansion, according to the Austrians).
  3. A government-created rise in price above ‘real’ (or endogenous) factors.

Take the third kind of bubble, which I think is what we are currently seeing in the British housing market. A ban on the construction of new houses would cause the price of housing to rise significantly, for instance (and this isn’t a million miles away from current government policy). Though the government policy is probably very harmful, given that it exists it is perfectly rational for markets to drive the price up, and that price should stay up for as long as the political factors dictate. The policy might be crazy, but the market’s reaction isn’t.

Let’s take a look at historical UK house prices (in real terms).

Clearly, prices were above trend in the 2000s and then fell after 2008, but compared to the early 1990s prices are still extremely high. I’m willing to believe that quite a bit of that rise was a type-1 or type-2 bubble, but unless you think we’re still in the midst of that kind of bubble (which could pop at any time), it’s not the whole story and doesn’t even seem to be most of the story. (As some commenters have pointed out, some aspects of this price increase were likely attributable to foolish financial wizardry, probably driven by regulation.)

More likely, that rise in house prices since the 1990s, since it is still high, is a type-3 bubble — a sensible reaction by markets to foolish government policies constraining the construction of new homes. I can’t explain why this rise only took place in the 1990s (population growth and decreases in household sizes may explain this, but I don’t know), but unless you’re saying that right now markets are wrong and you know better, that rise doesn’t seem like the sort of unsustainable bubble that leads to sudden crashes.

Type-3 bubbles are different to type-1 and -2 bubbles in that they do not run the risk of sudden crashes. A type-3 bubble is created by government fiat and it can only be undone by government fiat. This difference is sufficiently great that I suggest a new term for type-3 bubbles: “balloons”. A term like that might communicate the fact that prices have been blown up by human agency and, unlike bubbles, require an active popping or disinflating before they go away.