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Monday, June 5, 2017

Politicians Don’t Understand Energy Economics

Fixing prices just doesn't work, unless the goal is to win political favors.

Good politics and bad economics have been on display in British political conversations as the parties release their manifestos for the upcoming elections. Prime Minister Theresa May’s suggestion that energy prices be capped and migration controls strengthened was outstripped in economic foolishness only by Labour’s £48.6 billion tax increase and their proposal to nationalize the National Grid.

These proposals ignore economic realities and reflect a complete misunderstanding of how markets work – even markets for goods as vital as energy.

Price Caps Are Not the Answer

Politicians can garner support by promising to fix prices that are distasteful to consumers. Legislators often attempt to force the economy to bend to their collective will through price controls like the proposed cap on energy prices. May defended her proposition by claiming that energy markets were “not working as they should.” This should sound familiar since Labour proposed a similar cap in 2015. Claims of market failure are found everywhere but, more often than not, they only reflect the dissatisfaction of the speaker and not any engagement with the source of the problems plaguing the market in question.

Price caps will make things worse by hindering competition. As long as the meddlers in office use the levers of government to limit what individuals can do, consumers lose. The form of the price cap does not matter. Politicians simply do not have all of the information necessary to make choices for others. Only the person on the spot has the necessary information. The economy is more about knowledge of the scarcity of goods and less about money than many people realize.

In the case of electricity, high prices are distasteful to consumers and politicians can garner support by promising to fix prices at a lower level. However, those high prices, are the carrot that brings in more producers and innovators, lowering prices in the long-run. Price controls only hurt existing producers and their customers. One British energy company, for example, recently reported that their average profit margin per consumer is only £52.

Price controls are likely to push marginal producers out of business or into financial distress, leaving their consumers in the dark. Companies that can’t raise their prices either to temper increased demand for their services or to account for the scarcity of the services and goods they provide, won’t be able to stay in business. If operating costs go up, a business must be able to reflect that in their prices.

Self-Interest, Subsidies, and Energy

One intervention justifies the next.

Government-caused problems in energy markets don’t stop with price caps, however. One intervention justifies the next, either because policymakers try to plug the holes in their plans, or because there is now less stigma against interfering than before the first intrusion occurred.

People who advocate for market intervention are often well-meaning, but good intentions can disguise self-serving ends. The advocates for the recently approved Hinkley Point nuclear plant had many ties to the politicians who ultimately approved the plant. Reportedly, May’s husband, Philip May, could benefit directly from the deal, as he has a 10 percent stake in the French firm granted a contract related to Hinkley’s completion. The revolving door between business and government should make everyone skeptical of government’s alleged altruism.

The nuclear energy industry is not the only beneficiary of government favoritism. Fossil fuel producers, despite their age and level of development, receive a surprising and regrettable number of handouts from governments around the world. According to the International Energy Agency, fossil fuel companies received $493 billion in subsidies worldwide in 2014. The UK provides production subsidies of £5.9 billion (over $7 billion).

“The party has opted for ideology over economic sense.”

In the UK, a coal plant, Fiddler’s Ferry, that was slated for retirement was ultimately saved by a government contract and the promise of more subsidies. Support for fossil fuels is lamentable considering the worries raised by climate scientists and environmental activists about their role in climate change.

Political favors and games always make subsidies problematic, but at least energy sources like wind and solar can claim a public goods defense of their R&D subsidies – even if it’s not a compelling defense.

Although Sebastian Payne of the Financial Times was writing only of the Labour party, his words aptly apply to the current conversation about energy policy: “The party has opted for ideology over economic sense.” If policymakers truly believe their rhetoric about the importance of energy, they should stop playing political games with ratepayers’ power and lights.

  • Josh Smith is a Master’s student in economics at Utah State University where he specializes in public choice theory and environmental policy. He works for Strata as a policy analyst. His writing has been published in outlets including Newsweek, the Hill, and Yahoo News.