Energy market fail – the case for ordoliberalism

For once David Cameron has done the roughly right thing in restricting the energy companies to only four tariffs although I would have liked to see even fewer.

For years the received wisdom has been that competition – not just in energy, but generally – is a Good Thing; any evidence of that a market isn’t working properly is routinely greeted with calls for more competition.  It’s become so ingrained that almost no-one stops to question why it don’t always work as it’s supposed to.

Unfortunately for market fundamentalists, a growing pile of evidence suggests that their economic theory is wrong because it’s simply not an accurate description of how the real world works and ‘free market’ competition isn’t delivering the goods.  How this has been working (or rather, not working) was discussed on last week’s edition of ‘This Week’  with  guest Martin Lewis of Money Saving Expert (starts at 5:15).  His site has done a survey of its 14 million users and found that 80% don’t want the present system so this is political dynamite.

Martin Lewis pointed out that the energy market works as a regressive tax; affluent, middle class internet users pay the least while those in fuel poverty, disproportionately the poorest and oldest pay more, often substantially more.  He said that, whether or not Cameron really meant to say what he said on the subject recently, what he actually said is exactly what the public want, namely regulated prices.  For consumers competition has failed.

Michael Portillo reflected the uncertainty of many politicians.

“I think politicians reaching the point where they are beginning to lose faith in the ability of competition to produce the best deal for consumers but I think that is a big psychological and, kind of, philosophical moment if that’s what you actually conclude because, you know, for the last 20 years it’s been based on the idea that competition was going to give people a deal and in most things in life that’s exactly what happens. If you go to shops, telephones, if you fly on airlines, competition has brought down prices”

Note the positively baroque construction of his opening,“reaching the point where they are beginning to lose faith …“.  You can almost hear the gears shifting.  Whether he realises it or not he is calling the end of the era of neoliberal belief in the infallibility of free markets which Thatcher ushered in with her general election victory of 1979.   The old paradigm still rules by default in the absence of a better replacement but it’s mortally wounded and can’t stagger on much longer.

Portillo still clings to faith that competition reliably delivers in sectors other than energy.   However, here too evidence is piling up that not all is well with the received wisdom although, inevitably, the picture is complicated so no simple statement suffices.  I see at least three main problems (there are others but that would involve a book, not a blog post).

The first is the problem of ‘market failures’ including that markets don’t factor in externalities and that they reflect short-term supply and demand which makes them terrible where the long-term is important like planning for transport infrastructure or energy.  Market fundamentalists typically claim that market failure is rare and exceptional.  Indeed the whole basis of their faith is that ‘free’ markets (i.e. free of any government regulation) deliver optimal outcomes.

In reality, market failure is the norm.  To result in anything like a good outcome that is stable over time requires a long list of tightly specified preconditions which never, or almost never, occur in the real world.  For instance, any business sector with economies of scale (i.e. almost all) will tend towards concentration and oligopoly until the point is reached where competition is no longer effective.  The board game of Monopoly is a familiar example of how an early advantage drives growing concentration of power and inequality until it’s game over.

The second problem is that ‘free’ markets rarely exist – and then only briefly.  It doesn’t take long for oligopolistic businesses to work out how to influence the levers of power.  It helps the influencers that too many politicians are horribly star-struck and easily succumb to the glamour of money.  It can be revolving doors between companies and government, informal understandings with senior regulators and politicians, participation in standards-setting or even writing legislation.  The ways commercial power wins are limited only by human imagination – which is to say almost unlimited.  The result is the emergence of an interconnected elite.

Moreover, power abhors a vacuum so when government is weak the private sector quickly seizes an opportunity to fill the void.  If government decides not to regulate as a matter of either policy or weakness someone else will step in and the ‘law’ becomes whatever the new Mr Big says it is.   The law ran thin on the frontier of 19th century America so the theme of many westerns is the story of a big rancher employing a gang of thugs to enforce his own self-serving version of the law.  Much the same is true of Wall Street today thanks to the gutting of effective regulation as a policy choice.

The third problem is that real full-blooded competition is simply TOO effective for firms to survive it.  They must find ways of reducing the pressure on them.  The easiest way to do this is to merge with or take over rivals until the market is an oligopoly.  Hence the small numbers of serious players (typically 4 – 6) in a whole range of sectors from banking to supermarkets to energy.

It’s not that I’m against competition, far from it, but left to their own devices markets aren’t stable and won’t deliver the public policy goods.  Like advanced fighter planes the trade-off for high performance is that they are unstable.  The solution for planes is fly-by-wire systems that react faster than any human pilot ever could.

The solution for markets is the equivalent.  It’s a constant battle to keep them ‘open’ (subject to challenge) and keep them working for the public good.  This is a very different from what neoliberals advocate.

Equally, because full-blooded competition is ruinous it means that government should arrange things so that it is muted, so that there is a gentle pressure to improve and to innovate but not the imperative to eat the seed-corn to survive until next week.  That in turn means limiting pricing ‘freedom’ (aka anarchy) in sectors like energy.  And that is why I think Cameron, for once, is on the right track except I would like it to be even simpler – allow only one fixed and one variable tariff for each company with premiums and discounts for dual fuel or direct debit etc. expressed as a percentage.

This is ordoliberalsim and is the approach of most German liberals.  It’s worked rather well for them.

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