When the Thatcher government privatised British Telecom in the 1980s, they created a regulator to cap prices. They did the same with the privatisation of water, electricity and gas. No one suggested then that Thatcher’s policy was Marxist or State intervention. So is there any justification for such accusations now that Theresa May is proposing that the energy regulator should reintroduce a cap?
When the utility companies were first privatised, they each had a monopoly in their own market (or a near-monopoly in the case of BT). Until competition emerged, prices were capped at a level which the independent regulators determined was sufficient to allow the companies to recover their costs, including the “cost of capital”. That latter term is the label economists use to describe the level of profit which is sufficient – but no more than sufficient – to encourage investors to put up the capital required to finance the companies’ functions.
In those areas where competition has emerged, the price caps have been withdrawn. Where competition does not exist, or is insufficient to have an effect, price caps remain. The supply of water is still subject to a price cap.
In the case of energy, numerous companies entered the retail market with a range of price offerings and it was thought that competition was having the desired effect. For those customers who shop around, there are, indeed, competitive options. Very effective ones. But for customers who don’t shop around – or who select a fixed-term deal and then don’t look again when the deal expires – the energy supply is automatically put onto the company’s default tariff. It is those default tariffs where doubts have been raised as to whether they are responding to the full force of competition.
At first sight, that may seem odd. When shopping for goods and services, we don’t spend time in advance of every purchase searching for the best price. We know, for example, that supermarkets compete with each other on price and we don’t have to do the research each time we head for the shopping aisle. Sometimes we look around. Sometimes we rely on the fact that others have been looking. So long as enough people are keeping an eye on prices at any given time, providers will be driven to compete. The rest of us can buy the product at the resulting price.
But imagine a world in which supermarkets could somehow tell which customers had scoured the market for the best deals and they offered those customers a lower price, with higher prices charged to the shoppers who didn’t know what was available elsewhere. In some markets, that is almost exactly what happens. In a car show room, vehicles are marked with a sticker price which is often an invitation to negotiate, not the final price at which a deal might be done. Customers don’t, of course, have to do research before they are allowed to negotiate; they can just bluff in order to see if a reduction can be obtained. But those who know what prices are available elsewhere can walk away from the showroom if the offer can be bettered.
In the case of energy, it’s a whole lot simpler for the sellers. Customers who don’t ask about the options are placed onto the default tariff. Those who do ask, or who look up online, are shown a range of options. It is the very absence of an enquiry which signals to the energy company that a particular customer doesn’t know about the market level, or they don’t care (enough) about it to act on the information. These customers are charged a higher price – not so much higher that it triggers the desire to look around after all – but sufficiently high that the Competition and Markets Authority concluded last year that customers were, in aggregate, paying £1.4 billion a year more than they would have done in a fully competitive market.
In its report, the CMA advocated a range of measures to revitalise competition and reduce the prices paid by customers. One member of the five-person panel went so far as to suggest a price cap, although the others thought competition could be achieved without that step.
The proposal isn’t Marxist. It’s not a return to the 1970s when successive UK governments controlled prices and wages in an unsuccessful attempt to conquer inflation. It’s simply the application of an economic mechanism, first introduced to the UK by Margaret Thatcher, in which the price of essential utilities is capped at an economically rational level unless and until competition takes over and renders the cap redundant.