A brief Economist’s view on the current draft Energy Bill

UK energy markets are in a mess for two basic reasons.

First, market liberalization, which began in the 1980’s under Thatcher, has not yielded the investment necessary to secure future supplies in the face of an ageing stock of coal and nuclear powered generators. The Government estimates, for example, that £110 billion is needed by 2020 to update and expand capacity.  

Second, the environmental costs of the sector remain stubbornly high, accounting for around 40 percent of total UK carbon emissions.  And there remains a considerable way to go in order to meet the Government’s stated goal to reduce emissions by 32 percent against 1990 levels by 2020.

The Government released its draft Energy Bill in May, which is set to be finalized in the forthcoming Parliamentary session. At its core are two government procurement measures, designed to encourage “green” energy investment, particularly in nuclear power; and help expand overall generating capacity, particularly from natural gas.

The case for policy intervention in relation to the first problem is well established. To avoid economically costly black outs, we need spare capacity. But operating such safety margins is not profit maximizing from the generators’ perspective. Thus procuring additional capacity on our behalf through a competitive tendering process, as is provided for under the draft Bill, appears not unreasonable. 

However, managing the later issue is more problematic. There are a number of economic theories for managing externalities. In the case of a global concern such as climate change, the lessons from Pigou are arguably much more powerful than, say, Coase (efficient outcomes are unlikely to be achieved through bargaining when everyone on the planet is affected, including future generations). Essentially, we should be trying to systematically tax the sources of the problem, like fossil fuels and deforestation. The extra revenue could be handy too, and arguably a far better tax base than investment or labour, say. 

Some progress has been made to this end, with the establishment of an EU Emissions Trading Market (ETS) in 2005, which covers the power and industrial sectors (although the revenues from this policy have so far been squandered through handouts of pollution rights to industry participants). But governments across Europe, including in the UK, have generally preferred to subsidise alternative technologies than strengthen the disincentives for polluting investments.

The draft Energy Bill effectively extends existing subsidies, which currently flow mostly for the wind industry, to Nuclear. The Government asserts that such temporary support is essential to ensure the necessary advancement in green technologies. However, this argument is weak, not least because the proposed contracts are long term, often extending over several decades (and subsidies are politically difficult to reverse in practice). And the effectiveness of past financial support is often only weakly demonstrated.

Even accepting the case for subsidy for a moment, the proposed measures raise a number of issues. A system of fixed payments to energy suppliers essentially transfers financial risk from new energy investments onto consumers. Arguably, this may be justified only to the extent that households are more willing and able to assume such risk than the industry players. This is far from clear…

…Moreover, the proposed system of contacts requires the government to forecast future energy prices in order to determine the “correct” subsidy level to particular technologies. This is inherently challenging and increases the chances of “regulatory capture”. Getting such assessments wrong may result in either too little (or the wrong type) of investment, and/or excessive rents flowing to private investors.

So faced with such a draft bill, and an understanding of the basic economics of the issue, what should the politicians do?

Unfortunately, reform cannot wait. Action is required now to avoid potentially costly supply shortages in the future, especially given the currently weak investment climate. However, the policy on renewables is a mess and needs rethinking. Working with EU partners, the Government should strengthen the incentives for green investment under the EU ETS; in particular by tightening the emissions cap and broadening the scheme’s coverage. It could also simplify the schemes’ administration, and raise some cash by auctioning pollution rights rather than the currently complex system of handouts.

It should also seek to roll back subsidies for “green” (as well as “brown”) energies, which are imposing significant costs on consumers at a time of falling real wages (remember that the term subsidy can refer to many things, including favourable tax treatment relative to other markets). 

By removing, rather than adding, to energy market distortions (and avoiding interventions in favour of specific technologies) the government may ultimately achieve cleaner energy, and a more efficient allocation of scarce resources in this critical sector...

English Talent Stifled?

During the coming term (subject to confirmation!) we'll be talking about the economics of sport in Contemporary Issues. One thing we'll think about is applying the economically appealing concept of competition into the context of sport.

Roy Hodgson has spoken directly into that arena today, bemoaning that English talent is being stifled because of lack of opportunity in the Premiership. I should make it clear - I'm a big fan of Hodgson and fully believe he was the right appointment back in the Spring. However, his talent lies in coaching, rather than analysing events through the lens of economics.

You'll hopefully recall the first and second theorems of welfare economics from econ101a last year - that a competitive outcome is Pareto optimal, and that a Pareto optimal outcome is also a competitive outcome. In laymans terms this says we can't do better than the competitive outcome. Restrict competition, and while you might benefit some, you'll have an overall net negative impact - you'll negatively affect others.

English players, forced to develop within the Premiership system, have about the best training imaginable - each week they play against (and alongside) the greatest players in the world (bar those that have left for Barcelona or Real Madrid). They aren't in squads because they are protected by rules telling teams how many players from particular types of countries they can field.

The most likely impact of this is that the English players that make it are of world class - the other likely consequence is that there are fewer of these players. So what Roy Hodgson faces, compared to, say, what Bobby Robson faced in the late 1980s, is a smaller pool of higher quality players. But Hodgson knows that the ones he can put in his team are familiar with playing against the best players in the world week in, week out.

Surely that's much better than having a large pool of mediocre players?

Taxes and the Rich

There are few things more emotive than taxation and "the rich", and I have little doubt that as undergraduate students you have a few opinions on these issues.

It turns out Nick Clegg has made a public pronouncement (via the Guardian) that the rich should pay more tax - at least for a while...

The purpose of 217 is to encourage you to think about issues like this as an economist - to put your learning into practice.  So the think we should try our best to do is put politics out of the picture for as long as we possibly can, and try to think about things objectively - if that's possible!  Bernard Jenkins, a Tory MP, is very quickly political in the linked BBC article, trotting out the usual line that Clegg is indulging in the "politics of envy" (John Redwood does at least try and defend the Tory approach to taxation and the rich - something we are often quick to ridicule). Let's try and leave that behind.

One fairly commonly known theory, and one often cited when discussing matters of taxation is that of Ricardian equivalence, proposed by the famous economist himself.  It says that people are aware of the government's budget constraint, and hence realise that any cut in taxes now (or increase in spending) will have to be paid for, and hence they expect higher future taxes and so do not increase personal spending now but instead save up for when the tax bill will come in the future.

It's an intellectually appealing theory - we like to think people are rational and make sensible decisions like this. However, it does rely on a number of assumptions, as any economic theory does. For example it requires for its full effect that tax imposition is even across society, hence that all will feel the pain of increased future taxes to pay for current spending. In our progressive tax system, this is unlikely. It also does not reckon with our impatience - we want jam today not jam tomorrow and hence we'll spend today and face the consequences tomorrow.

We'll think a lot about policy in econ217 over the coming year, and one thing it's important to recognise is that nothing can be proven one way or the other using the tools of economics - neither data nor clever reasoning constitute proof in matters such as this, particularly when we are trying to predict the future. But this also does not render what we will discuss as meaningless - it will still pay for political parties to put in place economically sensible policies rather than trying to use economists for intellectual cover for ideologically driven policies (a common trait of all political parties).  It should be an interesting year!

Be Inspired!

Even if you're not a football fan or even a Man City fan, City have potentially given you a boon today - see http://www.youtube.com/watch?v=ikm52r7RlKc&feature=youtu.be.

City are making available incredibly detailed data on all football matches from last season - could make for an ideal extended essay when you reach your third year!

Sign up here: http://www.mcfc.co.uk/Home/The%20Club/MCFC%20Analytics

Moneyball UK

If you're a football fan and an economist, you may have come across Moneyball, the story of some data junkies who revolutionised how teams approach baseball in the US, and you may have seen the response of many cynics to Liverpool's attempt to adopt statistical techniques to augment their pursuit of success.

Sadly for those cynics, Manchester City provide the ultimate rebuttal of their sneering at the use of statistics in football, as this Guardian article shows. Vincent Kompany, a man whose stock never seems to stop rising, instigated weekly reviews of highly detailed OPTA data on City's defensive performances on arrival at the club, and it's hard to argue that they didn't help, since City were one of the best defensive sides in the league last season (and the one before that).

However, for those of you football fans and studiers of econ217ab, there's a huge opportunity coming your way.  City are setting up MCFCAnalytics from today, and at 5pm are releasing OPTA data from the 2011-12 season free of charge. This kind of data costs thousands of pounds usually, yet it's precisely the kind of data necessary to pursue theories about how football works - have you got a budding theory about why City kept winning? About why teams always win at home? You can start now to investigate it as the data will be available!

I'd like to specifically encourage you ahead of your third year, when you'll write your extended essay. Data like this could form the basis of a fascinating essay.  I've currently got students looking into how and why players trust each other, I've done research personally on whether Premiership referees discriminate, and have many plans for future research projects using this kind of data. Making use of this data to either look at footballing strategy or test economic theories will be one of the options you can choose at the end of the coming year when you start thinking about your extended essay...

Rail Fares

Yesterday saw the announcement that rail fares are going up by 6.2% in January, which has naturally caused plenty of consternation, with Guardian blogs fuming about the social exclusion going on.  The same sentiment is declared on Liberal Conspiracy too, with another sentiment being expressed: Controlling train fares protects the consumer.

However, is that true? Is it really true that controlling prices protects customers? In Contemporary Issues we'll spend quite a bit of time looking at reasons why governments might intervene in various markets to do things like control prices.

If you think you agree with the sentiment that controlling prices protects customers, hopefully you'll be challenged about the bases on which you hold that view, while if you think it is much more complicated, the course will help you to articulate that sentiment better.

A view that controlling prices protects customers ignores the possibility that customers are affected by the quality of a good being produced, and also its quantity. The upward sloping supply curve we are all used to now tells us that if the price is held low, then the quantity supplied will be low - it's not worth firms providing.

The supply curve is just one analytical tool we'll make use of in the course, but hopefully your appetite has been whetted already...

Perspectives on Football

One of the topics taught on econ217ab is the economics of sport. This coming year this section will be heavily influenced by the Olympics that just finished; in previous years the focus has been more towards football, and if you are interested in how economists think and approach football, you might be interested in the following new site: Football Perspectives.

The idea of this website is to provide blog-style posts which have slightly higher analytical content than might be standard in a blog post. It is similar in essence thus to Vox, a more general policy-orientated research blogging site.

Both are great resources and well worth a read if you're thinking of getting in some advanced reading ahead of the coming year's course!