So much for competition

The way markets are structured is critical to delivering an efficient allocation of resources. During the 1980's the movement to increase competition in markets in order to drive prices down and consumer service up was the basis of the privatisation and deregulation programme.

The idea is essentially that monopolies can exploit their customers and the more firms in the market the better it is for keeping costs and prices down.

In some markets economies of scale means you can't efficiently have hundreds of firms. One such market is energy supply, but you could certainly have up to 15 or 20. But when you have oligopoly market structures there is a tendency to collude and so some regulation to ensure fairness and maintain competition is needed.

So the energy market, dominated by six big suppliers, is one that might fall into a situation where they each decide not to compete too hard for business and all keep prices quite high.

Many people have been disappointed by recent high energy prices, some believe that the firms are keeping prices high when they need not. Others think that pricing is unfair with some people getting good deals while others (without Internet or able to pay by direct debit) pay too much.

So the government are introducing a new regime where there will be fewer price plans and customers will have to be put on the lowest available tariff.

This seems to be abandoning the idea of competition as a way of making sure resources are allocated efficiently.

The fear is that this will eliminate competition. The big firms will set similar but higher prices and while some people will be better off the good deals will disappear. The danger is that the government has just done the firms collusion for them and will prevent prices being forced down in the market.

The BBC survey the change here and make some excellent points

Energy prices - a reason to reconsider?

Five of the six big energy companies has announced very high price rises, up to 11%. This is going to have a very large impact on household budgets.

There are two areas I'd like to think about, one fairly obvious and the other more reflective.

1. Fuel Poverty

Fuel Poverty is a relatively new term that refers to a situation where households spend more than 10% of their income on keeping warm. (The definition is vague on gross or disposable income, but only the latter makes sense.)

Clearly an 11% price rise will cause more households to fall into this category. If we taxed energy then people would explain that this was a 'regressive tax'. It would fall more heavily on the poorest households as it takes up a greater proportion of their income.

Therefore we should be worried about these energy price rises on the grounds of equity and income distribution. The Sunday Mirror article below looks at the effect on Fuel Poverty which may now affect one in four households.

2. The privatised energy market

In the 1980's the energy market was privatised. The aim was to introduce competition and force prices down and so making everyone better off.

The effectiveness of this policy should now be reassessed. Has it led to lower prices? Is there actually competition? Was it, in retrospect, a good idea?

Supply side policies take a long time to yield their results. It took two attempts to get the gas market right as well.

Is there really competition in this market? All the big companies are going to raise their prices by about the same amount. This is to be expected as their raw material costs are changing in exactly the same way.

If government still controlled this market then they could moderate the price rises, allow special tariffs to vulnerable groups etc. But the energy companies are private, profit making, firms and they work in the interests of their shareholders.

The Government has proposed forcing all energy companies to make sure customers are on the lowest possible tariff. This implies one tariff per company, probably all pretty identical. A major blow to competition and without any price controls. Politically popular but hardly market economics.

The Daily Mirror article is here

Another rail fiasco

The decision to award the West Coast Main Line franchise to First Group in August has already caused a commotion. Virgin had launched a legal challenge claiming 'somebody does not like us at the DfT' (Department for Transport).

Well its not only people in the DfT who find Richard Branson a pain in the arse, but that was not the reason Virgin lost. Officials miscalculated the time value of money and passenger numbers in the 13 year franchise bid. It does make a difference when money flows are received as inflation and interest rates are key elements.

The whole process is now up in the air and will have to be examined again.

For us the process is the issue. How do we assess long term transport projects? Stephen Glaister a former LSE and Imperial professor is a specialist Transport Economist. He looks at the issues in this excellent Guardian article here. (Essential for A2!)

Glaister's article is here

Road privatisation - is this the death of sensible road pricing as an option?

The Prime Minister announced that there is to be a consultation on putting the road network, at least partially, into private ownership.

This move has many implications and Transport Economics will be changed forever.

The Independent article raises most of the important issues. How will the roads be 'privatised', will the same mistakes be made as in past privatisations? Has PFI ever really worked? Will this scheme bring the investment the roads need?

But there are two issues I need to highlight.

The report suggests the cost of congestion is £7bn a year. I know this was estimated at £15bn in 1990, so this seems far too low a figure. I have asked for information on the source of The Independent's figure, but the difference seems to me to be so massive that it would change the result of any Cost-Benefit Analysis.

The issue that really bothers me about this plan is that it effectively abandons any thought of a national road pricing scheme. Such a scheme, where charges vary according to the time of day and level of congestion and co-ordinated on a national basis, holds the answer to the road problem.

Road pricing will pass on external costs, reduce road use and encourage alternative modes of transport. Such a scheme uses all the principles of charging that economists know can lead to an optimal outcome and a sustainable transport policy.

Can you imagine a road network with a mixture of public and private roads, a variety of tolls and SatNav's that direct traffic down the cheapest route, which will probably be past a school or old peoples home? Let's not even start on what happens when firms and investors walk away from their franchises!

Vital reading for Grecians, but important for everyone.

The Independent article is here

Has Rail Privatisation failed?

Yesterday The Guardian compared the NHS reforms to a 'failed Rail Privatisation'. I'm not at all clear on the NHS aspect of this but the article largely dealt with rail anyway.

The article chronicles many of the worst aspects of what was a botched privatisation in the rail industry. But even so I found  the negative aspects of it somewhat overstated. The problem of rail privatisation was its success allowing a huge rise in use.

That is very little consolation to those who stand everyday on overcrowded trains and pay the world's highest fares, but a more than 50% rise in passenger km's since privatisation seems like a measure of success, not failure.

The problems of the rail industry were highlighted in the McNulty report (a copy is now on the website in the Transport Economics page). The poor privatisation and subsequent meddling of an incompetent government (Prescott and Byers primarily) has prevented the intended competition from keeping costs down and the necessary investment has not happened because nobody trusts the government or PPP.

If the NHS reforms led to 50% more patients being treated on essentially the same health infrastructure wouldn't that be counted as success? Really the rail industry needs £20bn of new infrastructure investment in the next five years and about the same each five years after that without a single high speed line being built.

The Guardian article is here

Increasing competition or normal oligopolist behaviour?

In October it was reported that the big six energy companies had increased profits from £15 to £125 per customer per year. This drew the attention of the regulator Ofgem.

When the nationalised industries were privatised the idea was to move from state monopoly to a competitive market where the consumer got a better deal. What we got in a lot of cases was either private monopolies or strong oligopolies with high barriers to entry.

Ofgem are trying to improve the situation by forcing the 'big six' energy companies to auction off some of the electricity they generate to allow new entrants into the market.

However this week a number of the big six announced price cuts. Does this mean the fear of new entrants is forcing them to act (a contestable market)? Ofgem would be delighted if this were true. But this behaviour is consistent with oligopolist's profit maximising behaviour.

The warmish winter means spot market prices for energy are lower this year than the last two years. With lower than expected costs one firm moves price down to gain market share. The others lower prices to match them to protect their market share. The kinked demand curve model and game theory would both predict this move.

The Telegraph report the story here