Why we really do want to abolish corporation tax reason 672
You'll have noted that there's a certain amount of shouting going on at present about the corporation tax. And while there is much of that shouting going on very little of it seems to be well informed. For the truth is that we should solve this "problem" just by abolishing corporation tax itself. Around here we've been through the arguments many a time and I've been known to bore people to tears on the point. But it is still true that we want to get rid of it. The most basic reason being that companies simply don't pay it anyway: all taxes mean the wallet of some live human being gets lighter. As a company isn't a live human being (no, legal personality is not the same as being a natural person) therefore it's not the company bearing the burden of the tax. We've rehearsed this part of the argument a number of times.
There's another supporting argument mentioned here though. Corporation tax is a dreadfully inefficient tax. For that reason alone we'd rather like to get rid of it and have something more efficient.
All taxes have deadweight costs (sorry, almost all of them do which we'll come to). The simple existence of the tax sticks an oar into market pricing and thus causes some people not to do what they would have done in the absence of the tax. Sometimes we desire this, of course: taxes on pollution say are meant to reduce the amount of pollution. But on making profits and incomes and things like that we don't want to reduce the activity. In this sense corporation tax, to put it politely, sucks. How much though?
"The domestic distortions that the corporate income tax induces are large compared with the revenues that the tax generates," the Congressional Budget Office wrote in a 2005 report. It found that for every dollar raised by corporate taxation, the cost due to distortions was between 24 and 65 cents.
An entirely horrendous number I hope you'll agree. And if we look over here we can see that the OECD agrees. Corporation tax is very much more distorting than other forms of taxation. We thus should get rid of corporate taxation and replace it with something less damaging, something less distortionary and with lower deadweight costs. Like, for example, repetitive taxes on immovable property (or Land Value Taxation perhaps) which is one of the very few taxes which has negative deadweight costs. For you can't avoid it thus there's no distortions and the weight of the tax is likely to lead to more efficient use of the available land.
It's true that this issue of corporate taxation has been brought into public view as a result of various lefty agitrots and NGOs. Which is fine: free speech for all n'all that. But now that the issue is being talked about we, the sensible few, should coopt that public mood.
Now that everyone is talking about corporation tax let's do something sensible about corporation tax. Let's abolish corporation tax.
Why Ireland and developing countries should have a low corporate tax rate
As you know there's much ventilating going on about corporate tax rates about the place. Special venom is reserved for Ireland's low rate and various development charities are turning the air blue with complaints about taxes in the developing countries. The thing is though, a small and open economy like Ireland should have a low corporation tax rate: and developing countries should probably have one of zero.
The reason is that thing called tax incidence. Companies don't pay corporation tax: it's some combination of the shareholders and the workers who do. This is not a point in argument: the only argument is about what the portions are, not the fact that the burden falls upon these two groups. We also know what it is that influences which group: it's how large the economy is in relation to the world economy and how open it is to capital movement. The smaller and more mobile, the more the workers get it in the neck.
The mechanism is simple enough. It's pretty much straight from Adam Smith in fact. There's an average rate of return to capital: a jurisdiction that taxes that return to capital will have a return lower than that global average. So, some domestic capital will flow out seeking the higher foreign returns, some foreign capital will not flow in for the lower domestic ones. There's thus less capital employed in the economy. Adding capital to labour is what drives up the productivity of labour: the average wages in a country are determined by the average productivity in that economy. So, tax companies, get less capital employed, wages are lower than they otherwise would be. The workers are bearing part of the burden.
As I say, the smaller the economy and the more open it is then the more of that burden is upon the workers. And in a wonderful result back in 1980 Joe Stiglitz showed that the burden upon the workers can actually be more than 100%. That is, the workers lose more in wages than the government gets in tax.
Ireland's a small economy, 3.5 million people or so and as it's in the EU has about as close to perfect capital mobility as it is possible to get. Thus it ought to have a lower corporation tax rate than larger economies. And it does, so that's just fine then. Attempts to push it up (as various EU types are currently muttering) would simply lower wages in that country.
And the effect is even greater in developing economies. By definition they're small economies: that's why we call them developing because they haven't developed a large economy yet. And the current rows about tax rates in them are all about foreign investment: so obviously we're talking about mobile capital here. And it's entirely possible that for some (actually, for the smallest, it's certain) that the burden on the workers' wages is more than 100% of the tax being raised. All of which makes Christian Aid's wafflings about tax avoidance and evasion very interesting indeed. Given that it is the workers, those poorest of the poor, who are bearing the burden of corporation tax in such places then a charity committed to improving the condition of the poorest of the poor would be arguing for zero coroporation tax rates in such places.
Unless, of course, they were simply ignorant of the basics about tax incidence. But that couldn't be possible, could it? No one who is ignorant of a subject would be campaigning on it, would they?
Does speculation really harm the world's poor?
Development activist Deborah Doane said yesterday on comment is free that Goldman Sachs should admit it drives food prices up through speculation. She excoriates the finance giant for what she sees as its role in 44m across the world being in food poverty, suggesting its charitable efforts amount to little given its speculative activities. She assembles an array of sources purportedly supporting her case.
But the way Doane does this is perplexing. She implies in her first paragraph that the World Bank agrees with her conclusion, but the link she includes mentions only a UN official's opinion, making no reference to the WB. And while, apparently, more than 100 studies support her argument, her article provides no evidence this is the case. Moreover she makes no attempt to deal with the basic economic argument against her thesis.
On the one hand the most limited version of Doane's thesis—that speculation increases prices—is undeniable. When speculators buy into the market, they raise the price then. But the overall case makes little economic sense. If speculators' influence is big enough to boost prices when they buy in, it is big enough to cut prices when they sell out. That is, speculators both add to, and take away from, prices.
A speculator makes money by buying in times of relative plenty, when prices are low, and selling in time of relative scarcity. For helping society ration effectively—making sure the differing scarceness of a good is reflected in its price, thereby improving individual decision-making—the firms earn a return. If a speculator, by contrast, buys in at the top of the market, reducing supply when it is most needed, and sells at the bottom, when it is least needed (relatively) they lose money. This is how the profit and loss system, in a good institutional structure, encourages and rewards socially-minded behaviour. And speculation should smooth volatility in markets. A jump in price will encourage sales from speculators, bringing the price back down. A dip in price will encourage speculators to buy, bring the price back up. This result dates back to a 1953 paper from Milton Friedman, which is hard to find online, despite being cited 2411 times according to google scholar.
Having said all this, it's possible there are some circumstances where this simple common sense argument fails to obtain. A widely-cited 1990 paper by Andrei Shleifer, Larry Summers, Brad DeLong and Robert Waldmann finds that the way other traders buy and sell can change the way speculation works. If so-called noise traders' buy, rather than sell, when prices rises hit, i.e. their strategies include elements of positive feedback, early buying from speculation can trigger a spike. Anticipating this, speculators will have an incentive to buy extra, generating a bigger price increase and a bigger return, along with more volatility in the face of new information.
The authors look at some hugely interesting survey, experimental and real world evidence supporting the assumption that some traders might use positive-feedback strategies, and even argue that the strategy could persist in the long-run, despite its irrationality. Though on average those pursuing the strategy will be driven out of the market as they lose money, investors see different episodes differently, and some will enjoy huge returns through holding extra risk. So it is actually rational for speculators to target price movements driven by others' irrationality, rather than market fundamentals.
All this said, it's unclear this model delivers the results Doane relies on. Certainly markets working in this way would produce bigger spikes in both directions, but there's no reason to expect prices would be higher overall. If anything, the suggestion seems to be that prices would be below where fundamentals suggest in times of scarcity and above in times of relative plenty—alleviating shortages more than under the more straightforward model. The extra profits speculators make would come out of the pocket not of the poor commodity consumers, but from the noise traders, following their irrational strategies.
23 Things We're Telling You About Capitalism XIV
Our fourteenth thing is simply that American executives get paid far too much money and that this is wrong. In itself this is proof that a market manner of doing things is ineffective: just the simple fact that the average US CEO gets 300 times the wage of one of his workers proves this.
And we should admit that Chang has some useful points to make here. It's entirely possible that there is rent seeking in the way that CEO pay is determined. Interlocking boards, where you scratch my back with a pay rise and I'll approve your's next month could be partly to blame. The agent/principal problem may well be in play as well. While the shareholders are the legal owners of the company we can all find examples of organisations being run for the benefit of the managers, not the owners. So there is some truth to the processes which Chang points to as raising US CEO incomes.
However, not enough truth for his contention that these pay rates are in some manner wrong or unjustified.
For example, the comparison between the 30 or 40 times average wages that CEOs used to be paid and the 300 they are now. Back when the average US CEO was running a US domestic market company. This simply isn't the case now: the large corporations there (as with the large corporations everywhere in fact) are now global companies. They're massively larger than they used to be so it's not entirely surprising that pay for those running them has gone up.
The two major mistakes made though are not quite so simple.
The first is that Chang wants to claim that people are paid according to their marginal productivity: only if a CEO is worth 300 times the average worker should he be paid that. But that's really not quite how labour markets work. Yes, average wages in a country are going to be determined by average productivity, this is true. But the wages of individuals are going to be determined by supply and demand of those particular skills. Given the mess certain CEOs make of running large corporations we can also see that the supply of the necessary skills is fairly small. We'd thus expect a high price to be paid for them.
But even this is still understating the point. The job of a CEO is not just to make profits for the shareholders: it's to avoid making losses for them. The value therefore of a CEO is not just the profit booked at the end of the year: it's the losses avoided. And those losses can, of course, amount to the entire value of the firm itself as Chrysler and GM shareholders found out.
The second is that Chang hasn't recognised that CEO compensation is like that of traders or footballers. We're in a tournament here. There's no static benchmark by which we measure the performance: that performance is only ever relative to everybody else in the same field. You can be a very fine footballer indeed and never make it to the Premiership simply because there are a couple of huindred players who are better than you are. You could make a perfectly adequate CEO: but you'll not get there if there's a few hundred to a few thousand who are better at it than you are. So CEO pay isn't being based upon some critical appraisal of some abstract standard: it's all about whether you're actually better than the other candidates or not.
And we do very much know one thing about what happens to pay in such tournament markets. It soars: because being 5% better than the other guy means that the employer wants to have you, not the other guy.
And that's really what is behind high executive pay. Yes, there's undoubtedly rent seeking, there's certainly some aspect of larger companies paying larger amounts and so on. But the real point is that it is indeed a tournament and as I say, the one thing we know very well about tournament markets is that they pay massively to those who win the tournaments.
23 Things We're Telling You About Capitalism XIII
Thing 13 is simply that trickle down economics doesn't work. Making the rich richer doesn't make everyone richer therefore we shouldn't be planning to make the rich richer. The whole thing is based upon the marginal propensity to invest: investment is good for the future of the economy, the rich invest more of their incomes than the poor do thus if the rich get more of the money then there will be more investment and that's good for the future. Chang insists that this idea is wrong, based as it is upon the classical economists. The rich don't necessarily invest more therefore allowing them to have more of the pie won't increase investment and so no glorious future.
There's a very serious problem with this argument of Chang's. For the flip side of this marginal propensity to invest is the marginal propensity to consume. And it's an absolutely standard part of Keynesian economics (most definitely not classical economics then!) that the poor have a greater marginal propensity to consume than the rich do. Indeed, we do get people telling us that in economic hard times we should be taking money of the rich to give to the poor. Precisely because the rich will just save and invest it while the poor will spend it thus boosting aggregate demand.
Here is such an argument in fact:
“For example, in an economic downturn like today's, the best way to boost the economy is to redistribute wealth downward, as poorer people tend to spend a higher proportion of their incomes.”
The greater marginal propensity to consume is exactly the same thing as the lower marginal propensity to save and invest: if the poor are more likely to spend then this is the same statement as the rich are more likely to save. The really unfortunate thing for Chang's rejection of the idea that the rich invest more is that this sentence comes from Chang. In this very same chapter where he urges us a to reject the greater marginal propensity to invest of the rich. Oh dear, eh?
It's also probably true that Chang should be deprived of his economists' secret decoder ring or confusing wealth and income as he does in that sentence. Wealth is a stock, income a flow, and never should the two be confused.
There's a common rhetorical flourish throughout the chapter that should have been avoided as well. He veers between talking about a redistribution of income upwards in recent decades and the way in which the growth in incomes has gone disproportionately to the already rich. The two are very much not the same statement: the first is that extant incomes have been snatched, like a humble crust from a Dickensian waif's lips, to be awarded to the rich. The second is that of the new incomes that are being created the upper part of the income distribution is getting most of that new income: the crusts are still safe in the waif's hands. The truth is that there has not been a redistribution of incomes upwards: the last few decades have seen average (both mean and median) incomes rise therefore nothing has been taken away from anyone. It is true that a large portion of the new income created has gone preferentially to those already gaining high incomes.
You may be happy about that or not but that is what has been happening, not the first but the second.
And now we should look at the proof that Chang uses to show that allowing the rich those higher incomes doesn't improve the growth of the economy. It is, fairly simply, that in more equal times like the 50s and 60s then economic growth was higher than it has been since the 80s, when inequality started to rise. What more proof could we require that the rich getting more of the pie doesn't grow said pie?
At which point we'd probably recommend that Chang read his own chapter 9. In which he tells us, entirely correctly, that as economies mature growth will become more difficult and thus, presumably, slower. Chang's (and, interestingly, the correct, which is an amusing coincidence) argument is that in the long term economic growth comes from improvements in total factor productivity (tfp). This tfp is easier to increase in manufacturing than it is in services. Chang uses this to argue that therefore economies should have lots of manufacturing so that tfp can be improved: an argument we rejected as there's only so much manufacturing that we actually want.
But look at what that does to Chang's subsequent argument about economic growth. We know very well that manufacturing has fallen as a portion of western world economies in recent decades. Indeed Chang tells us that manufacturing as a percentage of total production fell, in Britain, from 37% in 1950 to 13% today. That's the manufacturing where tfp growth is easier than in the services which have grown faster (for yes, manufacturing output has still grown, just not as fast as services) which has shrunk as a portion of the economy. And it's Chang himself who tells us that this makes future economic growth more difficult as a result of that difficulty in increasing tfp in services.
Yet when it comes to comparing growth rates in manufacturing heavy and services heavy economies the lack of growth is all about how the rich have all the money. Go figure. Consistency isn't just the hobgoblin of little minds you know.
One final point about why we don't want to be taxing those high incomes too much. It isn't, as Chang purports, because only the rich can make everyone else rich by investing. Rather, it's because the process of people getting rich is what makes us all richer. Assuming no rent seeking (which we free marketeers do indeed abhor) and the lucky sperm club then the only way you can get rich, become rich, is by satisfying the desires of others. You need to be producing something that others are willing to purchase. That they are willing to purchase it shows that they value it more than it costs them: by definition this makes them richer. As the influx of cash makes you richer.
It's not the static state of being rich that makes everyone better off: it's the activity of producing what others value that makes both the producer and consumer richer. And that's why we don't want to take huge bites out of the incomes of people who are doing this: because we'd like them to be seen to be well rewarded so that others are willing to take the risks of similarly producing value that all can enjoy. After all, we know that taxing something produces less of it: thus taxing the creation of wealth will produce less wealth.
Letter losses + parcel profits = Royal Mail privatisation
This week Royal Mail, the UK's state-owned letters and parcels delivery business, is expected to announce profits of £300m-£400m. A few years back, the Royal Mail looked like a loss-making sunset business. Emails were replacing letters, and delivering bits of paper to 28m homes in every corner of the UK seemed like a good way to go broke.
Now we are sending even more emails – the Royal Mail's staples of greetings cards are being replaced by e-cards too. Bills and statements are going increasingly online, and more of us pay them online rather than putting a cheque in the mail.
But what is saving the Royal Mail is its parcels business. With email we are sending fewer letters, but with the web we are shopping more online. Losses in the letters business are being overtaken by profits in parcels. The UK online retail market was £78bn, up 12.8% on the year before. Department stores' online sales grew by an astonishing 37%. Around one-fifth of our retail purchases are now made online. A business that can deliver to 28m homes now suddenly has a value again.
What Royal Mail needs, though, is new capital to invest in this parcel delivery business. They know they won't get it from the government, which is deep in debt. They need new capital from the market and new strategic partners from business to help them invest it wisely and develop the parcels business. That means privatisation. On this weeks figure, it could be a £3bn business, which means a share offering to the public. On past form, the government will sell 51% and pocket a useful sum. But once the new capital is invested and is making the parcels business even more profitable, it could pick up even more when it sells the other 49%.
23 Things We're Telling You About Capitalism XII
Our twelfth thing about capitalism that we're not told is a masterpiece of straw manning. We're told that the free marketeers insist that government can never pick winners and are then presented with a couple of examples of supposed winners that have been picked by government. QED, the free marketeers are wrong.
But that isn't actually our argument: we don't insist that government, or planning, can never produce a winner. Only that it's less likely to do so than a free market approach to such decisions. At which point the proof falls apart.
Chang does tell us of the foolishness that accompanied the 60s and 70s approach to the planning of economies. The famous line from Eugene Black, the World Bank President, that developing countries were fixated on the three totems - the highway, the integrated steel mill and the monument to the head of state. The monuments got overturned along with the head of state, the roads were unused and the steel mills, as I've already mentioned, were built with gay abandon and then left to rot.
Chang's response to this is that South Korea managed it though! POSCO was set up as a state planned and run, financed, company and it has ended up as a thriving steel company. Even though S. Korea didn't have either the iron ore or the coking coal that would normally be domestically produced to feed such a series of plants. Thus planning can indeed work.
To which there are three responses: the first being that an example of not-A is not a refutation of generally-A. For example, we cannot refute the statement that ugly blokes generally don't end up with good looking women by observing the beauty of Simon Cowell's latest squeeze. We could refute ugly men never by such an observation, but not generally. So it is with our observation that governments are generally bad at picking winners, generally make bad investment decisions, is not refuted by the observation that one government, once, managed to invest in a decent enough steel company.
Which is where Chang's straw man argument comes in: he has claimed that the free market argument is that governments can never, while the actual argument is simply less often than alternative methods.
The second is that the power to direct the economy as S. Korea did in the time Chang is talking about isn't something that's available in a free society. You'll note that I've mentioned this before but it's worth using some of the examples that Chang himself gives us:
“However, even when all those carrots were not enough to convince the businessmen concerned, sticks – big sticks – were pulled out, such as threats to cut off loans from the then wholly state – owned banks or even a “quiet chat” with the secret police......(...)....In the 1960s, the LG Group, the electronics giant, was banned by the government from entering its desired textile industry and was forced to enter the electric cable industry.....(...)...In the 1970s, the Korean government put enormous pressure on Mr. Chung Ju-Yung, the legendary founder of the Hyundai Group, famous for his risk appetite, to start a shipbuilding company. Even Chung is said to have initially baulked at the idea but relented when General Park Chung-Hee, the country's then dictator and the architect of Korea's economic miracle, personally threatened the business group with bankruptcy.”
One can hear, all the way from Cambridge, the lascivious licking of the lips at this display of firm authoritarian government in true Confucian style. But I do rather think we'd all agree, being the good little liberals that we are, that whatever the economic results of such plans we'd rather not have a General as dictator with the power to insist upon such things. As indeed we don't and as I've been pointing out, as a result we would get planning driven by democratic concerns, something very different.
The third argument is that Chang is entirely ignoring opportunity costs here. Which is astounding in self-professed economist. For opportunity cost is the first and most important thing that one has to grasp about the subject (the only other is that there's no free lunch). The actual argument is not whether government can decree that a steel mill, or a shipyard, gets built. Nor even whether such projects will make a return on their investment, survive into the future. It is rather whether that money and investment would have produced better returns if employed in another manner? What could S. Korea have built instead of a steel mill or shipyard? Perhaps the profits would have been larger in building a world beating textiles industry?
By resolutely ignoring this point Chang is here showing that whatever it is that he's talking about it's not really economics. For as I say, opportunity cost is the heart of the subject.
The final argument against government picking investments is best described as momentum. The most important part of an economic system is not actually the decision about what to do. It's about what to stop doing. More specifically, how do we decide that a project, an investment idea, as gone wrong and needs to be killed off? It is in this that governments are appallingly bad, horribly, hugely, worse than the private or free market sector.
To take once recent example: the London Olympics. Before the selection of which city would hold it we were told that it would cost some £2.5 billion or so to stage. Once the decision had been made the budget started to balloon. One of the things that drove it through the £10 billion barrier was the realisation that the government plans hadn't included the VAT that the government would be charging itself. A reasonable estimate of the final cost is £20 billion and change. A private sector adventure that was going ten times over budget would have led to a phone call to Paris asking if, despite having lost the selection competition, they'd still like to have the Games. Or even to stick them in Athens, which already had all the stadia from a previous one.
The impetus in politics, the incentive, is never to admit to having made a mistake. Thus government designed projects, even if they turn out to be disasters, tend not to get cancelled. Doubling down, good money after bad, this is how it works. Whereas the free market sector does indeed look at error, agree that it's an error, and closes it down.
Which is as I say the clinching argument against that state planning of investment and industry. It's not that governments can never pick a winner: even the blind monkey finds a banana occasionally. It's not just that governments are less likely to pick a winner either. Nor that private industry hasn't decided upon some stinkers along the way. Even if government and the market were equally capable of picking winners, government's a lot worse at closing down, bankrupting, the losers. And so are resources wasted by government in a manner that the private sector does not.
Chart of the week: UK inflation dips in year to April
Summary: UK trimmed mean inflation is 2% - exactly
What the chart shows: The chart shows UK headline consumer price inflation, the old RPI-X measure and trimmed mean inflation, all as 12-month % changes
Why is the chart important: The Bank of England has forecast that inflation, while coming down, will remain above target for the foreseeable future. But the headline or overall rate of inflation is subject to a number of volatile influences. In some countries, eg, the United States, underlying inflation is measured by stripping out food and energy changes. By contrast, a so-called ‘trimmed mean’ measure strips out the fastest and slowest changing components every month, regardless of which they are, in order to achieve a better picture of underlying trends. April data show that the trimmed mean rate is bang on target at 2%, implying that the headline rate could come down more rapidly than expected – as in fact it already did in April
Think Piece: Regulation and the UK's energy market
Stephen Littlechild, Professor emeritus at the University of Birmingham, fellow of Judge Business School at the University of Cambridge and a top regulator from 1983 to 1998, explains how politicians and regulators have, by misunderstanding how markets work, regulated to boost energy firms' profits at the expense of higher bills for consumers.
Britain’s competitive retail energy market was the first in the world, and for many years the most competitive. It had the most active suppliers, and the most active customer switching. This competition and choice brought better offers for customers. It may not seem like it because of recent energy price increases. But these reflect increases in fuel costs like gas, higher costs of renewable energy and other obligations on suppliers, not a lack of retail competition.
In fact, retail competition was sometimes too fierce, witness the problem with doorstep mis-selling. But Ofgem took action to fix that problem.
Retail profits in the domestic sector used to be minimal; Ofgem calculated that many were negative. New entrants came into the market, but until recently most found it tough to survive.
Retail competition has been enhanced by a dozen switching sites. Each seeks the best way to attract users, to offer the simplest calculations, to include the most relevant information and the clearest comparisons, to facilitate subsequent switching. No other country can boast as lively, innovative and effective market for information and assistance to energy customers as Britain.
If it ain't broke, break it: how to increase prices and profits in the GB retail energy market
Britain’s competitive retail energy market was the first in the world, and for many years the most competitive. It had the most active suppliers, and the most active customer switching. This competition and choice brought better offers for customers. It may not seem like it because of recent energy price increases. But these reflect increases in fuel costs like gas, higher costs of renewable energy and other obligations on suppliers, not a lack of retail competition.
In fact, retail competition was sometimes too fierce, witness the problem with doorstep mis-selling. But Ofgem took action to fix that problem.
Retail profits in the domestic sector used to be minimal; Ofgem calculated that many were negative. New entrants came into the market, but until recently most found it tough to survive.
Retail competition has been enhanced by a dozen switching sites. Each seeks the best way to attract users, to offer the simplest calculations, to include the most relevant information and the clearest comparisons, to facilitate subsequent switching. No other country can boast as lively, innovative and effective market for information and assistance to energy customers as Britain.
So what went wrong? Someone or something had to be blamed for the energy price increases. Ofgem was unable to find evidence of market failure. It concluded that the problem was customer failure. Customers were paying high prices because they were unable or unwilling to understand suppliers’ offers. So the market had to be simplified.
An increasingly bizarre series of proposals and directives has emerged from Ofgem, Government and now Which? magazine for dumbing down the retail market. All are well-intentioned, none shows any understanding of competitive markets, none will increase customer engagement, and all will make customers worse off.
Ofgem was first. It noticed that suppliers based in one area were offering lower prices to customers in their competitors’ areas. In 2009 it decided that requiring suppliers to charge the same price to all customers would bring the benefits of the lower prices to all customers - Right? Wrong. Suppliers predictably found it more profitable to raise their low prices to new customers than to lower their prices to existing customers.
Customers suffered because the low-price offers were withdrawn. They also began to lose interest in switching supplier: the switching rate has since fallen by nearly a half. But suppliers did not lose out from this reduction in competition. Quite the opposite: Ofgem’s calculations show their retail profit margins increasing to an all-time high: from minus £10 per dual fuel customer in May 2009 to about £50 from 2010 to 2012 to £100 now.
In 2011 Ofgem proposed that all suppliers should offer the same monthly standing charge – which Ofgem itself would specify. It overlooked – or didn’t care – that this prohibited tariffs with no standing charge, which are popular with pensioners. And that Ofgem would now be jointly responsible for setting energy prices. Ofgem withdrew its proposal.
Meanwhile, suppliers found other ways to compete – for example by offering lower prices online. Customers benefited – until Ofgem decided that this made the market too complicated. In October 2012 Ofgem proposed that suppliers would be allowed only four tariffs per fuel. This of course is tough on customers with minority tastes, like green tariffs, or even tariffs with no standing charge. And innovation will cease if a supplier can only innovate by withdrawing an existing tariff that supplies about a quarter of its customers. But now it’s simplicity that counts, not the availability of products that customers want.
There are other petty restrictions. Discounts must be the same each year, expressed in pounds not percentages. If this restriction had been in place, it would have banned the best offer in the market earlier this year. And in future it may not be viable for suppliers to offer discounts that don’t use percentages to tailor the discount to the size of bill. But the availability of good offers is no longer a relevant consideration.
At the same time, another bright idea popped up at Prime Minister’s Question Time. Just in time for the County Council Elections. The campaign leaflet says “Conservatives in Government have forced energy companies to put customers on the lowest tariff”. Leave aside that this is not yet enacted, and still just an idea that Ofgem might reluctantly trial. Leave aside too why Conservatives in Government and not Ofgem are now regulating energy companies. Let us just ask: what does it mean and is it a good idea?
If it means that energy suppliers will be forced to put their own customers on to the lowest tariff offered by their rivals, is there the remotest chance of this working? Suppose it means that energy suppliers will be forced to put customers on the lowest tariff they themselves offer. But if a supplier offers a discount on its standard tariff coupled with an exit charge of £50, do we really want to force that supplier to put all its customers on a tariff that locks them in? And if a supplier wanted to offer a discount for new customers, but was forced to put all its existing customers on the same discounted tariff, isn’t it obvious that it would be more profitable not to offer the discount in the first place? Once again, the proposal will drive out the best offers.
The latest bonkers suggestion is from Which? magazine. It says that Ofgem’s proposals for simplifying the market don’t go far enough. The government should require single unit prices for each energy tariff, like petrol prices on a garage forecourt. Simplicity is flavour of the month, and petrol is a competitive market, so what’s wrong with this? Lots.
First, Which? seems to be asking for a single uniform price across the whole of the country. But distribution network charges vary considerably across the country. To impose a uniform retail price or network charge would require massive geographic cross-subsidisation between network operators and between customers that would be neither workable nor obviously equitable.
Second, forcing all tariffs to have a zero standing charge would mean that suppliers would not be allowed to offer a lower unit price to larger customers that are more economic to serve, and suppliers would no longer be interested in attracting smaller customers. The likely impact on different kinds of customers has not been considered.
Third, limiting the variety of energy products so that customers are faced with only one price per supplier would enable and encourage suppliers to coordinate prices. If one supplier breaks ranks then other suppliers will either follow or that supplier will fall back into line. Customers will find that suppliers offer similar prices almost all the time. Where then is the incentive to engage in the market?
All these schemes assume that regulators and governments know more about customers than those who make a living by discovering and providing what customers want. These schemes won’t really simplify the market and they won't persuade customers to engage more. But they will restrict competition, and customers will be worse off because the best offers will disappear. Suppliers will find it costly to comply with the proposed 126 pages of new regulatory red-tape, but the costs will be passed through to customers and the suppliers will grumble all the way to the bank.
Britain’s claim to have a leading competitive energy market and regulatory body is no longer tenable. “If it ain’t broke, break it” may sound like action, but it will not, ultimately, be persuasive to customers.