Energy: a change of pace

By Richard North - September 19, 2022

I’m by no means alone in having reservations about The Replacement’s so-called “energy guarantee”, even if the Telegraph’s Liam Halligan argues that, although risky, the risk is worth taking.

Martin Wolf of the Financial Times thinks otherwise, asserting that the package puts The Replacement’s government’s economic credibility at risk. The plan, he says, is poorly targeted, too generous and overly dependent on public borrowing

Wolf relies to an extent on the analysis produced by the Institute for Fiscal Studies, which dismisses Miss Trussed and Kwasi Modo as “gamblers on a huge scale”.

The Institute estimates that the two-year energy package is likely to cost £100 billion (4 percent of GDP) in the first year alone, although it puts the total cost potentially at £150 billion (although I’ve seen £170 billion cited).

To this, we are told, should be added the expected tax cuts amounting to more than 1 percent of GDP but, according to Paul Johnson, director of the IFS, the worst of it all is “The failure to provide any official sense of a costing was extraordinary, and deeply disappointing”.

Wolf calls this “frightening” – which is not an inappropriate view, given that the sums involved seem to be second only to Gordon Brown’s government spending in 2008 on the banks bailout, without the prospect of clawing some of the money back.

Despite that, Wolf concedes that some sort of energy package was necessary – he could hardly have suggested otherwise, and he hardly strengthens his case by claiming, without qualification that “the soaring prices of energy are the result of a Russian war on Ukraine”.

Nevertheless, we can agree that it was necessary to protect the British people and the economy from the immediate consequences of the price hike, but Wolf has argued that the rise has been too huge to be dealt with only by targeted assistance.

In the short run, Wolf argues, there should be price controls, coupled with additional financial help for those households most adversely affected by what would still be (and indeed are) very large price rises.

With that, Wolf has four objections to the package. Firstly, he says, it is too generous – meaning too generous to too many. If instead, the aid had been targeted on the more vulnerable, they could have been treated more generously while the price cap could have been set at, say, £3,500, still below the predicted cost of £4,586 from 1 January, but affordable.

Wolf, as with others, would then like to see a higher cost for general (less financially challenged) consumers, as a sharper spur to energy efficiency, using the price signal to promote economy.

The second objection is that too much of the cost falls on public borrowing, with the government bearing all the cost of lowering the prices. Wolf would prefer price controls imposed on domestic energy producers. He also uses the same terminology as the European Commission, arguing for additional taxes on windfall profits or on those able to pay more.

Higher taxes for better-off taxpayers would have been fully justifiable in such circumstances – historically such taxes have helped pay for war.

This “failure” to raise taxes on the better off or increase support for the least well off, is Wolf’s third objection, rendering, in his view, the package to be “ill-targeted”.

According to the IFS, the gain from the package of support is 14 percent of household budgets for those in the bottom decile and only 5 percent for those in the top decile, because the former spend far more of their income on energy. But, in cash terms, the top decile will receive some £2,000 each, against £1,600 for the poorest.

According to the Resolution Foundation, we are told, if one adds the expected changes to national insurance, the richest households gain over twice as much in cash terms as the poorest. Moreover, the latter will still be harder hit by the rise in energy prices relative to their incomes than the former.

Fourthly, Wolf points out that the package is unsustainable. He raises something which is potentially extremely troublesome – the possibility that energy prices continue to be so high for more than two years.

This is something I raised in an earlier post, raising the question of what the government will do in that event, which could come even sooner, since the planned support package for business expires in six months. If the crisis lasts as long as that, Wolf says, the government would have to let prices rise, target assistance better and raise taxes. He argues it should set out its follow-up plan soon.

Finally, of his four objectives, Wolf argues that the combination of a massive fiscal loosening with low unemployment, high inflation and a weak exchange rate creates significant macroeconomic risks.

Although the package has the advantage of lowering peak measured inflation, supposedly by some four percentage points, but Wolf argues that it seems likely that the Bank of England will consider that the boost to demand will offset the gain from lower headline inflation. In that case, it will have to adopt higher interest rates than would otherwise have been the case.

He also speculates on whether the impact of such a combination of looser fiscal policy with tighter monetary policy would also raise the exchange rate. That, he says, depends on the most important impact of all, which would be on confidence in the UK.

In his view, the new growth target, the fiscal loosening and the expected decision to introduce permanent tax cuts look like one of those “dashes for growth” that have blown up this economy (and those of many others) in the past. That, says Wolf, is a risk the country cannot afford to take, especially given the risk-aversion in today’s world economy and the aftermath of Brexit.

The UK, he says, is not the US. The foreigners who finance it have to believe it is managed by sober and responsible people. With soaring inflation and fiscal loosening, the UK is now on trial. Chancellor Kwarteng’s duty, he says, is to avoid its being found guilty.

Halligan’s view, though – is wholly different – who strongly supports the idea of the “dash for growth”. To an extent, however, he is undermined by the electricity generators themselves, who believe they should be subjected to a windfall tax rather than being pushed into signing cut-price power supply contracts this winter, which forms a core part of The Replacement’s plan.

This is a startling development, as fears are growing that other proposals for tackling excess profits may be too complex to implement at short notice. Industry executives themselves believe they could be more damaging than the The Replacement’s proposals, which have so far ruled out a windfall tax.

Senior executives at several power generation groups have told The Times that while they did not want a windfall tax, they now believed it may be the best option for this winter, since it would only target actual profits.

One said they would back a windfall tax if it was “implemented in a fair way and doesn’t stifle investment – so you get allowances if you’re going to continue to invest”. Another senior executive said: “I don’t think anybody thinks that anything other than a windfall tax is the best way forward”.

Says The Times, this marks “an extraordinary change of tune” after a furious industry backlash when a windfall tax was first mooted by Rishi Sunak in May. But it puts The Replacement rather on the back foot when, to date, she has been intent on gratuitously offering the energy industry a massive subsidy, which it is now set on rejecting.

With real politics about to re-emerge after the long hiatus, issues which have so far been put on hold for far to long are going to come back with a vengeance. The Replacement may now be forced for the first time to justify her package in open debate, where the lack of scrutiny has gone on for far too long – even if it seems set to continue.