The madness of Truss’s energy price cap

 

 

The madness of Truss’s energy price cap

It’s going to cost hundreds of billions and make blackouts more likely

Sam Ashworth-Hayes

6 September 2022, 12:20pm

 

 

hile Boris Johnson used his farewell speech to praise the ‘vital symmetry between government action and free market capitalist private sector enterprise’, the formerly free market Liz Truss was busy briefing out price caps on energy. There are only three possible explanations for this sudden change of heart: No. 10 is haunted by the malign ghost of Clement Attlee, the building is riddled with lead piping, or the electoral incentives facing the Conservative party are so perverse that when push comes to shove, even free marketeers are willing to abandon the free market in the race to expropriate from the young to pay for the old.

 

Given that Truss has yet to officially enter her new residence, my money is on the last option. It’s hard to explain how else the party could see freezing household energy bills as a good idea: the government is about to spend a combined total of £170 billion on making sure we get blackouts this winter; £130 billion to cap energy prices for households and an estimated £40 billion to do the same for businesses.

 

The core problem is that without Russian gas there isn’t enough energy to go around Europe. It’s a problem that has been compounded by the fact that half of France’s nuclear reactors have been offline this summer and Norway, a major supplier of hydroelectric power, has had record low rainfall. With limited supply and high demand, people are bidding against one another for energy use. Prices will rise, and keep rising, until demand is reduced sufficiently to match supply. That’s if the market is allowed to function.

 

Instead, Liz Truss is apparently planning to freeze household bills at or below £1,971, well below the actual market price of supply; the wholesale price alone for October-December is expected to be £2,491. The Times carries a slightly different version of the story where the cap is allowed to rise to £2,500 – still below the total cost of electricity.

 

The government will pay the difference between these figures through loans to energy companies. With artificially low bills, households will have little incentive to reduce energy use. Normally, business prices are uncapped. This means that they pay full market rate, and when households are subsidised that rate goes up: demand matches supply by reducing business energy use. Given that many companies have relatively fixed energy use, the way higher prices bring down energy use is by driving them out of business. 

 

Spending £130 billion on driving a particularly sharp recession is not traditionally viewed as good economic policy, but Truss has managed to go further: prices may also be capped for businesses, which aren’t currently covered by the energy price cap. This means that both sides of the market – households and businesses – can rack up massive energy bills, safe in the knowledge that the Treasury is covering the tab. This will drive up wholesale prices and the cost of the policy (an additional £40 billion to cover businesses) without actually letting the market do the work of matching demand to supply. And when demand is greater than supply, you get blackouts.

 

A far better idea would be to scrap the price cap entirely, letting households pay the full cost of their energy use while doling out massive quantities of cash to those on lower incomes or with higher needs. This would preserve price signals and the incentive to use less, while also giving people enough money to keep their homes warm.

 

Instead, our new free market prime minister appears to be proposing a set of socialist price caps that are expected to cost taxpayers a total of £170 billion, perhaps more, that will stop the market functioning properly – and will still see us without sufficient energy this winter. It gives wealthy households more support than poor, removes the incentive to invest in insulation and heat pumps, and leaves us facing blackouts unless we find a non-price method for rationing energy. At this rate, it’ll only be a few weeks before some bright spark starts suggesting energy lockdowns to preserve electricity for Our NHS.

 

The big question is why a free marketeer would adopt such a profoundly damaging policy in the first place. It’s certainly not ideological; the reaction from economists is in the region of Edvard Munch’s ‘Scream’, without the jolly overtones. It’s not practical; nothing in the policy is actually going to make it easier to keep the lights on. And once implemented, a price cap will be incredibly hard to remove. Can you really see politicians deciding to triple prices next year? They’re more likely to just go ahead with full nationalisation of the energy sector.

 

Part of the problem is that the Conservative party is just the Labour party on a five-year lag; once Starmer suggested freezing prices, the blue team were inevitably going to follow along at some point. But a bigger problem is that the Tories are increasingly the party of the non-working and economically inactive.

 

The Tory vote is old. Pensioners don’t work and don’t pay much in taxes. They certainly don’t benefit from investments that pay off 20 years down the line. They’re very happy to rack up massive bills in the present day and pass them off to their grandchildren. And they vote in massive numbers.

 

This gives Conservative politicians strong incentives to find ways to take from the young and the future to give to the old and the present-day. It is toxic in the long term – we have a dysfunctional housing market, twisted to prop up pensioner assets, and high taxes to fund pensioner healthcare and pensions that are destroying family formation and living standards among young people. This is the only way the current Conservative party can see itself clinging on to power. Changing the prime minister isn’t enough to change that.

 

 

Sam Ashworth-Hayes is a former director of studies at the Henry Jackson Society.