As Elizabeth noted in Fuelling the Political Playing Field, there has been much debate recently about energy prices in the UK. Four of the ‘Big Six’ energy companies have now announced price rises. They average 9.1% – way above the rate of consumer price inflation and even further above the average rate of wage increases. What is more, they are considerably above the rate of increase in wholesale energy prices, which, according to Ofgem, have risen by just 1.7% in the past year.
The bosses of the energy companies have appeared before the House of Commons Energy and Climate Change Select Committee to answer for their large price increases. The energy companies claim that the increases are necessary to cover not only rising wholesale prices, but also green levies by the government and ‘network charges’ for investments in infrastructure. 
However, it is hard to see how, even taking into account all three of these possible sources of cost increases, the scale of price increases can be justified.
Another possible explanation for the price hikes is that they are partly the result of a system of transfer pricing (see). The energy industry is vertically integrated. Energy companies are not only retailers to customers, but also generators of electricity and wholesale shippers of gas. It is possible that, by the producing/shipping arms of these companies charging higher prices to their retailing arms, the retailers’ costs do indeed go up more than the wholesale market cost. The result, however, is higher profits for the producing arms of these businesses. In other words, a higher transfer price allows profits to be diverted from each company’s retailing arm to its producing arm.
This is an argument for making the wholesale market more competitive and for stopping the by-passing of this market by producing arms of companies selling directly to their retailing arms. What the companies are being accused of is an abuse of market power and possibly of colluding with each other, at least tacitly, to support the continuation of such a practice.
So is the answer a price freeze, as proposed by the Labour Party? Is it an investigation of the energy market by the Competition Commission? Or is it, at least as a first step, much more openness by the energy companies and transparency about their pricing practices? Or is it to encourage consumers to switch between energy companies, including the smaller ones, which at present account for less than 5% of energy supply? The videos, podcasts and articles consider these issues.
Webcasts and Podcasts
Energy bosses blame high bills on wholesale prices Channel 4 News, Gary Gibbon (29/10/13)
Why are energy bosses being questioned? BBC News, Stephanie McGovern (29/10/13)
Key questions Big Six energy companies must answer The Telegraph, Ann Robinson (29/10/13)
Energy bosses offer excuses for prices rises The Telegraph (29/10/13)
Energy bosses face MPs over price rises BBC News, John Moylan (29/10/13)
Energy boss ‘can’t explain’ competitors’ price hikes The Telegraph (29/10/13)
Ovo boss: Competition Commission would take too long BBC News (30/10/13)
Dale Vince: Energy market is ‘dysfunctional’ BBC Today Programme (30/10/13)
Tony Cocker: Public mistrust energy industry BBC Today Programme (30/10/13)
Ed Davey: Energy deals not just for ‘internet savvy’ BBC Today Programme (31/10/13)
Articles
Energy giants ‘charge as much as they can get away with’ The Telegraph, Peter Dominiczak (29/10/13)
UK energy markets need perestroika Financial Times (27/10/13)
Britain’s energy utilities must embrace glasnost Reuters, John Kemp (29/10/13)
Small energy firms ‘escape levies’ BBC News (30/10/13)
Is the energy market structurally flawed? BBC news, Robert Peston (30/10/13)
The energy market needs a Competition Commission investigation Fingleton Associates, John Fingleton (12/10/13)
Energy firms raised prices despite drop in wholesale costs The Guardian, Rowena Mason (29/10/13)
Only full-scale reform of our energy market will prevent endless price rises The Observer, Phillip Lee (26/10/13)
Energy Giants Blame Rising Bills On Green ‘Stealth Taxes’ Huffington Post, Asa Bennett (29/10/13)
Big Six energy firms ‘like cartel’ Belfast Telegraph (30/10/13)
Energy boss says he hasn’t done sums on green levies The Telegraph, Georgia Graham (30/10/13)
Graphic: How your energy bills have soared in ten years The Telegraph, Matthew Holehouse (30/10/13)
British energy suppliers’ explanations for price hikes just don’t add up The Guardian, Larry Elliott (31/10/13)
The 18th energy market investigation since 2001: Will this one be different? The Carbon Brief, Ros Donald (31/10/13)
Energy: Is there enough competition in the market? BBC News, Hugh Pym (26/11/13)
Information and Reports
Wholesale [electricity] market Ofgem
Wholesale [gas] market Ofgem
Response on wholesale energy costs Ofgem Press Release (29/10/13)
Response to Government’s Annual Energy Statement Ofgem Press Release (31/10/13)
Real Energy Market Reform The Labour Party
Questions
- Why may the costs of energy paid by the energy retailers to energy producers/shippers have risen more than the wholesale price?
- Explain what is meant by transfer pricing. How could transfer pricing be used to divert profits between the different divisions of a business?
- How can transfer pricing be designed by multinational companies to help them minimise their tax bills?
- Why is policing transfer pricing arrangements notoriously difficult?
- What evidence is there to show that switching between retailers by customers can help to drive retail energy prices down?
- How did the old electricity pool system differ from the current wholesale system?
- Should electricity companies be forced to pool the electricity they generate and not sell it to themselves through bilateral deals?
- Comment on the following: “The current electricity trading arrangements ‘create the very special incentive for the oligopolists. …The best of all possible worlds is where nobody invests. As supply and demand close up, the price spikes upwards, and supernormal profits result.'”
There has been an interesting debate recently about whether the austerity policies being pursued in the UK are the correct ones. What would have happened if the government had pursued a more expansionary policy? Would the increase in borrowing, at least in the short term, have triggered a financial crisis?
Without austerity policies, would the eurozone crisis have led to a collapse in investor confidence in the UK, especially if Greece had been forced out of the euro?
On the one side, Kenneth Rogoff argues that increasing the UK’s budget deficit would have been dangerous and could have led to a flight from the pound. Generally, but with some reservations, he supports the fiscal policies that have been pursued by the Coalition.
I am certainly not arguing that the UK or other advanced countries handled the post-crisis period perfectly. There should have been more infrastructure spending, even more aggressive monetary policy and probably more ruthless bank restructuring. But there has to be a balance between stimulus and stability. To assume we always knew things would calm down, and to retrospectively calibrate policy advice accordingly, is absurd
Paul Krugman and Simon Wren-Lewis challenge Rogoff’s arguments. Paul Krugman uses a version of the IS-LM model to analyse the effect of a loss of international confidence in the UK following problems in the eurozone and worries about excessive UK borrowing.
In the model, the LM curve (labelled MP in Krugman’s diagrams) illustrates the effect of an increase in real GDP on interest rates with a particular monetary policy (e.g. an inflation target or a Taylor rule, 
which involves a mix of two policy objectives: an inflation target and real GDP). As GDP rises, putting upward pressure on inflation, so the central bank will raise interest rates. Hence, like the traditional LM curve, the monetary-policy related LM curve will slope upwards, as shown in the diagram.
Initial equilibrium GDP is Y0. The rate of interest is at the minimum level, r0 (i.e. the rate of 0.5% that the Monetary Policy Committee has set since January 2009). This, in the model, is the liquidity trap, where any increase in money supply (a rightward shift in the LM curve) will have no effect on interest rates or GDP.
In Rogoff’s analysis of a crisis triggered by excessive borrowing and problems in the eurozone, the IS curve will shift to the left (as illustrated by curve IS1) as capital flows from the UK and confidence collapses. Real GDP will fall to Y1. This will be the outcome of fiscal expansion in the world of the early 2010s.
Krugman argues that the opposite will occur. The outflow of capital will drive down the exchange rate. This will lead to an increase in exports and a decrease in imports. Aggregate demand thus rises and the IS curve will shift to the right (e.g. to IS2 in the diagram. Real GDP will rise (e.g. to Y2 in the diagram). If the rise in aggregate demand is sufficient, the economy will rise out of the liquidity trap and interest rates will rise (e.g. to r2 in the diagram).
Not surprisingly, Rogoff challenges this analysis, as you will see if you read his second paper below. He doesn’t criticise the model per se, but challenges Krugman’s assumptions. For example, a depreciation of sterling by some 20% since 2008 doesn’t seem to have had a major effect in stimulating exports (see the chart in the news item, A balancing act). And exports could well have declined if the eurozone economy had collapsed, given that exports to the eurozone account for around 44% of total UK exports.
Rogoff’s assumptions in turn can be challenged. Simon Wren-Lewis argues that, provided a credible long-term plan for deficit reduction is in place, maintaining a fiscal stimulus in the short run, to keep the recovery going that was beginning to emerge in 2010, would help to increase investor confidence, not undermine it. And, with a policy of quantitative easing, which involves the Bank of England buying central government debt, there is no problem of a lack of demand for UK gilts by the private sector.
What is clear from this debate is the willingness of both sides to accept points made by the other. It is an extremely civilised debate. In fact, it could be seen as a model of how academic debate should be conducted. There is none of the ‘shouting’ that has charaterised much of the pro- and anti-austerity lobbying since the financial crisis burst onto the world stage.
Britain should not take its credit status for granted Scholars at Harvard from Financial Times, Kenneth Rogoff (3/10/13)
Ken Rogoff on UK austerity mainly macro, Simon Wren-Lewis (3/10/13)
Phantom Crises (Wonkish) The Conscience of a Liberal, Paul Krugman (3/10/13)
Three Wrongs do not make a Right Scholars at Harvard from Financial Times, Kenneth Rogoff (7/10/13)
Is George Osborne really a hero of global finance? The Guardian, Robert Skidelsky (24/10/13)
Questions
- Explain how the policy-dependent LM curve illustrated in the diagram is derived.
- What would cause the policy-dependent LM curve to shift?
- Explain what is meant by the ‘liquidity trap’. Why does being in a liquidity trap make monetary policy ineffective?
- How would you determine whether or not the UK is currently in a liquidity trap?
- How is the level of (a) public-sector debt and (b) private sector debt owed overseas likely to affect the confidence of investors concerning the effects of an expansionary fiscal policy?
- Compare the UK’s total external debt with that of other countries (see the following tables from Principal Global Indicators, hosted by the IMF: External debt and Short-term external debt).
- What insurance policy (if any) does the UK have to protect against market panic about the viability of UK debt?
- What areas of agreement are there between Rogoff on the one side and Krugman and Wren-Lewis on the other?
In many parts of the world, life in the oceans is dying out. The term ‘dead zones’ is used to describe seas that are devoid of marine life. And these zones are growing in size and number.
It’s not just the decline in fish and other marine species that’s worrying environmentalists and many others; it’s a growth in rubbish. Part of this is caused by natural disasters, such as the 2011 Tsunami in Japan that washed huge amounts of debris into the Pacific Ocean. But much of it is caused by rubbish carried down rivers and into the seas, or rubbish jettisoned from ships. The problem is particularly acute in areas of the oceans where currents circulate the rubbish into huge rubbish dumps. There are two such areas either side of Hawaii in the Pacific. Both are vast.
The first article below tells the tale of Newcastle (Australia) yachtsman Ivan Macfadyen. He completed the 2013 Melbourne to Osaka double handed yacht race earlier this year as skipper of his yacht Funnelweb and then went on to bring the yacht home to Australia via America and race the famous Trans-Pac Yacht Race from Los Angeles to Hawaii along the way.
Exactly 10 years before, when [he] had sailed exactly the same course from Melbourne to Osaka, all he’d had to do to catch a fish from the ocean between Brisbane and Japan was throw out a baited line.
“There was not one of the 28 days on that portion of the trip when we didn’t catch a good-sized fish to cook up and eat with some rice,” Macfadyen recalled. But this time, on that whole long leg of sea journey, the total catch was two. No fish. No birds. Hardly a sign of life at all.
After reaching Osaka in Japan, they sailed on to San Francisco via Hawaii.
“After we left Japan, it felt as if the ocean itself was dead,” Macfadyen said. “We hardly saw any living things. We saw one whale, sort of rolling helplessly on the surface with what looked like a big tumour on its head. It was pretty sickening.”
“I’ve done a lot of miles on the ocean in my life and I’m used to seeing turtles, dolphins, sharks and big flurries of feeding birds. But this time, for 3000 nautical miles there was nothing alive to be seen.”
In place of the missing life was garbage in astounding volumes.
As economists, you should readily understand that here we have a case of over-exploited common resources – a Tragedy of the Commons of epic proportions. One ship’s rubbish may make a tiny difference, but when the cost of dumping is near zero and when the oceans are not policed, what is rational for a single ship becomes a disaster when repeated tens of thousands of times by other ships
Again, overfishing is the result of seemingly rational behaviour by crews of individual fishing boats. But as Economics (8th edition) points out on pages 328–30:
Common resources are not owned but are available free of charge to anyone. Examples include the air we breathe and the oceans for fishing. Like public goods, they are non-excludable. For example, fishing boats can take as many fish as they are able from the open seas. There is no ‘owner’ of the fish to stop them. As long as there are plentiful stocks of fish, there is no problem.
But as more people fish the seas, so fish stocks are likely to run down. This is where common resources differ from public goods. There is rivalry. One person’s use of a common resource diminishes the amount available for others. This result is an overuse of common resources. This is why fish stocks in many parts of the world are severely depleted, why virgin forests are disappearing (cut down for timber or firewood), why many roads are so congested and why the atmosphere is becoming so polluted (being used as a common ‘dump’ for emissions). In each case, a resource that is freely available is overused. This has become known as the tragedy of the commons.
… When I use a common resource, I am reducing the amount available for others. I am imposing a cost on other people: an external cost. If I am motivated purely by self-interest, I will not take these external costs into account.
Try doing some research to find out just what has been happening to the state of the oceans in recent years.
Articles
The ocean is broken Newcastle Herald (Australia), Greg Ray (18/10/13)
Our Planet Is Exploding With Ocean Dead Zones Business Insider, Dina Spector (26/6/13)
Health of oceans ‘declining fast’ BBC News, Roger Harrabin (3/10/13)
Chaos in the Oceans Huffington Post, Evaggelos Vallianatos (14/10/13)
Ocean Health Suffers from Overfishing, Index Finds Live Science, TechMedia, Douglas Main (16/10/13)
Information
Dead zone (ecology) Wikipedia
Common Fisheries Policy Wikipedia
Reform of the Common Fisheries Policy Fisheries DG, European Commission
Ocean Health Index OHI
Questions
- How does a common resource differ from a public good?
- What is the equilibrium use of a common resource? Demonstrate this with a diagram.
- What is the socially efficient use of a common resource such as a fishing ground?
- In what ways have modern ‘industrial’ methods of fishing compounded the problem of the overuse of fishing grounds?
- What criteria, other than social efficiency, could be used to determine the optimal use of a common resource?
- Explain how the Common Fisheries Policy of the EU works. Are there any lessons that can be learned by other groups of countries from the experience of the CFP?
- Are there any ‘good news’ stories about the state of any of the oceans? If so, to what extent are they the result of deliberate human action?
- To what extent is the Internet a common resource?
First the good news. Employment is rising and unemployment is falling. Both claimant count rates and Labour Force Survey rates are down. Compared with a year ago, employment is up 279,092 to 29,869,489; LFS unemployment is down from 7.87% to 7.69%; and the claimant count rate is down from 4.7% to 4.0%.
Now the bad news. Even though more people are in employment, real wages have fallen. In other words, nominal wages have risen less fast than prices. Since 2009, real wages have fallen by 7.6% and
have continued to fall throughout this period. The first chart illustrates this. It shows average weekly wage rates in 2005 prices. (Click here for a PowerPoint of the chart.)
The fall in real wages is an average for the whole country. Many people, especially those on low incomes, have seen their real wages fall much faster than the average. For many there is a real ‘cost of living’ crisis.
But why have real wages fallen despite the rise in employment? The answer is that output per hour worked has declined. This is illustrated in the second chart, which compares UK output per worker with that of other G7 countries. UK productivity has fallen both absolutely and relative to other G7 countries, most of which have had higher rates of investment.
The falling productivity in the UK requires more people to be employed to produce the same level of output. Part of what seems to be happening is that many employers have been prepared to keep workers on in return for lower real wages, even if demand from their customers is falling. And many workers have been prepared to accept real wage cuts in return for keeping their jobs.
Another part of the explanation is that the jobs that have been created have been largely in low-skilled, low-wage sectors of the economy, such as retailing and other parts of the service sector.
But falling productivity is only part of the reason for falling real wages. The other part is rising prices. A number of factors have contributed to this. These include a depreciation of the exchange rate back in 2008, the effects of which took some time to filter through into higher prices in the shops; a large rise in various commodity prices; and a rise in VAT and various other administered prices.
So what is the answer to falling real wages? The articles below consider the problem and some of the possible policy alternatives.
Articles
Inflation, unemployment and UK ‘misery’ BBC News, Linda Yueh (16/10/13)
Employment is growing, but so are the wage slaves The Guardian, Larry Elliott (16/10/13)
Living standards – going down and, er, up BBC News, Nick Robinson (26/7/13)
Revealed: The cost of living is rising faster in the UK than anywhere in Europe, with soaring food and energy bills blamed Mail Online, Matt Chorley (16/10/13)
Cutting prices to raise living standards is just a waste of energy The Telegraph, Roger Bootle (6/10/13)
Downturn sees average real wages collapse to a record low Independent, Ben Chu (17/10/13)
Why living standards and public finances matter Financial Times, Gavin Kelly (29/9/13)
Social Mobility Tsar Alan Milburn Calls on Government to Boost Wages to End UK Child Poverty International Business Times, Ian Silvera (17/10/13)
Do incorrect employment growth figures explain low UK productivity? The Guardian, Katie Allen (23/10/13)
Data
Unemployment data ONS
Average Weekly Earnings dataset ONS
Consumer Prices Index ONS
International Comparison of Productivity ONS
Questions
- How are real wages measured?
- Why have real wage rates fallen in the UK since 2009?
- What factors should be included when measuring living standards?
- Why has employment risen and unemployment fallen over the past two years?
- What factors could lead to a rise in real wages in the future?
- What government policies could be adopted to raise real wages?
- Assess these policies in terms of their likely short-term success and long-term sustainability.
You may have been following the posts on the US debt ceiling and budget crisis: Over the cliff and Over the cliff: an update. Well, after considerable brinkmanship over the past couple of weeks, and with the government in partial shutdown since 1 October thanks to no budget being passed, a deal was finally agreed by both Houses of Congress, less than 12 hours before the deadline of 17 October. This is the date when the USA would have bumped up against the debt ceiling of $16.699 trillion and would be in default – unable to borrow sufficient funds to pay its bills, including maturing debt.
But the deal only delays the problem of a deeply divided Congress, with the Republican majority on the House of Representatives only willing to make a long-term agreement in exchange for concessions by President Obama and the Democrats on the healthcare reform legislation. All that has been agreed is to suspend the debt ceiling until 7 February 2014 and fund government until 15 January 2014.
A more permanent solution is clearly needed: not just one that raises the debt ceiling before the next deadline, but one which avoids such problems in the future. Such concerns were echoed by Christine Lagarde, Managing Director of the International Monetary Fund (IMF), who issued the following statement:
The U.S. Congress has taken an important and necessary step by ending the partial shutdown of the federal government and lifting the debt ceiling, which enables the government to continue its operations without disruption for the next few months while budget negotiations continue to unfold.
It will be essential to reduce uncertainty surrounding the conduct of fiscal policy by raising the debt limit in a more durable manner. We also continue to encourage the U.S. to approve a budget for 2014 and replace the sequester with gradually phased-in measures that would not harm the recovery, and to adopt a balanced and comprehensive medium-term fiscal plan.
US default: Congress votes to end shutdown crisis The Telegraph, Raf Sanchez (17/10/13)
US shutdown: Christine Lagarde calls for stability after debt crisis is averted The Guardian,
James Meikle, Paul Lewis and Dan Roberts (17/10/13)
America’s economy: Meh ceiling? The Economist (15/10/13)
Relief as US approves debt deal BBC News (17/10/13)
Shares in Europe dip after US debt deal BBC News (17/10/13)
Dollar slides as relief at U.S. debt deal fades Reuters, Richard Hubbard (17/10/13)
US debt deal: Analysts relieved rather than celebrating Financial Times, John Aglionby and Josh Noble (17/10/13)
Greenspan fears US government set for more debt stalemate BBC News (21/10/13)
Questions
- Explain what is meant by default and how the concept applies to the USA if it had not suspended or raised its budget ceiling.
- Is the agreement of October 16 likely to ‘reassure markets’? Explain your reasoning.
- What is likely to happen to long-term interest rates as a result of the agreement?
- Will the imposition of a new debt ceiling by February 2014 remove the possibility of using fiscal policy to stimulate aggregate demand and speed up the recovery?
- What is meant by ‘buy the rumour, sell the news’ in the context of stock markets? How was this relevant to the agreement on the US debt ceiling and budget?
However, it is hard to see how, even taking into account all three of these possible sources of cost increases, the scale of price increases can be justified.
This is an argument for making the wholesale market more competitive and for stopping the by-passing of this market by producing arms of companies selling directly to their retailing arms. What the companies are being accused of is an abuse of market power and possibly of colluding with each other, at least tacitly, to support the continuation of such a practice.
