Tag: subsidies

The UK rail industry was privatised by the Conservative government in the mid-1990s. As Case Study 14.8 on the Economics 10th edition website states:

The management of rail infrastructure, such as track, signalling and stations, was to be separated from the responsibility for running trains. There would be 25 passenger train operating companies (TOCs), each having a franchise lasting between seven and fifteen years. These companies would have few assets, being forced to rent track and lease stations from the infrastructure owner (Railtrack), and to lease trains and rolling stock from three new rolling-stock companies. …In practice, the 25 franchises were operated by just 11 companies (with one, National Express, having nine of the franchises).

In 1996, at the start of the franchise era, the train operating companies were largely private-sector companies such as National Express, Stagecoach, Virgin Rail and Prism Rail. By 2020, most of the franchises were operated by a foreign state-owned business or a joint venture with a foreign state-owned firm.

As a result of poor performance (see above case study), Railtrack was effectively renationalised in 2002 as Network Rail – a not-for-profit company, wholly dependent upon the UK Treasury for any shortfall in its funds.

TOCs had mixed success. Some performed so poorly that their franchise contracts had to be temporarily taken over by a state-owned operator. For example, in June 2003 the Strategic Rail Authority withdrew the operating licence of the French company Connex South Eastern. The franchise was temporarily taken over by the publicly-owned South Eastern Trains from November 2003 until March 2006 before being returned to a private operator.

Perhaps the most troubled franchise has been the East Coast Main Line between London and Scotland. It was renationalised in 2009, reprivatised in 2015 and renationalised in 2018.

The effect of the coronavirus pandemic

The spread of the coronavirus and the accompanying lockdowns and social distancing saw a plummeting of rail travel. Passenger numbers fell to just 10% of pre-pandemic levels. In March 2020, the UK Government introduced Emergency Measures Agreements (EMAs), which temporarily replaced rail franchise agreements. TOCs were paid a 2% fee (based on pre-Covid costs) to run trains and losses were borne by the government.

When the EMAs ran out on the 20 September, they were replaced by Emergency Recovery Measures Agreements (ERMAs), set to last until no later than April 2022. Under these measures, the fees paid to TOCs were reduced to a maximum of 1.5%. These consist partly of a fixed fee (again based on pre-Covid costs) and partly on a performance payment, depending on punctuality, passenger satisfaction and financial performance. As with the EMAs, the new arrangements involve virtually no risk for the TOCs (except for the size of the performance-related fee). Costs and revenue will be passed to the Department for Transport, which will bear any losses.

TOCs were required to run a virtually full service to allow reduced passenger numbers to observe social distancing. Despite journeys still being only 30% of pre-pandemic levels, social distancing on trains meant that many trains were sold out.

The ERMAs also contain provisions for the replacement of franchises when they come to an end. The precise nature of these will be spelt out in a White Paper, which will respond to the recommendations of the Williams Review of the railways. This review was set up in 2018 in the aftermath of difficulties with various franchises and a chaotic nationwide timetable change. The review’s findings were originally scheduled to be published in Autumn 2019, but were then put back because of the general election and the disruptions caused by the pandemic. The government hopes that it will be published before the end of 2020.

It is expected that the review will recommend replacing the franchise system with something similar to the currents ERMAs. TOCs awarded a contract will be paid a performance-related fee and revenues will go to the government, which will bear the costs. While this is not quite renationalisation, it is not the previous franchise system where TOCs bore the risks. It is in effect a contract system where private companies are paid to deliver a public service.

The CrossCountry franchise

The first test of this new approach to contracting with TOCs came this month. Arriva’s franchise for running CrossCountry trains ran out and was replaced by a three-year contract to run the services, which span much of the length of Great Britain from Aberdeen to Penzance via Edinburgh, Glasgow, Newcastle, Sheffield, Birmingham, Bristol and Plymouth; from Bournemouth to Manchester via Reading, Oxford, Wolverhampton and Stoke; from Cardiff to Nottingham via Gloucester, Birmingham and Derby; and from Birmingham to Stanstead Airport via Leicester and Cambridge.

The contract will last three years. The Department for Transport will gain the revenues and cover the costs and pay Arriva (owned by Deutsche Bahn) a management fee that is ‘performance related’ – as yet unspecified. This, like the EMAs and then the ERMAs, will remove the risks from Arriva.

Nationalisation in Wales

The Welsh government has announced that Transport for Wales will be taken over by a publicly owned company in February 2021. TfW operates many of the routes in Wales and the borders and most of the branch lines in Wales, including the valley commuter lines into Cardiff. It is currently owned by KeolisAmey (a joint company owned 70% by the French company, Keolis (part of SNCF), and 30% by the UK company, Amey), which took over the franchise in 2018 from Arriva. The Welsh government considered that KeolisAmey would collapse if it did not provide support. Ministers decided that nationalisation would give it greater control than simply subsidising KeolisAmey.

James Price, chief executive of the Welsh Government, stated that this allows it:

to reduce the profit we pay to the private sector massively over time, and make sure that when the revenue comes back, it comes back in to the taxpayer.

Under emergency measures, KeolisAmey has already been supported by the Welsh government to the tune of £105 million (£40 million in March and £65 million in June) to continue operating the franchise. Passenger numbers fell by 95% as the pandemic hit.

Is nationalisation a better way forward, or should private train operating companies continue with the government taking on the risks, or should the franchise system be amended with greater support from the government but with the TOCs still bearing risk? The articles below consider these issues.

Articles

Questions

  1. Explain how the franchising system worked (prior to March 2020).
  2. To what extent could each franchise be described as a ‘contestable monopoly’?
  3. What incentives were built into the franchising system to deliver improvements in service for passengers?
  4. What were the weaknesses of the franchising system?
  5. In the context of post-pandemic rail services, compare the relative merits of nationalisation with those of awarding contracts where the government receives the revenues and bears the costs and pays train operating companies a fee for operating the services where the size of the fee is performance related.
  6. What are the arguments for subsidising rail transport? What should determine the size of the subsidy?

There is increasing recognition that the world is facing a climate emergency. Concerns are growing about the damaging effects of global warming on weather patterns, with increasing droughts, forest fires, floods and hurricanes. Ice sheets are melting and glaciers retreating, with consequent rising sea levels. Habitats and livelihoods are being destroyed. And many of the effects seem to be occurring more rapidly than had previously been expected.

Extinction Rebellion has staged protests in many countries; the period from 20 to 27 September saw a worldwide climate strike (see also), with millions of people marching and children leaving school to protest; a Climate Action Summit took place at the United Nations, with a rousing speech by Greta Thunberg, the 16 year-old Swedish activist; the UN’s Intergovernmental Panel on Climate Change (IPCC) has just released a report with evidence showing that the melting of ice sheets and rising sea levels is more rapid than previously thought; at its annual party conference in Brighton, the Labour Party pledged that, in government, it would bring forward the UK’s target for zero net carbon emissions from 2050 to 2030.

Increasingly attention is focusing on what can be done. At first sight, it might seem as if the answer lies solely with climate scientists, environmentalists, technologists, politicians and industry. When the matter is discussed in the media, it is often the environment correspondent, the science correspondent, the political correspondent or the business correspondent who reports on developments in policy. But economics has an absolutely central role to play in both the analysis of the problem and in examining the effectiveness of alternative solutions.

One of the key things that economists do is to examine incentives and how they impact on human behaviour. Indeed, understanding the design and effectiveness of incentives is one of the 15 Threshold Concepts we identify in the Sloman books.

One of the most influential studies of the impact of climate change and means of addressing it was the study back in 2006, The Economics of Climate Change: The Stern Review, led by the economist Sir Nicholas Stern. The Review reflected economists’ arguments that climate change represents a massive failure of markets and of governments too. Firms and individuals can emit greenhouse gases into the atmosphere at no charge to themselves, even though it imposes costs on others. These external costs are possible because the atmosphere is a public good, which is free to exploit.

Part of the solution is to ‘internalise’ these externalities by imposing charges on people and firms for their emissions, such as imposing higher taxes on cars with high exhaust emissions or on coal-fired power stations. This can be done through the tax system, with ‘green’ taxes and charges. Economists study the effectiveness of these and how much they are likely to change people’s behaviour.

Another part of the solution is to subsidise green alternatives, such as solar and wind power, that provide positive environmental externalities. But again, just how responsive will demand be? This again is something that economists study.

Of course, changing human behaviour is not just about raising the prices of activities that create negative environmental externalities and lowering the prices of those that create positive ones. Part of the solution lies in education to make people aware of the environmental impacts of their activities and what can be done about it. The problem here is that there is a lack of information – a classic market failure. Making people aware of the consequences of their actions can play a key part in the economic decisions they make. Economists study the extent that imperfect information distorts decision making and how informed decision making can improve outcomes.

Another part of the solution may be direct government investment in green technologies or the use of legislation to prevent or restrict activities that contribute to global warming. But in each case, economists are well placed to examine the efficacy and the costs and benefits of alternative policies. Economists have the tools to make cost–benefit appraisals.

Economists also study the motivations of people and how they affect their decisions, including decisions about whether or not to take part in activities with high emissions, such air travel, and decisions on ‘green’ activities, such as eating less meat and more vegetables.

If you are starting out on an economics degree, you will soon see that economists are at the centre of the analysis of some of the biggest issues of the day, such as climate change and the environment generally, inequality and poverty, working conditions, the work–life balance, the price of accommodation, the effects of populism and the retreat from global responsibility and, in the UK especially, the effects of Brexit, of whatever form.

Articles

Report

Questions

  1. Explain what is meant by environmental externalities.
  2. Compare the relative merits of carbon taxes and legislation as means of reducing carbon emissions.
  3. If there is a climate emergency, why are most governments unwilling to take the necessary measures to make their countries net carbon neutral within the next few years?
  4. In what ways would you suggest incentivising (a) individuals and (b) firms to reduce carbon emissions? Explain your reasoning.
  5. For what reasons are the burdens of climate changed shared unequally between people across the globe?

When an industry produces positive externalities, there is an argument for granting subsidies. To achieve the socially efficient output in an otherwise competitive market, the marginal subsidy should be equal to the marginal externality. This is the main argument for subsidising wind power. It helps in the switch to renewable energy away from fossil fuels. There is also the secondary argument that subsidies help encourage the development of technologies that would be too uncertain to fund at market rates.

If subsidies are to be granted, it is important that they are carefully designed. Not only does their rate need to reflect the size of the positive externalities, but also they should not entail any perverse incentive effects. But this is the claim about subsidies given to wind turbines: that they create an undesirable side effect.

Small-scale operators are encouraged to build small turbines by offering them a higher subsidy per kilowatt generated (through higher ‘feed-in’ tariffs). But according to a report by the Institute for Public Policy Research (IPPR), this is encouraging builders and operators of large turbines to ‘derate’ them. This involves operating them below capacity in order to get the higher tariff. As the IPPR overview states:

The scheme is designed to support small-scale providers, but the practice of under-reporting or ‘derating’ turbines’ generating capacity to earn a higher subsidy is costing the taxpayer dearly and undermining the competitiveness of Britain’s clean energy sector.

The loophole sees developers installing ‘derated’ turbines – that is, turbines which are ‘capped’ so that they generate less energy. Turbines are derated in this way so that developers and investors are able to qualify for the more generous subsidy offered to lower-capacity turbines, generating 100–500kW. By installing derated turbines, developers are making larger profits off a feature of the scheme that was designed to support small-scale projects. Currently, the rating of a turbine is declared by the manufacturer and installer, resulting in a lack of external scrutiny of the system.

The subsidies are funded by consumers through higher electricity prices. As much as £400 million could be paid in excess subsidies. The lack of scrutiny means that operators could be receiving as much as £100 000 per year per turbine in excess subsidies.

However, as the articles below make clear, the facts are disputed by the wind industry body, RenewableUK. Nevertheless, the report is likely to stimulate debate and hopefully a closing of the loophole.

Video

Turbine power: the cost of wind power to taxpayers Channel 4 News, Tom Clarke (10/2/15)

Articles

Wind subsidy loophole boosts spread of bigger turbines Financial Times, Pilita Clark (10/2/15)
Call to Close Wind Power ‘Loophole’ Herald Scotland, Emily Beament (10/2/15)
Wind farm developers hit back at ‘excessive subsidy’ claims Business Green, Will Nichols (10/2/15)
The £400million feed-in frenzy: Green energy firms accused of making wind turbines LESS efficient so they appear weak enough to win small business fund Mail Online, Ben Spencer (10/2/15)
Wind power subsidy ‘loophole’ identified by new report Engineering Technology Magazine, Jonathan Wilson (11/2/15)

Report

Feed-in Frenzy Institute for Public Policy Research, Joss Garman and Charles Ogilvie (February 2015)

Questions

  1. Draw a diagram to demonstrate the optimum marginal rate of a subsidy and the effect of the subsidy on output.
  2. Who should pay for subsidies: consumers, the government (i.e. taxpayers generally), electricity companies through taxes on profits made from electricity generation using fossil fuels, some other source? Explain your thinking.
  3. What is the argument for giving a higher subsidy to operators of small wind turbines?
  4. If wind power is to be subsidised, is it better to subsidise each unit of output of electricity, or the construction of wind turbines or both? Explain.
  5. What could Ofgem do (or the government require Ofgem to do) to improve the regulation of the wind turbine industry?

The Clean Energy Bill has been on the agenda for some time and not just in the UK. With climate change an ever growing global concern, investment in other cleaner energy sources has been essential. However, when it comes to investment in wind farms, developers have faced significant opposition. The balancing act for the government appears to be generating sufficient investment in wind farms, while minimising the negative externalities.

The phrase often thrown around with regards to wind farms, seems to be ‘not in my backyard’. That is, people recognise the need for them, but don’t want them to be built in the local areas. The reason is to do with the negative externalities. Not only are the wind farms several metres high and wide, creating a blight on the landscape, but they also create a noise, both of which impose a third party effect on the local communities. These factors, amongst others, have led to numerous protests whenever a new wind farm is suggested. The problem has been that with such challenging targets for energy, wind farms are essential and thus government regulation has been able to over-ride the protests of local communities.

However, planning guidance in the UK will now be changed to give local opposition the ability to override national energy targets. In some sense, more weight is being given to the negative externalities associated with a new wind farm. This doesn’t mean that the government is unwilling to let investment in wind farms stop. Instead, incentives are being used to try to encourage local communities to accept new wind farms. While acknowledging the existence of negative externalities, the government is perhaps trying to put a value on them. The benefits offered to local communities by developers will increase by a factor of five, thus aiming to compensate those affected accordingly. Unsurprisingly, there have been mixed opinions, summed up by Maria McCaffery, the Chief Executive of trade association RenewableUK:

Maria McCaffery, chief executive of trade association RenewableUK, said the proposals would signal the end of many planned developments and that was “disappointing”.

Developing wind farms requires a significant amount of investment to be made upfront. Adding to this cost, by following the government’s advice that we should pay substantially more into community funds for future projects, will unfortunately make some planned wind energy developments uneconomic in England.

That said, we recognise the need to ensure good practice across the industry and will continue to work with government and local authorities to benefit communities right across the country which are hosting our clean energy future.

The improved benefits package by the energy industry is expected to be in place towards the end of the year. The idea is that with greater use of wind farms, energy bills can be subsidised, thereby reducing the cost of living. Investment in wind farms (on-shore and off-shore) is essential. Current energy sources are non-renewable and as such new energy sources must be developed. However, many are focused on the short term cost and not the long term benefit that such investment will bring. The public appears to be in favour of investment in new energy sources, especially with the prospect of subsidised energy bills – but this positive outlook soon turns into protest when the developers pick ‘your back yard’ as the next site. The following articles consider this issue.

Residents to get more say over wind farms The Guardian, Fiona Harvey and Peter Walker (6/6/13)
Local communities offered more say over wind farms BBC News (6/6/13)
Locals to get veto power over wind farms The Telegraph, Robert Winnett (6/6/13)
Wind farms are a ‘complete scam’, claims the Environment Secretary who says turbines are causing ‘huge unhappiness’ Mail Online, Matt Chorley (7/6/13)
New planning guidance will make it harder to build wind farms Financial Times, Jim Pickard, Pilita Clark and Elizabeth Rigby (6/6/13)
Will more power to nimbys be the death of wind farms? Channel 4 News (6/6/13)
Locals given more ground to block wind farms Independent, Tom Bawden (6/6/13)

Questions

  1. What are the negative externalities associated with wind farms?
  2. Conduct a cost-benefit analysis as to whether a wind farm should be constructed in your local area. Which factors have you given greatest weight to?
  3. In question 2 above, were you concerned about the Pareto criterion or the Hicks-Kaldor criterion?
  4. If local communities can be compensated sufficiently, should wind farms go ahead?
  5. If the added cost to the development of wind farms means that some will no longer go ahead, is this efficient?
  6. Why is there a need to invest in new energy sources?
  7. To what extent is climate change a global problem requiring international (and not national) solution?

The total EU budget in 2010 was €123 billion. Just under half of this (€58 billion) was spent on supporting agriculture. The programme of support – the Common Agricultural Policy (CAP) – has changed over the years. For a start, despite its being a large proportion of the EU budget, this proportion has actually been falling. In 1980, the CAP accounted for 69% of the EU budget; in 1990 it was 60%; in 2000 it was 52%; in 2010 it was 47%.

The types of support have also changed. The main method in the past was effectively to set minimum prices for various foodstuffs and for Intervention Boards to buy up any surpluses that arose from such prices being above the market equilibrium. Massive food ‘mountains’ resulted. Sometimes these surpluses were dumped on the world market; sometimes they were thrown away; sometimes they were simply kept in storage. Export subsidies and import levies (taxes) were also used to reduce surpluses. This, of course, was highly damaging to farmers in many countries outside the EU, especially in various primary exporting developing countries.

Reforms have taken place in recent years. The most important has been to replace high intervention prices with direct payments to farmers unrelated to current output. Whilst such payments still provide a substantial outgoing from the EU budget, being unrelated to current output, they do not encourage farmers to produce more and thus do not generate surpluses. Prices in most cases are allowed to be determined by the market.

The EU has just announced further reforms. These include:

&#8226 Capping total CAP spending at current levels until 2020
&#8226 Capping the total payment to any one farm to €300,000
&#8226 Relating subsidies to acreage rather than previous output
&#8226 Making 30% of the direct payments dependent on farmers meeting environmental criteria.

The following videos and articles examine the proposals and assess their likely benefits, their likely drawbacks and their likelihood of being implemented.

Videos
EU plans to reform Common Agricultural Policy for farmers BBC News, Jeremy Cooke (12/10/11)
EU unveils controversial agricultural reforms Euronews (12/10/11)
Towards a new Common Agricultural Policy Euronews (14/10/11)
Queen to lose out in shake up of Europe’s farm payments Channel 4 News (12/10/11)
Cautious welcome for EU agriculture policy shake-up STV News (12/10/11)
CAP reform proposals YouTube, Dacian Cioloş, European Commissioner for Agriculture and Rural Development (in French with English subtitles) (12/10/11)

Articles
EU farm chief: CAP plans represent profound reform Reuters, Charlie Dunmore (12/10/11)
UK to dismiss Common Agricultural Policy reforms as inadequate Guardian, David Gow (11/10/11)
EU Farm Policy Debate Pits Top Receiver France Against U.K. Bloomberg Businessweek, Rudy Ruitenberg (12/10/11)
EU plans CAP reforms for ‘greener’ farm subsidies BBC News (12/10/11)
Common Agriculture Policy farm subsidy plan unveiled BBC News (12/10/11)
Q&A: Reform of EU farm policy BBC News (12/10/11)
CAP reform: Shepherd and steward of the land BBC News, Jeremy Cooke (12/10/11)
EU agriculture policy ‘still hurting farmers in developing countries’ Guardian: Poverty Matters blog, Mark Tran (11/10/11)
EU aid to farmers to continue over next decade Financial Times, Joshua Chaffin (12/10/11)

EU publications
CAP Reform – an explanation of the main elements Europa Press Release (12/10/11)
The European Commission proposes a new partnership between Europe and the farmers European Commission Press Release (12/10/11)
EU farm policy after 2013: Commission proposals welcomed with reservations European Parliament Press Release (12/10/11)
Legal proposals for the CAP after 2013 European Commission: Agriculture and Rural Development (12/10/11)

Questions

  1. Explain why the old system of price support under the CAP led to food surpluses. Use a diagram to illustrate your analysis.
  2. What is the significance of price elasticity of demand and supply in determining the size of these surpluses?
  3. What reforms have been introduced to the CAP in recent years? What effects have these had?
  4. Explain the new proposals for the CAP after 2013.
  5. What are the likely benefits of these proposals?
  6. What are the likely drawbacks of the proposals?