New Thinking: On Professor Helm’s political economy

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New Thinking: On Professor Helm’s political economy

On Professor Helm’s political economy

Matthew Lockwood, IGov Team, 30th October 2017

On Professor Helm’s political economy

Dieter Helm’s much anticipated cost of energy review has already attracted a lot of critical response, for example on his call for an economy-wide carbon price, the idea of folding the CfD and the Capacity Market into auctions for ‘equivalent firm capacity’, making renewables cover their own intermittency costs, and indeed querying his starting point that energy costs are ‘too high’. CarbonBrief has a useful summary of all the various points that have been made.

As others have noted, a key question is what the government will now do with his recommendations, and if they try to take them up, whether some of them – like his economy-wide carbon price – will be politically feasible to implement. I would argue that the political economy of policy making and implementation is not merely an interesting side-issue in Helm’s review, but is actually central to his agenda. This is not least because Helm is rather unusual amongst energy analysts in thinking explicitly about political economy. The question is whether his thinking makes sense.

At the heart of the review, and its policy recommendations, is the idea that policy is too complex, and that complexity is a big source of cost. At the outset, Helm states that:

‘It will be hard to reduce the costs of energy without a radical simplification of the multiple interventions.’

Essentially, he argues that policy complexity has been created by lobbyists (both incumbent and ‘green’) because it benefits them by allowing them to extract rents.

‘For each intervention there is a long list of policies, regulations and strategies…It would be beyond the comprehension of any civil servant, minister or participant in these markets. A classic feature of capture holds: the particular interested party would have superior information. Asymmetric information between the government and regulators on the one hand, and the vested interest on the other, is a bigger problem, the more complex the interventions.’

Complexity creates cost:

‘Understanding, compliance and lobbying have created numerous costs on companies (consumers do not really have the opportunity to significantly influence the details). Every main energy company and every main energy-consuming company has its own regulatory team, and a number of significant and in some cases highly effective trade bodies have emerged. Most of this is deadweight welfare loss, both directly in the administrative costs and more seriously in the resulting allocative distortions.’

Complexity is such that policy makers cannot possibly understand all the interactions, so tinkering by adding more policies is hopeless and radical simplification is the only solution. Simplification of policy is the way to counter lobbying, but will be resisted:

‘My proposals for a long-term framework are designed to sharply reduce this burden. It is intended to be as lobby-proof as possible. As a result, many vested interests will not welcome reduction in their scope for lobbying and capture.’

Helm is not alone in making these arguments (see for example here, here and here). He has, of course, also made them before. What are we to make of his analysis?

First, in his desire to present the flow of his argument, Helm can (ironically) oversimplify.  For example, on page 41 of the review he has a list of the twelve energy efficiency schemes currently in operation as an example of complexity. Initially, twelve does seem like a lot of measures to achieve a single goal. However, once you start to look at these in detail, it quickly becomes clear that there are a number of different categories to which different policies apply: commercial and industrial companies, public sector organisations, owner-occupier households and private landlords. Since all of these types of actors do in fact have different incentives, perceptions of cost, access to finance etc., it is not actually unreasonable to have different policies for each of them. In fact, not having differentiated policies can simply mean policy failure; for example, for a long time we had no policy that addressed the split incentive problem for energy efficiency in private rented properties.

Once this kind of sensible differentiation is taken into account, the complexity of policy is sometimes less of a problem than might appear from a simple list of all policies. For example, for owner-occupiers there are effectively only three policies – the ECO, Building Regulations and products policy, which do not overlap that much, mostly addressing insulation, building fabric and boiler efficiency, and end-use product efficiency separately. This may not be the best possible and simplest arrangement, but it is not impossibly complex.

Thus some policy complexity is driven by the complexity of the world, and is not only inevitable but sensible. The problem lies in being able to distinguish ‘good’ and ‘bad’ complexity.

That said, Helm is clearly right about the basic problem. At IGov we have also critiqued this complexity and its role in helping incumbents shape and benefit from energy regulation. Helm’s approach seems to be to place the blame solely on lobbyists:

‘Complexity has significant additional costs for energy, because the greater the complexity, the greater the scope for capture by rent-seeking lobbyists and interest groups. Each intervention changes returns. Once gained, they tend to get capitalised. As a result, any moves to reform and change arrangements – for example, by phasing out particular subsidies – creates losers, and often capital losses. Understandably these are resisted, and the complexity makes it much easier to protect specific interests, while at the same time reducing the ability of households and industrial users to defend their general interests in general efficiency. It is no accident that the growth of complexity has been closely matched by a growth in lobbying (and vice versa), and that much of the debate about subsidies has become toxic.’

Again, as with the identification of and characterisation of complexity, there is clearly some truth here but also some oversimplification. There are other important sources of policy complexity than lobbying. At a fundamental level, complexity in energy policy arises from the layering of new policies on old ones, instead of the replacement of those old policies by new ones. It is this that creates the complex interactions that Helm discusses. James Mahoney and Kathleen Thelen have argued persuasively that layering happens when there are actors who are powerful enough to veto the removal of old policies, but not powerful enough to block the addition of new ones. These actors can of course be lobbyists, but they are also going to exist within government itself. For example, on the issue of multiple carbon prices, which is a particular preoccupation of Helm’s, it is entirely that plausible that the Treasury itself wanted to keep the CCL when the EU ETS and then the Carbon Price Support mechanisms came in rather than replacing it, as it was a useful source of revenue, and there would be a political risk in rolling all of these into one big, more visible tax.

This example also points to another source of complexity in energy policy. Successive governments have been very averse to applying taxes to households to try to drive particular behaviours (such as increasing energy efficiency or cutting carbon). Gas and electricity attract a lower level of VAT. There is no direct carbon tax on household energy use (and even pass through costs have been framed as ‘green taxes’ by parts of the print media). There was an attempt to bring in a secular trend increase in fuel duty in the late 1990s but it was dropped like a hot potato in 1999 when resistance emerged and has not been picked up since. This political aversion can plausibly be attributed to the fact that the UK is a low wage economy, where the politics of tax in general is fairly toxic, certainly compared with the higher wage economies of Scandinavia. The political infeasibility of using taxes on households for energy policy means that governments are pushed into work-arounds like the suppliers’ obligation and product policies, which are inevitably more complex and open to lobbying. But sweeping these away to be replaced by an energy tax and carbon tax on all those voters is unlikely to be amongst those of Helm’s recommendations that are taken up by the government (especially one with no majority).

Finally, there is the question of what to do about the problem. Helm’s approach, as indicted above, is to simplify radically, bringing in policies (e.g. uniform carbon prices) that are harder to lobby on. One problem here is that just identifying a problem and calling for a simplifying solution is not the same as actually introducing that solution. Helm has a throw-away line about how vested interests will not welcome his proposals (and presumably thinks it is up to politicians to work out how to implement them), but given that he gives such a central place to political economy in his approach it is a bit odd that he doesn’t say more. The point is that, for example, it has been pointed out by many analysts and for years that taxes in the energy sector overlap and tax carbon at radically different rates, but so far rationalisation has proven impossible.

A second issue is that, if you could simplify policy, it might well help in the short run (depending on the policy, staying with the example of a carbon tax, as many others have pointed out, even a stable and unified carbon price would not drive longer-run investment or innovation). But as long as lobbyists (and interests in government, and politics) exist, it is likely to gain complexity again over time. This is exactly what happened to the simplifying tax reforms in the US in the 1980s.

For me, there is a deeper theme here. This is that lobbying is worse wherever there are large oligopolistic or monopoly interests. In Denmark, for example, where policy and regulation does appear to be less complex and where there seem to be less gaming, this is in part undoubtedly because most actors are relatively small, and often not for profit (and the one big one, DONG, comes under a lot of scrutiny precisely because it is the one big actor). The trouble is that UK energy markets do seem to produce precisely the kind of large corporate actors that can and do throw money at lobbying. Some of Helm’s preferred policies will tend to just reinforce this pattern. For example, he likes auctions, and while well-designed auctions might help drive down costs, they also tend to work best for large players, and can lead to the kind of concentration we are now seeing in offshore wind, for example. More widely, Helm likes to let markets rip, but the reality is that in market with barriers to entry and economies of scale, big players get established and become powerful lobbyists.

So lobbying, and interests in government and the politics of taxing households are always going to be there. Simplifying policies (even if it can be done) is not a long-term solution. The alternative is to try to change the policy making process to address some of these issues, at least as far as possible, by making it more transparent and legitimate. Recent IGov work on lobbying in the design of the Capacity Market discusses some of the ways in which this might be done, but it is a theme we will return to again in the future.

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