30 August 2022

How the next Prime Minister can get through winter


In a week’s time Britain will have a new Prime Minister, and the same problems. Liz Truss or Rishi Sunak will not be able to wave a magic wand and summon new energy supplies into being across Europe. They will be able to decide how much support to offer households, and how much to offer businesses. And if they get the decision wrong, the Conservative party can look forward to a decade in the cold.

The core problem is that there isn’t enough energy to go around. Reduced gas flows from Russia are driving up prices across Europe as the price mechanism reconciles high demand with low supply. Britain doesn’t buy Russian gas, but does buy in the same energy marketplace, and imports electricity from the continent when local power output is low. Now that Germany and other countries are looking to secure new sources of supply, the price Britain pays is rising.

Nothing Truss or Sunak can do in the next three months will address this; the problem they face is how to allocate the energy supplies we still have access to. In a different world, politicians might be tempted to let the market decide. In this one, there is absolutely no prospect they will; there is already substantial demand from Tory voters to start nationalising energy companies, let alone from the left. Even if we take ‘nationalise’ as shorthand for ‘please do something before my toilet freezes’, Britain’s next prime minister won’t get through the winter politically intact without substantial government intervention.

Fortunately, there are good economic reasons to step in as well. If households had access to perfect credit markets – banks knew what they’d earn in the future with perfect clarity, could be sure they’d make their repayments, and weren’t tied up by government regulations – then they would very likely borrow money to pay their bills this winter, spreading the cost out into the future rather than eating it all in one go.

But credit markets aren’t perfect, and the households without access are those that are likely to be worse off to begin with. Governments, meanwhile, can basically borrow and spread the bill indefinitely. So long as the growth rate of the economy is greater than the rate of interest it pays on its debt, the debt to GDP ratio will tend to shrink over time; fiscal sustainability is baked in.

These arguments make a strong case for intervening on the behalf of households. Businesses, too, are affected by imperfect credit. There are arguments that they should have taken precautions to ensure their own fiscal sustainability, but they tend to do quite poorly when faced with the twin observations that government-imposed lockdowns eroded cash buffers, and government-imposed foreign policy – no matter how morally laudable – is exactly why prices are high. Giving otherwise viable businesses struggling to access credit cash to help them through the winter is just good policy.

And for those who fear the end of the free market, relax. Britain doesn’t have a free market in energy. It doesn’t have anything close to it. Per unit prices are capped for residential consumers, ensuring that they pay less than business users, while supply is heavily tilted towards desired forms of generation by subsidies and taxes. In this context, the government putting a thumb on the scale and tilting consumption towards households really isn’t the end of the world.

With that said, there are smart ways of achieving this goal, and there are what might politely be termed ‘less smart’ policy decisions. The free marketeers have a point: what we don’t want is the Government deciding exactly how much energy goes to households, and how much goes to companies. What we mean by ‘a thumb on the scale’ is policies which give households money while preserving price signals; give households incentives to reduce use, and money so they can spend it on heat and power if they need to.

As is traditional in economic matters, the Labour party has come up with a policy guaranteeing the worst of all worlds. Fixing the price cap destroys price signals, drives demand up, drives the prices paid by businesses up, drives more businesses to the wall, and also punches a massive hole in the Government’s budget.

The second worst option is ‘doing nothing’. Liz Truss is currently toying with this policy suggestion, claiming that cuts to national insurance and green levies will suffice, then backtracking to say direct support might be needed after all. The latest suggestion – cutting VAT – would put a lot of cash back into people’s pockets without distorting prices. In this sense, it’s not a bad idea. The big flaw is that it is hugely expensive, costing £38 billion or more per year, and is poorly targeted. The very fact that energy is limited means that we can’t have everyone continue on as they were; there will be some pain. Wealthier households are better able to bear this. From this perspective, cash payments through benefits to those out of work and on low incomes should catch a substantial proportion of those who need the most help.

There is far less discussion of support for businesses, who compete directly with households for power. Each support package for residential consumers makes things harder for business consumers as prices rise. Providing support for households gives us this outcome by default. Letting businesses shut down, however, is a policy choice. It may still be the right one – if we think energy prices are going to be high for years, many businesses will simply cease to be financially viable. But if we think prices will start falling, then the case for giving energy-intensive industries support along the lines of that offered during covid is stronger.

As things stand, no one knows what our next prime minister is planning. Businesses are waiting to find out if they will survive, people whether they will be employed, families whether they can keep their house warm. This uncertainty is not costless, in economic or welfare terms. The sooner a new PM makes their mind up and tells us what they’re going to do, the better.

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Sam Ashworth-Hayes is an economist and writer.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.