It looks as though Theresa May’s plan to help the ‘Just About Managing’ by capping energy prices has not worked. Ofgem has announced that it will increase the price cap for customers on default tariffs, such as standard variable, by £117 to £1,254 a year, while the price cap for customers on prepayment meters will increase by £106 to £1,242 a year.
This should not come as a surprise to anyone who has even glanced at an economics textbook. A cap on energy bills is, essentially, a form of price control.
History is littered with examples of the negative effects of such policies. If you visit the Louvre in Paris, you will be able to see the Code of Hammurabi. It contains the legal code of ancient Mesopotamia from roughly 1754 BC and includes numerous provisions ranging from what to do to an adulterous couple caught in the act (bind them together and throw them into the river), to marking the brow of a slanderer. It also lists how much people were allowed to charge for providing various goods and services.
Or, take the Ancient Egyptians. They had a penchant for trying to control the price of grain. The Nomarch Henku had “I was lord and overseer of southern grain in this nome” inscribed on his tomb in approximately 2830 BC. What is more, the Lagid Dynasty founded in 306 BC capped both the price of grain and workers’ wages. To enforce the policy, the civil service grew in size as price control inspectors were recruited. The end result was economic collapse.
As for Ancient Greece, the death penalty was imposed on anybody who circumvented the price control laws. Thankfully for many Athenians, people did ignore these laws, which is the only reason why they did not starve to death as a result of the grain shortage.
The Romans also decided to implement price controls, again with disastrous consequences. Trade all but stopped and the people starved thanks to the Emperor Diocletian’s Edict of Maximum Prices which introduced price ceilings for food, clothing, sea travel, and wages.
It was not just the ancients who learnt the hard way that price caps do not work. During the Reign of Terror, Robespierre extended the Law of Suspects to include the General Maximum which introduced price controls to France. As the number of emaciated corpses rapidly increased, the revolutionaries realised that they had to scrap the law.
In order to prevent profiteering, the Allied authorities implemented price controls in Western Germany after the defeat of Hitler. As a result, the people faced severe shortages of essential items, not least food. Thankfully, the portly, cigar smoking Minister for Economic Affairs, Ludwig Erhard, believed that markets could cure the malaise. One Sunday evening, without consulting the US authorities, he scrapped the price control laws. Almost immediately, the shelves began to fill up, people could get their hands on what they needed, and Germany was well on the way to recovery.
The dire economic consequences of price controls can still be witnessed today. One only has to look at the unfolding tragedy in Venezuela where people are forced to eat zoo animals and children are starving to death due to socialist policies such as price caps enforced by the murderous Maduro regime.
As this panoply of examples shows, price caps do not work. They not only fail to tackle the problem they are trying to solve, they often make things much worse.
The energy market is no exception. Research looking at the impact of energy price caps on consumer behaviour in Australia found that people living in areas with regulated price caps are far less likely to access better deals than those living in areas with a deregulated energy market.
This is not to suggest there should be no action to reduce the high cost of energy to hard-pressed households. High bills are one of a number of factors contributing to the high cost of living in the UK, with many households experiencing fuel poverty.
So, what can be done? A good start would be to look at the heavy regulation of the energy market. In a recent paper for the Adam Smith Institute, Sam Dumitriu points out that, far from helping consumers, Ofgem rules have actually led to a fall in switching rates.
For example, switching rates increased from the 1990s until 2008 as a result of liberalisation. However, the introduction of license condition 25A, which banned suppliers from charging higher markups in their home regions, reduced competitive pressures within the market. Then there are the regulations which led to a decrease in doorstop selling and the introduction of simpler tariffs.
Although these regulations were well=intentioned, they reduced consumer engagement and choice, meaning lower rates of switching and higher prices. If we want to see lower prices, then the market needs to be allowed to work. Energy companies need to be able to focus on targeting disengaged consumers, thereby increasing competition.
Energy prices are also expensive in the UK as energy companies are forced to include minimum shares of energy from renewable sources in their portfolios. Given these are often expensive and inefficient, that cost is passed on to consumers in the form of higher bills. As a 2014 report from the IFS found, environmental policies “drive up energy prices directly through the environmental charges in the bill but also indirectly, and significantly, though the impact on generation and network costs”.
Of course, there are legitimate environmental concerns. Global warming is real and it needs to be tackled. However, the current method of reducing carbon emissions is not working and places an unacceptably high burden on household budgets. Instead, the Government should introduce a border-adjusted carbon tax, a move which most leading economists argue will help to effectively tackle climate change.
If we want people to tackle the high cost of living and reduce energy bills for people, while also protecting the environment, then more government is not the solution. The price cap needs to be scrapped and many of the regulations which limit consumer choice need to be removed. Only when the energy market is allowed to work will we see energy bills come down.