A guest post by Paul Hunt
The case for a pro-cyclical fiscal contraction accompanied by a significant “internal devaluation” has been convincingly demonstrated by many commentators and, in particular, on this site by Philip Lane (most recently here).
But Philip has been equally strong on the requirement to tackle rent capture and inefficiencies that increase costs and prices and, to some extent, justify calls for the retention of current nominal pay levels, as in:
“As a complement to pay reductions, it is also vital to more vigorously tackle monopoly power in many sectors of the economy, since a reduction in markups and monopoly rents (often shared between owners, managers and workers in these firms) is an important source of real depreciation and improved competitiveness.” (Irish Economy Note9, p3)
However, apart from a recognition of the importance of this task, it appears that little attention is being paid to what could be done in the short to medium term. There can be no doubt that the bubble economy facilitated increased rent capture and inefficiencies in the sheltered sectors of the economy, but quantifying the scale and extent – not to mind devising effective remedies – is a daunting task. And the political and economic power of the beneficiaries is not insignificant. So it is, perhaps, not surprising that there is little evidence of these problems being tackled effectively.
But a start must be made somewhere and the focus here is on public infrastructure and utilities such as transport, energy, communications, and water and waste water that are, to varying extents, owned, directed, overseen and regulated by Government departments or associated statutory regulatory bodies. There are three reasons for this focus. First, the inefficiencies are significant, are relatively easily quantified (compared to other sheltered sectors) and have economy-damaging impacts. Secondly, since there is significant state direction, it is possible to devise and implement effective remedies quite rapidly. And finally, comparisons with other developed economies (and Ireland’s major trading partners) highlight serious deficiencies in these areas that need to be addressed. The nature of the economic crisis and the fiscal situation prevent the Government from pursuing textbook Keynesian interventions, but that should encourage an even greater focus on enhancing the infrastructure and utilities “platform” to improve the competitiveness of the tradable sectors and to attract new investment.
And to clarify the potential in this area the focus is narrowed to look at the regulated energy businesses. This narrowing of focus reflects personal knowledge and experience, but does not prevent the identification of factors and remedies that have a broader relevance.
The high levels of electricity and gas prices in Ireland (particularly, when compared using Eurostat data with those in other EU member-states) frequently attract attention. Specific features of the individual national markets may go some way to explain the differentials, but, unfortunately, much public attention is focused on the perceived high levels of staff pay in the ESB and Bord Gáis where even significant reductions would have a negligible impact on final prices. (The public perception of the ESB or Bord Gáis has not been helped by the legal requirement to award pay increases under the social partnership agreement or the ability of both (and other semi-states) to avoid the pension levy imposed on public sector workers – even though, by any criteria, Bord Gáis is extremely efficient in operational terms and the ESB has a well-deserved international reputation in the management and operation of electricity systems.)
The resulting public indignation diverts attention from serious specific failings in investment decisions and the financing of investment and more general failings in energy policy and regulation that cost consumers dearly. The public impression is that, since these businesses are in majority state ownership, the state contributes to the financing of investment. The reality is that, apart from some limited forgoing of dividend payments, there has been zero direct exchequer financing of investment by these semi-states within living memory. In the case of the ESB, the significant increase in network investment since the early 2000s has been financed 75% by consumers with much of this being provided up-front in the form of customer capital contributions and via excessively high revenues awarded by the energy regulator. It would be difficult to devise a more inefficient and, for consumers, more costly approach to investment financing. Bord Gáis network investment financing is similarly inefficient.
The unwillingness of successive governments to contribute to the financing of electricity interconnection with Britain (as well as, perhaps, a desire to shield the sector from inefficiency-highlighting competition) has delayed construction. (it is now going ahead with EU co-funding and an EIB loan.) A second gas interconnector, IC2, to Scotland was constructed when LNG importation and, possibly, some reinforcement of the existing Scotland to Northern Ireland interconnector would have made much more sense. IC2 has seen little use and, when Corrib gas and the new LNG importation facility come on stream, it and, most likely, some of the capacity on the first interconnector will be redundant – yet Bord Gáis will recover the full sunk costs of these dubious investments leading to prices being higher than they should be.
Energy regulation has been subverted to facilitate these inefficiencies and to award excessively high revenues that subsidise expansion by the ESB and Bord Gáis into other areas both in Ireland and abroad. The reductio ad absurdum was probably reached with the foray by Bord Gáis into the electricity market: all gas consumers are being penalised to subsidise supply to the much smaller number that switch to Bord Gáis. But, of course, this was greeted as evidence that competition is taking hold in the market.
This naïve belief in “competition” as a panacea for all ills would be touching and charming if it were not so costly for households and businesses. And this naïve belief, unfortunately, is shared by the European Commission and there appears to be a limited appreciation of the genuinely competitive market structures and arrangements that are required to secure investment in specific, long-life assets and to generate benefits, ultimately, for consumers. In Ireland’s case it has led to a policy-decision to reduce the ESB’s share of the generation market on the island to no more than 40%, irrespective of the costs that will be incurred or the fact that this will limit the ESB’s ability to compete in the increasingly integrated regional markets within the EU.
It is possible to estimate the cumulative effect of these failings as comprising €300 – 400 million of the total of the annual bills for electricity and gas. The challenge is to strip out as much of these additional and unjustified costs as possible.
The simplest and most effective approach is to fully separate the network and supply businesses, possibly merge the ESB and Bord Gáis generation and supply businesses and sell the resulting 3 (or 4) businesses via trade sales. It should be possible to generate in excess of €6 billion. The contested market values of the networks are likely to be higher than the current book values, but below the artificially inflated regulatory values which will lead to lower network revenues and lower final prices.
There is a strong case for pursuing a similar approach, though with a different mix of competition in and for the market and an innovative approach to the requirement for subsidy, in the transport sector. The existing water and waste water activities of the local authority providers could be extracted, merged into a number of regional businesses, sold off and made subject to regulation. Conversely, state investment may be required in Eircom (in collaboration with the new ownership structure) to leverage an accelerated development of its network and activities.
And regulation of these sectors should be combined in a single, suitably empowered, regulatory body.
It is probably futile to attempt to demolish the usual arguments about the importance of public ownership of “strategic assets”, the need to preserve and fatten-up “national champions” (such as the ESB), the losses that would be incurred in a “fire-sale” of national assts, the anti-privatisation “lessons” of the Eircom debacle and the malign impact of carpet-bagging, asset-stripping private equity ghouls, but these arguments should be seen for what they are: spurious, self-serving and woolly. When one surveys the costly, inefficient mess that state ownership and direction has created it is difficult to believe that private sector investment and participation, subject to effective policy and regulatory control, would be worse.