Far too many of our politicians don’t grasp how markets work

By Allister Heath From The Telegraph.

Ed Miliband’s disastrous threat to introduce extreme price controls into the domestic energy market has cost the country dear

"Imagine that the energy market worked the way many politicians – Labour, of course, but even some members of the coalition – apparently believe that it operates. It would be impossible to know how much turning on the radiator or taking a bath was going to cost. Prices to consumers would vary drastically and immediately depending on supply and demand conditions in the global economy. It would be chaos, and the politicians would be the first to rush to denounce it.

The good news, of course, is that it doesn’t work that way, never has and never will. Prices for consumers are deliberately smoothed. We know how much we are going to pay because our energy providers buy gas in advance. The energy most of us consume today was generally purchased by our provider in 2013 or 2014, at the market prices of the time. This allows gas companies to contractually agree a fixed price with their customers, and at least allows a degree of medium-term predictability. Risk is passed on, albeit at a price; insurance is never costless.

All of this is one reason why the 30pc or so drop in wholesale prices since the commodity’s recent peak are only now starting to have an impact. It takes time for price changes to filter through to consumers; in theory, it could easily take two years for the entire decline to be felt. E.ON recently announced that it would be cutting prices by 3.5pc; British Gas owner Centrica is pushing through a 5pc cut, reducing the bills of 6.8m people by an average of £37 a year from February 27. By waiting a little longer, Centrica was able to cut by more. Both firms are actually taking a risk: they are assuming that wholesale prices won’t bounce back immediately and permanently.

Some believe the firms should have cut earlier. But if companies like Centrica start cutting prices by 1pc every few weeks, they would also then have to start hiking them by 1pc every few weeks when conditions reverse, as they undoubtedly will one day. In extremis, one returns to the idiotic scenario described at the start of this article, something which nobody in their right minds would want.

Others believe that prices should be falling by more. But how? Wholesale only represents half or so of the total price of gas. Other costs include transport and distribution costs, which are going up partly as a result of increased spending by National Grid. Green taxes and other costs have also risen over the past few years. Energy firms’ profit margins are pretty low, as their annoyed shareholders would be the first to point out.

Take a hypothetical supplier that buys wholesale gas gradually over a two-year period in advance of delivery. Such a company would expect its wholesale costs for the year to be roughly 11pc lower as a result of the slide in market prices. Given that wholesale only accounts for half the bill, and there are lots of other uncertainties and changing costs, a 5pc drop in consumer prices seems exactly right.

Ed Miliband’s disastrous threat to introduce extreme price controls into the domestic energy market has had entirely pernicious and predictable effects. It has frightened companies and added risk that shareholders are only too aware of. It has probably slightly increased the cost of capital, reducing investment in an area that is desperate for it. It has incentivised at least some companies to agree to even longer supply contracts, thus further delaying the positive impact of falling wholesale prices. It has been a disastrous policy that has cost the country dear. Labour needs to go back to the drawing board, and fast, if it wants to rebuild its shattered economic credibility.

Take wealth statistics with a pinch of salt

Hold the front page: 22-year-old US medical students, who generally go on to earn many millions during their lifetimes, are officially among the poorest people in the world. Ditto MBA students who’ve just joined Goldman Sachs or McKinsey. Genuinely, heartbreakingly poor workers who subsist on $1 a day in emerging economies, by contrast, are deemed to be better off than these two demographics – or so the statistics would have us believe.

Why, you ask? How could this possibly be so? The reason for these nonsense numbers is that the medics and business school graduates have very large unsecured debts, far bigger than almost anybody anywhere, and thus have a hugely negative net wealth. A poor worker in an emerging economy is deemed far richer – in part because they don’t have access to credit.

Absurd? Of course, but that is the methodology used in most reports on global wealth inequality. As the Adam Smith Institute points out, it makes no sense to look at net wealth without also examining the incomes people are likely to earn in future from wages, investments and pensions. The shock and oft-cited statistics about the share of total wealth owned by the richest are based on such misleading net wealth figures. If gross wealth were used, or if adjustments were made for disposable income and living standards, the picture would look significantly less unequal. The bottom 80pc may statistically own just 5.5pc of the world’s net wealth, but that is because they have mortgages. They control far more of the world’s assets than such numbers suggest.

The latest Oxfam study on net wealth falls into the same trap. It also has two other failings. For years, the share of net wealth held by the top 1pc globally kept on falling; it started to rise again with the global recovery and quantitative easing but remains lower than it was 15 years ago, a point which the report didn’t emphasise. Its most eye-catching finding – that the top 1pc could soon own more than half of the world’s net wealth – is just an extrapolation of very temporary trends and exceptional circumstances. Who knows what will happen next? Stock markets could fall, and the top 1pc’s share could decline. There is no science here, mere speculation.

The report misses the real story: the collapse in genuine global poverty and the explosion in living standards in India, China and much of Africa in recent years. There is much more wealth than there used to be, and far more previously poor people now share in its fruits. African poverty, measured correctly, fell by 38pc between 1990 and 2011. Any system that delivers such a wonderful improvement gets my vote."