The false lure of renationalisation

November 4, 2013

In 2007, Gordon Brown strained to avoid what he considered politically toxic:  nationalising a private company (Northern Rock). Now in 2013, the Government runs RBS and the East Coast mainline franchise. Labour front-bencher, Maria Eagle, has argued for the renationalisation of the railways. And Chuka Umunna has made the case for continued nationalised ownership of Royal Mail.

While Ed Miliband has reshuffled Maria Eagle from the transport to environment portfolios (perhaps to plot renationalisation of the water industry instead), he has also clearly signalled a policy direction towards greater 1970s-style government control of private companies – with his proposals for confiscation of house builders’ land assets and a mandatory energy price freeze.

Even the Coalition Government, which has privatised 52% of Royal Mail, has brought forward the Energy Bill that – while not renationalisation – will produce an awkward half-way house in that direction, requiring energy companies to deliver, and bill-payers to back, government’s industrial plans.

The political direction of travel appears to be backed by the majority of the public.  A September 2012 GfK NOP poll found 70% support for returning rail to public ownership; a July 2013 YouGov poll found that 67% were against privatisation of Royal Mail (of the 53% those who were aware of it); a May 2012 poll for the Sunday Express found that 71% of the public supported renationalising the water sector; and a September 2013 Comres poll found 69% support for nationalising the energy industry “like it used to be”.

Even if renationalisation has yet to reach official mainstream party policy, its lure remains strong – and in the country that, under Margaret Thatcher, pioneered the huge global wave of privatisations.  Why is renationalisation so popular?

There is little demand to renationalise British Airways, BP or Rolls-Royce. The focus is on ‘utility’ sectors (broadly defined) where there is, or is perceived to be, little or no competition.

The public appear to be driven by:

  • concern about rising prices, in rail and energy in particular and water to an extent;
  • a sense that making profits – often perceived as excessive profits – is unjustified in these utility sectors;
  • concerns about service quality, including hosepipe bans in spring last year (when the Sunday Express poll was taken) and overcrowding on trains; and
  • a lack of trust in the motivations of private utilities, reinforced by examples like mis-selling in the energy retail sector, and a belief that ‘publicly-owned’ (i.e. state-owned) companies would act more in line with the public good.

So would renationalisation be likely to temper rising prices, improve quality of service; and improve the behaviour of utilities?

The main drivers for rising energy bills are world gas and coal prices, with a smaller but growing contribution from government policies to promote investment in renewable energy and other ‘green’ policies. The principal drivers for recent increases in rail fares are the government’s policy to switch more of cost of the railways from taxpayers to fare-payers, and the need to renew and expand rail infrastructure in response to increasing passenger numbers.  The need to meet tighter statutory environmental standards has been a large driver for water bill increases.

None of these drivers would go away if the utility companies were renationalised.

But renationalised utility companies wouldn’t need to make a profit, so surely that would reduce prices to customers?

Normal profits are the return to investors from risking their capital. Without the expectation of profit, they would simply invest elsewhere.  If, instead the Government increased taxes and used the money to invest in the same – but now nationalised – utility company, it ought to demand a similar level of ‘profit’ on behalf of taxpayers.  If it didn’t, it would simply be subsidising the industry with taxpayers’ money.  Arguments can be made for some taxpayer subsidy, for example, to reflect benefits from a utility’s activities that accrue to wider society, beyond simply customers, such as reducing pollution or boosting the economy’s growth potential. But of course taxpayer subsidy can be implemented without renationalisation – as is currently the case in rail.

Investment in infrastructure carries risk however it is paid for, and the investors bear the cost of any unexpected losses.  Under the formerly nationalised electricity sector, the taxpayer took the hit on the hugely over-budget nuclear power stations of the 1970s and 80s; whereas it is BP’s shareholders who are bearing the costs from the Gulf oil spill.

But what about excessive profits in utility sectors?

It is first worth remembering the wider context. After privatisation, the formerly nationalised utility companies all made massive savings through improved efficiency. Academics have estimated the net benefits to customers from privatisation and restructuring of electricity (alone) at up to £20 billion, driven by large reductions in workforce and better choices of generation investments. In the words of Sir Ian Byatt, first Director General of the water regulator Ofwat, “25 years ago we knew that nationalised industries were inefficient: we did not know how inefficient.”

The cost to society of nationalised industries was excessive.  It just wasn’t expressed as profit – but instead taken as inefficiency, and often captured by unionised staff.

The inefficiency persisted because there was no pressure from shareholders at threat of losing their money.  But once the utilities were privatised, and where effective competition developed, the commercial threats and opportunities created strong pressures to become more efficient and to pass savings on to customers.  Where competition was absent, for example in relation to water companies and National Grid, pressure instead came from new regulators, independent from both the company and from political pressure, able to financially incentivise private companies.

Importantly, privatisation also meant increased transparency. Excessive costs to society were previously hidden within the nationalised companies.  But privatised companies have incentives to maximise profits and must (within accounting rules) declare them.  We are able to have the current debates about whether we are paying too much for utilities because of this transparency, and therefore accountability of, of private utilities.

Alongside privatisation came independent regulators and competition authorities able to use and to drive further this new transparency, to investigate and, if necessary, to act – to improve competition or to protect consumers through regulation.

In contrast, a nationalised industry is the responsibility of government.  Politicians get the blame for what goes wrong.  So there is an incentive, not for transparency and accountability, but to tell a positive story, and to weaken regulatory oversight.  Recent experiences in the NHS appear to be an illustration of this.

Politicians’ reluctance, or simply lack of information, to expose failure in nationalised industries and services can lead to huge waste.  The formerly nationalised electricity industry was allowed to continue to pursue its programme of nuclear power station building long after it had failed – at a £50 billion cost to taxpayers that only became clear on privatisation of the nuclear power stations.

Nationalised industries are also more vulnerable to short-term political objectives trumping the longer term interests of society.  It would be much easier for a government to implement a Miliband-style price freeze in a nationalised industry, at the cost of underinvestment, higher taxes and/or poorer quality services.

Overall, it would seem very unlikely that renationalisation would produce better quality services.

Those old enough ought to remember how service quality used to be before utility privatisation.  Gone are the days of waiting six months to have a phone line installed.  Frequently late and unpleasant trains that people avoided have been replaced (recently) by record passenger numbers (about double 20 years ago) and the highest punctuality rates since records started. Gone are frequent power cuts. The ‘dirty man of Europe’ has given way to clean rivers and beaches.

There is far less incentive on nationalised companies to respond to customers’ needs and to deliver quality service.  Customers cannot vote with their feet and leave.  Nor can a regulator, properly independent of both the company and politicians, be relied on to hold nationalised companies to account for service performance. Network Rail has recently come under pressure, rightly, from its regulator for missing punctuality targets.  But most telling is that – prior to 1992 – no credible data for punctuality even existed.

There is also less scope for nationalised industries to raise capital to invest in improving services because they compete with other government spending departments, like education and health.  In contrast, privatised utilities have made huge investments.  In water, for example, well over £100 billion has been invested since privatisation – with no support from or risk to the taxpayer.

But there are limits to incentives and accountability – we also want to trust utilities to do the right thing.  Can we trust publicly-owned utilities much more than private ones?

There is good and bad behaviour in both public and private sector organisations.  Privatised energy companies have been found to have misled customers, but then so too has the publicly-owned Post Office.  Privatised water companies have been found to have ‘lied’ to the regulator, but then NHS managers have been accused of covering-up poor performance and even abuse of patients.

So it is far from clear that we can place greater trust in publicly owned industries.  The key for any industry is that there are incentives for good behaviour, through transparency, accountability and, best of all, by enabling customers to exit so companies have an incentive to look after their reputation.

None of this is to argue that we shouldn’t take the public’s current concerns about utilities’ prices, quality of service and trust levels seriously.  But if ‘something must be done’, the best that can be said about renationalisation is that it is ‘something’.  Implementing it would be worse than doing nothing.  There are much better alternatives to improving the deal that consumers get from utility sectors.

First, the Government can ensure it does not unnecessarily exacerbate rising prices.  For example, it could:

  • constrain those ‘green’ energy policies that deliver little benefit (in emissions reduction) but have a very high cost, including subsidies for deploying the highest cost generation technologies
  • ensure the investment priorities it requires of the rail and water sectors make the best use of customers’ money.

Second, the Government can do more to promote choice and competition.  Of the two parts to the liberalisation agenda that the Thatcher government initiated, ending monopolies was almost certainly more important than privatisation per se.  But the combination of the two – the dynamism of competition (new entry, innovation and price discovery) coupled with the threat that shareholders could lose all their investment – usually delivers greatest benefit.

Things the Government could do include the following.

  • The Water Bill takes important steps towards reducing water companies’ monopoly positions, particularly in retail services.  But it should go further, as supported by the Environment Select Committee, water regulators and even some water companies, to allow exit from as well as entry to the water retail market.
  • The Government could reform rail franchising, to enable more head-to-head ‘on-rail’ competition – both between more overlapping franchisees and with more ‘open access’ train companies (like First Hull trains).  Maintaining monopoly franchises is a damaging way to maximise Treasury revenues / minimising subsidies.
  • The Government should think again about its plans, in the Energy Bill, to replace electricity market processes with costly central planning of the generation capacity, mix and prices.
  • The Government should cease to back restrictions on the number of tariffs that energy retail companies can offer. This is likely to be counterproductive, encouraging companies to remove their cheaper tariffs from the market and dampening competition.
  • Instead, the Government should support a reference of the energy market to the Competition Commission, as John Fingleton, former chief executive of the OFT, has recently written.  Rather than continued political insinuation of ‘predatory’ behaviour and increasing but ineffective regulation, we need the Competition Commission’s expertise and independence to properly understand the market and to make, if appropriate, structural remedies.

Third, where competition is not possible or cannot be sufficient, for example in ‘natural monopoly’ water pipes or the electricity grid, the Government needs to do more to safeguard strong and effective sectoral regulators, independent of the regulated companies and of politicians.

Regulators’ jobs are hard to do well, given their information disadvantage compared to the companies they regulate, and regulation can be no substitute for market processes where those can be developed.  If freed from political influence and focused and accountable for the narrow task of protecting customers, independent regulators can have a great deal success.  Ofwat, for example, has recently thrown down a gauntlet to water companies, saying they believe companies can reduce water bills by an average of up to £45 in the next 5 year price control period.

The Government therefore needs to reverse the recent trend towards greater political influence over sectoral regulators. It also needs to refrain from loading additional objectives onto them, which reduce regulators effectiveness in protecting consumers and leads to their politicisation.

The public have legitimate concerns about price and service quality in a number of ‘utility’ sectors – and they want something done.

Rolling back the clock to nationalisation appears superficially attractive, but would make matters worse.  The Government has much better options for bearing down on prices and improving choice and service quality.

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