Government-created cartel

It is a commonplace of economics that competition drives down prices. Economies of scale drive down costs. The combination of the two may achieve the lowest prices. But normally one would not expect cartels to deliver low prices, however much the privileged position of the cartel-members allowed them to achieve economies of scale. Rather the reverse.

Not according to this Government, though. In setting up Phase 2 of the Low Carbon Buildings Programme, they have consciously created a 7-member cartel in order to generate economies of scale. Here is the justification from the DTI website:

"Phase 2 has an innovative design – a framework-type arrangement has been set up in order to provide an element of certainty for those suppliers who successfully competed to be part of the framework. Recipients of grants will have to purchase their microgeneration technologies from these framework suppliers. This should allow those suppliers to offer lower costs (with the larger volumes bringing economies of scale) and, in the knowledge they will be receiving large numbers of orders, feel able to make the investments in the supply chain required to develop the microgeneration industry."

The £50 million scheme is limited to five technologies: biomass heating, ground-source heat-pumps (GSHPs), solar thermal, solar photovoltaic (PV) and wind. It is limited to projects of specific size (no more than 50 kW electrical or 45 kW thermal). It is limited to the public sector and charitable organisations. It is limited to seven "framework suppliers".

It does not even treat the selected technologies or suppliers equally (details obscured in the FAQ for the scheme). Some suppliers are eligible to supply some technologies, and some are eligible to supply others. Only one (British Gas) is eligible to supply all technologies. No more than three of the seven is eligible to supply any one type of technology. If you want a combination of more than one technology, your choice is likely to be down to one or two potential suppliers.

Even the technologies included within the limited range of options are treated differently. While some renewable technologies are excluded completely, even those technologies that have been included do not face a level playing-field within this very partial structure. Photovoltaics are eligible for 50% grants, GSHPs and wood-fired boilers for 35% and solar thermal and wind for 30%. The justification provided for this differential treatment is that "The grant percentages are based on analysis by the DTI." Very enlightening.

Applicant projects have to demonstrate that they can meet the "£/tonne of CO2 benchmark figures". Although one would think that all carbon emissions have the same impact and that the value of all carbon savings should therefore be equal, these benchmarks vary, not just according to technology, but also according to what fuel they are assumed to be displacing (what if it's a new project not displacing any fuel?) and for wind, the size of the project. Carbon saved by the smallest wind turbines is assumed to be nearly four times more valuable (at £1,049/tonne of CO2) than carbon saved by the largest eligible turbines (£294/tonne of CO2). Carbon saved by PV is assumed (at £990/tonne of CO2) to be at least twice as valuable as savings by other eligible technologies (other than tiny wind turbines), and more than ten times as valuable in some cases.

Heat supplied by a GSHP is assumed to be a little more valuable than from a biomass boiler if it displaces electricity (£119 vs £106/tonne of CO2) or coal (£86 vs £83), significantly more valuable if it displaces oil (£225 vs £171) or LPG (£263 vs £185), but less valuable than biomass if it displaces gas (£212 vs £315). And savings from both technologies are assumed to be less than half as valuable as if the heat were produced using solar thermal technology. In reality, solar thermal and biomass heat are, apart from construction costs, carbon neutral (as a reasonable approximation), whereas GSHPs are only somewhat (0 - 100%) better than a gas-fired condensing boiler in terms of carbon emissions. If any differentiation is to be made, that is the only rational basis, and all other distinctions, especially ones as arbitrary as those used, are irrational, prejudicial and inefficient.

The assumed lifetime of the technology over which the carbon-cost of the project should be estimated is longer for PV (25 years) than for the other technologies (20 years). There is no basis in practical experience for these distinctions (or, in the case of the disadvantaged technologies, for their equation). It is hard to think of any reason for the distinction other than that the longer lifespan helps to make PV look better than it is, and that Government wished, for some reason, particularly to favour PV (well, it is the favoured renewable technology of Big Oil).

The scheme is unabashedly picking winners, to a level of detail for which the term micro-management is insufficient - perhaps this is one of the first instances of nano-management, or better still, nano-mismanagement. And yet, even if the laws of economics have been revoked and economies of scale are more important than competition in driving down prices, it has little chance of delivering these economies, the only justification for a thoroughly bad, nay corrupt, scheme.

114 different models of photovoltaic panels are eligible, 20 models of solar thermal panels, 19 models of GSHP (in 52 different sizes), 12 models of wind-turbine, and 25 wood-fired boilers or stoves (in 43 different sizes). Henry Ford did not deliver economies of scale by offering 190 alternatives.

The framework suppliers are middlemen. They are not manufacturers of equipment. They are not even, in some cases, suppliers and installers of equipment. They are frontmen for installers, suppliers and manufacturers. Economies of scale may be realised through mass-production, and to a lesser extent through mass-installation. But the benefits of mass-marketing are marginal and will accrue mostly to the privileged marketeer rather than to the customer.

Every single GSHP manufacturer on the list is foreign. The only British manufacturer of GSHPs (Kensa Engineering) is not included on the list. Some of those on the list, such as Viessmann, have been producing GSHPs for so long and in such volume that the potential to achieve one-sixtieth (they have 3 of the 190 models eligible) of a £50 million grant will be a drop in the ocean that will make no difference to their costs of production.

The same goes for the wood-fired boilers. Fröling, who produce tens of thousands of boilers per year at their Austrian factory and have supplied over 100,000 boilers in total, will barely notice the impact of a couple of hundred thousand pounds in grants. Again, there are no British manufacturers on the list.

And as for solar photovoltaic, well, you may just have heard of Sharp, Sanyo, Kyocera and BP. These are not companies for whom a few hundreds of thousands of pounds is going to make or break the commerciality of their production.

Inclusion on this list is a necessary condition of being able to compete in the relevant sectors, where the grant will give framework suppliers and their listed equipment an economic advantage over the competition. It will deliver competitive advantage, not economies of scale. Exclusion from the list prejudices companies who might otherwise be competitive (an open letter to Alistair Darling from one excluded supplier - Genersys - explains how prejudicial this state-mandated oligopoly will be). Why should all customers not have a full range of choices, and why should all businesses not have equal access to markets?

The privileged seven are, apparently, companies "who successfully competed to be part of the framework". What is meant by competition in this context? In markets, it is straightforward - the product that most closely matches the customer's requirements wins the competition. That competition is re-run every time a new purchase is sought. The market allows for a range of suppliers to compete to satisfy the infinite variety of customers' wishes.

Competition to be a privileged recipient of government favour is something entirely different. Depending on whether you view the Government as a customer or a patron, there is either only one customer or none. That customer or patron is not judging applicants on how well their equipment suits customers' demands - they have no idea what those customers' demands will be, and whatever they are, they will certainly not conform to some average. Instead, the Government is judging the applicants according to some arbitrary beauty parade, the outcome of which is as subjective, prejudicial and liable to abuse as any other beauty parade.

Take one of the framework suppliers - Dulas. They are well-known as a supplier of biomass installations, and yet they are listed as eligible to supply only solar and wind equipment. Or take Renewable Energy Solutions, who have been primarily a developer of wind projects, and yet are listed as capable only of installing wood-fired boilers. Or take British Gas and Eon, neither of whom have much experience with any of these technologies, and certainly less experience than many who lost out in the beauty parade, and yet who are listed to supply all (in BG's case) or several (for Eon) of these technologies. Were these really the most suitable suppliers of this type of equipment that the Government could select? Or were their motives altogether murkier?

This mechanism, like most of the myriad of grant schemes and other interventions in the market, is bunce for the Government's pals. It has nothing to do with encouraging the market. Like most of their interventions, it will actually narrow and therefore harm the market in the long-term, by deterring or driving out businesses who despair of their dependence on government favour that is unlikely to be forthcoming.

Intentional or otherwise, Darling and his Labour pals have become the most corrupt and incompetent government ever to get their sweaty hands on the levers of power, eclipsing even the disgrace of the Major years. Their saving grace is that there is no reason to believe that the alternatives would be any less corrupt or more competent. Until we have a return to principled politics, we will bounce from one disastrous micro-managing government to another. We need to sack the lot of them, not because they are intentionally corrupt or even because they are stupid (they are probably neither), but because they do not have a set of overarching principles that allows them to distinguish right from wrong, good from bad.