The beginning of the end

If the faint-heartedness of the cuts announced today* doesn't demonstrate the difficulties that the new British government will have when it comes to more difficult decisions, and that businesses and individuals will have in investing in the face of such uncertainty about and pervasiveness of government action, here is a small illustration from the renewable energy sector in which I work.

In the "good times", both Tories and LibDems had rejected an approach to pricing carbon and resource dependence based on fundamental principles, and had instead pledged to continue some of Labour's expensive, micro-managing, winner-picking policies, and to implement some new expensive, micro-managing, winner-picking policies of their own. They had not modified this position in the light of our economic difficulties, and so went into the election proposing a mess of interventionist policies that we couldn't afford.

One of those policies was the Renewable Heat Incentive proposed by Labour. Although the proposed levels of support were irrational and expensive, the Tories and LibDems both promised to carry it forward and to implement it by April 2011. However, the rent-seekers in the renewables industry have been shocked and disappointed to find no mention of it in the Coalition's detailed Programme for Government.

The renewables industry received some support today from a report by Cambridge Econometrics predicting (correctly) that the Government would have great difficulty meeting its targets for renewables and carbon reductions, and pointing out that renewable heat and transport (which the Coalition have largely ignored) are the keys to improving their chances:

"The role of renewable energy in heat supplied and transport will be critical in determining whether or not the official carbon-budget targets are met, as there is now a firm policy commitment, but as yet no firm policies in place (ie after 2015 in the case of transport and over the remainder of the forecast period in the case of heat). If, the incoming Government puts in place effective policies that promote the increased use of renewable energy in transport and for heat supply, and if the vehicle fuel efficiency targets in road transport are extended beyond 2015 as currently proposed, it seems quite likely that non-traded sector emissions will move more in line with the carbon-budget target in the third 2018-22 period. However, the key issue, that will need to be urgently resolved by the incoming Government, will be to specify fully the details of these policies, as this will determine whether or not the carbon targets in the third budget period will in fact be met."

It will have been disappointing to the Government to be told that it will have trouble meeting its existing targets without significant strengthening of policy in these areas, because in the Programme for Government, the Coalition is proposing to go much further than those targets without any significant effort in these sectors (e.g. from Section 10: "supporting an increase in the EU emission reduction target to 30% by 2020", "increase the target for energy from renewable sources", "a huge increase in energy from waste through anaerobic digestion", "reduce central government carbon emissions by 10% by 2020", etc.).

It is an unfortunate coincidence, then, that the same day that Cambridge Econometrics pointed out this reality, the Government chose to announce as one of its cuts the closure of the only mechanism currently supporting renewable heat - the Low Carbon Buildings Programme - without confirming what will follow it and when. This has sent the renewables industry into more of a spin, though in truth the mechanism was a dog and closing it was one of the best things the Government could have done, if it had had the thought to specify what if anything would replace it. Without that, the industry is left swinging and various investment that the Government presumably wants to encourage (judging by its ambitious plans in the Programme) is put on hold, some of it possibly not to return.

In the current fiscal "fiddling around the edges" round, these tensions can be ignored, and industry can be left to shoulder any damage. But next year, the tensions can no longer be ignored. If they honour their commitment to push through the Renewable Heat Incentive, they risk (in its current, targeted form) pushing large additional increases in costs onto either taxpayers or energy-bill payers (it hasn't been decided yet) with very little benefit in return for those who pay for it, just when they are inflicting very much more serious cuts in spending and probably tax rises too. If, on the other hand, they renege on their commitment on the RHI, they don't have a snowflake's chance in hell of hitting their existing renewables and carbon targets, let alone the more aggressive targets they plan.

They may try to carry on lying, like their predecessors, about the ability of certain favoured technologies within the electricity sector to achieve the targets. But the more we see of developments in countries that are the model for this delusion, like Germany and Spain (which are both aggressively rowing back on exactly the unaffordable sort of "Feed-in Tariff" on which the Coalition plan to rely), the more ridiculous this position gets. It will be increasingly clear that there is a stark choice within their declared preferences - to moderate the targets, or to impose the proposed expensive mechanisms in the face of an intense fiscal squeeze (I am discounting the third possibility that they might go back to the drawing board and consider a more rational and less targeted approach).

Heaven knows which option will be seen as the least bad, or how long they will be able to keep up the lying. That uncertainty translates into an impossible investment environment. Finance for renewables projects is already getting harder to find, as the financiers start to doubt whether the Government will really be as generous as proposed in the coming fiscal squeeze, or alternatively whether their loans won't be devalued by monetary inflation, if the Government tries to print its way out of its dilemma. Sovereign risk (or the Big Player Effect, as Roger Koppl has christened it) brings everything grinding to a halt, as it has increasingly done under the interventionist governments of the past two decades. The rent-seekers create an environment in which their own prospects (along with everyone else's) are harmed by the likelihood that the unsustainable rent they have managed to extract temporarily could at any moment be curtailed when government wises up to how unaffordable and ineffective it is.


* They didn't even manage the £6bn of net savings they promised - they trumpeted £6.25bn savings, but £500m is "recycled" to additional expenditure meaning an actual net saving of £5.75bn. This is not the first time recently that both parties have tried to count savings that weren't being saved because they were being "recycled". The proposed cuts - to spending on IT, advertising, consultancy, property spending, a handful of quangos, renegotiated contracts with suppliers, etc - are fine as far as they go, but they are designed to give the impression that the necessary savings can be achieved without cutting back on what government does. And as for offloading 20% of it onto local authorities, whose council tax is already felt very heavily by many, and whose pension funds are already heavily leveraged - I hope (but doubt) that they will be able to distinguish between councils struggling to fund necessary services and councils spending aggressively on make-work programs.