Picking Losers

EEC/CERT/CESP/Warm Front

These programmes¹ are examples, like the EU-ETS, where government intervention hands commercial advantage to the VILE (Vertically-Integrated Large Energy) companies, to little beneficial effect.

The VILE companies point to the fact that demand for domestic energy has fallen in the last couple of years, as evidence for their success. I have argued this was largely a response to price increases, increasing disparities between costs-of-living and disposable income, and warmer winters (until last year), and not the effect of their energy-efficiency programs. In my opinion, the timing demonstrates the point. EEC was introduced in 2002, and Warm Front in 2000, but domestic energy demand carried on rising until 2005², which coincidentally was when global wholesale gas prices spiked (consumers did not feel the full effect until Winter 06/07, but there was already concern and initial increases in 2005).

It is difficult to prove the relative significance of different factors on this basis. The VILE companies can argue that it would take time for the modifications funded by EEC and Warm Front to accumulate and their effect to be felt. But a small news item in last week's New Statesman offers a pretty clear way to assess which was the more significant factor. If efficiency improvements were the main factor, so the elderly and underprivileged (the main targets of these programs) could maintain a decent temperature whilst consuming less energy, you would expect excess winter deaths to fall. If the price rise was the main factor, so people were choosing to heat their houses less because of the cost, you would expect excess winter deaths to rise.

According to the New Statesman, "excess winter deaths rose by 49 per cent in England and Wales last year in comparison with the year before." The information appears to have come from a page on the National Statistics website.

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Schumpeter wins, we lose

I've been angry for years about the level of economic ignorance amongst politicians, civil servants, journalists, financial professionals, intellectuals, the public, and, above all, the mainstream economics profession. Though every experience provides new evidence of our collective stupidity, after a while it is hard to keep raging. It's not that the anger has gone, it's just that the utter futility of expressing it yields eventually to weariness and frustration.

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Mandelson's latest "winner" in pension fraud?

I can't beat the beautiful job Richard Tyler did in yesterday's Telegraph on a classic example of winner-picking under our Lord and master's revived industrial policy, so I'll just quote bits of it. Click the links to read the articles - they are well-worth reading.

Staff at a company whose parent group was rescued by Lord Mandelson's taxpayer-funded venture fund have discovered that their pension payments have gone missing.

Chris Allner, head of private equity at Octopus Capital, one of two fund managers appointed by the Business Department to invest the £75m fund, said: "In respect of us investing taxpayer and bank money, we are comfortable that we did as much as we could to uncover all the potential and actual liabilities of the [KeTech] group."  

A spokesman for the Department for Business declined to comment on the investigation into the missing pension money but said the investment in KeTech would "help secure the future of more than 130 jobs which were at risk".

As some readers have commented on my blog, imagine owning and running a successful business, which still has bank support. Then you discover that your poorly run rival has not only been bailed out with public funds but it can now undercut you on price because they have been incentivised with cheap/free money to retain more staff than they actually need.

Lord Mandelson champions active government. He sees political mileage and economic benefit to be had from the state doing more. His "industrial activism" has industry excited. It likes the sound of central planning, certainty and government subsidies. But it wants to see how the strategy is to be implemented in practice.

Lord Mandelson tells me that his department can conduct surgical strikes that will ripple out and benefit the wider economy. "Our investments may be small but they can be disproportionately economically significant if those investments are taking place in the right, innovative, fast growing companies. That's how I would justify our activism," he says.

So I asked him if this meant heading back to a 1970s style of industrial policy where government tried to pick winning companies? He hesitated. "It's not picking winners. It's backing some winners but inevitably not all. Most will not need our help but those that do need our help, we should."

That's a "yes", then.

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Crisis demonstrates need for industrial policy, says President

From the Socialist Republic of Britain's Telegraph Agency:

In the time of crisis Belarus Britain attaches a special significance to the development of industrial giants, President of Belarus Alexander Lukashenko the Board of Trade Peter Mandelson told reporters during his working trip to the Minsk oblast Rotherham steelworks on 11 August 17 July.

“We have some industrial giants that have access to global markets. These giants should be modernized and developed. That is what we have actually been doing for a long time. We have to use their potential in full,” the President said. He mentioned MAZ, MTZ and BelAZ Jaguar Land Rover, Corus and Rolls-Royce as examples. He added that Belarus Britain has to set up new productions that will work on local raw materials in the digital and green sectors. According to the President, if he were to decide which industries to focus on when the Belarusian British economy had just started to develop, he would choose the processing industry and tourism entertainment industry and low-carbon energy. “In the past we built industrial giants for the whole Soviet Union British Empire, and now we are left alone to handle them. It was wrong to build such enterprises as we do not have our own resources for them our resources were limited, they exploited our imperial power and emitted greenhouse gases. But since such companies have been built, we have to be ahead of others all the time modernizing them and selling our products what we did before the crisis. When the crisis is over, our products will be in demand again.”

According to the President, it makes sense to invest in new technology during the crisis. It is necessary to find resources to buy seven rapeseed processing plants at wholesale nuclear power stations. The head of state the government reminded that in the future the rapeseed nuclear production should reach 1 million tonnes 75 million MWh. Rapeseed Nuclear electricity can be widely applied in the food industry, in the production of feed-stuff and fuel goods and services. On August 10 March 15 the President visited the GrodnoBioproduct company France that specializes on rapeseed processing nuclear power, industrial policy and corporatist alliances between big business and big government. Alexander Lukashenko Peter Mandeslon tried the food cooked on rapeseed oil nuclear electricity and liked it a lot. “It is a healthy product which I recommend you to try,” the President said.

You may substitute almost any Western nation and political leaders for Britain and Mandelson above, and get something that sounds pretty consistent with conventional economic wisdom and the policies of our governments. It has come to something when Western economic policy is practically indistinguishable from that of Alexander Lukashenko and Belarus, or indeed from his Soviet forebears. Not that we've gone at all socialist and authoritarian, or anything...

Sign of The Times

A couple of small stories on the property market recently have illustrated the extent to which the media seem to have given themselves the job of talking up the market. For a brief while, The Express stood alone in its determination to see every oncoming train as the light at the end of the tunnel. But now most of the media seem to have joined the corporations and the politicians in the determination to see the good news in every story. It is as though they all looked into the economic abyss around March, decided that the psychological theory of the business cycle was the only hope, and thenceforth have treated stories of optimistic surveys, positive projections and "smaller than expected" losses and declines, as more important than hard statistics of economic decline, stagnation, deficit and devaluation.

The first example was from last week. Persimmon announced a pre-tax profit of £9.8 million. Compared with expectations of a loss, this was treated as good news. Nevermind that this headline figure was one-third of last year's figure, which itself was a feeble profit for a company of Persimmon's supposed size and valuation. But even that modest amount was a fiction. This "profit" was only achieved by writing up (increasing the book value of) Persimmon's landbank. Without this write-up, they would indeed have made a spanking loss. But this was treated as the second piece of good news in the story. Let's not question whether it was reasonable for Persimmon to write up the value of their landbank when they and their competitors are making losses in a stagnant market where prices are down further from the level when they wrote down the value of their landbank. To the media, this convenient fiction must unquestionably be a sign that property values are heading upwards. So a real loss against a background of minimal activity and falling values is converted into a profit and rising values. Hallelujah!

The second example is from a snippet in today's Times, which was short enough to quote in full:

"Signs of life returned to the office sector yesterday as Land Securities announced that it had let offices at Thomas More Square, on the edge of the Square Mile in London, to News International, parent company of The Times, for £4.2 million a year for ten years, with an 18-month rent-free period. The deal, for 192,000 sq ft, was one of the biggest lettings so far this year and would provide a boost to the London office market, where vacancy rates had risen by 4 per cent, according to CB Richard Ellis."

Well, that is good news. Presumably, News International employees had previously been homeless: hot-benching in the park, networking on street corners, posting their reports at Internet Cafes. They must have been, because if they had been at another office, there would be no net gain to report, and no boost to the market in general, just a benefit to the new landlords and a loss to the old. In a slump, it wouldn't be surprising to find companies moving offices, as they are able to trade up (moving to a more salubrious neighbourhood) at reduced costs (for example, 18 months rent-free, though in this case, that is just a coincidence, nothing to do with a weak market, nay, an indication of its strength). In other circumstances than the current benign climate, it could be seen as part of the downwards pressure on prices in a market with excess capacity due to reduced economic activity. A cynic might even call a movement to more upmarket premises at reduced costs a sign of bad times. But that can't be it in this case, because this was not just a nice change of venue for News International and a convenient rent-holiday, but a general boost to the office property market. Apparently...

I'm glad we're in such good shape. As the wishing-well approach is working so well, let's close our eyes and wish really hard for victory in Afghanistan by Christmas, a return to balanced government budgets next year, and an end to poverty within the decade.

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The Economist is dead. Long live The Ecommunist

The Economist just published its suicide note. Unusually, it has done it well in advance, in the full flush of health and optimism. But it has nevertheless committed itself fully to a course that guarantees its eventual demise, or at least irrelevance and circulation-collapse.

It has been the corporatists' bible and the managerialists' handbook for some time. But it maintained a veneer of commitment to free markets. Its leader this week, however ("Big is back" in praise of a new era of corporate giants), nailed its colours firmly to the wall. In the immediate aftermath of an economic collapse caused by irresponsible big government allied with irresponsible big corporations, exacerbated by one bailing the other out on the basis that they were Too Big To Fail, The Economist has hailed the revival of big corporations from a supposed slump in recent decades. Of course they are going from strength to strength - big government wants to work with big corporations, because it is difficult to centrally-plan and micro-manage an economy of small, competing organisations each with a different vision. Big government therefore provides explicit or implicit guarantees, and endless competitive advantages, to its corporate friends, just as it did previously for nationalized industries (many of them the same companies, but in privatized form nowadays). This isn't something new, it is a continuation of a long-term trend. And it isn't something to be celebrated, but to be feared. It is another step along the progression towards big-block National Socialism. But that doesn't stop The Economist from rubbing its hands in glee.

In the short term, they are backing a winning horse. Of course governments faced with increasing economic difficulties will look to their corporate friends to help them out, and vice versa. We can look forward to a decade or more of increasing corporatism as the signature of our economic decline, to parallel the decade of increasing state-socialism and trades-union power of the 70s. But people will eventually come to understand the harm that this symbiotic relationship causes, just as they came to understand the harm that the "beer and sandwiches" symbiosis between state-socialist governments and the unions caused in the 70s. And at that point, The Economist, the voice of corporatism, will become as relevant and loved as Tribune and The Morning Star.

I look forward to the day. The Economist represents all that is bad about twentieth-century, mainstream, mathematical economics. The day it dies will be the day that people have realised that the purpose of economics is not to calculate outcomes in order to obviate the need for markets, but to teach us that such calculation does not work.

For those looking for the modern equivalent of what The Economist once represented, try MoneyWeek instead.

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The limits of the laws

There is something rotten in the rugby world, and it's not Dean Richards. The sanctimonious twaddle being spoken on the subject of Harlequins' "bloodgate" by commentators and former professionals is nauseating. Rugby, they would have you believe, is a saintly game whose halo has been tarnished by the diabolical Richards.

Nonsense. Rugby has always been about seeing what you could get away with. A flanker's job is, near enough, to see how much he can frustrate the opposition with unseen cheating. If the ball comes out slowly from every opposition ruck and maul, he will be lauded by players and commentators. Skid-marks down your back where you have been rucked out of the way are worn with pride. If you can create a hole by distracting the opposition (a tug, nudge or foot on the laces) and get away with it, you will be congratulated as much as the try-scorer (privately, in the changing room after the game, if your team-mates are sensible). Rugby afficionados will talk knowingly of "getting your retaliation in first", and never fail to raise a smile at mention of the "99 call".

But there are degrees of cheating, which rugby players understand without it having to be codefied. Whatever you can do to gain advantage without excessive danger is OK (not when it's being done to you, but grudgingly in retrospect, even if you are on the receiving end of it). Players may punch each other without opprobrium, if sufficiently provoked and face-to-face (a "Mendez" is another matter), unless they are stupid enough to get seen by the referee and let the side down with their dismissal (it is the yellow card, not the flying fist, that is the real sin). But high tackles, spear tackles, taking the man in the air, eye-gouging, sharpened studs (remember that, you commentators talking of a more decent past?) and so on are infra dig. They are not manly, honest give-and-take - a contest of brutal force (e.g. shoulder in the stomach of the ball carrier or tackler) that pits man against man. They are sly attempts to disable the other player, risking longer-term injury or worse to the opponent for the sake of temporary advantage, at small risk to the villain.

Two considerations discourage the use of dirty, dangerous techniques, while allowing for the merely naughty, cunning or intemperate. One is the ability to recognize that it is just a game, and while you should leave nothing on the field in your attempt to defeat the opposition, you will hope to enjoy a drink in the bar with them afterwards. But probably more important is the thought of what the game would descend to if these techniques became commonplace. Rugby players understand that, if you dish it out, you have to expect to receive it too. If one of the opposition tries something dirty on one your team-mates, it is understood that you (probably at least two of you) will seek to inflict something at least as unpleasant back on him (if you can do it legitimately - say a two-up crunch tackle - all the better). The use of really dirty, injury-threatening techniques is therefore avoided by sensible rugby-players, for fear that the game would descend to a retributive quagmire where the description of the game as a "war of attrition" won by "the last one standing" would be more literal than figurative.

So a sensible honour code has evolved that serves the interests of players who observe it. The code is based around long-established rules (the "laws" of the game), and is able to distinguish between the mischievous and the malicious. But this code is thrown into confusion when the rules are changed. Whatever their intent, rule-changes usually throw up new opportunities for illicit advantage.

The game has been afflicted in recent years by ever greater legislation (e.g. the ELVs) by micro-managing officials who think you can perfect human nature, or at least control it, through increasingly detailed and complex rules. It tries to replace mutual defence, self-reliance and judgment with prescription, intervention and authority. It has caught the health-and-safety disease.

The result is a game in flux, trying continuously to work out how to respond to the latest changes, what the opposition might do to take advantage of them, and whether you can afford not to do the same. No precedent has been established for whether a particular abuse of a law is acceptably cunning or unacceptably dangerous. So tricks are tried, and, if caught, punished. It cannot have been obvious in advance that Harlequins' sin would fall into the "unacceptably dangerous" category, and I would be very surprised if Harlequins are the only club to have stretched this particular law. Indeed, a limping exit is not uncommon. The fake blood may have been novel, but is that really what differentiates between gamesmanship and heinous crime?

Don't blame those who are testing the limits of authority. People always will. Blame the people who thought it was in the interests of rugby to confuse the hell out of it. Blame the people who, now remote from the playing field, take out the aggression and frustration for which they no longer have an outlet, by demonstrating their power to manipulate the laws of the game. Blame the people who think they know best what is good for other people whose activities are controlled by the laws they impose, based on an arrogant assumption of superiority and perfection of knowledge. Blame the people who assume that other people will be automatons who do exactly what they intended, rather than human beings who behave unpredictably, imaginatively, cleverly or stupidly.

Does it sound like a lesson for life and legislature?

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The national sub-prime borrower

Here's a bemusing statistic to follow on from the earlier post.

Question: Given that the US federal deficit is expected to be $1.8 trillion this year, taking the total national debt to $12.8 trillion, by how much does the US government expect their interest payments on that debt to increase?

Answer: They don't, they expect interest payments to fall by 44%, from $253 billion in 2008, to $143 billion in 2009. And next year, when they expect to run a deficit of another $1.3 trillion, taking national debt to $14.4 trillion, they expect interest payments to fall further to $136 billion.

Confused? I am.

A. Interest rates

One explanation is relatively simple. Short-term interest rates have fallen. Tim Worstall recently provided a useful explanation of the yield curve. If they are able to borrow both the new debt and the rolled-over debt at lower rates than before, then interest payments might fall even if the principle has increased. Depends on the amount of the increase in the principle and the fall in the rates.

The average maturity of Treasury bonds is said to be around 5 years. Longer-term rates aren't that much lower now than they have been over the past decade. Yields on 5-year bonds are down to around 2.5% (from 5% a couple of years ago and 3.5% a couple of years before that), and get lower the shorter the bond, down to a fraction of one percent for 1-month and 3-month bonds.

US Treasury yield curves, 1990-2009 

If the Treasury borrowed much of the new and rolled-over debt on medium- to long-term bonds, net interest payments would be going up (or at least not down by anywhere near as much as assumed), as the increase in the principle would exceed the reduction in the rates on that portion of the existing debt that was rolled over. To achieve the reduction in interest payments that they assume, a substantial proportion of the existing debts must be coming to maturity this year and next, and must be renewed (along with the new debt) as short-term borrowing. So a large proportion of their debt will end up on short-term rates.

The trouble is, short-term borrowing needs to be renewed frequently, and short-term rates don't stay low in a recovery (nor do long-term rates come down). There is no scenario that I can think of where the economy rebounds to the extent that the Obama administration is assuming, from the point of view of the tax-revenue it is able to yield (see previous post), and short-term rates stay at a fraction of one percent. At that point, the recovery kills itself, because the interest that has to be paid on the projected national debt of $14.4 trillion in 2010 or $15.7 trillion in 2011 should be at least 3% and probably higher, given the strength of the assumed recovery implied by the tax revenue. That's $430 billion of interest payments in 2010 (compared to their assumption of $136 billion) and $628 billion if average rates are nearer 4% in 2011 (compared to their assumption of $254 billion).

Those discrepancies would mean either increased taxes to cover the extra payments, or increased borrowing to cover the increased deficit. The former would stunt growth just when it was starting to recover, reducing tax revenue in a vicious circle. The latter would further increase the cost of borrowing, making it necessary to borrow more, in another vicious circle. Taken at face value, it's hard to see how this house of cards can't collapse. It's Catch-22.

Ironically, it's a similar predicament to the situation that sub-prime borrowers got themselves into. The government is being tempted by the equivalent of teaser rates to borrow greatly in excess of what its assets are worth and what it can afford to pay back. Those rates aren't fixed for long, and are likely to be significantly higher when they come to renew (or their income significantly lower, if the economy hasn't rebounded in the way they project). And by then, they'll have racked up even more debts.

Unfortunately for the American people, there is no "jingle mail" option when its government can't afford the payments and its debts exceed the value of the economy. Or should that be "unfortunately for the bond holders", because the government will have to take one of the two options that are closest to "jingle mail": default or inflate?

B. Net interest

But this is where another explanation for the apparently improbable figures comes in. It's the explanation that has me really confused. The figure that the US government has to pay is not the whole of the interest payments due, but the net interest. The net interest takes account of the fact that the largest holder of government debt is... the government! It owes the money to itself. As this is effectively a transfer of money from one part of the budget to another, it nets-off these amounts and only counts the net interest (i.e. the interest payable to all external holders of government debt).

I can just about wrap my head around the origins of this circular notion. The US government first started to hold substantial amounts of its own debt after 1983, when the Reagan reforms to the Social Security budget left it with a surplus of social-security tax receipts over social-security outlays, and facing substantial future obligations. They used the surplus to buy Treasury bonds, which in a sense you could see as a sensible investment to provide for future obligations.

But it doesn't really stack up. Unlike corporate bonds, the money received by the government in exchange for its bonds is not invested in profitable assets that will provide the return to repay the bonds over future years. Whether used for current expenditure or capital investment, the government gets no yield from the expenditure, other than the hope that its measures will cause the economy to grow more quickly than it otherwise would have, which will allow for higher tax revenues. Ultimately, government bonds will have to be paid out of future tax receipts. And if the government hadn't borrowed from itself, the money for social-security obligations would have had to come from... future tax receipts. All that has really happened is that a convenient excuse has been found to make a surplus in one part of the government's activities available for current expenditure anywhere the government likes in its budget, and a slightly greater moral obligation has been placed on the government to raise tax in future to pay for obligations it was almost certainly going to pay for anyway.

And there was no real surplus. The US government's deficits ran at around $200 billion a year on average between 1983 and 1995 (in nominal terms, nearer to $300 billion in today's money), and at similar levels (in real terms) from 2002. Total government outlays were $800 billion at the start of that period, which should give some idea of the relative size of the deficit. In practice, this device was a way to disguise imprudent and spendthrift expenditure as somehow prudent and parsimonious.

The net effect has been to swell the US government's share of gross national debt from 17% in 1985 to 44% in 2007, while that gross debt has been increasing significantly (from $1.82 to $8.95 trillion in nominal terms, from $3.12 to $8.95 trillion in real terms, at 2007 dollars, or from 43.8% to 65.6% of GDP).

US national debt interest payments, 1962-2019 

We have become familiar with the concept of Quantitative Easing since the onset of the Credit Crunch. It might be thought that this is a sign that the policy had been running longer than we realized. But for the purposes of calculating the net interest, the Federal Reserve is treated as external to government. Payments due to the Fed are included in the net interest figures. QE as we understand it today would have resulted in an increase in the net interest payments. The Federal Reserve was not until recently a big buyer of government debt - it held only 5% of outstanding securities in June 2008 (around 10% of that big blue chunk in the pie chart below). The government had not got its money through the relatively transparent (if misguided) process of Federal Reserve balance-sheet expansion. It seems that the federal government simply issued itself IOUs in order to increase the amount of money it appeared to have available to spend. Rather than spending directly the tax it raised, it used some of the tax to buy its own debt. The money was made available for expenditure in the same way as if it had spent the tax directly, but the government had made obligations to itself to pay itself money in the future (money that will have to be raised from taxation and spent on the budgets for which the debt is earmarked, in much the same way as if the debt didn't exist).

Estimated ownership of US securities, 2008

It seems a strange thing to do. But in any case, the government doesn't have the tax receipts to buy as much of its own debt as usual, so the Fed is indeed buying a large chunk of federal debt this year (i.e. the government will have to expend future taxpayers' money to repay money borrowed from the Fed, which the Fed created out of thin air, and which was used to allow the government to continue to run unsustainable deficits and indirectly to blow bubbles in the stockmarket). The government's share of its own debt is projected to increase by "only" $150 billion (to $4.3 trillion), whereas debt held by the public (including the Fed) is expected to increase by $2.7 trillion. Last year, debt held by the public increased by twice as much as in the previous highest year ($768 billion, compared to $382 billion in 2004). This year's increase is 3½ times higher again, taking the total debt held by the public from $5.8 trillion to $8.3 trillion. This means that the share of the debt that is paid out of taxes to recipients outside the government has increased by a significantly higher proportion than the increase in the gross debt. And it is expected to increase by a further $1.35 trillion next year and nearly $1 trillion the year after that.

This is the context against which the net interest payable (the interest payable on the debt held by the public including the Fed) is supposed to fall dramatically and remain relatively low. The principle amount on which net interest is payable will more than double between 2007 and 2011, the economy will recover so strongly that it yields record tax revenues, and yet interest payments will remain modest, apparently. I'll have some of whatever the Obama administration is drinking.

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"Austrian economics invented after WWII" says lefty blogger

The left tend to enjoy a smug, patronizing sense that their views are the product of great intelligence, altruism, and encyclopaedic knowledge, while the right owe their views to ignorance, prejudice and a brutish love of money.

But for some reason, this superiority is insecure enough that they often feel the need to censor the challenges of their thuggish, stupid opponents. Surely, with the weight of reason and knowledge on their side, they can win any argument in a fair and open exchange?

Let's test that.

On Richard Murphy's Tax Research UK blog, a commenter posted to warn that some people were mentioning the Austrian school of economics in policy discussions (horrors!). I queried quite gently the claim that "the only country which carried out their ideas went bust" (I genuinely don't know which that is, and until I do, I can't say for sure that it isn't true), and pointed out the role of Mises in trying to stabilize the Austrian currency after WWI, when similar circumstances but different policies in Germany allowed inflation to get more irretrievably out of control and opened the door to the Nazis.

A reply to a flippant response from Richard Murphy led to the following peach from Paul Sagar:

"Bruno,

The Austrian school refers an economic (and political) strand of thinking exemplified in Hayek, but with many other followers. It was developed after WWII, in specific response to the rise of state socialism.

It has never been put into practice. Especially not in the interwar period.

You twit."

The Austrian school was developed after WWII in response to the rise of state socialism! Really?

So Carl Menger, founder of the Austrian school of economics, born 1840, died 1921, magnum opus (Principles of Economics) published in 1871, was not an Austrian-school economist? You might expect someone commenting patronizingly on economics to have heard of Menger and know that P of E was published in 1871, as the year in which the marginalist revolution, on which all modern economics is based, was launched with the simultaneous but coincidental publication of works by Menger and Jevons.

Eugen von Böhm-Bawerk (1851-1914), Friedrich von Wieser (1851-1926), Ludwig von Mises (1881-1973), and Richard von Strigl (1891-1942) were not Austrian-school economists, were they not? Friedrich von Hayek (1899-1992), Fritz Machlup (1902-1983) and Gottfried Haberler (1900-1995) developed none of their ideas before the war, did they?

What a world-class plonker. It seems he never made the leap to the concept of object permanence as a toddler - if Paul can't see it, it doesn't exist.

Why would you post with such assertive confidence on a subject about which you know nothing, especially as there were hints in the post to which you were replying that you might get picked up? And if this is your modus operandi, should we not also treat with caution any other statements you make with the blind confidence of the blissfully ignorant. How sweet to be an idiot, as Neil Innes sang.

As the original focus of Richard's and Paul's posts was Glenn Beck, who is every bit as creepy, weird, extreme and inclined to misrepresentation in support of his views as they say, I posted the following on Paul's blog:

"It looks like right and left alike are capable of ignorant lies, putting ideology ahead of the facts. See Paul's contribution on the Tax Research UK blog at http://www.taxresearch.org.uk/Blog/2009/08/16/the-cato-institute-at-the-heart-of-misinformation/. This may shed some light on the depth of knowledge, understanding and perspective underlying Paul's views."

It will be interesting to see if Paul allows a link to clear evidence of his ignorance to stand, or whether he removes the post to hide his arrogance and stupidity.

UPDATE: (in case people don't bother clicking through.) It seems I had it back to front - Paul has shown himself to be a sensible and decent guy, while Richard Murphy has provided the perfect illustration of the type of intellectually-insecure lefty that I was talking about.
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Tax hiatus or deficit problem?

It is becoming popular amongst Keynesians (and perhaps some monetarists too) to suggest that Western governments do not have a deficit problem, they just have a hiatus in their tax receipts. Government's job, therefore, is to help the economy get back to a healthy state as quickly as possible (through deficit spending, low interest rates and quantitative easing), at which point tax revenues will be restored, the deficit will be eliminated, and normal service will resume.

Ummm... No. Here's a statistic that shocked me:

In real terms, the projected US deficit this year is more than the combined US deficits for the three years from 1943 to 1945.

This is from White House figures (see Table 1.3 of the Historical Tables of the Office of Management and Budget). Converted to year 2000 dollars, the projected deficit in 2009 is $1,440.1 billion ($1,841.2 billion in current dollars), and the deficits in 1943, 1944 and 1945 were $486.2, $448.2 and $456.8 billion respectively (in 2000 dollars). These were the previous highest deficits run until this year, with somewhat more justification.

This deficit isn't principally due to a collapse of tax receipts below the norm. In real terms, the total projected tax receipts in 2009 are higher than the total receipts in 2003 and 1997. In between, we have had two huge bubbles (in fact we were already well into the first bubble by 1997).

US tax receipts, 1940-2009, real (2000 dollars)

Depending whether you think we returned to trend in 2003-4 or remained above it (we could get a better fit with the period from 1940-1995 on the assumption that it remained above), the projected downturn has overshot the trend by somewhere between a few billion dollars and a couple of hundred billion dollars. That leaves $1.25 to $1.4 trillion in 2000 dollars ($1.5 to 1.8 trillion in current dollars) of deficit unaccounted for by tax revenue that might reasonably be anticipated, in the absence of another bubble even bigger than the preceding two.

That doesn't stop the Obama government from projecting exactly that, however. Here is how the above graph looks if we add in their projections for tax revenue to 2014:

US tax receipts, 1940-2014, real (2000 dollars) 

By 2011, they project that tax receipts will have returned to a level where they exceed the 2000 peak during the first bubble, and are only a little short of the 2007 peak in the second bubble. The following year (2012), they plan to excede the 2007 tax peak by almost 10%, and by nearly 20% by 2014. And even then, spending will be so much higher than these new peaks that they will still be running deficits of nearly $400 billion, and the deficit will be going back up again. They project the average spending in the period 2009-2014 to be 27% higher than it was at the tax-revenue peak in 2007, at which time they were already running a deficit of $133 billion.

All of this is in real terms, in 2000 dollars. The figures in current money will be significantly higher.

There is only one way to try to achieve this, and that is to blow the biggest bubble in history - a bubble to make the roaring twenties or the recent lunacy look sane. Failure and disaster are inevitable. The only question is when. Will markets buy this fantasy for a while (i.e. continue to buy Treasuries and/or hold off dumping the dollar) or will they return to sanity soon and prevent the US government from running up a bill it can't afford to pay back?

Note that this is not to say that other countries are much better, their projections more realistic, or their market bubbles more rational. This is the most egregious example of a more widespread delusion. All governments' stimulus plans and projected budgets are unrealistic. They will have to be curtailed, and hence will fail to deliver the economic recovery that markets are currently pricing in (but which they wouldn't have delivered even if they could somehow have been funded). It's not about flight from one currency to another, but flight from all fiat currencies.

There will be no alternative to major real cuts to government budgets, services and welfare provision, at the same time as unemployment is soaring from a reduction in public-sector employees to match the earlier reduction in private-sector employees. A shrunken economy will face a higher tax burden (proportionately) because of the imbalance between private-sector earnings and public-sector costs, despite reduced numbers of public-sector employees. The weight of taxation will inhibit economic recovery.

Our troubles have only just begun.

POSTSCRIPT:

I was remiss in providing graphical representations only of the trajectory of tax receipts and not also of federal outlays to give a visual indication of the (budgetary and reality) gap. So here it is:

US federal tax receipts and outlays, 1940-2009, real (2000 dollars)

Clearly, the trajectories set by the historical trend over the past 35 years are unsustainable. And yet the projections of the Obama administration are massively more optimistic than those unsustainable trends. They are so fantastic that they make the Lord of the Rings look like cinema verite. What people need to ask themselves is what happens when governments fail to deliver on their fantastic projections?  

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Securing the UK's Energy Future (for us)

One thing leads to another. The APPGOPO report covered in the previous post refers to the first report by the UK Industry Taskforce on Peak Oil & Energy Security (ITPOES) on "The Oil Crunch: Securing the UK's Energy Future", which has been out for half a year, but I hadn't come across before.

The impact of peak oil isn't hard to anticipate. It's not a volume constriction, it's a price constriction (putting aside for the moment complications like EROEI and carbon impacts). We are more than halfway through the "easy oil". If demand exceeds supply of easy oil, as it will soon once economies start to grow again, the marginal supplies will come from increasingly expensive producers, which will drive up prices dramatically. Costs of carbon and the recursive effect on prices of low EROEI from more marginal production will exacerbate the price-impact. The threat is that we won't be able to afford to do many of the things that were fundamental to our economy, not that the oil couldn't be made available for a while longer if we could afford it. But it may feel like an insufficiency of oil, there not being much difference in practice between "not enough" and "not enough that we can afford".

What won't we be able to afford? Simple: road and air transport.* These two forms of transport are almost completely dependent (99%) on oil, and conversely, the vast majority of our oil consumption (75%) goes to transport (12% goes to non-energy uses like petrochemicals and plastics, less than 0.5% goes to electricity production, and the rest goes to heat). We could relatively easily replace oil in the other energy sectors, but on the road and in the air, we are not remotely ready for the dislocation of high oil prices.

So what do this small group of corporations, who have appointed themselves our spokesmen on this issue, have to say? Their assessment of the risk is well done, but (as usual when a handful of corporations get together on a mission) the solutions they favour are not.

"Peak oil is about much more than transport" (p.28). What a surprise. A group that contains a VILE company, a solar-panel supplier, two businesses in the construction sector, a search-engine provider (???), and three public-transport operators think that peak oil means we need more government intervention in lots of areas that have little to do with peak oil. For instance, they think we need much more solar power (and support to deliver it). They think we need much more (subsidy for) wind and nuclear power (coincidentally, Scottish & Southern Energy, their VILE-company member, has substantial plans for wind and nuclear). We need massive efforts to encourage (read: support) energy-efficient construction. And, on the transport front, we need greater emphasis on (support for) bus and rail public-transport options. The latter is not unreasonable (if self-interested and marginal), and they also promote some more obvious and sensible solutions for the long-run, like increased use of electric transport options, but they have a wilful determination to ignore the technical challenges, they have no suggestion for something as key as international air transport (other than that we shouldn't have any more of it), and they have lots of suggestions for stuff that is marginal at best but which happens to be of interest to their members. 

Their wilful ignorance of technical challenges, blind optimism, and enthusiasm for the irrelevant (if not downright unhelpful) reaches its peak with their espousal of a 100% renewable-energy objective (p.6).

"The renewables industry is confident that 100% renewables energy supply is possible in 20-40 years, according to the overwhelming consensus of participants at the Tenth Forum on Sustainable Energy, held in Barcelona in April. They should be given the opportunity to prove it."

This is backed up later (p.39) by reference to a number of studies (by renewables enthusiasts) claiming to show that 100% renewables is feasible.

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Total Economic Quackery

The All Party Parliamentary Group On Peak Oil (APPGOPO) has released a report backing Tradable Energy Quotas (TEQs) as "the fairest and most productive way to deal with the oil crisis and to simultaneously guarantee reductions in fossil fuel use to meet climate change targets". This should serve as a warning to classical-liberals that (a) not everything that uses market mechanisms is a free-market or liberal concept, and (b) despite the presence of one or two saner members in their midst (such as Vince Cable and David Laws), the Liberal Democratic party (to which APPGOPO's chairman, John Hemming MP, belongs) is still fundamentally a beard-and-sandals, Fabian, Rawlsian, meddling, fiddling, egalitarian bunch of moralizing whackjobs, who would happily suck all the fun and reward out of life in the name of "fairness".

TEQs, as the name suggests, is "an energy rationing system" where each adult receives an equal quota of energy (measured in carbon terms) that they are entitled to use annually, calculated as equal shares of 40% of the total amount of energy/carbon permitted to be consumed annually under a falling profile set by the Committee on Climate Change in accordance with the national Carbon Budgets that have recently been enshrined into law. This system is allegedly designed "to prevent the intense competition for fuels that will otherwise develop, and to ensure that every energy-user can access their fair share".

So far, so student-socialist, but the cunning of the modern socialist is that he has learned to dress his communist wolf in a capitalist fleece. So the remaining 60% is bought in weekly government auctions by banks and brokers (no rent-seeking opportunities there) on the instructions of their clients in all those organizations who want to be allowed to use energy. And trading is allowed between possessors of the initially-egalitarian personal quotas and of the auctioned rights. The system thus lays claim to be a "market mechanism", combining "social justice" with the efficiency of capitalism in the approved manner of the Third Way prophets.

It is, in this way, different only in detail of implementation, from other cap-and-trade mechanisms, though the details are particularly draconian and deluded. Capitalists (of the type that we need to save capitalism from) who extol the virtues of cap-and-trade and yet look at personal rationing like this and shudder, ought to ask themselves if they haven't been fooled by the inclusion of the word "trade" in an approach that is fundamentally about overriding the efficient allocation of scarce resources by means of state-imposed rationing. Trading mechanisms within these rationed systems are no more than publicly-authorised black markets, which have the same benefits as real black markets under state-rationed systems, but do no more to eliminate the inefficiency and iniquity caused by the distortions that result from such a system.

We are already familiar with a system that distributes resources on the basis of social utility and provides incentives for people to use more or less of the resource depending on its scarcity. It is called the free market.

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Lucas - I'm sorry you misunderstood me

Is it me, or is Robert Lucas's apologia for modern, mathematical macroeconomics in this week's Economist, effectively saying that their models are pretty good at predicting the economy will carry on in the direction it's currently going, until it doesn't, which point they are incapable of predicting? I think most of us could manage that, without needing a degree in maths and swathes of meaningless formulae. I predict that the current bear rally in the stockmarkets will continue until it doesn't. But I may have to turn to other tools than macroeconomic models if I want to avoid losing money when the market turns. Tools to help me moderate my losses in that situation are not as useful as tools that help me to avoid the losses in the first place, particularly if the tools to moderate my losses are at the expense of those who were more prudent than me.

The most pathetic and disingenuous of his arguments is that, not only were their models incapable of predicting the sharp reversal of the Credit Crunch, but that no one could, and that the sensible policy was therefore to carry on regardless, and deal with the mess if and when it arrived. It takes mathematical genius to be so disconnected from reality. It was perfectly possible to see the mess we were getting ourselves into, and to say what we ought to do to stop it from getting worse. Followers of the Austrian school called it, as usual. But they were laughed out of court before the crisis by people who had swallowed the neo-classical macroeconomic swamp juice. Instead of apologizing and admitting that their paradigm is wrong, Lucas tries to associate everyone with his failures, and claims credit for suggesting the tools that have launched us on the next stage of irrational and distorted economic development.

How does someone like Lucas get the reputation he has in the economics community? Doesn't that tell us something about the wider irrationality of the mainstream economics establishment? Why are the mainstream economics schools not admitting that the Austrians got it more right than they did, and that that tells us something about the validity of the different paradigms? Is it because of their public-choice incentives? Few governments and corporations are going to pay good money for the anti-interventionist, sound-money insights of the Austrian school.

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The nuclear magic bullet

A virtue of The Economist's focus this week on the vulnerability of our energy systems, regardless of whether they have got everything right (and there's plenty that's good as well as some that's bad) is that it has brought attention to the issue. Unfortunately, for every sensible comment, there are usually several from people who have picked their magic bullet and just trot out their usual unthinking platitudes without considering the complexities.

The favourite magic bullets are usually one form or another of renewable electricity, or nuclear power. For example, several nuclear freaks gave us the benefit of their opinions in response to a perfectly sensible post on Raedwald's blog.

I provided some information on there to explain why nuclear won't be a magic bullet, but I want to provide a bit of supporting analysis here.

The nuclear lobby often points to our import of power from France as illustration that the French nuclear-based system is more reliable than our mixture of generating technologies. They like to paint the story as though we are reliant on French nuclear power. Let's see how well that holds up to scrutiny.

I have looked at half-hourly system-demand data for the current year to end of May, available from National Grid/Elexon. The total or average volume of the flow over the French interconnector doesn't tell us much. We are net importers of a relatively small volume of our power (partly constrained by the capacity of the interconnector). But the more interesting question is when that power flows.

Looking first at how it varies by time of day:

Flows over French interconnector for each half-hour period of day

It's a mixed bag. System demand is (not surprisingly) higher during the day than at night, and has two peaks during the day, morning and evening. The French send the most power during our evening peak, so that is definitely them responding to our demand. But they send more over at night (when we don't need it) than they do in the morning and early afternoon, suggesting that we are providing an outlet to dump the inflexible output from their nuclear plant at night time. That's a fairly 50:50 relationship, then. They give it to us when we most need it, but we take it from them when they most need to dump it even though we don't need it then.

That is an average of winter and spring performance. Our needs are greater in winter (i.e. we are getting closer to using the full capacity available in order to meet demand), so let's see how they help us out at that time. Taking just the first three months of the year:

Flows over French interconnector in winter for half-hourly periods of the day

Our system demand is higher over a 3-month winter average than over a 5-month winter/spring average. But the French send us significantly less power during the winter than they do for the 5-month period. In fact, during most of our morning peak of demand, they are taking power from us (negative flows), rather than the other way round. They are still helping us out during the evening peak, but to a lesser extent. And they are still dumping their power on us at night, though again to a lesser extent. That's not 50:50. At the time of the year when supplies are tightest, they are using us more than we are using them.

We can see that picture more clearly if we look at the weekly averages:

Flows over French interconnector, weekly averages

As average system demand decreases, as the weather improves and the days get longer, the French send us more of their power. That's back to front, if French nuclear is helping to meet our needs, but consistent with the UK acting as a dumping ground for excess French nuclear production. Most noticeably, in the week with the highest demand so far this year (week 2), they were actually net importers from the UK. How very helpful of them.

If nuclear is not subsidised and the safety and environmental factors are rigorously controlled, then it is a useful part of our electricity mix. But it is an inflexible part of the mix, which is why France pushes her power out to her neighbours when demand is lower at home, and pulls it in when demand is higher. We can't all do that. We can use hydro to store the power to some extent, but it depends on the geographic and political constraints (the UK's potential is very limited), and even France, with massive hydro investment, cannot fully balance supply and demand in this way. To the extent that nuclear output cannot be matched to demand through stored hydro-power, there is a limit to how much of our electricity can be supplied by nuclear. In the UK, with limited hydro, but grand plans for inflexible, intermittent wind power, the practical limit is probably in the region of 10-12 GW, operating at fairly constant output to provide around 20-25% of our electricity. As electricity is only a minority of our total energy consumption, that equates to around 4% of our final energy consumption, or 8% of our primary energy supply.

As I said, nuclear can be a useful part of our systems, but it's no magic bullet for our broader energy issues.

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Energy ≠ Electricity, Part 963

It's The Economist's turn to be hit repeatedly with a big stick on which we have painted the inequation: Energy ≠ Electricity.

Their leader, "How long till the lights go out?" is on an important subject and makes quite a lot of important and correct points. But it is underpinned by the usual myopia. They are concerned about fossil fuels as an input, but only about electricity as an output, as though that's what we mainly use our fossil fuels for.

So let's try once again:

  • Of the 154.9 million tonnes of oil equivalent (mtoe) total final consumption of energy in the UK in 2007, 29.4 mtoe (19.0%) was consumed as electricity.
  • Of the 235.8 mtoe of primary demand for energy (i.e. before conversion and supply to customers), 80.1 mtoe (34.0%) went to the production of electricity.
  • Of the 90.9 mtoe of primary demand for gas, 30.4 mtoe (33.4%) went to the production of electricity. Most of the rest went to the production of heat (for heating buildings or for industrial purposes).
  • Of the 84.4 mtoe of primary demand for oil, 0.7 mtoe (0.8%) went to the production of electricity.
  • Of the 29.4 mtoe of final consumption of energy in the form of electricity, 79.8 mtoe of primary energy was used in its production, of which 30.4 mtoe (38.1%) was gas, 33.8 mtoe (42.4%) was coal, 14.0 mtoe (17.5%) was nuclear, and 0.9 mtoe (1.1%) was renewable.
  • Of the 59.8 mtoe final consumption of energy for transport, 59.1 mtoe (98.8%) was oil, and 0.7 mtoe (1.2%) was electricity.
  • Of the 65.7 mtoe of other final energy consumption (besides transport and electricity), primarily heat, 50.4 mtoe (76.7%) used gas, 11.3 mtoe (17.2%) used oil, 1.7 mtoe (2.6%) used coal, and 2.2 mtoe (3.3%) was from other sources (heat supplied direct, converted fuels like LPG and coke, renewables, etc). Some of the electricity excluded from these figures was also used to produce heat.

From these figures, it isn't hard to work out that:

  1. Much more gas is used for heat than for electricity.
  2. Electricity has much more diverse sources of energy than heat or transport.
  3. Electricity has almost nothing to do with our dependence on imported oil.
  4. Electricity is nowhere near as important as heat to our dependence on imported gas.

How to make a bad argument for a good idea

There are lots of good arguments for a carbon tax. Trust The Economist to come up with a bad one.

"A tax on carbon is hardly going to stop the lights going out in a few years, but it would provide a floor price for power, giving investors a clearer sense of likely profits."

Is that just a typo? Did they mean "a floor price for carbon"?

If not, they are confused. A carbon tax will only give investors a clearer sense of likely profits by removing one component of their costs that has a volatile price - the cost of carbon, particularly under the EU-ETS (if they replace these mechanisms with a carbon tax, rather than supplement them as companies like EDF would prefer). To the extent that it increased the minimum price at which power could be produced from the cheaper, fossil-fired technologies, it would increase the confidence of producers of low-carbon energy, but not the confidence of those who must pay the carbon tax, who would have to raise their prices accordingly, aiming to retain similar margins, but more exposed to competition from volatile producers like wind energy, and just as exposed to other inherently volatile components, such as fuel costs and demand.

What a carbon tax would do would be to make alternatives to fossil fuels relatively more competitive, displacing the use of fossil fuels in the most marginal applications, reducing demand, prices and dependence on imports of fossil fuels. That is all good and wise, but it is related only peripherally to a floor price for power and greater certainty about profits, other than for low-carbon producers.

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Thresholds of pain

The Government and the opposition parties believe that climate-change and energy policy should revolve around identifying the technical solutions and their potential, calculating what each of them needs to encourage their deployment, and implementing mechanisms that provide just the "right" level of support for those solutions. They do not believe that, to whatever extent Anthropogenic Global Warming is a reality, emissions of greenhouse gases are an externality whose impact (and therefore social cost) is the same however and wherever they are emitted, and that the most efficient way to encourage less to be emitted is to apply that social cost to those emissions regardless of provenance.

Our politicos' assumptions of omniscience and omipotence tend to be undermined by reality. When it comes down to the reality of providing just the "right" level of support, they are amazed to learn (if they ever do) how many variables have to be taken into account, and how often it turns out that the information they were working on was wrong or has changed. Policy-making becomes a process of arbitrarily picking those variables that you will take into account (and about which you hope it is safe to generalize) and those variables that you will ignore and expect those who are disadvantaged just to suck it up, and then regularly changing them in ways that are unpredictable to investors. Such policies thereby achieve the brilliant combination of being altogether too changeable and complex (by taking account of too many variables) and yet partial and insufficiently reflective of the real-world (by ignoring so many inconveniences).

The recent banding of the Renewables Obligation (RO) was one such case, piling further complexity, irrationality and partiality onto many existing layers of partiality, irrationality and complexity. Now we have another case looming. A banded RO might be complex, irrational and partial, but it wasn't complex, partial and irrational enough for the politicians and civil servants. Some variables, particularly scale, weren't sufficiently covered. So they are bringing in a micro-generation Feed-in Tariff (micro-gen FiT), to support similar (though not identical) technologies to the RO, supposedly at a smaller scale, though the upper size threshold for the micro-gen FiT encompasses a large number of the projects currently included in the RO. They are also introducing, at more leisurely pace, a Renewable Heat Incentive (RHI), which will probably work in a similar way to the micro-gen FiT, but in the heat rather than electricity sector, and without (probably) the upper size limit.

The micro-gen FiT will provide a value beyond the ordinary electricity price, for each unit of electricity produced by an eligible micro-generation installation. It will be tailored supposedly to provide the "right" level of support for each technology. But that isn't specific enough, because the economics of a 5 kW micro-gen unit are very different to the economics of a 5 MW "micro-gen" unit (the upper threshold for eligibility, thanks to some strange definition of "micro" for public-choice and rent-seeking reasons) of the same technology. So the Government declared their intention to "band" the micro-gen FiT (and the RHI) not just by technology, but by scale too (and they were also considering banding by type of consumer, but hopefully have abandoned that option).

We know what the effect of banding by scale is. People make all sorts of irrational decisions about the type and size of plant, in order to achieve the maximum level of support under the bands. So, with the proviso that the whole approach is wrong but recognizing that something rubbish was inevitable and trying to minimize the damage, I came up with a suggestion for how they could achieve the same benefits that they wanted to achieve with banding without the harmful effects of banding. The suggestion was to "front-load" the mechanism, so projects would get a higher price for their first X MWh, and then a lower price thereafter. Large projects would get through X in a couple of months and would have to rely on the lower price for most of their lifespan, making the mechanism fairly similar to an unbureaucratic grant for them. Small projects would take years to get through X, and would therefore receive a higher level of support for a longer part of their lifespan. Medium-sized projects would fall in between, in terms of the effect of the front-loading. There were many advantages to this approach, but most importantly, there was no size threshold, so there was no disincentive to install simply the most appropriately-sized unit and technology for the circumstances.

To its credit, the industry broadly adopted and supported this idea, and extended it from the RHI (for which I had suggested it) to the micro-gen FiT. To rather less credit, but typically for a committee camel, the industry decided that they could improve the concept by making it more complicated, which was the form in which it was promoted to the government. Still, their bastardized version was a lot better than the Government's idea of banding by scale. Amazingly, for anyone with any experience of "consultation" in recent years, there were even some signs that the Government was giving the concept some serious thought.

We still wait for details of the RHI, but the Government has recently provided more detail on how it sees the micro-gen FiT being implemented. And guess what? Front-loading is out, and they are sticking with banding by scale.

We have to assume that this irrationality will apply in due course to the RHI as well. And I have some first-hand experience of the effect of that assumption.

As I have mentioned too often in recent posts, our company supplies wood pellets. I therefore have a stronger-than-average interest in installing a pellet-boiler for my home. As it happens, the cluster of three houses where I live make a particularly suitable opportunity for a micro-district-heating scheme powered by a shared pellet boiler.

We got quotes from a number of suppliers. They sized the project variously at between 60 and 80 kW. The prices unfortunately were all too high to be justifiable by the fuel-cost savings to be made, even though we were displacing the most expensive fossil fuel (LPG) and would have taken a longer-term view than most customers (given the commercial interest). The reasons why the capital costs are too high (and significantly higher than in other countries) is another story, also related to the effect of government intervention.

But sticking to the case in point, the main reason why the value did not justify the investment was the absence of any carbon value. Indeed, the low rate of VAT on domestic fossil fuels effectively creates a negative carbon cost, as those fossil fuels are cheaper than they would be if they were simply treated as any other product in the market. But after extraordinarily-prolonged cases of first myopia and then prevarication, something is on its way: the RHI. Doesn't that make the difference and justify the investment?

  1. When should I assume it will come in? The Government refused to drive it on the same timetable as the micro-gen FiT, which means that unlike the latter, the RHI will certainly not be introduced before the next election. The Government promise April 2011, but what value should one place on any policy promised by this Government to be introduced long after the next election?
  2. The Tories have said they would introduce something similar, so perhaps one would take a view on that (though I doubt it will be top of their legislative agenda). But what form should I assume the RHI will take? The Government couldn't even bring out some suggestions to accompany the panoply of consultations and policy-statements on low-carbon policy that they have released in the past couple of weeks. As I said, I am reduced to assuming that they will apply similar logic to the RHI as they apply to the micro-gen FiT. But what confidence should I place in that sort of assumption? They have shown an exceptional ability to reinvent the wheel at every turn so far.
  3. Perhaps I could take a view on the sort of mess that will emerge, knowing the similar predilections of Labour, Conservatives and civil servants for micro-managed complexity (whatever their denials). I am prepared to take an informed gamble that the RHI will be a FiT, that it will be banded by technology and scale, and that it will be introduced by 2012. But that is as far as I can go, and I probably know more about this than any other potential pellet-boiler customer. What will be the thresholds for the bands, and what will be the levels of support within each band? One can try to read the runes from what the Government has so far published, but in reality it's not much better than picking numbers at random. How does one invest on the strength of that?

For instance, what if (as is not unlikely, but not predictable) they make 50 kW a threshold between one band and another? And what if the level of support for boilers below that size is double the level of support for boilers above that size? How much of a plonker would I look if I now installed a 60 kW boiler? In those circumstances, I will obviously want a 50 kW boiler, and find ways to eke it out (larger buffer tank, or top-up from another heat-source). Or if I really want more than 50 kW, maybe I will divide the project and install two 35 kW boilers, attributing each nominally to a different property to be able to claim the higher rate on each, even though that is a dreadfully economically-inefficient solution compared to one 70 kW boiler. But what if I try to hedge my bets by going for one of these options, and then find that they have set the thresholds at 30 or 100 kW? Sizing sub-optimally is then money down the drain.  

Clearly, I can't invest now, precisely because of the thing that is supposed to encourage this market. And whenever I do, I will not necessarily be installing the most suitable setup for the location, but the most suitable setup for the perverse incentives. A government proposal aiming to put right their failure over many years to treat heat equally to other forms of energy has, in practice, created the opposite effect for the foreseeable future. And all because they are so ill-educated in economics and deluded about the quality of their information and competence that they can't just do the simple and right thing: front-loading at the least, or better still scrap most of the existing and proposed mechanisms, replace them with a carbon tax, and let the market figure out where and how carbon can best be saved at less cost than the social cost of the emissions.

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Merton doesn't Rule, OK

One way that politicians and civil servants have tried to drive the uptake of renewables is through the application of what became known as the Merton Rule (after one of the first councils to introduce the measure) to planning policy. The Merton Rule stipulates that developers must include a certain proportion of on-site renewable-energy production (typically 10 or 20 per cent, depending on the council) within the fabric of the buildings they are developing.

Why a particular proportion should be encouraged is not clear. Faced with a choice of a technology that could supply a notional 10% of the property's energy needs for £X at an operating cost of £Y/MWh, or another technology that could supply 80% of the property's energy needs for £2X at an operating cost of £0.1Y/MWh, the rational developer focused on the bottom line (and they mostly are) will install the former as the most cost-effective way to meet the Merton Rules.

Nor is it obvious why one would want to target incentives at new-build, rather than providing equal incentives for the existing housing stock, which is vastly more significant. In one way, older buildings offer greater potential, as the lower energy-efficiency results in more energy-consumption (relative to its size), which means higher utilization of any renewables installed, which means faster recovery of the capital cost.

Nor is it fair to assume, as the planners do, that one knows how much energy a particular technology will contribute in particular circumstances, and how much energy will be consumed in total in that property. It's an arbitrary measure that rewards bullshitters (those who provide inflated claims for how little energy will be required for the building or how much energy their technology will produce).

But let's say that they really could plan and assess this accurately. The system would still encourage perverse outcomes. As a supplier of wood pellets, we are seeing at first hand one of the more perverse consequences.

For individual properties, solar panels (thermal or PV) are probably the winning option for many developers. But for larger properties, such as blocks of flats, installing a pellet-boiler that could meet part of the heat load is often a good option.

To minimize cost and maximize convenience, the pellet boiler will be installed to feed the hot-water buffer tank in tandem with one or more gas boilers. Because the Merton Rule is satisfied regardless of whether the equipment ever runs (it requires only that it should produce a certain amount if it were run), and because gas (and oil) are currently cheaper as fuel than pellets (because of stupid energy policies designed to keep domestic fossil fuels as cheap as possible), the developer has no interest in installing a pellet boiler that will run effectively because the plan is for it to rarely run at all. It will be undersized (because you only need renewables to be able to supply a fraction of the properties' energy, and heat is such a big proportion of the whole). It will be the cheapest model available, regardless of whether that model will give trouble-free and efficient operation. It will have an inadequately-sized fuel store, which further pushes up the cost of running, as many suppliers will not supply small loads, and those that will (such as us) will charge much more per tonne for small, frequent deliveries than large, infrequent deliveries. The fuel-store will be located wherever suits the architect, regardless of whether it is practical to get the pellets to that location. The flange, to which the delivery-lorry connects in order to blow the pellets into the store, will be positioned wherever is convenient to the architect and developer, regardless of whether the delivery lorry can get near it, or can stop there (e.g. on double-yellow and red lines). The reality is that no one intends to run the boiler, so who cares?

Recently, this logic may have taken a step further. A developer is touting around a pair of "barely used" pellet boilers of the cheapest, nastiest type, which he is taking out of one of his sites. Are we seeing the start of the next wave, where developers will install the obligatory renewables just long enough to get signed off by the planners and Building Regulations officers, before taking them out and selling them on for installation in the next development that needs to meet the Merton Rule targets? A handful of boilers and solar panels could deliver multiple permissions and positive SAP ratings. The authorities' figures will show that large numbers of properties are running on renewable energy, while in reality most of those properties carry on being as dependent on fossil fuels as ever. The figures for numbers of properties where renewable boilers were installed will no doubt be presented as a tremendous success, and the authorities will be mystified when our fossil-fuel consumption figures once again don't fall in proportion to the displacement that has supposedly been achieved (just as for EEC/CERT/CESP). There will be more head-scratching, and then someone will come up with an even more complex and perverse scheme to encourage displacement of fossil fuels whilst keeping the costs of those fossil fuels as low as possible. And so the cycle continues...

It's very simple. If you want people to use less of something, you need to make it more expensive. If you try to make them use less of it by pushing efficiency-improvements at them whilst keeping the price cheap, demand will rebound - it's an effect well-known to economists as the Rebound Effect. The purpose of these policies is to get us to reduce our fossil-fuel dependence, whether for environmental, economic, social or energy-security reasons. And yet the Government persists in trying to keep domestic energy prices as low as possible while promoting these policies aiming to reduce our consumption, and all the opposition parties and most of the commentariat support them. We really are cursed with one of the dumbest intellectual classes of any nation on earth.

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Poor consumers

Speaking of the IEA (see previous post), Richard Wellings, their excellent Deputy Editorial Director, has posted a piece on their blog, on the recent slew of climate-change policies and targets from the Government. It is mostly well-judged, but there is one point where we diverge. I need graphics to illustrate why he is mistaken, so I'm posting here rather than in the comments section on his site.

Richard rightly criticizes the impossibly ambitious targets, the delusional claims about the benefit to the economy, and the impact on what remains of our industry of increasing the costs of energy. But he overstretches when he brings domestic consumers into the picture:

"Then there is the impact on the less well off. People on benefits, for example £64 per week Jobseeker’s Allowance, may already be using around one third of their (non-housing) incomes to pay utility bills inflated by existing environmental policies."

Actually, we have the cheapest domestic energy of the EU-15 countries. Here is the comparison for gas (from European Commission, DG TREN Staff Working Document, Report on Progress in Creating the Internal Gas and Electricity Market, 11/3/1009, SEC(2009) 287):

EU gas prices 2008 

Notice that only 6 New Accession countries had cheaper domestic gas than us (on old, unsustainable, subsidised Russian prices), so not only all the other EU-15 countries were dearer, but several of the New Accession countries as well. And notice that the reasons why domestic gas is so cheap are not only that the untaxed price is competitive, but significantly that we apply less tax to our domestic gas than any country except for Latvia. Doesn't look like domestic gas prices are too inflated by existing environmental policies, does it?

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