How micro reform of electricity has failed

The soaring price of electricity is testament to the disastrous failure of a major item on the 1990s agenda of micro-economic reform – establishing a national electricity market.

In practice, nothing worked out the way the reformers' economic textbooks told them it would.

The failure occurred because the people charged with implementing the reforms – governments and their bureaucrats – did so in ways that defeated the object of the exercise.

They either had ulterior motives, or people charged with regulating the national market in the interests of consumers were "captured" by the big businesses they were regulating.

These are the conclusions I draw from the exposition of the market's many problems given by Rod Sims, chairman of the Australian Competition and Consumer Commission, in a speech this week.

Before reform began, the electricity industry consisted of separate state government-owned monopolies, each generating, distributing and selling electricity, with little trading of power between them.

The reformers' idea was to get a competitive market going, with individual power stations across the eastern states competing to sell electricity into a national grid, and competing electricity retailers at the other end buying the power and selling it to households and businesses.

There was no reason the power stations had to be government owned, so they could be privatised, as could the retailers. New retail firms could be allowed to compete with the big privatised retailers.

The transmission and distribution networks remained natural monopolies, of course, but there was no reason they too couldn't be privatised – provided there was regulation of the prices they could charge.

Victoria's Kennett government was the first to sell off everything in 1994, joined much later and more hesitantly by South Australia, NSW and Queensland.

The consumer price index shows retail electricity prices have doubled in real terms over the past decade, whereas the competition commission's calculations show the average retail consumer's bill has increased by "only" about 50 per cent in real terms.

Three main factors explain the difference. First, the price index is based on the retailers' "standing offer" price, whereas some households have taken advantage of cheaper offers.

Second, many households have responded to price increases by finding ways to reduce the amount of electricity they use, thus reducing the increase in their quarterly bills.

Third, many households with solar panels buy a lot less power from the grid and many get unrealistically high credits for the power they put into the grid.

Sims' people estimate that, of the total increase in household power bills, 41 per cent is explained by increased charges for the distribution network, 19 per cent by increased "wholesale" prices for power generation, 24 per cent by increased retail costs and profit margin, and 16 per cent by the increased cost of the renewable energy target and household solar power incentive schemes.

The excessive increases in charges by the natural monopoly distribution networks of poles and wires occurred because, about a decade ago, the state governments – which owned most of the network businesses and greatly profited from them – succeeded in weakening the rules for regulating their prices.

Some states also lifted their standards for avoiding blackouts to unrealistic levels, thus allowing their networks to increase the cost base on which they get a set rate of return.

When a regulator tried to stop the networks charging for "inefficient costs", the NSW and ACT governments took her to court and got her stopped. Although the NSW government was in the process of privatising its networks, it wanted to preserve their profitability so as to maximise their sale price.

For most of the past decade, the highly sophisticated wholesale market designed by the reformers worked well, keeping prices low while generating capacity exceeded demand.

But now that's changed as ageing coal-fired generators are closed and aren't sufficiently replaced by new generators because of the "regulatory uncertainty" created by the present federal government and its climate-change deniers.

Apart from the contribution the misregulation of the gas market is making to higher wholesale electricity prices, prices are also rising because two or three big companies – Origin, AGL and Energy Australia – have been allowed to dominate both the wholesale and retail ends of the market.

Reformers' models always envisage a market composed of a large number of firms competing vigorously on price, but it hasn't worked out that way. It's taken less than a decade for the national electricity market to become oligopolised, giving the few big firms greater pricing power and ability to induce regulators to "see it my way".

State governments have been happy to sell businesses to the aggrandising oligopolists because they offered higher prices than other buyers. The competition commission's efforts to block these takeovers were unsuccessful.

Meanwhile, the oligopolists were figuring out ways to game the wholesale bidding system.

Retail electricity prices were regulated for many years, but the reformers persuaded state governments to deregulate them since competition between the many electricity retailers could be relied on to keep prices in check.

It hasn't worked out that way. Oligopolistic firms are adept at non-price competition, and so it's proved.

The commission's estimate that 24 percentage points of the overall increase in real power costs have come from the retail level breaks up into 7 points for higher profit margins and a remarkable 17 points for higher costs – mainly, I presume, the costs of marketing, advertising and sales people to flog an essential service. Remarkable.

Being entirely a creation of government policy, the national electricity market is heavily regulated by at least three agencies.

But the regulators have been surprisingly slow to recognise that the market is falling far short of what the reformers promised, and also slow to implement their corrective actions.

They've been far more conscious of the need to avoid annoying the oligopolists than the need to stop consumers having to pay more than they should.

Read more >>

TAFE mustn't be another bad deal for the young

When they look at the economy that older generations are leaving for them, young Australians have a lot to be angry about. Some of their fears and resentments are misplaced, but most aren't.

Oldies who should know better have, for their own reasons, given them an exaggerated impression of the likely extent and timing of digital disruption in the jobs market.

There's much resentment of the higher education tuition fees the young have to repay, but I've never thought it unreasonable to ask them to contribute about half the cost of their qualifications, which will greatly increase their lifetime incomes – especially when repayments are geared to the size of that income and the loan carries a real interest rate of zero.

But I must add some qualifications. It is a bit rich for federal governments to have been tightening up on subsidies to students at the same time as they've been increasing subsidies to the retired, particularly those who believe themselves entitled to a handout because they're "self-funded" (that is, too well off to get the age pension).

You can understand why young people resent being lumbered with education debt when governments have gone for years tolerating distortions in the tax system – negative gearing and the capital gains tax discount – that favour older people buying investment properties over first-home buyers, and push the price of homes and the size of home loans even higher.

And it's understandable that graduates should be uncertain about the economic value of their degrees at a time when so many uni leavers are taking so long to find a full-time job – which is partly because the past few years of weakness in employers' demand for workers is being borne mainly at the entry level, and partly because universities have lowered the average value of their degrees by lowering entry standards and by educating far more people for particular occupations than are ever likely to be needed.

A big part of this last problem comes from the way successive "reforms" by both sides of politics at both levels of government have stuffed up the choice between going to uni and going to TAFE or a for-profit provider of VET – vocational education and training.

The plain truth is, while it's right that, in our ever-more complicated, knowledge economy, almost all students need further education after completing their schooling, it's wrong to believe everyone should go to university.

The less academically inclined – of whom there will always be many – would be better served going on to vocational education and training, as would the economy (that is, the rest of us).

Yet recent times have seen multiple pressures for every kid to go to uni. The first and most potent is that being a graduate carries more social status – an irresistible lure to many parents and students.

The long-standing policy of encouraging students to stay to the end of year 12 adds to the presumption that young people will and should go on to uni. The last years of high school are overwhelmingly academically inclined.

It was always accepted, in principle, that not all students were suited to university and that, for many, their last years of schooling should be a "pathway" to a trade or other technical qualification.

Great idea; doesn't seem to have amounted to much in practice.

And then we have the introduction in 2012 of demand-driven federal funding of undergraduate places at university, which has prompted a huge increase in student numbers as unis – some more than others – dropped their entry standards so as to maximise their federal grants.

Would it be surprising if this led some students to go to uni when they should have gone to TAFE?

I'm told that, at NSW TAFE's big campus at Ultimo in Sydney, more than 30 per cent of the students are there because, though they already have a uni degree, they can't find a job.

I'm told there's a shortage of architectural drafters because people who should have done the tech course have gone to uni to be architects. Then they're disillusioned when they're put to work doing drafting.

But would it be surprising if school leavers are steering clear of vocational education when they've read so many stories about the tribulations of TAFE and some private providers ripping off the young and trusting, so as to rort the federal government's VET version of the student loan scheme?

The truth is that the efforts of federal and state governments of both colours to make VET "contestable" by making for-profit education providers part of the system have been a disastrous failure.

Now the federal bureaucrats have belatedly sorted that mess, we're left with private providers who will only ever cherry-pick the most popular and profitable courses, usually those with low capital costs.

So we're back to relying on good old government-owned TAFE – always the education system's poor relation, towards which the feds' commitment runs alternatively hot and cold.

But the misguided reformers were right to believe TAFE needs to change from its old complacent, inflexible ways, where the convenience and income of staff were given priority over the changing needs of employers and of young people wanting to gain skills relevant to the needs of present and future employers.

TAFE will need to change a lot if it's not to be yet another respect in which the young are getting a bad deal.

Read more >>