Capping energy tariffs won’t lead us down the road to Venezuelan-style ruin

The North Norfolk radio personality Alan Partridge once threatened to switch to a different petrol station because he felt the fuel on sale at his usual forecourt was “a bit obvious… a bit petrolly”. But normal people don’t care where they get their energy from so long as it’s a good value. No one prefers the gas supplied by EDF to that from Centrica. The electricity from SSE doesn’t work any better than npower’s version. The only real source of competition in the retail energy market is price.

The same applies to current account banking. The days when we would take pleasure from visiting an avuncular bank manager for a useful chat about our personal finances are, for better or worse, over. The limit of what most of us demand nowadays is a half respectable interest rate, a non-extortionate overdraft charge and, if we’re in a particularly demanding mood, a functioning website.

We’re often told that the magic of competition in a free market drives prices down and the quality of services up. But while generally true, it’s not universally so. If a seller knows more than the buyer about the product, ostensibly free markets can deliver some glaringly unsatisfactory outcomes.

The economist John Kay has written about “competitive misinformation” in markets such as retail energy where this kind of information asymmetry exists. The contracts offered by energy firms are nigh on impossible for the typical customer to understand. The same is usually true of the small print that outlines banks’ overdraft charges.

The complexity is intentional. It is designed to extract fat profits from the less savvy. The seller knows more than the buyer. The result is customer confusion and inertia. Half of us have been with our bank for more than a decade and only three per cent switch each year. Around two thirds of energy customers never switch and end up on the costly “standard variable” tariff.

And this inertia is a major source of profit for an oligopoly in both industries; the big four in banking and the big six in energy. The Competition & Markets Authority concluded last year that the latter “enjoy a position of unilateral market power over their inactive customer base”, earning them excess profits of £1.4bn a year. The CMA says banks cream off around £1.2bn a year from unarranged overdraft charges.

When companies sell essentially the same product at different prices to different customers it’s usually the rich who tend to pay more: think of first class train or plane tickets. But in energy and banking it’s often the poor, elderly and least clued-up that end up being penalised. Their loss is the gain of those who do switch, claim the oligopolies.

But even active customers still suffer notoriously poor levels of service in both banking and energy. When a bank’s website crashes all customers are in the same boat. When a large energy company messes up its billing system no one is immune from the fallout.

One response to failing markets is to try to level out the informational playing field. This could be done by giving the least savvy customers more information through easy-to-use tariff or fee comparison websites, or by compelling providers to periodically remind customers that they might be able to switch to better deals.

Another response is to jump-start competition by breaking up the oligopoly of providers in the hope that this will encourage a larger number of smaller providers to focus on customer service and more transparent pricing in order to grow their respective market shares.

But the first route hasn’t worked so far (although some still insist the breakthrough just need the right technology). And politicians and regulators have consistently balked at the second option, seeing structural reform of this nature as being too logistically and legally challenging.

So now we’re circling a third option: capping prices. Proposals to cap standard variable tariffs relative to better deals are being worked up for the Conservative manifesto, and the Labour MP Rachel Reeves is campaigning to limit bank overdraft fees.

It’s a gross error to assume that all markets are alike and always work perfectly. These economic forms are only valuable for the welfare their deliver; they are not an end in themselves. Structural reforms would probably be more effective and less prone to damaging political opportunism than price capping. But in already heavily regulated sectors such as retail banking and household energy provision it would be hysterical to suggest, as some free market fundamentalists do, that caps are the slippery slope to ruinous Venezuelan-style socialism.

Fundamentalist critics might care to consider a different risk: the discrediting of the many parts of the free market system that are working well from a chronic failure to fix those salient sectors that manifestly are not.

#oligopoly #energycapscompetitionandmarketsauthority #switching #banks #competition #currentaccounts #behaviouraleconomics

Why are we so ignorant about who is and isn’t rich? Blame psychological bias and misinformation

‘When Austin Powers’ nemesis Dr Evil came out of deep freeze and held the world to ransom he hilariously imagined that one million dollars was a lot of money. The response to the suggestion of shadow Chancellor John McDonnell last week that those earning an annual salary of more than £70,000 makes one rich has prompted similar guffaws.

Doesn’t he know how much it costs to buy a house in London these days? Doesn’t he know how expensive private school fees are? Honestly, how out of touch can you get? Of course, as many have pointed out, it’s not McDonnell who is out of touch.

The most recent data from HMRC shows that the median average pre-tax income is around £22,400. An income of more than £70,000 a year will actually put you in the top five per cent of all UK earners. When Ed Miliband proposed a “mansion tax” on properties valued at more than £2m in 2015, right wing newspapers exploded with fury, screaming about how that this would lay waste to middle England.

In fact, it would have affected around 100,000 homes, less than half a per cent of the total UK residential dwelling stock. The average house price today, by the way, is around £220,000. And wealth is a far more unequally distributed than income, with the luckiest tenth owning almost half of all the assets.

Rich is like the inverse of “middle class”. In Britain, everyone seems to think of themselves as middle class, whether they’re earning hundreds of thousands of pounds a year or taking home barely more than the minimum wage. Being middle class (preferably the “hard working” variety) is a badge of honour. But people are extraordinarily reticent about allowing themselves to be labelled rich. Many would sooner present themselves in the Daily Mail offices as a Brexit saboteur.

Is this simply because people don’t want to pay more tax and fear that admitting wealth will invite a raid from opportunistic politicians? Up to a point. But another big influence is reference point psychology.

People don’t have a mental snapshot of the national distribution of income or assets in their heads when they consider the question of whether or not they are “rich” or “well off”. They answer an easier question instead: where do they feel themselves to be relative to their peer group and relative to their own expectations? 

This helps explain why research shows people from all over the income distribution have a tendency to place themselves in the middle of the pack when asked to guess. We all know some people who are doing better than us and some who are doing worse.

Even the indisputably prosperous are prone to this. Consider the FTSE 100 chief executive who is awarded a compensation package of £4m a year. Rich? Not when you consider that the boss of an American company earns five times as much. What about the investment banker who extracts a bonus worth tens of millions of pounds from his employer? Well off? Not compared to that banker’s hedge fund or private equity friends who might earn ten times as much. And so on right up to the billionaire classes.

But this psychology can be found well down the pay scale too, even among those who earn below £70,000. As HL Mencken put it, wealth is “any income that is at least one hundred dollars more a year than the income of one’s wife’s sister’s husband”.

So where does this fiesta of unscientific relativity leave tax policy? In a dire state is the answer. Most public finance experts, at least those who are not employed by the super-rich to evangelise for tax cuts, now agree that residential property in the UK is inefficiently and unfairly taxed. But it’s proven impossible to reform the system in a more equitable direction because the bulk of the public can be so easily misled by politicians and the partisan media into believing that they personally will feel the pain.

The consequence is that residential wealth, which has risen substantially in recent decades, is under-taxed relative to income, which impedes our national productivity growth and encourages us to plough our savings into property, leaving us perpetually prone to a dangerous orgy of housing speculation. If we are ever to escape from this doom loop of public ignorance, dysfunctional policymaking and financial instability, the first step out will probably be an acknowledgement of the source of the problem: misinformation and right wing propaganda.

When political commentators react like scalded cats to the very suggestion that someone on more than three times the average income could be labelled well off, there is a problem. When we are inundated with chin-stroking discussions in the broadcast media (even among public broadcasters like the BBC) about who can fairly be considered rich, that tells us something important and troubling about whose financial interests the essential channels of information in our society are, directly or indirectly, serving. And it’s not those who really are in the middle.

#incometax #JohnMcDonnel

The treatment of David Dao by United Airlines is a lesson in the economics of air travel

“Economics tutors should thank United Airlines. The hapless company has furnished them with a perfectly intuitive case study in the power of financial incentives.

Was the right answer to a lack of volunteers to be bumped from the overcapacity Chicago to Louisville flight last week to select one at random and then drag the unfortunate victim kicking and screaming from his seat when he refused to accept? Or was it, as many have suggested, to increase the compensation offer until someone willingly came forward? 

The sharp fall in the share price of United’s parent company following the avalanche of bad publicity generated by the brutal treatment of Dr David Dao (captured on other passengers’ smart phones) provides a clear answer. Talk about a false economy.

United’s gross misjudgement on this occasion seems to have been the fruit of a bad general policy. As the Wall Street Journal has pointed out, other US airlines with higher overbooking rates have fewer “involuntary removals” than United. Why? It seems the answer is that they offer more generous incentives to encourage passengers to volunteer to be bumped. Volunteers receive gift cards rather than travel vouchers with the same airline. They may have the same nominal value but passengers, naturally, prefer the greater choice that comes with gift cards.

But there’s still something of an economic mystery lingering in the background. How, it’s been asked, could an airline ever be so out of touch as to consider treating one of its passengers like United treated Mr Dao, even before the heavies of the Chicago airport police were summoned? And how could the company’s chief executive, Oscar Munoz, have been so catastrophically cloth-eared as to (at least initially) defend the removal and even blame Dao for not vacating his seat with good grace? Doesn’t United grasp that treating its customers well is the very reason it exists? 

Well, only up to a point. Economics tutors might also consider a lesson in the economic incentives of the airline as well as of the passengers. Airlines make surprisingly little money from the regular passengers who fill the back of their planes. Around two-thirds of their revenue is estimated to come from a minority of business and first-class customers, with their flatbeds, generous legroom and other perks.

On short-haul flights there are also vanishingly small profit margins per passenger. This is the fundamental reason for the famously unsentimental treatment of passengers by the likes of Ryanair. Such budget carriers also make much fatter margins from selling expensive snacks on the flight, which is the reason why stewards are often more engrossed in their trolley-rolling duties than ensuring the comfort of passengers.

Intense competition is forcing more prestigious carriers in the same direction. British Airways has provoked outrage with its decision to cut complimentary meals on short-haul flights and to sell Marks & Spencer sandwiches instead. It may even do the same for long-haul soon. But it’s hardly surprising that the customer experience of non-premium passengers is neglected given they are so unprofitable.

Airlines compete on price rather than service nowadays. Most of us don’t fly frequently enough for customer loyalty to be a major concern for airline management (although United might be testing that proposition).

It’s not all bad news. Since deregulation in the 1980s and the advent of internet booking airline consumers have benefited enormously in many ways. Prices have tumbled in real terms and the number of routes has risen. But the regular customer experience has, for most of us, gone in the opposite direction.

The problem is that we labour under a cognitive dissonance, retaining a mental image of air travel as something for which one might wear a suit and tie and be served a three-course meal. But today flying is more like travelling by cross-country bus rather than stepping onto the deck of a luxury cruise ship. Or, if it’s a cruise ship, most of us are locked in steerage. The image of Dao being dragged down the aisle of a United Airlines plane may finally start to align public perceptions with that reality.”

#airtravel #airlines #DavidDao