Monopolies, Markets and Mumbo-Jumbo: Privatised Utilities

Telecommunications are - so far - the only sector of privatised provision of utilities where the original network of copper wires has largely been replaced by the use of airwaves. The great Volta achieved some measure of success with his experiments to transmit electricity without wires, more than a century ago. So it is not beyond the bounds of possibility that some equal genius, with the advantage of a century more scientific discovery to draw upon, will be able to distribute electrical energy safely without the infrastructure of a National Grid. But that it not yet on the horizon.

It is most improbable that gas or water could be distributed to their millions of domestic and commercial users other than by pipelines; and trains will always need tracks, even if they become vacuum tubes through which the vehicles are sucked or pushed at hundreds of miles per hour.

By selling the licence to use the copper wire telephone system [that was originally laid across the country by Post Office Telephones] to the shareholders of British Telecom [BT], the Thatcher government did not extinguish the material monopoly that POT had created: they simply sold the ownership of the system. Alongside the massive development of airwave communications, some rival firms have put their carbon-fibre equivalent of wires in some parts of the country, to compete with the mix of copper and carbon-fibre that BT now use; but in most of the country the BT infrastructure provides the single means by which a consumer can connect their devices to the global telecoms system. As a result of this fact, which is derived from the impossible cost of replicating or triplicating the BT infrastructure, 'competitor' companies of BT have to hire the use of BT capacity. An 'economic regulator' OFCOM was established at the time of privatisation with the task of making the 'competition' of BT and other providers look a bit like the sort of a market that Economists imagine in their fantasies, and teach to captive students on the basis that acceptance of the 'model' is necessary to pass the exam. Thus the students are in the equivalent position of students of literature who are studying 'nonsense' poems by Edward Lear: with the difference that the Eng Lit students know that the content is not real-world rational thought; while the Economics students are expected to pretend that the Econocratic model is superior to the reality that prevails in a corrupt and inefficient world.

The job of OFCOM in communications, like that of OFWAT in the mock market in water and that of OFGEM in the speculative sphere of energy, is to make rulings which set the basis for the provider firms to charge customers and to maintain and enhance their distribution systems. Each of these organisations hires youngish Economists who are still at least half-convinced of the 'scientific' validity of Econocratic assertions, and these constantly come up with ways of 'refining' the models that the regulators use to bring the regulated system closer to the models they had from their teachers. When one of these tweaks of the system seems to be effective, some of the Economists who introduced the new wrinkle are recruited on higher wages by the other regulators to tinker with their systems.

Hence we have seen water companies urged to invest massively in replacing old pipes: then suddenly to stop as the regulator realises that the notional capital value of the company is being increased too much [for their model] at the expense of consumers' bills. We see constant attempts to compel users of electricity to join in a game of swapping 'suppliers', when everybody knows that the competing firms all use the same power stations and wires: the competition is only in publicity and customer relations [including billing]: and on a basis of 'swings and roundabouts' over a ten-year period of staying with the same supplier there will be periods when that is the most expensive and periods when it is less expensive than a firm to which one might have switched.

The whole experience of privatisation is of an expensive game: paid for by the poor consumers. The gut reaction of the British people has been to agree that Labour has a point, in putting re-nationalisation of at least some of the utilities back on the political agenda.

Bonkers About Bankers; Wet About Water

The British media are currently commenting both on the future regulation of the water industry and about the report of a Parliamentary Commission that has been discussing the changes in banking regulation that the Treasury is likely to bring forward following the Vickers Report which proposed the saparation of retail from wholesale banking.

The common thread linking the OFWAT licensing package to the Vickers proposals is the attempt in each case to crystallise an illusory distinction between 'wholesale' and 'retail' operations. Behind both follies lies the Economists' dogma that 'competition' is a good thing; which in the crazy world of contemporary politics is pitted against the bureaucracy's recognition that a failure either of the domestic and industrial water supply or of the accessibility of cash to households and firms would be both economically and humanly cataclysmic in its consequences.

If the supply of water or of 'retail' bank accounts was left to rampant open competition with no restraints, some firms would grow by using both fair and unfair tactics; while others would be driven to bankruptcy. A failed bank or water company could leave its customers destitute or dying; so retail competition in banking and in water trading must be underpinned by a system that would ensure continuity of supply to the customers of failed suppliers. Hence the appearance of retail competition is pursued, by the politicians who hold the ring between ideologues and bureaucrats; who have some inkling of the extent of the damage that was done to the economy by the near-collapse of banking in 2008 and who are desperate to avoid being blamed for another ruinous cock-up.

At present both the water business and so-called banking are vertically integrated. Banks deal with every sort of financial transaction from managing children's saving accounts to ensuring that their whole complex pattern of operations has sufficient liquidity at all times. Water companies convey the fresh water supply from lake, river or aquifer to the kitchen sink [and Water-and-Sewerage companies carry the process forward to the point where the cleaned waste is returned to the environment]. Dogged Economists have come up with suggestions that in both cases 'retail' operations should be separated - or, at the least, 'ring-fenced' - from the risks and costs that are incurred in the 'wholesale' sectors if the industry; and that a show of competition, albeit closely controlled by regulators, should be fostered in the retail market. All this complex bureaucracy would be paid for by the users of banks and of water so that Economists would be able to claim that suppliers would be pushed a few metaphorical inches towards the nirvana of marginal cost pricing [a fantastical concept that any non-economists can pursue on Wikipedia if they have a few days to spare.

It is generally conceded by all observers except currently-orthodox Economists that water supply is a natural monopoly. So much capital is invested in securing abstraction points, purification plant, water mains, distribution pipes, customer connections and meters [where they are in use] - and in providing the energy to pump the water around the system - that it would be unimaginably expensive to install a second, third or fourth supply network simply to provide competitors for the incumbent company. The prices that customers would have to pay to finance the construction and maintenance of the unnecessary additional infrastructure would be prohibitive: to which must be added the maintenance costs for systems would be used at significantly less than their capacity. The nutters who propose 'competition' simply because that is the ideal of Economic Theory would love to be able to ignore the material realities of of water supply. The coalition government appears to be content to leave the physical infrastructure in the hands of geographical monopolists; albeit expressing some pious hope about eventually making it easier for new companies to take over access to raw water. This could only be achieved by changing the pattern of abstraction licenses, whose award is in the scope of the Environment Agency: not of OFWAT, and would almost certainly require the expropriation of some of the assets and contractual rights belonging to the incumbent companies. Economists argue that provided the new entrants could offer water at source at a 'wholesale' price that was competitive with other sources, the distributors would be compelled to buy a proportion of their supply from the new competitors. Alternatively, the distributors would be compelled to receive the water into their systems, and pump it around to the connection points at which the competitor's [or an associated business's]  customers would be billed by a 'retail' water company that would be a separate entity from the delivery company.

Anybody who pretends that cost to the customer would not increase with the creation of a raft of new companies that employed chief executives and nonexecutive directors on the usual terms, bearing the advertising and other costs of competition should look across at the energy sector, where boards are highly-paid, where competition is ritualistic under a fanciful regulator, and within which absurdly expensive green objectives are met by compelling customers through their bills to throw enough subsidy to constructors of windmills and nuclear power plant - and even converting coal-fired power stations to using biomass [which is increasingly challenged on ecological grounds]. The cost of capital for all the companies will also increase with every increase in the uncertainty of the companies' income flow that follows from fake competition and from the appropriation of upstream assets from the companies.

With sulkily expressed threats that they will return to the government's preferred agenda of legislated pseudo-competition as soon as possible, in the face of near-unanimous opposition from the industry, OFWAT has withdrawn a recent threat to change the basis of remuneration for shareholders within the price review due in 2014. It is still threatened that the regime will be changed to fit Economists' models; but the danger is deferred for an indefinite period.

Meanwhile the banking business gets massively more coverage in the media than does water; partly because editors and journalists do not recognise the immense difference between unconditional human needs, represented by water,  and the availability of convenient services, such as banking: and also in recognition of the fact that finance is under much more obvious scrutiny as the Economics editors and commentators try to elucidate the debate around the 'Vickers proposals'. Vickers has proposed, and the Establishment has rallied around the concept, that a 'retail-wholesale' bifurcation of banking should take place. The UK Treasury policy is said to be that the corporate structure of the post-2008 financial conglomerates should not be changed; in line with the pretence that the amalgamated banks will eventually expose 'where all the bodies are buried' and hygienically dispose of the remains. Meanwhile it is proposed that operating divisions within those massive entities - and in  the immensely smaller niche firms that operate as specialists in that sphere  - should manage 'retail' banking on the assumption of being underwritten by the government: while 'wholesale'  areas of the agglomerated leviathans would be allowed in theory - to fail. Even if this were practicable - which it is not - it would not address the basic issue. Very simple tests can confirm that a colourless liquid is or is not water; and more-complex tests can verify whether identified water is potable: equally simple tests can verify whether a passage of credit through a succession of bank accounts is financing a real-world transaction that supports material business [or business with a material objective, such as insurance or investment for pensions].

But just as a water company could not guarantee the current high level of service to British consumers if it did not control all the processes in the supply sequence, so a 'retail' bank needs to operate knowledgeably in the wholesale arena to ensure the best returns on investments for its shareholders and to give assurance to all its customers that they can receive their deposits - in cash - on demand. To concentrate on the wholesale-retail issue is nonsense. As has been argued previously in this blogsite and in thousands of pre-blog, pre-twitter era discussions I have argued - and asserted - that in finance the essential distinction is not between retail and wholesale but between categories of 'products'. In terms of the flow of business in this millennium, transactions to fund the movement of goods around the world and to support material industry - including investment - are swamped by contracts [and by the consequential notional flows of money] that are outstanding in the betting games of derivative and futures trading, short-selling and the multiple other forms by which 'banks' hove been institutional gamblers. Far from ensuring the liquidisation-on-demand of their retail depositors' assets, they made the whole banking business.insolvent: compelling already-bankrupt governments in the US, Spain and the UK to raise massive financial packages to rescue the complex banks. The logical split is that of finance from gambling: with banks that have retail operations being unconditionally forbidden to gamble. That simple measure would massively increase the stability of banking, and would set a tight cap on the losses that governments and central banks could be expected to bear in the peculiar event of the fortuitous failure of a retail bank.

As Britain's retail banking inescapably passes under EU regulatory control, the innovative and globally significant high gambling business could flourish even better than before if it was pushed wholly outside the banking regime. It could grow in importance as an employer, an export earner and a source of taxation.