Saturday, October 15, 2016
BREXIT BLUES. DEVALUATION WILL HIT DOMESTIC ENERGY CONSUMERS HARDEST.
For much of industry, the competitive benefits of devaluation will more than offset higher energy costs. The hardest effects will be felt by domestic consumers, especially the poorest. There are a few weapons that could be deployed to help the poor, but they will not reach everyone and are far from an ideal solution.
With the prospect of the UK leaving the EU, the slide in sterling was both predictable and predicted. It began on the night of the referendum and has gained more momentum with the growing belief, not only that exit is now very probable but that it will involve leaving the single market and the customs union, disadvantaging many of the UK’s key export earning sectors.
The calculus that underpins market sentiment on sterling is simple. The UK currently runs a big current account deficit at around 7% of GDP. This has hitherto been balanced by foreign direct investment and borrowing. The impact of Brexit has been threefold:
· A severe threat to Britain’s service industries, especially financial services
· The prospect of both tariff and non-tariff impacts on UK exports to its largest single market, the EU
· Evidence that foreign firms, most notably Japanese companies, may hold back on investment in the UK and move many of their activities elsewhere
These factors together have the potential to make it substantially harder to balance the books, and this is now reflected both in sterling and in the slowly rising cost of government borrowing. A fall in the exchange rate both provides an additional incentive for UK manufacturers to export and acts as a major brake on UK demand for imported goods, as these become harder to afford. It is therefore a necessary part of making adjustments to the UK economy.
This will de facto mean a cut in living standards. That is unavoidable. In current conditions the rising price of imports seems unlikely to set off compensating wage increases and an inflationary spiral, but the effects may be both severe and immediate, and the energy sector will be in the front line. The most clear cut impact will probably be through the impact on imports of gas. A 20% devaluation (around the level at the time of writing) means that imported wholesale gas will cost an extra 25% in terms of UK sterling. Given that wholesale costs account for about 40% of the retail price, this is likely to feed through as a 10% increase in prices to ordinary consumers. Other factors, not related to Brexit, will probably increase this figure further, to around 12%. Effects on retail electricity prices are likely to be more muted but will still be significant.
Industry too will have to pay more for its gas and electricity, but for those who compete in international trade, this will be of much less importance than the competitive benefit conferred by devaluation. Inter alia, as I anticipated in an earlier comment, this could transform the prospects for Welsh steel.
Inevitably fuel price rises, like food prices, bear most heavily on the poorest, for whom they are a much higher proportion of total income. This ought to be a major concern. Various approaches can be considered for alternative domestic tariff structures that avoid subsidies to utilities from the public purse, but they usually require a cross-subsidy between consumer groups.
One is the concept of lifeline tariffs, in which the first “block” of energy is provided either free or at a heavily discounted rate, but with a premium rate attaching to higher levels of consumption. Although this is superficially attractive there are some practical problems. One is that the correlation between income and level of consumption is far from perfect. Poorer consumers are not necessarily low volume consumers. Volume can depend on family size, fuel choice, nature of their dwelling, etc. To illustrate the imperfections of what ends up a scattergun approach, a lifeline tariff is almost bound to benefit second home owners.
A more promising approach is the promotion or subsidy of energy efficiency schemes that will reduce consumption but this approach too may not be adequate for the problem, as it is neither an instant solution nor is it likely to cover all cases of fuel poverty. So there is no simple answer to the problem. At root it is a problem of poverty rather than a problem of energy per se, and we have to accept the fact that the costs of energy are likely to rise above current levels (from what is likely to prove to have been an unsustainable historic low), from devaluation and for other reasons. Lifeline tariffs may be worth an experiment, and energy efficiency is a good thing per se, but otherwise this suggests that the problems of fuel poverty have to be confronted at source, ie poverty, rather than through additional interventions in the energy sector.