May 1st 2010

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Articles from this issue:

WATER: Government's misspent billions will destroy our farms

CANBERRA OBSERVED: Rudd gambles all on hospital reform

VICTORIA: "Big brother" laws could curb religious freedom

QUARANTINE: WTO apple ruling threatens Australian industries

ECONOMIC AFFAIRS: Privatisation has failed to deliver cheaper electricity

EDITORIAL: Can terrorists really acquire nuclear weapons?

POLAND: Aircraft crash annihilates Polish leadership

CLIMATE SCIENCE: Earth is never in equilibrium

ENVIRONMENT: 'Ship on the Reef': a critical review of this season's rerun

SCHOOLS: Dumbed-down Australian history curriculum

GENDER AND IDENTITY: Help for homosexuals who want change

CULTURE: Is the porn tide finally turning?

TRADE UNIONISM: Why America doesn't have a labour party

Perspective needed on Tony Abbott (letter)

Gratitude for public health system (letter)

AS THE WORLD TURNS: China's shameful massacre of unborn girls; Soft power and no plan for Iran; Countering terror; Scientific establishment forfeits public trust

BOOK REVIEW: WILLIAM CHARLES WENTWORTH: Australia's Greatest Native Son, by Andrew Tink

BOOK REVIEW: NOTHING TO ENVY: Love, Life and Death in North Korea, by Barbara Demick

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Privatisation has failed to deliver cheaper electricity

by Colin Teese

News Weekly, May 1, 2010
One of Melbourne's savvier economic and political brains, John Legge, reminds us of what a bad deal our community has got from privatisation. He used the announcement of the introduction of new electricity meters by the Victorian government to make his points. (John Legge, "Smart meters another dumb economic idea", The Age, April 13, 2010).

His arguments relate specifically to electricity generation in Victoria, but actually they apply pretty much across the board concerning privatisation.

Electricity in Victoria is, however, a good example.

Mr Legge contends that putting electricity generation and distribution into private hands has neither reduced prices nor served the broader public interest. What is more, the facts back him up.

Victoria's State Electricity Commission (SEC) generated and sold power to Victorian consumers from 1926 to 1998. In every single year it reduced the real price of power to customers. This meant that for ordinary households buying electricity took a smaller part of their earnings in each successive year.

Since privatisation, however, electricity prices to the consumer have gone up 50 per cent.

Managing price was undoubtedly the SEC's crowning achievement. But the SEC also trained thousands of apprentices in electricity and other workplace skills. Eventually, many of these highly skilled tradesmen found their way into the wider workforce. In a similar manner, the SEC also trained engineers and other skilled workers, not all of whom chose to remain in the commission's employ. Either way, the community got the benefit of skills-training provided by the SEC.

The current privately-owned generating company does none of this.

As to the matter of safety and security, the SEC maintained its generating and delivery systems in pristine condition. The same cannot be said for the private operators. For example, in last year's tragic Black Saturday bush-fires, some fires were started by poorly maintained power lines.

Nevertheless, readers might legitimately ask, how could the SEC have run a system cheaper and better than the current private operators, especially when we have been told repeatedly over the last 30 years that governments cannot do these things as well as private enterprise?

Well first, let us get that whole question into perspective. There are areas of economic activity where the profit motive delivers lower prices and better outcomes for the community. Competition and markets seem to work best where there are enough suppliers in genuine competition for market share.

Sadly, in modern economies, examples of such forms of economic activity are becoming more and more difficult to identify. Small retailers are the most obvious example we can point to; but it must also be acknowledged that these businesses usually suffer at the hands of large and colluding suppliers.

Perhaps the best example is manufacturing to meet end-user consumer demand; then again, here in Australia, we don't have much manufacturing left.

The reality is that competition and the operation of market forces — despite what many economists like to believe — do not always characterise economic activity in the 21st century. Perhaps it is time for market economists to recognise that the theoretical underpinnings for their so-called scientific view were developed in the 18th and 19th centuries. If economics is a science, it surely must be the only one still working on the basis of 200-year-old theories.

Theoretical economics tells us that genuine competition and functioning markets are essential for our economic system to work. "Perfect competition" provides the theoretical framework for competitive capitalism. In its pristine form, perfect competition means many suppliers facing many consumers with no one party in either group having the power to influence price.

In the modern world, that theoretical ideal, sadly, does not, and cannot, exist. As we all know, governments have had to establish competition and consumer watchdogs, such as the Australian Competition and Consumer Commission (ACCC), in an effort to prevent one side exploiting an advantage over the other. At best, competition works imperfectly.

The example of the duopolistic power of the two supermarket giants, Woolworths and Wesfarmers (the parent company of Coles), which dominate food retailing in Australia, readily illustrates this point. There is serious doubt about whether the undue market power they wield necessarily delivers superior service and cheapest prices to consumers.

What is more, many doubt whether, as buyers, they give their farmer-suppliers a fair go. Rather, they use their duopoly market power to squeeze farmers on price and then pocket the benefit of a higher profit on sales to their customers.

Another example is petrol prices. We all know that the various companies are selling the same product. If so, how does one company increase market share when there are only limited opportunities to persuade consumers to buy more petrol? Certainly not by competing on price: oil companies have discerned, correctly, that price competition would be ruinous for all of them.

So, implicitly or otherwise, they pursue a policy of live and let live at an economic price — and concentrate on keeping out new entrants! Call it collusion if you like, and certainly it is phoney competition, but given the kind of product they are selling it is probably the best way of preserving their respective businesses and serving their customers.

So the whole issue of competition and giving customers the best deal is nowhere near as straightforward as ideologically-inclined economists would have us believe.

And further, we can say definitively that it does not deliver good outcomes for public utilities.

Why is this so? Why do we end up with outcomes of the kind that Mr Legge draws to our attention? Technically, the answer lies in the phrase, "natural monopolies", but that is not much help to the ordinary reader.

Put simply, competition in power generation makes no sense — economic or otherwise. To have two power-generating companies, with their separate and enormously costly equipment, competing on price to supply us with power would be insanely wasteful of resources and simply would not work. And if generating companies wanted to invest in that kind of model for producing electricity, even the most irresponsible financial institution would not fund it.

There are many reasons why this is so.

For a start the demand for electricity is not susceptible to promotion. Customers use what they need; they can't be persuaded to leave the lights on when there is no need. Demand cannot be created.

Electric power generation has to be a monopoly. Even the ideologues concede that. But does it have to be a government monopoly?

Other things being equal, it's cheaper that way. Governments, in any reasonably well-run country, can borrow at cheaper rates than can private companies. This means that the burden of servicing the cost of the enormous outlays necessary to build electric power generation plants is lower. And they can fine-tune the system better with a combination of power plants to make certain that they can always meet the unexpected surges in demand.

Legge points out how the SEC used to do this. They had their highly efficient big power-plant delivering cheap power to meet normal anticipated demand day-in and day-out, and two other less efficient plants to come in quickly with extra capacity when needed to meet temporary demand surges.

However, at the urging of ideologically-committed market economists, the Victorian Liberal Government of Jeff Kennett in the 1990s decided to sell the SEC to a private power-generating company. It had been assured that the company would do a better job than the SEC, and more cheaply.

Why did this strike a chord with politicians? Well, for a number of reasons, the details of which deserve to be discussed in a separate article. For the moment, it is enough to say that in the political and economic climate of the time, the idea of privatisation held strong appeal to government and business alike. Both believed that customers could be enticed, with the carrot of cheaper electricity, to embrace the idea enthusiastically.

How wrong they were! Whatever may have been the case 20 years ago, customers now know they were sold a pup. The privatisation model is on the nose.

Things never worked out quite as planned — if only because, as pointed out earlier, funding privately-owned power generation is more costly than if governments undertake the task.

The private company which bought the right to take over the SEC's role can neither afford to do what the SEC did nor ensure back-up electricity generation to help with demand surges.

To get a semblance of competition into the system, the Victorian Kennett Government set up competing distributing companies which have to buy their power from the monopoly generating company.

They have one plant which at times will be generating more than is needed. To keep costs down, they must sell all the power this plant generates, even if it is not needed.

To buy at the cheapest price rather than pay the crippling price the generating company sets for peak power, it makes commercial sense for the distributing companies to buy more power than they need.

This can and does lead to the bizarre situation whereby the power station produces surplus power which is not needed, and the distributing companies buy power which they can't sell. Now it becomes clear why prices to customers have gone up 50 per cent since privatisation.

You will no doubt have guessed immediately who picks up the tab. The customer, of course! And that means mostly households, because the big commercial users usually operate on fixed-price contracts.

If you believe that the entire system so described seems incredibly convoluted compared with the public system that preceded it, you are correct.

Why, then, was this done? Sadly, the explanation of all that turns out to be even more convoluted.

Colin Teese is a former deputy secretary of the Department of Trade.

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