The government is stubbornly ignoring the harms and risks of its interventions into markets
In a free market system, prices are supposed to act as a signal, giving both producers and consumers essential information about value in relation to supply and demand. The British government is determined to put a stop to this.
In these pages, we have looked previously at the way that a range of caps, cross-subsidies, means-based pricing and interlocking entitlements via the universal credit system are making prices, and to some extent incomes, irrelevant. These range from banking and utilities charges in which those on lower incomes are charged lower prices subsidised by other consumers, to benefits which recipients automatically become entitled to by qualifying for other benefits. And many other interventions in between.
Over the last couple of weeks, we’ve been treated to a feast of this kind of thing by the government, both in their urgent responses to market volatility, and also to one completely non-urgent and banal concern where they nevertheless discern the worrying signs of a supplier using prices to do something other than cover their immediate costs.
The first of these came a fortnight ago when fuel prices began their alarming rise following the beginning of the shipping blockage through the Strait of Hormuz. As soon as it became clear that one of the most important oil production regions (and fuel refining hubs) would be effectively sealed off from the world market for the foreseeable future, it was clear to pretty much everybody that British motorists would not be spared a near worldwide price hike at the pumps. The immediate response of the British government was to accuse fuel retailers of profiteering, and to summon the Petrol Retailers Association to Downing Street for a well publicised dressing down.
The Chancellor’s office claimed that the Treasury had identified discrepancies between the rate at which individual retailers were raising their prices, and insisted that this was evidence of price gouging by a number of unscrupulous operators. Keen to take a rare opportunity to cast themselves as the unlikely defenders of the benighted motorist, Downing Street trailed the forthcoming admonishment, which was due to take place in front of the cameras, across the media. The Petrol Retailers Association issued a statement accusing the government of inflammatory rhetoric and threatened to withdraw from the appointment — and defended its members, saying that the varying rates at which retailers were raising their prices was down to the stock levels they held in reserve at the point at which wholesale prices had begun to rise. Those who still had stock that had been bought at lower prices were slower in passing on price rises to customers than those who had already begun buying at the higher rate.
The meeting eventually went ahead on more discreet terms, with little meaningful outcome and both sides describing the talks in politely constructive terms. But what appeared to be completely absent from the government’s response to the situation was any appreciation of the role — or at least the potential role — of prices in a situation like that. The public could clearly see that a supply shock was coming that was very likely to lead to higher prices, and which could feasibly have resulted in rationing or shortages. The obvious thing that many motorists were likely to do in that situation was to fill up their tanks urgently before the crisis really bit — this could quite easily have led to individual petrol stations running out of fuel while they awaited resupply. Images of vehicles queuing up outside stations, and signs declaring that they had run out, could then have caused a real panic and a run on the remaining stations with stock.
This was similar to the shortages of some staple supplies, most notably toilet paper, at the beginning of lockdown in 2020. Chaotic government communications made the public unsure of whether they would be allowed to go to the shops for a period of a few weeks, so many people went out to buy supplies. There was no shortage of toilet paper, but supermarkets were unable to restock their stores quickly enough to keep up with demand, leading to a perception by the public that there really were shortages, which led to panic buying. Some supermarkets responded to this in a rational manner by increasing the price of toilet paper to discourage customers from buying far more than they were likely to need. However, this was identified as profiteering, and retailers were strongly discouraged from doing so, with both the government and the media preferring rationing rather than constraining demand through prices.
The result was that supplies temporarily ran short in some places, and many of those who did the right thing and did not engage in panic buying did actually end up going without, for a short while. In both cases, we saw a strong impression from government (both Labour and Conservative) and from the public and the media, that it is morally wrong to use prices as a signal to limit excessive consumer behaviour, even if the alternative is supplies running out.
More recently, we witnessed Rachel Reeves highly anticipated intervention on broader economic impacts of the energy crisis. Bizarrely, despite spikes and volatility in global commodity markets, domestic energy bills in Britain are due to go down for three months beginning in April. Theoretically, they should then go back up, possibly quite sharply, in July despite UK energy demand being lower in the Summer months, and a reasonable possibility that commodity prices will have settled back to pre-crisis levels by that point.
This is a quirk of Britain’s price cap on domestic energy bills, which imposes a rigid system by which utilities companies calculate their estimated wholesale fuel costs based on a three-month trading period well in advance of the quarter in which the cap will apply. The April price cap was informed by wholesale data from roughly mid-November until mid-February, and the cap itself was announced on 25th February, just a few days before Trump’s intervention in Iran threw global markets into flux. But while the data window for the April price cap closed just prior to the trouble, the calculations for the July to September price cap had just begun, meaning that the cap will likely shoot straight back up in the Summer.
With suppliers unable to increase their prices, there is no signal there telling households to be especially careful with their energy usage
So while the world is experiencing high gas prices and severe worries about the reliability of LNG deliveries to Europe, British consumers will be enjoying a period of relatively low home energy bills. We may later find ourselves paying through the nose later on in the year, however, even if the crisis has passed. This robs the price mechanism of its potency to inform both consumer and producer behaviour. During a period in which fuel costs are higher, and in which we may even experience real shortages, people ought to be reducing their consumption as much as they can. But with suppliers unable to increase their prices, there is no signal there telling households to be especially careful with their energy usage, beyond the fact that prices in Britain are already very high anyway.
Given that prices are explicitly set by a statutory agency — standard tariffs now almost always cluster at or just below the cap — domestic energy bills are now an explicitly political matter. To some extent, this is rightly so; government policy is the most significant factor influencing energy costs in Britain, through carbon pricing, renewables obligations, contracts for difference and a bewildering variety of levies. But when a highly visible and sudden spike is likely to have an immediate and obvious impact on the price cap via wholesale fuel costs, there is suddenly an overwhelming pressure on the Chancellor to intervene. In this case, Rachel Reeves has suggested that she will offer targeted support for those least able to pay once the cap goes up in July, rather than a sector-wide subsidy.
It isn’t yet clear how that will be worked out, but it seems likely that it will be tied to eligibility for other benefits such as Universal Credit (UC) or Pension Credit (PC). Administratively, this is the most straightforward eligibility assessment that can be undertaken, especially when a benefit has to be rolled out urgently. As such it is a favoured form of means test; UC and PC recipients are already entitled to the Warm Home Discount and Cold Weather Payments, as well as the Energy Company Obligation to help with home energy efficiency. UC and PC recipients are also automatically entitled to heavily discounted tariffs for broadband internet, water and sewage provision, in addition to concessions on the ludicrous Television Licence, automatic Legal Aid as well as payments in advance toward funeral expenses. UC is linked to free school meals, as well as 85 per cent of any childcare costs incurred. UC recipients are also entitled to free medical prescriptions and dental care.
This means three things. Firstly, it means that eligibility for one benefit makes the welfare system liable for a huge range of other costs. Secondly, it means that people who are wholly or partially workless are insulated from costs that would consume a substantial and non-discretionary percentage of the median worker’s budget. Given inflation-induced fiscal drag and anaemic salary growth, this is a further disincentive for marginal cases to drop out of the workforce entirely.
But perhaps more insidiously than any of that, it is the growing sense that the most essential goods and services should be exempt from the price mechanism entirely, and that we should expect these things come what may. The ups and downs of markets — whether somebody is willing to provide something for the price that we are willing or able to pay — ought to apply only to frivolities. That said, a large number of admissions prices for attractions, days out or entertainment are either free of charge or heavily discounted for UC and PIP recipients as well.
However, it is the most essential goods and services where the price mechanism is most importantly needed. To ensure that people conserve scarce resources and to ensure that there is an incentive to provide those goods and services. In Britain we still seem to accept this idea for food, but long ago abandoned it for health care which we have just about kept going via direct government provision. However the economic model for many critical services in today’s Britain is cross-subsidy and means based pricing via private provision, rather than direct provision by the state. This relies on a lot of assumptions about productive citizens and existing suppliers with a lot of sunk costs keeping going in a market that none of them would have gone into had it been like that at the outset.
This brings us to this week’s latest attack on the price mechanism, which was the price cap that was announced on prescription charges for medication for pet animals. This was not a price cap on the medications themselves; merely on the prescriptions allowing pet owners to buy the medication elsewhere. These will now be limited to £20 for the first item on the prescription, and £12.50 for other items thereafter. This intervention follows an investigation by the Competition and Markets Authority (CMA) into rising veterinary bills which, anecdotally, I am aware is a real problem, particularly for animal rescue centres. However it seems telling that the CMA resorted to the bluntest tool available, rather than look at underlying market issues, including the wave of consolidation that has gone on in the sector, with many independent practices having been acquired by large chains.
All of this is a result of a stubborn … refusal to consider second or third-order effects of policy
It feels unlikely that this would have been the response in the 1990s or 2000s when the lessons of the marginal revolution were fresher in regulators’ minds. There might even have been cause to look into whether pet medications are over-regulated. Far fewer treatments are available over the counter in Britain than most other countries, with even some routine anti-parasitical drugs requiring professional involvement. But so normalised have price caps become that it is the automatic first response. The outcome is likely to be that it now becomes far harder to get an emergency prescription out of hours. If the pattern of other price caps is followed and all now cluster at or just below the cap, it may be that prices for regular prescriptions actually rise for many pet owners. The cap effectively becomes the minimum as well as the maximum charge.
All of this is a result of a stubborn — or perhaps pig ignorant — refusal to consider second or third-order effects of policy. We currently have a government dominated by people who are actively hostile to the idea that human beings respond to incentives (though this type of policy was also the hallmark of previous Conservative governments, especially that of Theresa May). We now see intervention upon intervention, with policy-makers desperately trying to address the consequences of their previous blow of the cudgel.
