Politicians’ love of behavioural insights is quickly forgotten if votes can be bought with populist measures
When elections are imminent, talk is cheap, and cheaper still are politicians’ promises. Sure, there is little doubt that British Prime Minister Theresa May’s decision to call a snap election on 8 June was inspired by the Brexit challenge she faces. But there is more to governing than just extricating the country from the EU. So the election manifesto needs to contain some other pledges that might engage the electorate more than what role the ECJ should or shouldn’t play.
One such promise from the Conservative party is to cap the energy prices for people who are on the so-called standard variable tariff (SVT). Estimates vary, but up to 18 million households (out of a total of just over 26 million) are assumed to pay this tariff. The government reckons that with a price cap could save these households up to £100 per year.
Switching is hard
The UK energy market is characterized by fixed price deals, which freeze your gas and electricity prices for a given period of time. Almost all suppliers offer a range of such deals, with varying durations. All of them also have a standard rate, to which you revert at the end of your fixed deal (unless you select a new deal from the same supplier, or switch to a different supplier). The SVT fluctuates with the prices on the world markets, and is the default for whoever is not on a fixed option.
As the market got privatized and deregulated, comparison websites appeared, allowing consumers to check prices and identify the best deal for them. This, together with a landscape that contains six large suppliers and more than 40 smaller ones, was expected to provide sufficient competition to maintain a dynamic market with low prices.
So why do millions of people pay “too much”? Ofgem, the UK energy regulator, reported that 7.7 million switches of electricity or gas took place in 2016, up 28% from 2015, and a six-year high. But that still leaves nearly 20 million users who didn’t switch. Maybe some of them moved to a new suitable fixed-price deal with the same supplier. However, only 15% of users regularly switch, and as if to illustrate the point, Energy Secretary Greg Clark admitted he never switched electricity or gas suppliers himself because it is “a hassle”.
All else is never equal
Unilateral interventions like a price cap generally suffer from a fundamental flaw, for they come with the implicit assumption that nothing else will change. Somehow, so the logic goes, the supposedly ill-gotten profit by the energy giants can be siphoned back to the hapless consumer without any side effect.
But things will change, and there will be side effects. Suppliers are not stupid, and will respond to such interventions in any number of ways. They will seek to save costs (almost always labour cost, thus reducing employment), or they will invest less (which will mean dearer or less reliable supply in the future). Or maybe they will raise the prices of the fixed tariffs to protect their revenue, thus transferring money from the pockets of the astute customers to the passive ones. And if the price cap is announced in advance, they will raise prices in anticipation.
The least likely course of action is that they will give away part of their profits to the tune of £1.8 billion each year (that is £100 times 18 million households).
But the problem remains that, according to Citizens Advice, some vulnerable consumers lose out to the tune of £300 per year on poor value energy tariffs. In a recent blogpost, James Plunkett points at the existence of two markets as a cause: an active market, in which about 1/3 of the households switch regularly, and a passive market, in which people rarely switch. The energy companies, so the narrative goes, take advantage of the inertia of the passive households to keep their prices high.
There is nothing sinister about this: companies always try to discriminate between different types of customers. This the reason why retailers give discounts to people who can be bothered to cut out coupons, rather than to everyone, or why travel tickets bought in advance are cheaper than those bought at short notice.
Rewarding bad behaviour
But the problem of the maybe 4 or 5 million vulnerable and poor households, many of whom really would have a hard time switching online, can be resolved through targeted benefits or subsidies. A blanket price cap that would benefit at least 13 million households who are by no means poor or vulnerable, on the other hand is a terrible intervention.
Not only is it terrible from an economic perspective, it is awful from a behavioural perspective too. In a market economy, prices are kept low and quality high through competition. So you need a sufficiently large number of suppliers on the one hand, and discerning consumers on the other hand, able and willing to switch providers if they’re not happy with price or service levels.
If you want to strengthen this mechanism you’d need to nudge consumers towards being more astute and active, by making it easier to do so. Of course, some people are strongly motivated and happily cope with the hassle of finding a slightly cheaper deal. Others have been encouraged by nudges like prompts on bills. Additional nudges might get even more of those who are on the fence to take the trouble to switch. Not only does this save those people money, but more importantly, it also contributes to the good working of the market.
But a price cap is an anti-nudge: it makes it easy for people to do the wrong thing. It reinforces the status quo bias, by giving free money to people who do not switch. For all we know, they stick with the status quo not because of a bias, but because they deliberately prefer to stick with the same supplier (for whatever reason). And that behaviour, which weakens competition, will be rewarded by the proposed measure.
Politicians have been boasting for years about their adoption of behavioural insights — the UK’s was one of the trailblazers in this respect. But what we observe here is that the best behavioural approaches are no match for brazen populism and economic illiteracy.
It is doubtful a nudge would be sufficient to prevent politicians from resorting to such vote-buying tactics. For that, we would really need a rather potent shove.
Originally published at koenfucius.wordpress.com on May 12, 2017.
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