From The
Independent:
"The UK’s Big Six gas and electricity suppliers
saw billions wiped off their stockmarket valuations after Theresa May outlined
plans to go ahead with a cap on energy prices."
This is on the back of
Theresa May's foolish announcement of a draft bill to impose an energy price
cap for consumers in order to “bring an
end to rip-off energy prices once and for all”.
Alas,
because Theresa May is unapprised of basic economics, she seems to have it in
her head that the nefarious energy firms are enjoying excessive profits at the
expense of their customers. Here's where she is going wrong (any Corbynites who
have the same idea about rent controls should grab a pen and paper too).
The
word ‘excessive’ is a strange one when talking about profits, because excessive
is a term that is relative to a perceived value or number. If the average
height for a woman is 5ft 5in, and your sister is 6ft 2in, her height is
excessive compared to the average. But ‘excessive’ profits in the market simply
mean higher than expected, where expected
means marginal revenues equal marginal costs of the standard textbook order we are more used to
(most firms make a lot less profit than you probably imagine).
If
an entrepreneur is making higher than expected profits, it indicates that he or
she evaluated future projections better than competitors did - or if there’s a
lack of competition, it indicates that he or she innovated ahead of others in
the market. To do this you need to find a gap in the market that isn’t being
filled, or identify better than others scarcity of supply or abundance of
demand that are not being matched in equilibrium. Such entrepreneurs are the
ones most likely to bid up the prices of goods that are not priced high enough,
or not in sufficient supply, and push down the price of excessive outputs.
That’s
short term. In the long run, though, we don’t want businesses to make excessive
profits above the average cost of capital, because it means there aren’t enough
competing forces for price efficiency. Competitors are the ones pushing the
boundaries of innovation in order that they obtain their share of the profits,
and in doing so they are contributing to increased value, better technology,
more efficiency, and greater well-being and prosperity.
And
that scenario is pretty much always what you see in a competitive market,
because in the short term when profits are
higher than
expected due to some niche being found, or innovation-based success being
enjoyed, there is room for others to enter that part of the market and add more
value to society (you can click on my Energy part of the side bar to read why there are quite naturally only a few big players in the energy industry, and how they are not charging 'rip-off energy prices' as our dearly confused politicians seem to think).
I wish our politicians would bear in mind this next important thing too. Most people don't know
what it's like to be a large employer, so they hardly ever put themselves in
the position of the corporation. They foolishly think that corporations have
plenty of spare capital knocking around that can be confiscated and used to
ramp up wages and pay people what politicians and their supporters have avowed that they
'deserve' (price caps are merely an indirect form of confiscation).
But even if it were not the
case that corporate profits aren't that high, there is an even bigger picture that
has to be factored in. Investors in large capital projects are not just the
ones making the biggest risk of no return, they are the ones that stand to lose
the most if the venture fails.
Good large scale
investment is much harder than it sounds - you not only need a good assessment
of the current market landscape, you need a solid eye for future landscapes and the concomitant
probabilities that accompany that evaluation. This is even more of a compelling
point when you remember that average profits hover around the 5%-7% mark. Time
you factor in the large amounts of planning, building, and other capital
investment to get the project off the ground, many entrepreneurs face a risk of
a huge loss for a relatively small gain.
Given the
foregoing, it's also easy to see how government policy designed to cap prices
or extract high levels of tax from these companies makes the reckless
assumption that the company's income will carry on at the same level - often
failing to realise that some way down the line, price fixing and heavy
regulatory protocols do a lot of invisible harm to businesses - harm that is
off the radar - because, like the butterfly effect, the long chain of events
that precede it are not tracked by the naked eye, and engender lots of tangible
costs down the line that make prospective investment more precarious that it needs to be.
I wish politicians
of all party colours would learn the very basic economic principle that you
cannot impose these burdening interferences on the signals of supply and demand
without changing a lot of behaviour and creating a lot of market disincentives that
will have the knock on effect of harming the consumers they think they are
helping. and make the marketplace more unstable for prospective investors.
