There are lots of ways to explain our energy crisis. One is to use an analogy. Imagine a dairy farm serving a distant island’s villages has an outbreak of foot and mouth disease. Half the cows have to be slaughtered. Milk production halves. The milk price doubles. As milk prices rise, the villagers are in danger of entering milk poverty. The elders in one village decide to subsidise the price of milk, funded by a loan from the distant mainland that drives a wedge between the now-lower retail milk price and the price received by the farmer.
The next day, the farmer’s wholesale milk price doubles again. The elders in the other villages had also decided to subsidise milk prices. The farmer, however, only has half her original herd. She can’t provide all the milk demanded at the subsidised price. The only option is for the wholesale price to rise even further. Funded by additional loans, subsidies could be increased again but the more the villages borrow, the worse the terms will be.
Eventually, and reluctantly, milk is rationed. There is no other way of immediately bridging the gap between the continued high level of demand at the subsidised price and the much lower level of supply.
Might Europe’s and the UK’s energy subsidies prove to be as ineffective as the villages’ milk subsidies?
The Germans have capped their gas prices; the French have given energy vouchers to millions of households; the Italians have frozen fuel bills at 2021 levels; the Spanish, Dutch and Poles have been similarly generous. The British Government has, belatedly, done much the same. The subsidies and other support mechanisms might buy a bit of time. With luck, there might be good news further down the track: a resolution to the Ukraine war that leads to an increase in gas supplies across Europe as a whole or, alternatively, an increase in other energy sources, such as liquid natural gas or renewables.
And fiscal support has worked before, averting economic collapse during the Covid lockdowns. In effect, a financial bridge was constructed between a pre-Covid and a post-Covid world that prevented the closure of thousands of businesses and, with it, a huge increase in unemployment. Yet while wholesale gas and electricity prices have dropped a little in recent weeks, they’re still a lot higher than they were in, say, June, and about 10 times higher than they were before the current energy emergency kicked off. And forecasting future energy price levels has never been easy. In 1973, for example, oil prices quadrupled and, despite hopes they’d come straight back down, they doubled again in 1979.
Had governments back then attempted to maintain a “subsidy strategy”, two things would likely have happened: first, wholesale oil prices might have risen still further and, second, there would eventually have been intolerable increases in borrowing costs.
In truth, oil-importing nations had to learn to live within their new, more limited, means. The increase in oil prices had made them worse off: parts of industry became a lot less competitive, unemployment began to rise and, for those nations which tried to boost growth, inflation was the more likely result.
All of this is directly relevant for today’s UK Government. Liz Truss and her Chancellor, Kwasi Kwarteng, have announced a growth target of 2.5 per cent a year. In any other circumstances, achieving an acceleration from a recent average of a little over one per cent with no inflationary resurgence would be remarkable. In current circumstances, it will be even more so.
Just at the point when events beyond our shores are conspiring to make us worse off, our Government insists that it knows how to make us a lot better off. Yet if — as my milk analogy suggests — we are forced into some form of energy rationing, it’s difficult to see how the Government’s ambition could easily be met.
In the Seventies, change happened only when businesses, governments and households eventually came to accept that energy prices had both risen and were likely to stay high. Subsidies may cushion the short-term blow but they do little, if anything, to persuade people that a new reality is upon us. If anything, they only allow us to postpone an adjustment that, reluctantly, we may eventually have to make.
