The UK energy crisis is a burden of war

Desperate times call for desperate measures. The UK has rightly supported Ukraine’s cause in its war with Vladimir Putin’s Russia. Today’s soaring gas prices are as much a weapon in Putin’s fight as missiles directed at Ukraine and, like them, they will kill. It would be a crime and a folly to let the domestic costs of the war fall disproportionately on the least well off. Solidarity in sharing these burdens is obligatory. So, too, is willingness to shed shibboleths. In wartime, markets are not sacrosanct. Price controls, even rationing, must be on the table.

The price of natural gas is nearly 5 times what it was a year ago. The result is a distributional shock, a terms of trade shock (since the UK is a big net importer of gas), an overall price shock, with inflation likely to hit 20 per cent, and a contractionary shock to gross domestic product.

The distributional shock is the most important. According to ING, even with the measures already taken by the government, the cost of energy could rise from 12 per cent of household disposable income for the lowest decile in 2021 to 41 per cent between October 2022 and September 2023. Even at the sixth decile it could go from 4 to 14 per cent of disposable income. This would be a massive (and massively unequal) squeeze on people’s real incomes. According to the Resolution Foundation, the UK is set to experience the largest two-year decline in median non-pensioner real disposable income after housing costs in 100 years.

It is evident that losses to less well off households on this scale would be morally and politically unbearable. So, too, would be the costs to businesses and the likely reductions in spending and gross domestic product. Something has to be done and it has to be massive, given the scale of this shock. So what should it be?

There exists a standard, professionally approved package. It is, as IMF staff have recently repeated, to allow price signals to operate freely and target the vulnerable. That approach would surely be better than the regressive tax cuts discussed in the Tory leadership contest. But this is one of those situations in which a difference of degree is a difference in kind. A rise in prices that is manageable by most of the population is one thing. A rise in prices that imposes such big costs on almost everyone, while giving huge windfalls to a few producers, is something else altogether.

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These price rises are unnecessarily and unsustainably large. It is also hard to target assistance, without creating a cliff edge between those who are helped and those who are not. Not least, it is very difficult to target the help in ways that allow for differences in household circumstances. None of this matters all that much if the price rises were smaller. But these ones are too large. The country cannot permit many millions to do without the energy they need, especially in winter.

So, what is to be done? Torsten Bell has argued in the FT that we need to cap energy prices at below the current market rates. I agree. Indeed, we need to do this, while also simultaneously targeting assistance at the most vulnerable, since it is certainly sensible, in terms of incentives and limiting the fiscal costs, to allow a significant, albeit constrained, rise in prices.

The UK has the substantial advantage that it is not overwhelmingly dependent on foreign sources of gas. On the contrary, almost half of total supply comes from the UK continental shelf. Furthermore, only 44 per cent of electricity is generated by gas, with another 43 per cent coming from “zero-carbon” sources (nuclear and renewables).

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So, while imported gas is a big tail, there is no reason at all why it should wag the energy dog. As an emergency measure, the government can and should impose price controls on domestic gas producers and generators of nuclear and renewable electricity. These prices should be substantially higher than prewar, but not at today’s “Putin levels”. The government should also subsidise the price of gas imports to these controlled levels. These controls (and subsidies) should end when prices of imports fall back, as they surely will.

The government will also need to fund the envisaged subsidies and targeted assistance to the vulnerable. Again, as in wartime, this should be done through additional borrowing and taxes on the well off justified as a special and temporary “solidarity levy”. This will not go down well with many members of the Conservative party. Yet the new prime minister needs to remember that this electorate need never again be their concern. The nation as a whole definitely is.

This is war. The government must act. Tinkering is not enough. Go big. Be bold.

martin.wolf@ft.com

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