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Public ownership and the performance of the UK ESI
Public ownership and the performance of the UK ESI Francis McGowan This article considers how far the performance of the UK electricity supply industry (ESI) has been affected by public ownership. It notes the difficulties for the ESI of defining performance and making comparisons, and focuses on specific areas where the ESI has been at fault (plant choice, construction times, etc). It argues that these shortcomings stem from the particular nature of the relationship between government and ESI in the UK not from public ownership per se and cautions against comparing an existing faulty structure with an idealised but untested system. Keywords:Electricity; Privatization; UK The privatization of the U K Electricity Supply Industry (ESI) will constitute the largest and most ambitious part of the government's policy of selling state industries. As such it will help to further the government's objectives of widening share ownership, boosting government revenues and reducing the government's borrowing needs. Ultimately, however, the justification for privatization has to rest on its effect on the economic performance of the industry. According to the rhetoric of the government the economic effect of privatization has been uniformly beneficial and substantial advantages are claimed for a transfer of the ESI to the private sector in terms of performance. Moreover, there is an implication that under public ownership, performance has been substantially less than ideal. Aside from the benefits of the policy itself the government believes that there are shortcomings with the current structure of the industry which justify the upheaval and considerable expense of privatization. Certainly, the record and reputation of publicly owned industries in the UK has been under attack in recent years and the ESI has suffered both by association and by its own shortcomings. But performance is a difficult factor to measure and the efficacy of ascribing it to a single factor - that of Francis McGowan is with the Energy Group, Science Policy Research Unit, University of Sussex, Brighton, BN1 9RF, UK.
E N E R G Y P O L I C Y June 1988
ownership - is far from self-evident. Focusing primarily on the experience of the Central Electricity Generating Board ( C E G B ) and its predecessors, this article sets out to assess how far the criticisms of the ESI's performance since nationalization can be attributed to public ownership. It examines the types of performance indicators and comparisons which are used and seeks to establish how far these demonstrate that public ownership p e r s e is at fault. Conversely it considers whether the benefits associated with privatization depend on the transfer of ownership or on other factors, such as the reorganization of the industry: is privatization necessary or sufficient to produce an improvement in performance?
DEFINING PERFORMANCE
There are two sets of conditions we can envisage where public ownership might be expected to affect performance. One is where public ownership entails substantial intervention by the government in the industry's operations, that is where the government chooses to use the industry as the mechanism for attaining objectives wider than those which the industry is charged with meeting. This can cover issues where the industry has a clear interest itself (but one which could conflict with those of the government) and those where the industry is not itself directly involved. The other situation is where the industry is itself inadequately managed, because of poorly articulated goals or the lack of constraints on management behaviour, or even the sheer size of the industry relative to any mechanisms of supervision or accountability. How might this gap in performance be assessed? Ideally, there should be some yardstick of comparison and some other case with which to make that comparison. In defining performance measures we can take a variety of indicators covering a wide range 221
Privatization: public ownership and ESI performance
of complexity and relevance for assessing the ESI under public ownership. In most assessments of private sector firms, the normal recourse is to the bottom line and a consideration of the company's profitability. Such a measure is difficult to employ in the case of monopolistic companies particularly when they are in public hands. Since most ESIs' profitability are either controlled by a public agency seeking to prevent an abuse of market power or owned outright by government which may place targets or requirements on profitability, assessing performance on this basis will be of limited use. 2 At one remove from profitability are the prices charged to consumers. While commonly used as a basis for comparison by defenders and detractors (generally on an international basis), they are fraught with problems. Not only do they share the usual problems of such exercises (fiscal regimes, exchange rates etc) but they also raise problems relating to fuel use and (as with profitability) regulation: can, for example, the price of Dutch electricity (which is so closely tied to the price of natural gas) be realistically compared with that of the UK? 3 A better basis might be to examine the costs incurred by the industry, either by taking a quantitative or a qualitative measure. Within this article the focus will be on the latter. Quantitative analyses of costs to be of any use need to take account of a range of conditions which affect those costs. 4 Therefore the attention will be on qualitative factors where the decisions of management (or those imposed upon them) will have increased the costs incurred by the industry.
system. The success of the CEB in the prewar period was coupled with the recognition that it was still limited by the imbalances and shortcomings of the existing system (for example the failure to take advantage of economies of scale in distribution because of small catchment areas). The election of a Labour government committed to public ownership, eased the nationalization of the industry, but it was a decision with far wider support. Public ownership was not intended to mean government control of the industry; it was designed to address 'market failures' and ensure better operation. Legislation has aimed at setting conditions for this to happen rather than sanctioning widespread governmental interference. However, government has for a variety of reasons been more closely involved in the fortunes of the ESI than was intended by the architects of nationalization. In the initial period after the war, for example, the government used the development of the ESI as a strategic instrument for reconstruction. 5 The Electricity Act of 1947 laid down a number of broad objectives which required the industry to act both as a guarantor and promoter of the public i n t e r e s t and as a business m i n d e d public corporation) This rather vague commitment has been at the root of the relationship between the ESI and the government ever since. While this Morrisonian principle of nationalized industry was interpreted by the industry as leaving them in charge, governments have not only sought to define more clearly how performance should be monitored, but have also intervened in the industry's affairs where they felt the public interest dictated.
Political influence and strategic choices
ASSESSING THE ESls' PERFORMANCE
The debate of the last few years surrounding the performance of the industry, and particularly the proposals for reorganizing the sector, are almost the mirror image of the debate surrounding the ESI in the interwar period. At that time, it was believed that public ownership would improve the operation of the industry. In the 1920s imbalances in supply and demand and the poor technical performance of many private and locally owned utilities prompted the Conservative government of the day to establish the Central Electricity Board (CEB) which built the national grid and took control over many power plants, allowing for a major rationalization of the
222
The reorganization which nationalization entailed undoubtedly helped improve the performance of the industry. The technical efficiency of the industry was considerably improved. As the Herbert Committee stated, 'the centralisation of responsibility for ownership and operation of generation and transmission under nationalisation enabled substantial gains in efficiency to be made'. 7 There were also advantages derived from standardization of equipment. In addition, the rationalization of the industry that this involved, helped by technical improvements in the sector, led to greater productivity. The influence of government on technological performance was not uniformly benign, however. In certain respects the governmemt imposed constraints on the choice of equipment, arguably detracting from its potential. For example, the plant ENERGY POLICY June 1988
Privatization: public ownership and ESI performance
size in the period following nationalization was constrained by government controls on how big plant could be constructed thereby restricting the potential economies of scale to be obtained by the industry. How much of a restraint on performance this constituted has been debated (it was regarded as a problem only during the 1950s). However, to the extent that it hindered better technical performance, it was one imposed by the government on the industry, rather than one chosen by the ESI itself. ~ A further barrier to performance might be adduced by the decision to engage in a programme of nuclear power plant construction. Again it is not clear how far this proved to be a burden rather than a benefit for the industry (in terms of the misallocation of resources which the massive investment entailed) but, again, it was largely a decision of the government rather than one taken by the ESI. 9 Moreover the bases of these decisions were undoubtedly taken for more reasons than short-run economic efficiency: security of supply and the links between civilian and military uses of nuclear power were just as important. Related to both these factors is the influence of government over the choice of power plant supplier. It has been suggested that the imposition of a 'buy British' requirement on UK utilities has meant that costs of plant have been higher than they would have been on the open market, thereby imposing additional capital costs on the ESI for industrial policy requirements. Yet, such protection has been and continues to be the norm in most nations with a heavy electrical industry (and consequently low priced exports from abroad may be to some extent dumped). It may be that if no such obligation existed the CEGB would be able to lower its capital costs, though this assumes that the utility would be able to control costs of construction (rather than of plant) rather better than it has done in the past. l° Government has also exerted influence over the industry's fuel purchasing decisions, and specifically the obligation to purchase domestically produced coal. This, it is believed, has raised the industry's fuel costs unreasonably. Although the agreement is directly between the utility and the coal industry, and the CEGB (in 1979 when oil prices were again rising rapidly) was anxious for the agreement, there is little denying that the agreement is politically determined. Certainly it is to be expected that privatizing the industry will give the ESI more negotiating clout v i s a vis the coal industry, and there is no real justification for the consumer bearing the cost of subsidy. But whether or not it is in the ESIs' long-run interests to see the UK coal
ENERGY POLICY June 1988
industry collapse is questionable. In recent years, such as after the oil crises, UK coal has been able to match internationally traded prices while foreign exchange fluctuations have also affected the competitiveness of the industry. It has only been in recent years with the collapse in oil prices, the fall of the dollar price of internationally traded coal and the exchange rate of the dollar that domestic coal had become unattractive. (Moreover, an increase in imports equivalent to one third of the UK coal industry would increase the world steam coal trade by 10%, putting considerable pressure on price). I1 All these are factors where ESI choices have been heavily conditioned by government decisions framed by wider considerations than simply the economic performance of the industry. In certain cases, those decisions appear to have conflicted with the optimal short-term performance of the industry. However, these are the kinds of strategic issues where governments have traditionally been involved in the industry, regardless of the complexion of ownership (and where government is, in the case of nuclear power, prepared to continue to intervene). As well as these interventions, which have been regarded as impairing the industry's performance, the government has also stepped in to improve the performance of the industry. These have included the setting of financial targets, performance objectives and external financing limits, each of which is designed to impose financial and efficiency constraints on the industry. Even these, however, appear to be used as much by the government for macroeconomic purposes as for improving the industry's performance. 12 Indeed, paradoxically, these measures, particularly the External Financing Limit, have often appeared to be more opportunistically abused than the 'political' interventions discussed above.
ESI management performance However, more specifically problematic for the ESI are those areas where its own conduct has been perceived as at fault. Criticisms in this regard focus on two areas in particular: the CEGB's forecasting and investment appraisal record and its management of power plant construction projects. In such a capital intensive industry, investment decisons are critical to the overall performance of the ESI. Yet it has been an area where the industry has been criticized over the years. The principal problem has been over optimistic forecasts based on too high an assessment of growth in both the economy and in energy demand, the effect of which
223
Privatization: pubfic ownership and ESI performance
was to encourage premature orders and increase costs. However, this was a period when many utilities were over optimistic about demand trends leading them to invest in surplus capacity. According to most assessments, moreover, these faults have been recognized and corrected.13 Construction is clearly an area where the industry has performed poorly. Moreover, it is a problem which has beset the industry throughout the post nationalization era. In the 1950s the Herbert Committee recognized that construction times had to be improved. The problem became particularly acute, however, in the 1960s and 1970s. In 1969, the Wilson Committee concluded that poor plant construction record was due to a rapid increase in orders overwhelming the design and production capabilities of manufacturers. On site, industrial disputes and the poor productivity of the contractors' workforces further lengthened construction times. Subsequent reports compared the CEGB's record with other countries, revealing that construction times and any delays which occurred were far shorter abroad than in the UK. Again the differences were attributed to poor productivity and labour relations on site and the redesign of equipment during construction, with the latter problem particularly acute in the nuclear construction programme. 14 Behind these specific faults is an implication that the CEGB had failed to manage properly. The problems ranged from poor investment appraisal (on the suitability of the AGR programme for example), failure to control changes in design and most importantly, an inadequate system of controls over plant construction companies. This latter problem stemmed from the poor contractual terms set by the CEGB with its suppliers (where essentially a cost plus pricing system was in operation). Another contributory factor has been a tendency towards 'gold plating' (ie overspecification in plant design), something which can be attributed to the CEGB's own preferences on the one hand and the lack of accountability or control over it on the other. Can these faults of management in appraisal, forecasts and controlling construction be attributable to public ownership? It can be argued that the industry was too complacent in its forward planning and in its control of construction, and that this complacency was due to the lack of a bankruptcy or takeover constraint or the discipline of shareholders. This may have been reinforced by the pattern of ownership which has placed considerable power with the CEGB (with little effective countervailing authority). But cost overruns, delays and poor fore-
224
casting are not unique to the UK nor to public ESls and, where they have occurred, they have generally not led to the collapse of the utility in question since the nature of the industry does not generally permit these 'market' constraints to operate. J5 Gold plating for example is a problem in the USA where private utilities predominate.
CONCLUSIONS
Has ownership affected the performance of the UK ESI? Few would dispute that in terms of day to day operations, the industry's record is good. The industry has witnessed a steady improvement in productivity over the period of public ownership, in latter years meeting the objectives set for it by the government.l~' This steady record of improvement is attributable in a large part to technological improvements but also to good labour relations between the CEGB and its workforce. The opportunity offered by nationalization to restructure the industry laid the basis for that improvement in efficiency, though it was largely the restructuring rather than the public ownership which has brought this about. Indeed, in some respects it appears that the style of public ownership in the UK has adversely affected the performance of the ESl both in terms of the framework in which it operates and in how certain activities have been carried out by the industry. The objectives which the ESI was set were problematic in two respects: not only were they vague in determining how the industry should be run but they also left the government considerable scope for influencing the industry's conduct. Some of these interventions have been designed to encourage the industry to better efficiency, but others were aimed at fulfilling broader governmental objectives at the expense of the industry's performance. While the government has every right to set policies which will impinge on the ESI, it should not expect the ESI and the consumer to bear the burden of those policies. The main area where the industry appears to be at fault - in planning investment and controlling construction costs - may be attributable to public ownership inasmuch as devising incentives for management to control costs is difficult (since there is no real bankruptcy or takeover constraint), particularly where the authorities confront a single monopolistic company. However, this should be qualified since on
ENERGY POLICY June 1988
Privatization: public ownership and ESI performance
the one hand the problem is not unique to the UK ESI while on the other, certain parts of the problem are quite widespread throughout the UK economy. In other words, the root of the problem may be organizational (the way in which the industry has been structured in relation to other parts of the industry, its controllers and its consumers), sectoral (to do with the problems of the ESI p e r se as it reaches 'maturity') or national (to do with the UK) rather than solely with the complexion of ownership. Such factors make the task of comparison difficult (quite apart from the more usual problems). Indeed when these are carried out it is far from clear that public agencies p e r se are at fault. Many of the examples used to show the poor performance of the UK industry reveal that those countries where the industry 'perforgns' better have themselves a substantial public ownership component. Moreover, where comparisons within countries have been possible, the public component is generally found to be as efficient as the private utility.17 A quick examination of ESIs in many countries reveals that the industry itself is under reorganization in all sorts of systems. The shortcomings of industries change as do the solutions proposed from country to country, but there is a general impression of challenge and reform. In most countries, however, the concern is less with ownership than with greater competition (something which has been relatively absent in most UK privatizations but seems to be recognized in the case of the Electricity White Paper). The problems of performance which have been identified could be tackled by redefining the relationship between the industry and government on the one hand and restructuring the industry itself on the other, without privatizing at all. Such a strategy would not of course provide the other benefits of privatization which the government is seeking, but it might bring about a better organized and more accountable ESI. Finally it is worth remembering that in the present context, the reality of an existing system - warts and all - is being contrasted with the ideals of a new regime, the virtues of which are theoretical. That privatization is necessary or sufficient for improving the performance of the industry, let alone justifying the considerable expense of a stock market flotation, is similarly open to question. 1For a useful account of the critique of nationalized industries see R. Rees, Public Enterprise Economics, Weidenfeld and Nicholson, London, UK, 1984, pp 11if; and H. Paris, P. Pestieau, and P. Saynor, Public Enterprise in Western Europe, Croom Helm, London, UK, 1987, chapter 9.
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POLICY June 1988
2Of course, the government may set targets on profitability as a spur to improved performance (indeed, return on investment has been a key consideration of government attempts to assess the efficiency of nationalized industries). Moreover, an examination of it may tell us about the relationship between the industry and its controllers in different countries. As a basis for comparison itself however, profitability is not a good guide. 3Until the oil price collapse Dutch utilities produced some of the highest cost power in Europe. Subsequently they have some of the cheapest power in Europe. 4One of the key sources used by critics of the UK system has been the Nuclear Energy Agency (NEA) study, Projected Costs of Generating Electricity from Nuclear and Coal-fired Power Stations for Commissioning in 1995, OECD, Paris, 1985. This is used both by A. Henney, Privatise Power, Centre for Policy Studies, London, UK, 1987 and A. Sykes and C. Robinson, Current Choices, Centre for Policy Studies, London, UK, 1987. However, the purpose of this report was not to assess the differences in costs between countries. Moreover, the authors in an earlier version of the report caution that those who publish costs, 'explain the purpose for which they are calculated and the basis on which they are derived. Simplistic comparison of different figures within or between countries may yield nonsensical conclusions'. NEA, The Costs of Generating Electricity in Nuclear and Coal Fired Power Stations, OECD, Paris, 1983, p 43. SSee D. Helm, and F. McGowan, Electricity Supply in Europe: Lessons for the UK, Institute for Fiscal Studies, Working Paper, 1988. 6See L. Hannah, Engineers, Managers and Politicians, Macmillan, London, UK, 1982, p 11. ZQuoted in R. Pryke, Public Enterprise in Practice, MacGibbon and Kee, London, UK, 1971, p 378. 8F. Brechling and J. Surrey, Economic Review, May 1966. The policy had its advantages inasmuch as it standardized production of power equipment at a time when the UK economy was still recovering from the war. 9For an account of the pressures on the CEGB see L. Hannah, up cit, Ref 6, pp 171ff and 241-4, H. Rush, G. MacKerron and J. Surrey, 'The advanced gas-cooled reactor: A case study in reactor choice', Energy Policy, Vol 5, No 2, June 1977, pp 95-105. I°B. Eckstein, The Pofitics of Power Plant Trade, Trade Policy Research Centre, London, UK, 1971, gives a good account of the close relations between utilities and power plant manufacturers throughout the industrialized world. 11For an account of the possible effect of privatization on coal purchases see A. Holmes, J. Chesshire and S. Thomas, Power on the Market, Financial Times Business Information, London, 1987, pp 103ff. While they suggest that the coal market is unlikely to tighten in the next few years, the price competitiveness of UK coal could be radically altered by shifts in the exchange rates of the pound and the dollar. 12L. Hannah, up cit, Ref 6, p 282; and A. Holmes et al, up cit, Ref 11, pp 92-5. 13See Monopolies and Mergers Commission, Central Electricity Generating Board, A Report on the Operation by the Board of its System for the Generation and Supply of Electricity in Bulk, HMSO, London, 1981, pp 41-47. 141bid, pp 248ff. ~5On the USA experience of similar problems see L.S. Hyman, America's Electric Utilities - Past Present and Future, Public Utilities Reports, Arlington, VA, USA, 1987, pp 115-6. 16For an up to date assessment of the industry's performance in relation to other nationalized companies and to the UK economy see R. Molyneaux and D. Thompson, 'Nationalised industry performance: still third rate?', Fiscal Studies, Vol 8, No 1, pp 67-8. ~ZR. Millward, 'The comparative performance of public and private ownership', in Lord Roll, ed, The Mixed Economy, Macmillan, London, UK, 1982.
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E N E R G Y P O L I C Y June 1988
ownership - is far from self-evident. Focusing primarily on the experience of the Central Electricity Generating Board ( C E G B ) and its predecessors, this article sets out to assess how far the criticisms of the ESI's performance since nationalization can be attributed to public ownership. It examines the types of performance indicators and comparisons which are used and seeks to establish how far these demonstrate that public ownership p e r s e is at fault. Conversely it considers whether the benefits associated with privatization depend on the transfer of ownership or on other factors, such as the reorganization of the industry: is privatization necessary or sufficient to produce an improvement in performance?
DEFINING PERFORMANCE
There are two sets of conditions we can envisage where public ownership might be expected to affect performance. One is where public ownership entails substantial intervention by the government in the industry's operations, that is where the government chooses to use the industry as the mechanism for attaining objectives wider than those which the industry is charged with meeting. This can cover issues where the industry has a clear interest itself (but one which could conflict with those of the government) and those where the industry is not itself directly involved. The other situation is where the industry is itself inadequately managed, because of poorly articulated goals or the lack of constraints on management behaviour, or even the sheer size of the industry relative to any mechanisms of supervision or accountability. How might this gap in performance be assessed? Ideally, there should be some yardstick of comparison and some other case with which to make that comparison. In defining performance measures we can take a variety of indicators covering a wide range 221
Privatization: public ownership and ESI performance
of complexity and relevance for assessing the ESI under public ownership. In most assessments of private sector firms, the normal recourse is to the bottom line and a consideration of the company's profitability. Such a measure is difficult to employ in the case of monopolistic companies particularly when they are in public hands. Since most ESIs' profitability are either controlled by a public agency seeking to prevent an abuse of market power or owned outright by government which may place targets or requirements on profitability, assessing performance on this basis will be of limited use. 2 At one remove from profitability are the prices charged to consumers. While commonly used as a basis for comparison by defenders and detractors (generally on an international basis), they are fraught with problems. Not only do they share the usual problems of such exercises (fiscal regimes, exchange rates etc) but they also raise problems relating to fuel use and (as with profitability) regulation: can, for example, the price of Dutch electricity (which is so closely tied to the price of natural gas) be realistically compared with that of the UK? 3 A better basis might be to examine the costs incurred by the industry, either by taking a quantitative or a qualitative measure. Within this article the focus will be on the latter. Quantitative analyses of costs to be of any use need to take account of a range of conditions which affect those costs. 4 Therefore the attention will be on qualitative factors where the decisions of management (or those imposed upon them) will have increased the costs incurred by the industry.
system. The success of the CEB in the prewar period was coupled with the recognition that it was still limited by the imbalances and shortcomings of the existing system (for example the failure to take advantage of economies of scale in distribution because of small catchment areas). The election of a Labour government committed to public ownership, eased the nationalization of the industry, but it was a decision with far wider support. Public ownership was not intended to mean government control of the industry; it was designed to address 'market failures' and ensure better operation. Legislation has aimed at setting conditions for this to happen rather than sanctioning widespread governmental interference. However, government has for a variety of reasons been more closely involved in the fortunes of the ESI than was intended by the architects of nationalization. In the initial period after the war, for example, the government used the development of the ESI as a strategic instrument for reconstruction. 5 The Electricity Act of 1947 laid down a number of broad objectives which required the industry to act both as a guarantor and promoter of the public i n t e r e s t and as a business m i n d e d public corporation) This rather vague commitment has been at the root of the relationship between the ESI and the government ever since. While this Morrisonian principle of nationalized industry was interpreted by the industry as leaving them in charge, governments have not only sought to define more clearly how performance should be monitored, but have also intervened in the industry's affairs where they felt the public interest dictated.
Political influence and strategic choices
ASSESSING THE ESls' PERFORMANCE
The debate of the last few years surrounding the performance of the industry, and particularly the proposals for reorganizing the sector, are almost the mirror image of the debate surrounding the ESI in the interwar period. At that time, it was believed that public ownership would improve the operation of the industry. In the 1920s imbalances in supply and demand and the poor technical performance of many private and locally owned utilities prompted the Conservative government of the day to establish the Central Electricity Board (CEB) which built the national grid and took control over many power plants, allowing for a major rationalization of the
222
The reorganization which nationalization entailed undoubtedly helped improve the performance of the industry. The technical efficiency of the industry was considerably improved. As the Herbert Committee stated, 'the centralisation of responsibility for ownership and operation of generation and transmission under nationalisation enabled substantial gains in efficiency to be made'. 7 There were also advantages derived from standardization of equipment. In addition, the rationalization of the industry that this involved, helped by technical improvements in the sector, led to greater productivity. The influence of government on technological performance was not uniformly benign, however. In certain respects the governmemt imposed constraints on the choice of equipment, arguably detracting from its potential. For example, the plant ENERGY POLICY June 1988
Privatization: public ownership and ESI performance
size in the period following nationalization was constrained by government controls on how big plant could be constructed thereby restricting the potential economies of scale to be obtained by the industry. How much of a restraint on performance this constituted has been debated (it was regarded as a problem only during the 1950s). However, to the extent that it hindered better technical performance, it was one imposed by the government on the industry, rather than one chosen by the ESI itself. ~ A further barrier to performance might be adduced by the decision to engage in a programme of nuclear power plant construction. Again it is not clear how far this proved to be a burden rather than a benefit for the industry (in terms of the misallocation of resources which the massive investment entailed) but, again, it was largely a decision of the government rather than one taken by the ESI. 9 Moreover the bases of these decisions were undoubtedly taken for more reasons than short-run economic efficiency: security of supply and the links between civilian and military uses of nuclear power were just as important. Related to both these factors is the influence of government over the choice of power plant supplier. It has been suggested that the imposition of a 'buy British' requirement on UK utilities has meant that costs of plant have been higher than they would have been on the open market, thereby imposing additional capital costs on the ESI for industrial policy requirements. Yet, such protection has been and continues to be the norm in most nations with a heavy electrical industry (and consequently low priced exports from abroad may be to some extent dumped). It may be that if no such obligation existed the CEGB would be able to lower its capital costs, though this assumes that the utility would be able to control costs of construction (rather than of plant) rather better than it has done in the past. l° Government has also exerted influence over the industry's fuel purchasing decisions, and specifically the obligation to purchase domestically produced coal. This, it is believed, has raised the industry's fuel costs unreasonably. Although the agreement is directly between the utility and the coal industry, and the CEGB (in 1979 when oil prices were again rising rapidly) was anxious for the agreement, there is little denying that the agreement is politically determined. Certainly it is to be expected that privatizing the industry will give the ESI more negotiating clout v i s a vis the coal industry, and there is no real justification for the consumer bearing the cost of subsidy. But whether or not it is in the ESIs' long-run interests to see the UK coal
ENERGY POLICY June 1988
industry collapse is questionable. In recent years, such as after the oil crises, UK coal has been able to match internationally traded prices while foreign exchange fluctuations have also affected the competitiveness of the industry. It has only been in recent years with the collapse in oil prices, the fall of the dollar price of internationally traded coal and the exchange rate of the dollar that domestic coal had become unattractive. (Moreover, an increase in imports equivalent to one third of the UK coal industry would increase the world steam coal trade by 10%, putting considerable pressure on price). I1 All these are factors where ESI choices have been heavily conditioned by government decisions framed by wider considerations than simply the economic performance of the industry. In certain cases, those decisions appear to have conflicted with the optimal short-term performance of the industry. However, these are the kinds of strategic issues where governments have traditionally been involved in the industry, regardless of the complexion of ownership (and where government is, in the case of nuclear power, prepared to continue to intervene). As well as these interventions, which have been regarded as impairing the industry's performance, the government has also stepped in to improve the performance of the industry. These have included the setting of financial targets, performance objectives and external financing limits, each of which is designed to impose financial and efficiency constraints on the industry. Even these, however, appear to be used as much by the government for macroeconomic purposes as for improving the industry's performance. 12 Indeed, paradoxically, these measures, particularly the External Financing Limit, have often appeared to be more opportunistically abused than the 'political' interventions discussed above.
ESI management performance However, more specifically problematic for the ESI are those areas where its own conduct has been perceived as at fault. Criticisms in this regard focus on two areas in particular: the CEGB's forecasting and investment appraisal record and its management of power plant construction projects. In such a capital intensive industry, investment decisons are critical to the overall performance of the ESI. Yet it has been an area where the industry has been criticized over the years. The principal problem has been over optimistic forecasts based on too high an assessment of growth in both the economy and in energy demand, the effect of which
223
Privatization: pubfic ownership and ESI performance
was to encourage premature orders and increase costs. However, this was a period when many utilities were over optimistic about demand trends leading them to invest in surplus capacity. According to most assessments, moreover, these faults have been recognized and corrected.13 Construction is clearly an area where the industry has performed poorly. Moreover, it is a problem which has beset the industry throughout the post nationalization era. In the 1950s the Herbert Committee recognized that construction times had to be improved. The problem became particularly acute, however, in the 1960s and 1970s. In 1969, the Wilson Committee concluded that poor plant construction record was due to a rapid increase in orders overwhelming the design and production capabilities of manufacturers. On site, industrial disputes and the poor productivity of the contractors' workforces further lengthened construction times. Subsequent reports compared the CEGB's record with other countries, revealing that construction times and any delays which occurred were far shorter abroad than in the UK. Again the differences were attributed to poor productivity and labour relations on site and the redesign of equipment during construction, with the latter problem particularly acute in the nuclear construction programme. 14 Behind these specific faults is an implication that the CEGB had failed to manage properly. The problems ranged from poor investment appraisal (on the suitability of the AGR programme for example), failure to control changes in design and most importantly, an inadequate system of controls over plant construction companies. This latter problem stemmed from the poor contractual terms set by the CEGB with its suppliers (where essentially a cost plus pricing system was in operation). Another contributory factor has been a tendency towards 'gold plating' (ie overspecification in plant design), something which can be attributed to the CEGB's own preferences on the one hand and the lack of accountability or control over it on the other. Can these faults of management in appraisal, forecasts and controlling construction be attributable to public ownership? It can be argued that the industry was too complacent in its forward planning and in its control of construction, and that this complacency was due to the lack of a bankruptcy or takeover constraint or the discipline of shareholders. This may have been reinforced by the pattern of ownership which has placed considerable power with the CEGB (with little effective countervailing authority). But cost overruns, delays and poor fore-
224
casting are not unique to the UK nor to public ESls and, where they have occurred, they have generally not led to the collapse of the utility in question since the nature of the industry does not generally permit these 'market' constraints to operate. J5 Gold plating for example is a problem in the USA where private utilities predominate.
CONCLUSIONS
Has ownership affected the performance of the UK ESI? Few would dispute that in terms of day to day operations, the industry's record is good. The industry has witnessed a steady improvement in productivity over the period of public ownership, in latter years meeting the objectives set for it by the government.l~' This steady record of improvement is attributable in a large part to technological improvements but also to good labour relations between the CEGB and its workforce. The opportunity offered by nationalization to restructure the industry laid the basis for that improvement in efficiency, though it was largely the restructuring rather than the public ownership which has brought this about. Indeed, in some respects it appears that the style of public ownership in the UK has adversely affected the performance of the ESl both in terms of the framework in which it operates and in how certain activities have been carried out by the industry. The objectives which the ESI was set were problematic in two respects: not only were they vague in determining how the industry should be run but they also left the government considerable scope for influencing the industry's conduct. Some of these interventions have been designed to encourage the industry to better efficiency, but others were aimed at fulfilling broader governmental objectives at the expense of the industry's performance. While the government has every right to set policies which will impinge on the ESI, it should not expect the ESI and the consumer to bear the burden of those policies. The main area where the industry appears to be at fault - in planning investment and controlling construction costs - may be attributable to public ownership inasmuch as devising incentives for management to control costs is difficult (since there is no real bankruptcy or takeover constraint), particularly where the authorities confront a single monopolistic company. However, this should be qualified since on
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Privatization: public ownership and ESI performance
the one hand the problem is not unique to the UK ESI while on the other, certain parts of the problem are quite widespread throughout the UK economy. In other words, the root of the problem may be organizational (the way in which the industry has been structured in relation to other parts of the industry, its controllers and its consumers), sectoral (to do with the problems of the ESI p e r se as it reaches 'maturity') or national (to do with the UK) rather than solely with the complexion of ownership. Such factors make the task of comparison difficult (quite apart from the more usual problems). Indeed when these are carried out it is far from clear that public agencies p e r se are at fault. Many of the examples used to show the poor performance of the UK industry reveal that those countries where the industry 'perforgns' better have themselves a substantial public ownership component. Moreover, where comparisons within countries have been possible, the public component is generally found to be as efficient as the private utility.17 A quick examination of ESIs in many countries reveals that the industry itself is under reorganization in all sorts of systems. The shortcomings of industries change as do the solutions proposed from country to country, but there is a general impression of challenge and reform. In most countries, however, the concern is less with ownership than with greater competition (something which has been relatively absent in most UK privatizations but seems to be recognized in the case of the Electricity White Paper). The problems of performance which have been identified could be tackled by redefining the relationship between the industry and government on the one hand and restructuring the industry itself on the other, without privatizing at all. Such a strategy would not of course provide the other benefits of privatization which the government is seeking, but it might bring about a better organized and more accountable ESI. Finally it is worth remembering that in the present context, the reality of an existing system - warts and all - is being contrasted with the ideals of a new regime, the virtues of which are theoretical. That privatization is necessary or sufficient for improving the performance of the industry, let alone justifying the considerable expense of a stock market flotation, is similarly open to question. 1For a useful account of the critique of nationalized industries see R. Rees, Public Enterprise Economics, Weidenfeld and Nicholson, London, UK, 1984, pp 11if; and H. Paris, P. Pestieau, and P. Saynor, Public Enterprise in Western Europe, Croom Helm, London, UK, 1987, chapter 9.
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POLICY June 1988
2Of course, the government may set targets on profitability as a spur to improved performance (indeed, return on investment has been a key consideration of government attempts to assess the efficiency of nationalized industries). Moreover, an examination of it may tell us about the relationship between the industry and its controllers in different countries. As a basis for comparison itself however, profitability is not a good guide. 3Until the oil price collapse Dutch utilities produced some of the highest cost power in Europe. Subsequently they have some of the cheapest power in Europe. 4One of the key sources used by critics of the UK system has been the Nuclear Energy Agency (NEA) study, Projected Costs of Generating Electricity from Nuclear and Coal-fired Power Stations for Commissioning in 1995, OECD, Paris, 1985. This is used both by A. Henney, Privatise Power, Centre for Policy Studies, London, UK, 1987 and A. Sykes and C. Robinson, Current Choices, Centre for Policy Studies, London, UK, 1987. However, the purpose of this report was not to assess the differences in costs between countries. Moreover, the authors in an earlier version of the report caution that those who publish costs, 'explain the purpose for which they are calculated and the basis on which they are derived. Simplistic comparison of different figures within or between countries may yield nonsensical conclusions'. NEA, The Costs of Generating Electricity in Nuclear and Coal Fired Power Stations, OECD, Paris, 1983, p 43. SSee D. Helm, and F. McGowan, Electricity Supply in Europe: Lessons for the UK, Institute for Fiscal Studies, Working Paper, 1988. 6See L. Hannah, Engineers, Managers and Politicians, Macmillan, London, UK, 1982, p 11. ZQuoted in R. Pryke, Public Enterprise in Practice, MacGibbon and Kee, London, UK, 1971, p 378. 8F. Brechling and J. Surrey, Economic Review, May 1966. The policy had its advantages inasmuch as it standardized production of power equipment at a time when the UK economy was still recovering from the war. 9For an account of the pressures on the CEGB see L. Hannah, up cit, Ref 6, pp 171ff and 241-4, H. Rush, G. MacKerron and J. Surrey, 'The advanced gas-cooled reactor: A case study in reactor choice', Energy Policy, Vol 5, No 2, June 1977, pp 95-105. I°B. Eckstein, The Pofitics of Power Plant Trade, Trade Policy Research Centre, London, UK, 1971, gives a good account of the close relations between utilities and power plant manufacturers throughout the industrialized world. 11For an account of the possible effect of privatization on coal purchases see A. Holmes, J. Chesshire and S. Thomas, Power on the Market, Financial Times Business Information, London, 1987, pp 103ff. While they suggest that the coal market is unlikely to tighten in the next few years, the price competitiveness of UK coal could be radically altered by shifts in the exchange rates of the pound and the dollar. 12L. Hannah, up cit, Ref 6, p 282; and A. Holmes et al, up cit, Ref 11, pp 92-5. 13See Monopolies and Mergers Commission, Central Electricity Generating Board, A Report on the Operation by the Board of its System for the Generation and Supply of Electricity in Bulk, HMSO, London, 1981, pp 41-47. 141bid, pp 248ff. ~5On the USA experience of similar problems see L.S. Hyman, America's Electric Utilities - Past Present and Future, Public Utilities Reports, Arlington, VA, USA, 1987, pp 115-6. 16For an up to date assessment of the industry's performance in relation to other nationalized companies and to the UK economy see R. Molyneaux and D. Thompson, 'Nationalised industry performance: still third rate?', Fiscal Studies, Vol 8, No 1, pp 67-8. ~ZR. Millward, 'The comparative performance of public and private ownership', in Lord Roll, ed, The Mixed Economy, Macmillan, London, UK, 1982.
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