Economics: Killing coal digs a pit for economy

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FAR from relieving the air of panic, Friday's cut in base rates merely confirms it. Would bank base rates have been cut if there had not been such a public drubbing of the Government's decision to sack 30,000 miners? I doubt it. Indeed, the circumstances for a base rate cut looked better at the beginning of the week, when the pound was stronger. By Friday, sterling was weak but interest rates still came down. This is policy by reflex.

I will return to the appalling state of the economy, but the economics of coal deserve a detour. Rarely can any major policy announcement have been so insensitively handled, or have done so much damage to business and consumer confidence. In one decision, ministers distilled the feeling both that the Government is out of control and that the economy is declining rapidly.

The Government appears to have assumed that Arthur Scargill's unpopularity would allow it to kill King Coal with a single argument: the privatised electricity companies do not want to buy coal. They prefer gas-fired stations. Why should we doubt their free decision any more than we question the choice of Marks and Spencer to stock blue lingerie or chocolate buttons?

But even someone entirely untutored in economics could see that the parallels simply do not hold. This is not a market with many producers and many purchasers whose outcomes are the free result of competition. The coal, gas and electricity markets involve substantial monopolists and oligopolists with the power to distort competition. It cannot be taken as given, even by market-oriented economists, that a market outcome is a socially desirable one.

First, the Government effectively gave 18 per cent of the total potential market for coal or gas to nuclear electricity four years ago. One subsidy does not necessarily justify another for coal, but let us not pretend that this carve-up was based on price. Nuclear cannot be privatised because there are still too many unanswered questions about risk, fuel storage and waste.

Secondly, the regional electricity companies (RECs) have a local monopoly, and can pass on rises in costs to their customers so long as they can persuade their regulator, Offer, that they are buying their supplies 'economically'. Many of them have entered into contracts to buy the electricity from new natural gas-fired power stations in which they have a shareholding.

At long last, Offer is now investigating these contracts. True, gas plant can produce electricity for 2.95p per kilowatt hour at present prices, compared with 3.25p per kwh for new coal-fired plant. Existing coal plant was largely built before 1973 and will need to be replaced by the end of the century. But the cost of existing coal plant varies between 2p and 3p per kwh. Why is so much gas plant planned so quickly?

The only respectable economic answer is that the RECs were afraid of the generating duopoly of Powergen and National Power, and scared of relying too much on a supplier as prone to industrial action as British Coal. But that argument needs to be tested publicly, and it has not been.

There is also a serious question about whether the gas price charged for the new capacity is likely to hold in the long term. After the initial rush to sign deals, British Gas raised its price so sharply that it brought down on itself the wrath of its own regulator, Ofgas. The price rise was limited to 30 per cent. Higher gas prices would call into question both the investment in gas plant and the coal redundancies.

If all these economic questions were satisfactorily answered, and if we were in a recovery so that unemployed miners could readily find jobs, there should be little argument about the restructuring of the coal industry. In any dynamic, growing economy, people need to adapt to changing patterns of demand for products and services even at the cost of personal upheaval. If we did not, we would all still be ostlers, smiths, maids and footpads.

But the economics of redundancy become quite different in the middle of a recession when the miners have nowhere else to work. The economy will lose the miners' output. The Government will lose the taxes of miners, to whom it will now have to pay social security on top of redundancy payments. It is doubtful whether the Treasury will be much ahead on the deal even in financial terms. What a terrible, sad mess.

EVEN before the coal debacle, the recession was taking a turn for the worse. Last week's figures for manufacturing output showed a decline in August which is probably the harbinger of many more. The summer CBI surveys suggested a build- up of stocks of unsold goods as production ran ahead of demand. As predicted, managers have returned from holiday to embark on a new round of cost-cutting, including redundancies.

The other alarming recent statistic was the 3 per cent fall in house prices in September. The drop will undermine consumer confidence, and make a retail recovery more halting. It will also deter first-time buyers, and stop chains from starting in the housing market. With few people moving house, demand for furniture and decorations will stagnate.

Debt deflation - the phenomenon of forced sale of assets to pay back debts, which then drive down asset prices and cause further forced sales - was a feature of the great depression of 1929-32. Ironically though, it may have been less of a threat then than it is today. Only a third of the population had any net assets. Today, two thirds of the population are home-owners.

However, other comparisons with the 1930s are more comforting. A solid social security net and the growth of the public sector have helped to stabilise the inter-war economy. At the time, there were no figures for national output. (The figures shown in the graph only refer to industrial production). But Professor Charles Feinstein's estimates suggest that national output dropped by 11.5 per cent in 1921 and 5.8 per cent in 1929-31. This compares with drops of 2.4 per cent in 1973-75, 3.2 per cent in 1979-81 and 2.4 per cent last year, with perhaps another 1 per cent this year.

Unemployment was much worse between the wars. As a proportion of the workforce, unemployment reached 10.1 per cent in September, whereas the rate among the insured population in 1932 was 22.1 per cent. Since unemployment was less severe among the poorer people in domestic service and farming who were not insured, the overall rate was probably 15.6 per cent in 1932, on Professor Feinstein's figures.

The experience of unemployment was far more devastating than it is today. If you were insured, you had to pass a means-test based on family liability, so that you were subject to snoopers seeing whether your wife or daughter were working. The economic historian Dudley Baines says that the benefit for two adults and two children, in today's money, was pounds 30 per week, a figure which was expected to cover rent as well. That compares with pounds 95.70 a week today, not including housing benefit to cover rent (typically, say, pounds 22 a week).

Thank heavens for the welfare state. We will need it. This recession is already the longest of the post-war period, and it now looks set to become the deepest.