Capping energy tariffs isn’t a one-way ticket to Venezuelan-style economic ruin

The North Norfolk radio personality Alan Partridge once threatened to switch to a different petrol station because he felt the fuel on sale at his usual forecourt was “a bit obvious... a bit petrolly”.

But normal people don’t care where they get their energy from so long as it’s a good value. No one prefers the gas supplied by EDF to that from Centrica. The electricity from SSE doesn’t work any better than nPower’s version. The only real source of competition in the retail energy market is price.

The same applies to current account banking. The days when we would take pleasure from visiting an avuncular bank manager for a useful chat about our personal finances are, for better or worse, over. The limit of what most of us demand nowadays is a half respectable interest rate, a non-extortionate overdraft charge and, if we’re in a particularly demanding mood, a functioning website.

We’re often told that the magic of competition in a free market drives prices down and the quality of services up. But while generally true, it’s not universally so. If a seller knows more than the buyer about the product, ostensibly free markets can deliver some glaringly unsatisfactory outcomes.

The economist John Kay has written about “competitive misinformation” in markets such as retail energy where this kind of information asymmetry exists. The contracts offered by energy firms are nigh on impossible for the typical customer to understand. The same is usually true of the small print that outlines banks’ overdraft charges.

The complexity is intentional. It is designed to extract fat profits from the less savvy. The seller knows more than the buyer. The result is customer confusion and inertia. Half of us have been with our bank for more than a decade and only three per cent switch each year. Around two thirds of energy customers never switch and end up on the costly “standard variable” tariff.

And this inertia is a major source of profit for an oligopoly in both industries; the big four in banking and the big six in energy. The Competition & Markets Authority concluded last year that the latter “enjoy a position of unilateral market power over their inactive customer base”, earning them excess profits of £650m a year. The CMA says banks cream off around £1.2bn a year from unarranged overdraft charges.

When companies sell essentially the same product at different prices to different customers it’s usually the rich who tend to pay more: think of first class train or plane tickets. But in energy and banking it’s often the poor, elderly and vulnerable that end up being penalised.

Their loss is the gain of those who do switch, claim the oligopolies. But even active customers still suffer notoriously poor levels of service in both banking and energy. When a bank’s website crashes all customers are in the same boat. When a large energy company messes up its billing system no one is immune from the fallout.

One response to failing markets is to try to level out the informational playing field. This could be done by giving the least savvy customers more information through easy-to-use tariff or fee comparison websites, or by compelling providers to periodically remind customers that they might be able to switch to better deals.

Another response is to jumpstart competition by breaking up the oligopoly of providers in the hope that this will encourage a larger number of smaller providers to focus on customer service and more transparent pricing in order to grow their respective market shares.

But the first route hasn’t worked so far (although some still insist the breakthrough just need the right technology). And politicians and regulators have consistently balked at the second option, seeing structural reform of this nature as being too logistically and legally challenging.

So now we’re circling a third option: capping prices. Proposals to cap standard variable tariffs relative to better deals are being worked up for the Conservative manifesto, and the Labour MP Rachel Reeves is campaigning to limit bank overdraft fees.

It’s a gross error to assume that all markets are alike and always work perfectly. These economic forms are only valuable for the welfare their deliver; they are not an end in themselves. Structural reforms would probably be more effective and less prone to damaging political opportunism than price capping. But in already heavily regulated sectors such as retail banking and household energy provision it would be hysterical to suggest, as some free market fundamentalists do, that caps are the slippery slope to ruinous Venezuelan-style socialism.

Fundamentalist critics might care to consider a different risk: the discrediting of the many parts of the free market system that are working well from a chronic failure to fix those salient sectors that manifestly are not.