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The writer is professor of economic policy at the University of Oxford
It wasn’t meant to be this way. The UK’s wave of privatisations in the 1980s and 1990s was intended to create private sector balance sheets that could be used to borrow to invest. But there was a flaw: the belief in light-touch regulation. So regulators decided that the balance sheets were a matter best left to the companies, and, even worse, positively incentivised them to borrow by mortgaging the assets and paying out the proceeds to investors. As the years passed, negative real interest rates and quantitative easing were added to the mix. Financial engineering became the main game in town — and a very profitable one.
Not only did the regulators let the companies get away with gearing up their balance sheets and paying out extra dividends, they also failed to ensure they did the day job: looking after the assets. Across the utilities there is a widespread perception that things are not working. When it comes to water, we see the tangible effect of sewage in our rivers.
None of this was inevitable: it is a result of spectacular regulatory failure. In theory, the regulators could now restate the balance sheets to allow debt only for new investment not paid for by current customers, demand that the rest of the equity is put back, make investors fix all those pipes and sewers, and ensure that electricity networks can stand up to storms. The chances of this happening are close to zero. The horses have bolted with their dividends.
The day of reckoning for this mismanagement, seen last week with the struggles of Thames Water, has arrived at a very inconvenient moment. All the utilities need massive investment to make them fit for purpose. Water needs billions to sort out sewage treatment, pipes and supply shortages. Electricity needs a massive investment programme to achieve net zero by 2035 (or 2030 under Labour plans) and secure supply.
The money will have to come mostly from outside the UK. Tinkering around with pension funds might help a bit, but the fundamental facts are that the UK runs a massive external current account deficit. Foreigners need to lend us the money to buy more than we sell so that we can live beyond our means, prop up the fiscal deficit, and pay for all the shiny new net zero infrastructure, better sewers, HS2 rail links, airport expansions and the completion of the fibre and mobile networks.
These (largely overseas) investors made hay while the sun was shining but they are unlikely to feel remorse at the excess payouts, volunteer to put back equity to deal with the shortfalls or stump up for the infrastructure renewal that is so obviously needed. If the nation doesn’t want to save, we must beg and beggars can’t be choosers.
Tinkering will not fix this. We need a fundamental reset and we need the investment. We will have to pay the costs of investment or be forced to do so through higher taxes. That would be a big hit on standards of living in the middle of a cost of living crisis. But net zero investment is going to cost. Cleaner rivers are going to cost.
Serious regulatory reform is needed too. It requires an integrated systems-based regulatory regime, with reasonable profits and costs paid for by customers and taxpayers. We currently regulate in silos and lack joined-up planning for electricity generation and networks and for river catchments. We can’t even efficiently fit smart meters — the programme is years behind schedule.
It is not impossible to fix all this but renationalisation is a red herring. Neither Conservative ministers nor Labour have come to terms with the fact that no one else will pay for all this. They both set targets, promise cheap, secure low-carbon power and clean rivers, while being unwilling to spell out uncomfortable truths about the cost. Until they do, bet instead on more ad hoc sticking plasters, more Thames Water-style casualties, postponed net zero targets and a further widening of the gap between the problem and delivering the solution.