Private Island: Why Britian Now Belongs to Someone Else (18 page)

The 1979 Conservative manifesto barely mentioned privatisation, or denationalisation, as it was sometimes called. In 1968,
when an internal party think tank called the public sector of industry ‘a millstone round our necks' and proposed some sell-offs, Thatcher – who had been researching the privatisation of power stations and failed to find ‘acceptable answers' – was sceptical. ‘One could not have two rival enterprises,' she said, ‘seeking to sell electricity in competition one with another.' Littlechild disagreed. And in the ferment of the 1979 election victory, theorists like himself saw a rare chance to test their ideas in a real, live, industrial society of fifty million people. In October 1981 he published a paper in the house journal of the radical free-market think tank the Institute of Economic Affairs called ‘Ten Steps to Denationalisation'. Appearing alongside articles with such titles as ‘Why Recession Benefits Britain' and ‘The Tumbril and the Classroom', Littlechild's proposals would have seemed to most politicians and business people of the time like the ravings of a revolutionary dreamer. As the mainstream right talked warily of selling off parts of the steel industry, Littlechild jumped ahead to what few others imagined could be the future: to the privatisation of the railways and the Post Office. ‘What the Post Office needs,' he wrote, ‘is an imaginative asset stripper.'

His most extreme ideas, by the standards of the day, were about electricity. In Britain at that time, electricity was produced and distributed by a state organisation with a no-nonsense Attleeera moniker, redolent of brown paper envelopes and blotched stencils and corridors smelling of disinfectant: the Central Electricity Generating Board, the CEGB. Littlechild suggested splitting the National Grid off from the power-generating side of the CEGB, privatising regional electricity boards, letting private companies build power stations to compete with the state, and forcing the CEGB to sell or lease its coal and nuclear plants. It turned out these were not dreams, but prophecies packaged in an implementable plan; all were to come about within a decade.

As the great shift from public to private ownership of Britain's technological veins and sinews gathered pace through the 1980s – telephones in 1984, gas in 1986, airports in 1987, water
in 1989, leading up to electricity and the railways in the 1990s – the public perception was that Britain was becoming more like the United States, where, it was popularly believed, everything, including electricity, was provided by competing private companies. No autobiography of a British free-market thinker was complete without an American epiphany, a journey across the Atlantic to where Ronald Reagan's United States seemed to hum and sparkle in a virtuous free market circle of efficiency and prosperity.

Apart from the reality that, for most Americans, it didn't, the problem was that extreme pro-privatisation Brits like Littlechild thought the US hadn't gone far enough. So radical were the Thatcherite free market evangelicals that they thought America's electricity system all too similar to the neo-Soviet horrors, as they saw them, of the CEGB.

In nineteenth- and early twentieth-century Europe, only the earliest nodes of new-technology networks – piped water, gas, electricity, railways, telegraph and telephone communications, services that societies quickly became dependent on – were built as capitalist ventures. Gradually the networks were taken over, completed and run by national or local government. The United States took a different route. America let private companies carry on providing vital services like electricity; it also let them have local monopolies. But in exchange for being protected from competition, the companies accepted limits on their profits. The limit was worked out as a percentage of the amount the company and its shareholders had invested in the company – in building a power station, for instance – and how much it would have to invest in future to keep the system running. It was called ‘rate of return regulation', and it set a ceiling on the profits capitalists were allowed to make on an investment in something society couldn't live without.

It wasn't perfect. There were regular disputes over how much the companies should invest and how much customers should have to pay. But the arrangement gave American society
a generally robust set of networks that powered it through its twentieth-century transformation. Looking ahead, in the 1980s, to the great sell-off that few Britons knew was coming, Littlechild concluded that Britain could be more free-market than America. He had a powerful ally in Alan Walters, Thatcher's economic adviser, and when it came to the first of the big privatisations – the sale of British Telecom – Littlechild was commissioned to come up with new rules for governing the private companies on which the country would depend in the new, profit-led world.

The formula he came up with in 1983 sounded benign enough when it was presented to the public. Few knew or cared what it meant, still less how radical a departure it was: it seemed a minor detail compared to the enormity of privatisation itself. Littlechild's formula, known as ‘RPI minus X', isn't the only reason Britain's private power industry is now, thirty years later, an overwhelmingly foreign-owned oligopoly. But it is key. The trouble with the American system, Littlechild thought, was that it didn't reward electricity companies (or phone, water or gas companies) for being more efficient: for sacking superfluous workers, using cheaper materials or cutting back on luxuries like research. On the contrary, it encouraged them to invest in high technology and fancy experimental kit, because the more they invested, the more profits the regulator would let them keep. This, in turn, led to higher prices for customers. To an efficiency-obsessed theorist like Littlechild it all smacked of what he saw as the ghastly mix of bureaucrats, engineers, unions and politicians running the CEGB.

Littlechild's solution for Britain was to replace the American ceiling on profits with a ceiling on prices. Privatised companies would only be able to increase their prices each year by an amount equal to inflation, measured by the Retail Price Index, RPI, minus an X-factor, which the regulator would set every five years. Prices were supposed to fall, in real terms, every year: it sounded like a good deal for the customer. But what wasn't
obvious to most people was how huge the opportunities were for privatised electricity companies to cut costs, and not just by laying off workers. In
The Queen of the Trent
, published in 2009 to mark the fortieth anniversary of Cottam power station in Nottinghamshire, Robert Davis quotes one of the employees:

Under RPI-X, there was a big incentive for managers to root out such practices. But there was no need for them to pass on the gains to customers in the form of lower prices, or to invest them in research and new plants. As long as they kept their prices in line with the X-factor, managers could bank the profits they made from cost-cutting, or pass them on to shareholders, jacking up their own salaries along the way.

Littlechild, who became the privatised electricity industry's first regulator, thought this was a good thing. He was happy to see the privatised electricity companies make fat profits in the early years, thinking that this would draw in new competitors eager for a slice of the pie. They would build new power stations, eating into the incumbents' profits, poaching customers by offering lower prices. The least efficient electricity firms would go bust, the most efficient would thrive, and electricity would be cheaper. As old power stations wore out, they would be replaced because it was profitable to replace them: the market would organise itself to produce as much electricity as customers were prepared to pay for. To begin with, before full competition was established, he, the regulator, imagined he would act as a surrogate, a kind of State Competitor General, enforcing occasional price cuts to keep the private companies on their toes. In the end, he thought, the need for regulation would wither away.
What Littlechild, an academic with no business experience, didn't fully take on board was that the reason private companies compete with each other isn't that they like competition. They hate it, and will only compete if forced to do so. Rather than competing with a rival on price or product or revenue, they'll try to eliminate the rival firm and take over its territory by buying it; or reach an unwritten agreement on an oligopolistic cartel of a few big firms, carving up the market between them.

Electricity isn't a commodity like copper or coffee or water. It's the only commodity that is both essential to modern life and effectively impossible to store. An electricity system must be able to manufacture and transport as much power as the society it serves demands at every given moment, and not one watt less. The only efficient way to achieve this is for society to invest vast amounts of manpower and resources over generations to plan, build and maintain a network of power stations and supply cables, with excess capacity to deal with breakdowns and peaks in demand.

Britain built just such a network in the mid-twentieth century, and by the time it was privatised it was a creation of devilish intricacy, even before the government sliced it into pieces, replacing central planning with commercial contracts between sellers, makers and transporters of power. The local sellers of electricity, the twelve regional English electricity boards, were privatised as twelve separate companies in 1990. They would now buy their electricity wholesale, supposedly at market rates, mainly from the three big privatised concerns that made it: National Power and Powergen, which took over the CEGB's big coal-fired power stations in 1991, and British Energy, owner of the newest nuclear stations, which was floated on the stock market in 1996. Holding it all together, transporting electricity between power stations and from region to region, was the National Grid, owned jointly at first by the twelve local electricity firms; after 1996, it was an independent commercial player in its own right.

But once the privatisers factored in the costs of spare capacity, and the different profiles of different kinds of power station, they came up with a system for setting the wholesale price of electricity so complicated that the only people who understood it were the people whose interest it was for it to be as high as possible – the people running the electricity firms. In the course of the 1990s, the cost of oil, gas and coal fell and aggressive management made power stations much cheaper to run, mainly by cutting workers. And yet the wholesale price of electricity stayed the same. The big private players found ways to manipulate the market to keep prices high. They were able to game the system by declaring, for instance, that a certain power station was temporarily unavailable to generate electricity. The price of electricity would then rise – at which point the power station magically came back online. One company fingered for doing this – in an early report by Littlechild – was Powergen, headed by Ed Wallis, a former CEGB official who ran the operation to get coal to the power stations during the 1984–85 miners' strike. But however unethically it was behaving, Powergen wasn't breaking any law. It was simply taking advantage of the opportunities for bilking customers that were built in to the rules.

There were many other tactics. In the privatisation carve-up, Powergen inherited two small coal-fired power stations: Hams Hall, outside Birmingham, and Ferrybridge B, near Pontefract. They were used only in emergencies or during maintenance on the local electricity network, when it couldn't handle the voltage from the National Grid. Soon after Powergen took over, it announced that, as a commercial decision, it was going to close both stations. This forced the Grid to upgrade its transformers in the area, to make sure local people and businesses never risked a blackout. But while the upgrade was being carried out, the Grid couldn't be accessed, and Ferrybridge B and Hams Hall became indispensable to Yorkshire and Warwickshire. The stations' electricity had to be bought by suppliers, no matter how much it cost. While similar stations elsewhere in the country were
charging between £20 and £30 per megawatt-hour, Powergen hiked Ferrybridge and Hams Hall prices to £120. According to the calculations of Littlechild's statistical elves, this abuse of market dominance brought Powergen an extra £88 million in profits – an extra £88 million, that is, carved out of customers' electricity bills.

Wallis was pilloried in the media in the mid-1990s as the classic bureaucrat-turned-fat-cat for his £460,000 salary and lucrative share options, but his career and establishment reputation don't seem to have been tarnished by the conduct of the company he ran. Until 2014 he was chairman of the Natural Environment Research Council, responsible for handing out government money to scientists researching climate change.

As well as rewarding management and shareholders for cutting costs, RPI-X rewarded them for cutting corners. Unlike water and rail, which badly needed investment when they were privatised, the privatised electricity companies benefited from half a century of high investment in an over-engineered, lovingly maintained power system that produced more electricity than the country needed. In the early years they could slash investment without anyone, apart from their staff, being aware of the effects. Over-investment switched to under-investment, but the consequences of this wouldn't become clear until later.

RPI-X also allowed companies to reap the benefit of windfalls that were the result of luck rather than smart management. Since electricity is one of those things, like food, that people need whether there's an economic slump or not, the companies did relatively well out of the recession of the early 1990s. Their overheads were half what the experts predicted. The companies paid out generous dividends to shareholders and were still swimming in cash. Littlechild could have stepped in to lower prices, but he held back, fearful of intruding on managers' RPI-X nirvana. When he did act, the stock market found the price cuts he ordered so laughably mild that the companies' share prices shot up. In December 1994, the property conglomerate Trafalgar
House tried to buy Northern Electric, one of the privatised electricity companies. It offered £11 a share: four times what the civil servants and City advisers had sold it for a few years earlier. Northern Electric's cash mountain was so large that it was able to give each shareholder a fiver for every share they owned in order to prevent the takeover. The economist Dieter Helm, in his book
Energy, the State and the Market
, writes: ‘Northern Electric in effect revealed that it could have given its domestic customers a year without paying any bills and still have been able to finance its functions.'