The curse of Government electricity: Pakistan

While Americans focus on terrorism in Pakistan, Pakistanis are overwhelmingly concerned about their poor electricity supply, thought to be 2/3s of total demand. Estimates are that the country loses 6% of its GDP to inadequate power supply, but this probably doesn’t include the investment that doesn’t occur because of the shortages, or the many health problems caused by people relying on poorly combusted biomass.

This provides a perfect case study of the line between appropriate government involvement in an economy and excessive interference. The most crucial factor was the acceptance of the government of responsibility for energy prices, treating them as a provided benefit rather than an economic good. As a result, consumers come to expect lower prices, and voters (or rioters) punish any effort to raise them. In theory, the intent is to help the poor, but the rich consume far more energy, as do industries, and so receive most of the benefit.

The result is that the utility doesn’t have enough income to invest in new production to meet rising demand, which impedes economic growth and reinforces poverty in a vicious circle. The public is skeptical of any effort to explain that costs aren’t being covered, and most politicians feel too insecure to face public outrage.

Oil and grain prices are heavily influenced by international markets and so far beyond the control of domestic politicians that it is easier for the public to understand when prices go up. Electricity prices are only partly affected by international fuel prices, and so citizens are less willing to accept that the government can’t control them, making rational reform all the more difficult.

The second biggest mistake was to rely on state owned enterprises (SOEs). SOEs are especially vulnerable to runaway costs, as politicians treat them as their personal piggy banks, providing jobs for friends. (Hardly unique to Pakistan; Boston’s Mayor Curley followed a similar practice.) And because SOEs are part of the government, they are sometimes harder to control. Reigning in a private company is often easier and more acceptable for regulators than passing restrictions on a different department of the government.

Obviously, the easiest solution is to never take responsibility complete control over prices in the first place, but lacking a time machine, that is not a solution available to governments like Pakistan’s. The twin problems—prices too low and poor cost control—are quite separate, but both result from government involvement in the market. Allowing power companies to recover costs can be accomplished through regulation, and was done so for many years in most of the US.

Distribution of electricity is a natural monopoly, but generation is not. However, moving from one system to another, and particularly raising prices, remains a puzzle that few governments have solved. The best practice is to calculate the extra cost to the poor and offer them equivalent cash grants, while raising prices to market levels. And to make the move politically acceptable, find a politician will to be sacrificed, fired as punishment in response to public outrage over the policy, which would quietly remain in place.

http://www.forbes.com/sites/michaellynch/2013/12/06/the-curse-of-government-electricity-pakistan/?ss=business%3Aenergy