How the utilities sector could play into the growth agenda


The new government’s recent “growth plan” has prompted huge debate and controversy. But whatever people may feel about the specific proposals, and who they benefit, it also raises relevant questions about the growth agenda more widely, and specifically for the utility sector. Associate Martin Hurst asks, how can the needs of net zero and the natural environment - both critical to utilities - be legitimately framed as good for growth?

We would argue that the government's plan boils down to three key aspects: certain (much publicised) tax changes; plans to significantly improve the supply side of the UK economy (which go well beyond a rebalancing towards lower tax) and a large unfunded cap on the average energy bill. In this article, we will focus on the first two, although we recognise the importance of the last one (not least in spooking the markets and as a way to avoid a major hit to short term consumer demand). 

The emphasis on growth, and particularly long term growth, from the new Tory Truss/Kwarteng administration is perhaps as much of a change from the Johnson/Sunak approach as the related shift towards a lower tax/lower public sector spending economy. But while the ‘trickle’ down theory cited behind the latter has aroused a lot of comment, (and criticsm) the growth agenda is perhaps less well understood. Unlike low tax policies, a long term growth agenda does not have to be the preserve of a particular political party – indeed some of the analysis was shared by Labour’s Gordon Brown and Ed Balls.  

So what could utilities do in practice? We would argue that the industry could be more active in selling the growth potential of environmental protection and net zero. This would create an advantage for the UK in what will be key growth industries of the future and be attractive for business and younger, skilled employees. Firms could argue for more training in green skills and climate adaptation. 

Finally, we need an intelligent and informed debate about the role of regulation in utilities; where it is needed (e.g. for market operation and certainty for investors and exporters) and where deregulation could genuinely help. 

There’s growth and growth! 

As a former treasury macro-economist (in the days of Nigel Lawson, Norman Lamont and Ken Clarke, which really dates me) I would distinguish between short term growth through short term demand stimulus - in the Chancellor’s words averting a major fall in consumer spending - while developing longer term ‘trend’ growth by improving the supply side. The government rhetoric seems to be more about the second (trend growth), and more of the non-tax elements of the growth plan are couched in these terms. But some of their actions are closer to the first (short term demand stimulus). There is, however, opacity about which measures lead to which sort of growth.

In normal times, with an economy at or close to recession and still recovering from the ‘hit’ of covid, some demand stimulus would (to a good Keynesian like myself) be in order. But here’s the rub; we are not in normal times. We have high inflation and a still tight labour market. A number of infrastructure projects, particularly the smaller ones, struggle to spend money because of the lack of labour and supply chain bottlenecks. 

The great danger against this uncertain background, is that rather than stimulating growth, the current package will simply increase inflation. And it is this fear, coupled with the risk premium associated with possible increased borrowing and debt, that sends jitters into the markets. Any hit to sterling will of course exacerbate this. And it also likely to lead to higher interest rates, which on top of the risk premium, further increases the government’s (and businesses’) cost of borrowing and servicing debt. 

For utilities this means that even reductions in real bills – as we currently see in water – may appear as significant annual cash bill increases: and we know who will get the blame for those. Falling sterling against the dollar would also increase utility input costs, with many inputs such as oil and raw materials, priced in dollars on world markets. 

Ironically, deficit financing, as the government is adopting, might have been more appropriate after the post 2008 recession triggered by the financial crisis, when austerity was the name of the game.

The supply side 

However, there are other key factors at play. The UK economy has fairly major supply side weaknesses. The Office for Budget Responsibility has estimated that the underlying rate of growth in the UK has fallen from 2.2% four years ago to 1.4% now. This really matters because longer term trend growth - the capacity of the economy to grow in the long term - is what pays in part for today’s spending. 

The UK’s standing in the various assessments of global competitiveness indices suggests that competitiveness has slipped over the past 5 years to somewhere between 12th and 23rd in the world. While we are still great at basic research, pretty good in terms of quality of life, digital and much basic infrastructure (notwithstanding urban congestion, and possible underinvestment in capital maintenance) we fall below par in skills/training, well planned tax policy, prices and the labour market.

Those of you with long memories may also remember ribald press comments about ‘ballsian endogenous growth theory’ which were attempts by Ed Balls, former Treasury special advisor and Shadow Chancellor, to boost the supply side. But there was a sound economic foundation to what he was saying. There is reasonable evidence that investment in training, research and development, and some infrastructure can boost ‘trend growth’. So, equally, there is some foundation to some of what the new administration is about. 

To its credit the new government also appears to recognise, and is trying at the margin, to address some of the constraints which have emerged over the past few years around labour market participation; such as over 50s deciding after lockdown they didn’t want to return to work and potentially its immigration policies for skilled workers. The FT no less has however suggested that we also need immigration of lower skilled workers – the care home, agricultural and construction worker we are struggling to recruit.

So, what might this mean in practice for utilities? Firstly, anything which eases labour bottlenecks must be helpful for the industry. Secondly, expenditure on energy and water resilience is being prioritised and is probably a good thing economically - though how best to do this is open to debate, and the timing needs to avoid exacerbating supply side constraints which would further drive up input prices. Thirdly, for those parts of the industry involved in risk-taking, lower corporation tax and some help for innovation is probably a help as is some of the (relatively minor) help for R&D. Finally, help for energy bills will reduce the spectre of non-payment and debt.

The gaps? 

But there are notable absences from the package as well as risks from other elements of the proposals for utilities. 

Firstly, demand management (and reduction) remains the poor relation in policy terms: and a libertarian desire to allow people to live their own lives, unfettered, sits ill with the sixth carbon budget finding that achieving net zero (and I would add energy and water resilience) through infrastructure alone adds significantly to the total bill. The House of Commons environmental audit committee also found a tendency across administrations to prefer ‘sexy’ infrastructure projects over demand management. 

Secondly, there is an urgent need to tackle skills, a classic supply side issue but one where spending seems set to be cut further in real terms by the delay in the spending review and the drive for ‘efficiencies’. The growth plan has a specific section on skills but is almost silent on training. The utility industry grows many of its own skills, but it can do more, and should urge government to invest in the building blocks: most notably further education and continuing support for apprenticeships.  

Third, while some deregulation can be good for the supply side, blanket deregulation is not. All utilities know the role of regulation in underpinning properly functioning markets. And for firms seeking to export, they will need to demonstrate compliance with foreign regulations; an inconsistent free-for-all in domestic markets can undercut this. Finally, as any economist will tell you, regulation can be an appropriate response to ‘market failures’ or ’externalities’ (e.g., pollution) and in many cases compliance with regulations can also help reduce corporate liability. Again, the industry should make the case for appropriate regulation – and there is a gulf where a well-reasoned analysis of regulation and the supply side ought to sit.

Fourth, the utilities industry needs to be involved in discussions around the so called new Enterprise Zones and the drive for housing growth. Efficient connectivity, a vital part of this, all too often gets lost in the debate.

Environmental reputation 

Most importantly, in apparently portraying the green agenda as a barrier to growth, the government ignores two key factors: the importance of ‘lifestyle’ as an attractor and the international recognition that the jobs of the future will be green jobs. 

There is clear evidence that lack of air pollution, clean water, and an attractive and accessible natural environment is a major attractor to many foreign businesses. Equally, if we are looking to attract internationally mobile younger skilled workers, the environmental reputation of a country and/or company or region is important. Before it was abolished, the South-East Regional Development Agency identified access to the natural environment as one of the key attractors to the region, to be built on and nurtured for its economic returns: a number of the LEPs (Local Enterprise Partnerships) have more recently reached similar conclusions. Finally, access to open spaces has been shown to be a powerful tool in preserving mental and physical health – and thereby reducing ever growing pressures on the NHS and increasing labour market participation. 

The director of business school INSEAD’s global talent competitiveness index recently said explicitly: “It is now time to ‘think post-pandemic’. Jobs linked to digital transformation and the greening of most sectors (finance, energy to transport, manufacturing and agriculture) will be in high demand across geographies.”

This is not about picking winners, in the pejorative sense of government picking its preferred  technologies (e.g., Concorde). It is about creating the environment and the prospect of ongoing returns for the technologies and skills of the future to develop in areas such as net zero, living with climate change and environmental protection where we know global demand will grow rapidly. While our utilities may not do much work abroad, many parts of the UK supply chain who work for them have world reputations, which we must not lose.

The UK not only has a comparative advantage in many aspects of net zero and the natural environment, it has globally respected ambassadors - think David Attenborough, Nick Stern, even King Charles. The utilities industry and its supply chain have a strong case to make for these areas to be nurtured rather than squandered. Failure to make changes now, and invest wisely, will cast a long shadow, whoever is in charge.