Freeing the electricity market

(Next Magazine, 2015/7/23, A002, Second Opinion, Bill Stacey)

Freeing the electricity market

Hong Kong is known to have the world’s freest economy, an accolade repeatedly affirmed by both the Fraser Institute and Heritage Foundation. Many advocates of capitalism, however, disparage our economy as a hopelessly cartelized, uncompetitive and driven by the worst kind of cronyism.

What is going on here? Why would genuine advocates of economic freedom choose to laud a place that some argue exemplifies the opposite? Why would others, among them The Economist, once an advocate of free trade, not recognize economic freedom in practice?

Part of the answer is that some who disparage our economy are setting up a straw man. They might say that economic liberty is a nice ideal, but argue that, in practice, it is impossible and has always become cartelized among cronies.

Hence, it is argued that what is bad about Hong Kong is the result of its market-friendly policies, and much residual good comes from the benign hand of an actively intervening government. The trouble with this view is that it is at odds with facts. Hong Kong does have more free markets, lower taxes and more bounded regulations in many areas than most other places.

The more credible critique of Hong Kong as a haven for economic freedom is that parts of our economy have indeed been less free and less competitive than they should be. Behind these subpar parts of our economy are usually regulations, vested interests and the hand of policy makers.

Rice importation, for instance, was subject to quotas until deregulation in 2003. Banking and finance has become more concentrated as regulation has become more complex, crushing smaller players and discouraging new entrants. Property markets changed in the post-war era, with the centrally planned new towns and public estates set up in ways that marginalized smaller and private developers.

However, some of our other critics simply misunderstand how economic freedom works, especially in a small, open and culturally distinctive economy like ours. Markets are dynamic and constantly adjust and adapt to ever changing incentives, ebbs and flows of talent pool and tastes of consumers. Textbook models of “perfect competition” rarely describe real markets, and such models are by no means necessary to beget the efficiency, choice and gains that are the hallmarks of free markets.

Our economy is open in the extreme and it is fully integrated with global markets. The number of companies in some local industries might be few, but they always face the threat of new entrants and technologies from the world over. They face keen competition from everywhere as businesses and individuals can easily move to get the lowest price and better quality.

For example, Hong Kong’s electricity market might have only two providers. This market was nevertheless more competitive than the broad vertically integrated regional monopolies in most countries. However, in the last 20 years, new technology has made it possible for the separation of generation, transmission and distribution of electricity thus enabling spot markets and trading of electricity. Our providers are too tightly bound by rate of return regulation, clean energy requirements and mandated energy supply contracts to reap the benefits of the new technology.

Should we redesign our electricity market to conform with the international model? That is not the way that market process works. Instead, we should review existing regulations with the aim of removing all barriers to entry. That might involve doing away with the Scheme of Control that caps the rate of return while allowing owners to open their power grids.

Our two existing providers should be free to source electricity from anywhere they choose, whilst potentially reconfiguring their business through merger or demerger. With our ties to the rest of China and new technology, a free market in electricity may well lead to innovative and cheaper solutions.

Markets designed by planners to have low and stable returns are unlikely to be truly competitive. As the new Competition Ordinance takes effect from December, we need to make sure these new overseers don’t meddle more in markets by inadvertently making them less competitive.

Bill Stacey