Energy price stabilization: lessons from the postwar era
Inflation has rebounded strongly in Europe over the past 18 months. In particular, the spectacular increase in energy prices (+20% for oil products and +34% for gas in a year in October) is affecting other sectors, especially transport. For example, Insee last May reported a 15% year-on-year increase in the price of SNCF train tickets, even as the company advanced a 7% reduction.
It must be admitted that the situation is explained by the results of the war in Ukraine, especially for short-term reasons. However, the structure remains little in question and, as we have done in our study, it does not seem uninteresting to go back to the basic principles of pricing services that have the characteristic of being dependent on extremely high fixed costs. For example, the construction of a railway line or a nuclear power plant.
At the heart of these issues we find the concept of marginal cost. This takes on new urgency at a time when energy prudence is being promoted by government authorities in the face of the risk of shortages and lack of supply.
High Priests
In France, the foundations were laid after the war. During liberation, electricity and railways, highly strategic areas during the reconstruction of the country were completely managed by state authorities. The issue of pricing these public services was largely addressed by engineer-economists such as Roger Hutter at SNCF or Marcel Boiteux and Gabriel Dessus at EDF.
All participate in the same consensus, leading to frequent exchanges and discussions on a theoretical and practical level. In his 1993 biography, Marcel Boiteux describes the “high priests” of economic calculation, “touched by the marginalist grace” instilled in them, mainly by the 1988 Nobel laureate in economics, Maurice Allais.
As early as 1945, Allais was commissioned by the then Minister of Reconstruction and Urban Development, Raoul Dautry, to study the SNCF’s economic model. The goal? Aim for the common good, that is, for Allais to provide maximum public service while minimizing cost to society.
The price policy of the young SNCF at that time (founded on January 1, 1938) was guided by two main rules: on the one hand, to apply multi-fare discrimination, i.e. different prices depending on whether one traveled in first, second or third place apply. class; on the other hand, to follow the principle of equality of all before public services, that is, the same price per kilometer for all consumers belonging to the same class.
As a first guess, it may be tempting to charge a moderate price for the service. We take the total cost and divide it by the number of units produced. The solution has the advantage of avoiding a budget deficit for a public company: users pay for the costs they create for society. Nevertheless, high prices will eventually discourage the use of public services, which Allais will highlight as inefficient in terms of social welfare.
The method required
Allais and his colleagues will quote a price based on what is called marginal cost, the cost of producing an additional unit of the good. For example, the marginal cost of electricity is more expensive per kilowatt-hour compared to ongoing production. The marginal cost of a train is the cost of an additional passenger on that train. The idea, seen another way, is that going from zero to one traveler doesn’t cost the same as going from 999 to 1,000 travelers.
This is the price we will try to charge the passenger who wants to board the train. Approaching this number in the traditional market is one of the effects of competition. However, SNCF and EDF were, by definition, public monopolies largely free from competitive pressures. Allais then concluded that the most economically efficient solution was to imitate free market prices.
The marginal solution is, in a way, an intermediate method where the average cost is free, i.e., the service is collectively financed by taxation, leaving all the massive initial investment to travelers. However, it poses great difficulties in terms of application.
Reduce forest size
Why are prices at marginal cost more desirable than the alternatives? One of the fathers of the introduction of this price, the polytechnic Gabriel Dessus, offered a fictional example to illustrate the advantages of marginalist pricing, which he himself tried to implement as a director of the commercial EDF. Let us freely continue the main lines of his remarks.
Let’s imagine that two energy sources can be used: firewood, which is found everywhere in the village, and a coal mine located in the center of the village. Let’s imagine that every villager is capable enough to take either ore or wood.
An hour’s work in the mine, or even half an hour of cutting, is necessary to warm up comfortably. Therefore, the villagers will prefer to heat themselves with firewood and take advantage of the extra half hour of rest. However, the distance to be traveled before reaching the forest will increase by cutting. After a while, fetching firewood will be more work than mining, and villagers will choose to work in the mine because this solution is more economical in time.
Suppose that logistical reasons force the municipality to adjust prices. How could the village head, who is concerned about the interests of the community, set the optimal price?
Price is also information
Imagine that the municipality sets the price of firewood at the beginning of each year at an intermediate price between the cost at the beginning of the year and the cost at the end, then it will be necessary to go further. This fixed price would force the villagers to use the forest throughout the year, although it would be desirable to stop sooner from the perspective of collective effort. By exploiting the mine a bit more, they would spend less time at work.
Unlike fixed pricing, marginal pricing prevents time wastage by “informing” consumers of the true value of the time they use the resource they are using. Villagers are then incentivized by prices to use feasible alternatives in a way that minimizes their effort. In fact, the issue with public transport and electricity is somewhat the same.
It is more expensive during peak hours
Marginal cost pricing was introduced in France with the desire to offer consumers an “informed” choice. They should be able to make optimal decision-making in terms of resource utilization from a community perspective.
For example, off-peak/off-peak pricing is based on marginal pricing in particular: an extra kWh costs almost nothing at night, when demand is low. But during the day, when the industry requires energy, the power plants are overloaded and unable to meet the excess demand.
The off-peak/off-peak tariff informs users that it is in the public interest to consume as much as possible during the night. Those who can change their consumption with some effort are encouraged to do so because of cost, and this change discourages the construction of large and very expensive electric parks.
Marginal fares also suggest paying more at peak times when trains are likely to be overcrowded. It encourages those who can afford to travel at a different time and serves the whole community through both good-sized infrastructure and less unpleasant travel conditions.
“Information through prices” also allows to adapt to new technologies and socio-political constraints, quickly and able to revise their choices: during the gas crisis, for example, rising prices push consumers to withdraw from alternative sources; or, for lack of something better, using the resource sparingly.
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HDR Lecturer in the History of Economic Thought at the University of Paris 8, Catholic University of Louvain (UCLouvain) and by Thomas Michael Mueller Economics lecturer at Cote d’Azur University.
This article was originally published on The Conversation.
