What is going on here?
I have many favourite quotes about economics and economists. Let me share a current one:
If economists could manage to get themselves thought of as humble, competent people, on a level with dentists, that would be splendid!
(Source: Keynes, J. M., “Economic Possibilities for Our Grandchildren” (1930) in Keynes, J. M. Essays in Persuasion (London: MacMillan and Co., 1931).)
Not for the first time I have reason to give thanks to another great economist for this reminder and insight.
An accomplished dentist is one who identifies the source of the patient’s problem - “What is going on here?” – and draws effectively on old and new techniques from the store of knowledge to relieve that problem.
(Source: Kay, John and Mervyn King, Radical Uncertainty: Decison-making for an unknowable future. Chapter 21 Practical Knowledge p. 388.)
In my recent re-reading of these 400 plus pages from Kay and King I was reminded that when I think about the economic possibilities for my now 2 grandchildren the humblest thing to do is simply ask:
"What is going on here?"
On 8th October Ofwat updated its assessment of water company performance using the latest data now available for the financial year 2023-24. Let’s look at (some) of the data without the prejudice of any headlines.
Source: Author analysis of data from ?https://www.ofwat.gov.uk/publication/water-company-performance-report-2023-24/)
The average company is under-performing. The median company is under-performing. And circa 70% of our water companies are under-performing.
Naturally, I am going to ask “what is going on here”?
The obvious answer to this question is that water companies are, by and large, continuing to under-perform in the current 5 year regulatory period.? We can also recognise that overall the extent of this under-performance has increased relative to the previous year (I previously noted performance for the previous year here).
The detail of the data is beguiling. We also know from the data published by Ofwat that our water companies are delivering less service than expected while spending more than expected:
The sector’s expenditure on wholesale water exceeded cost allowances by 39% in 2023-24? compared to an overspend of 25% in 2022-23. The sector has overspent its cumulative wholesale water cost allowances by 18% in the first four years of the 2020-25 period, compared to 12% in the three years to 2022-23.
The sector's total expenditure on wholesale wastewater exceeded cost allowances by 25% in 2023-24, compared to an overspend of 3% in 2022-23. In total the sector has overspent its cumulative wholesale wastewater cost allowances by 7% in the first four years of the 2020-25 period, compared to 1% in the three years to 2022-23.
So what answer does Ofwat come to?
As we review companies' performance over the last year, there has never been a stronger case for a culture change in the water sector. We have recently proposed the largest ever investment package for 2025-30, but this year's performance report is stark evidence that money alone will not bring the sustained improvements that customers rightly expect.
Let me put my emphasis. “Culture change. Stark evidence. Rightly expect.” These concluding words are being used to explain the data, rationalise the under-performance and diagnose the source of the problem.
Now for another question. Are we passing the accomplished dentist test?
"What is really going on here?"
I am going to tackle this question in two steps.
#1 What is really not going on here?
The danger of beguiling data is that it all too easily allows us to think we have explained everything when in fact it can’t.? Sometimes the humble thing to do is admit we don't know.
John Kay would remind us we can’t interpret the data in front of us divorced from the model we use to generate our data.? So the idea the water company under-performance is a direct consequence of who owns, controls and regulates our water companies is an incomplete model driven narrative.? And it is a narrative that can - on the balance of probabilities - be refuted.
For example, using the same published Ofwat data there is no – that is NO – association between current water company under-performance and how our water companies are financed.? The amount of debt used to finance our water companies does not remotely explain the under-performance being reported by Ofwat.
The figure presented below shows at best the relationship between cumulative under-performance and the amount of water company debt (represented by the actual % Gearing) is (statistically) zero.
Source: Author analysis of data from https://www.ofwat.gov.uk/publication/water-company-performance-report-2023-24/)
#2 Are we looking in the right place for the diagnosis?
In my experience there is only one thing guaranteed of an economic regulator.? The only thing guaranteed is that the regulator will get it wrong.? There is no shame in that whatsoever. It is just intrinsic to the radical uncertainty that John Kay and Mervyn King so eloquently describe.
?And what will be wrong is how things turn out versus what we expect. Nowhere in this diagnosis of water company under-performance is there any reflection on whether the problem is what was expected rather than was or was not achieved.? So let’s remember, regulatory performance is not an absolute. It is relative to an expectation:
Water companies provide essential services; we want these to be the very best for customers and communities and to protect the environment. The 2019 price review set, and companies accepted, stretching performance commitments for 2020 to 2025 to improve service to customers and better protect the environment.
If we truly madly deeply want to understand what is really going on here, then we should be humble enough to revisit those original expectations. Perhaps entertaining the idea that setting "stretching" targets has proved - with the benefit of new information - to be too much of a stretch.
Do we want our regulators to engineer a higher chance of out-performance (like I think they used to) or do we want them to over-engineer (and compensate us) for a higher chance of under-performance?? The latter feels more descriptive of where we have currently landed in water regulation.
Perhaps it is time for a revisit to the dentist's chair?
Senior Legal Counsel and Manager at Pay.UK
5 个月Having worked in economic regulation now for nearly thirty years and in four very different industries, I keep being drawn back to the lack of accountability and sober self-examination on the part of regulatory institutions. Or as the lawyer in me might say, Quis custodiet ipsos custodes?
Senior Advisor: Net Zero Policy at Energy Systems Catapult & Associate at Sustainability First
5 个月Great stuff Scot - and 'what is really going on here?' is definitely the right question to ask. And probably better answered by looking at industry trends in absolute performance across a range of metrics over something like a 40 year period. (and normalising them if standards have racheted up over time (e.g. discharge consent compliance). Despite recent headlines I suspect the sector has a fairly good story to tell, in terms of delivering better service to more customers with very little change in real prices.
Europe Resilient Watersheds Programme Director at TNC
5 个月Super interesting - My observation is that there is huge pressure on Ofwat and companies to over-claim the efficiencies they can achieve to keep prices down but without knowing how they are going to achieve them. If the weather is kind, and they don't have major infrastrcuture failures despite ever more sweating of assets, they might get away with it for 5 years - but wihout proper (forward looking) indicators of the underlying asset health at some point the system falls apart.