By Ricardo Hausmann
CAMBRIDGE – In the traditional (and somewhat outdated) distinction between left and right, left-wing parties represent workers, while right-wing parties represent the owners of capital. When the left is in charge, according to this view, it tends to use its power to reduce the share of national income that goes to capital, either through raising corporate taxes or taxing personal capital gains.
Some left-wing politicians, however, attempt to minimize capital’s share by regulating or nationalizing capital-intensive industries, such as electricity and infrastructure. For example, Colombian President Gustavo Petro recently announced that he would default on the terms of road concessions and freeze tolls. Yet, given the terms of the contract, this forced the finance ministry to compensate investors, and left future investors on notice. Petro also announced his intention to take responsibility for setting household utility bills away from the independent regulator, so he can personally cut electricity costs.
In Mexico, President Andrés Manuel López Obrador (widely known as AMLO), has launched an overhaul of the electricity market that would cement the monopoly of the state-run Comisión Federal de Electricidad (CFE) and effectively roll back previous pro-market reforms enacted by his predecessor, Enrique Peña Nieto. As a consequence, private investment in the Mexican energy sector has collapsed.
Petro and AMLO should heed the lessons of South Africa and Venezuela, where the attempt to cement the state electricity monopoly has led to collapsing grids and massive power outages. To overcome the disaster, made more challenging by the need to shift to clean energy, both countries will need to reverse course and regain investors’ trust.
The inefficiency of South Africa’s state monopoly in electricity became obvious in 2007, when insufficient capacity led to widespread blackouts and forced the government to start rationing electricity. Ideological resistance, together with rampant corruption within President Jacob Zuma’s administration and at the state-owned utility Eskom, prevented the government from liberalizing electricity generation until seven months ago, when it was already too late to prevent catastrophe. On February 10, President Cyril Ramaphosa declared a national state of disaster, announcing a R254 billion ($13.9 billion) bailout of Eskom and vowing to accelerate new private energy projects.
In Venezuela, Hugo Chávez’s decision to nationalize the electricity sector in 2007 led to frequent outages and sharply reduced electricity generation by 2009, culminating in a week-long national blackout in March 2019. In spite of massive public capital transfers, the country’s power generation is still below its 2007 levels.
Electricity, roads, battery storage, and solar and wind energy are capital-intensive industries, which means that businesses must spend heavily on fixed assets and then recoup their investment over long periods of time. This gives governments an incentive to make unrealistic promises to entice investors and then try to expropriate their assets or their positive cash flows through nationalization or price controls. Under these conditions, investors will demand higher returns on capital in order to protect themselves, but this will just give governments even more incentive to expropriate. Markets cannot function well under these conditions.
But as South Africa and Venezuela show, relying on state-owned monopolies can lead to energy crises of historic proportions. Government control gives the illusion of lower prices, but at the cost of leaving companies without the financial resources necessary to modernize and expand their networks or raise new capital, leading to chronic shortages and the need for fiscal bailouts. Moreover, state-owned utilities tend to be hotbeds of corruption.
This conundrum can be solved by enabling private companies to increase their share of electricity generation and empowering independent regulators to oversee them. Entrusting pricing power and regulatory oversight to an independent board, rather than elected officials, improves accountability and leads to better long-term outcomes.
The economic rationale is similar to the one underlying central-bank independence. When investors purchase long-term government bonds, they part with money today, expecting to get their money back over time with interest. But that gives governments an incentive to erode the value of future payments through higher inflation. In anticipation of this, markets will demand higher interest rates, raising inflation expectations and rendering the market inefficient. But by empowering independent central banks, governments hope to gain the market’s trust, thus obtaining price stability and lower borrowing costs.
Combining private electricity providers and independent regulatory oversight has helped Chile, Colombia, and Peru overcome previous energy crises. By convincing markets that the risk of expropriation was low, Colombia secured massive investments and cheaper electricity. But now, Petro is threatening to reverse the progress made by his predecessors.
Part of the problem is that many on the left are still ideologically opposed to markets. Because they see capital as abusive, they view political power as the means to constrain it. But left-wing politicians like Petro and AMLO fail to understand that this logic will inevitably backfire. Since new investments are forward-looking, expectations of government coercion will make capital scarcer and more expensive. To ensure that they can adequately meet their economies’ electricity needs in the context of the energy transition, many countries, including Argentina, Colombia, and Mexico, have much to gain from opening up to private investment in energy generation and restoring their credibility by setting clear rules of the game and empowering independent regulators to enforce them.
Unfortunately, as the Indian economist Montek Singh Ahluwalia once observed, credibility grows as slowly as a coconut tree and falls as fast as a coconut. Until leftist governments adopt a more capital-friendly approach, as Uruguay has done, capital markets will continue to punish them.