Lights out at the Israel Electric Corporation

The public is once again called upon to bail out an unproductive, inefficient and badly managed public behemoth.

Electricity lines 390 (photo credit: Thinkstock/Imagebank)
Electricity lines 390
(photo credit: Thinkstock/Imagebank)
The government has just announced that the price of electricity will go up by another 9 percent, bringing the total hike in electricity tariffs to 25% since last August.
Many reasons have been advanced to explain this price increase; some even appear economically sensible. For example, it is reasonable to assume that prices will go up when demand increases, due to say unusually cold weather, and when supply decreases say as a result of sanctions placed on Iran.
However, this well-known market mechanism is hardly relevant in Israel, simply because there is no real market for electricity.
The Israel Electric Corporation operates as a public monopoly and the Public Utilities Authority-Electricity decides what the price of electricity in the country will be.
Indeed, the latest electricity price increase has little connection to the forces of supply and demand. It is more easily explained by the pathetically bad management of our nation’s energy supply. This was recently recognized by Standard & Poor, which downgraded the IEC, signaling to all that the current financial situation at the IEC is nowhere near sustainable. But even if the government continued to provide support to the IEC, through wads of taxpayer money, there would be no light at the end of the tunnel.
The IEC simply needs to start balancing its budget so that revenues cover costs. As with any company under financial stress, three options are available; increase revenues, decrease expenses, or do a combination of both.
Perhaps not surprisingly, most of the discussion in the media and in political circles focuses on only one solution – increasing revenues.
Cutting costs is perhaps only whispered behind closed doors. No one dares mention that possibility out loud. So the result is that the Israeli public is once again called upon to do its civic duty and bail out an unproductive, inefficient and badly managed public behemoth, directly through an increase in tariffs and indirectly through taxation.
Of course, since the IEC is a public monopoly, consumers simply cannot decide to switch to an alternative provider. The IEC holds the public hostage, meaning the IEC management has no incentive to become more efficient and reduce expenditures. It is another perfect example of what economists call “moral hazard.” The IEC is not the one that bears the consequences of its inefficiency and waste. Why should the IEC try and reduce their production costs (e.g., the salaries of their relatives working in the firm) if they are fully insured by the government (i.e., the Israeli public)? In Israel, the doctrine should probably be called “Too Connected to Fail,” rather than “Too Big to Fail.”
Instead of asking how much the IEC should raise tariffs, the question should be, how could we reduce the cost of generating electricity? One of the main reasons the cost of producing electricity in Israel is so high is because of huge labor costs deriving from past collective agreements on wages and pensions.
According to a World Bank study, salaries at the IEC are among the highest in the world. On average, workers at the electrical monopoly earn 38% more than employees with similar skills in the private sector.
The union is so powerful that government officials are afraid to confront it. It is much less costly for them to treat the Israeli public as the fryers, or suckers. Their fear is understandable – the union will not hesitate to use its most powerful weapon – the strike – to cripple the country and saddle it with additional huge bills to pay.
The union knows very well that as far it can keep the IEC a public monopoly, it will be able to extract unreasonable compensation at the threat of an economic bullet.
That’s the reason they so fiercely oppose privatization. Even more shamefully, the workers’ committee is asking for a payment of NIS 100,000 for each employee in order to agree to only a partial privatization of the utility.
The Electricity Sector Law of 1996 that was supposed to implement the first steps towards private sector participation and competition has totally failed. If it had succeeded, Israel would now have a multiple provider service similar to the one adopted by many OECD countries and each of us would enjoy a cost effective and competitive market for electricity. According to the International Energy Agency all the countries that implemented a privatization of the electrical distribution (also known as multiple providers) enjoyed a decrease in the final electricity price. In the UK and Australia, labor productivity increased by 40% to 50%.
This is exactly what happened in Israel when in 1997 the monopoly of Bezeq was broken and replaced by a multiple provider scheme. The results speak for themselves: the real price of international calls fell by 87% and the price of the “domestic phone basket” by approximately 25% almost immediately after the reform was implemented.
It is time that the Israeli public demanded real reform in the electricity market. The government should stop surrendering to the unions and should serve the entire civic body, not just the privileged workers at the IEC. Only through a competitive market for electricity will the 2.5 million clients of the IEC be able to voice their opinion louder than the 12,000 IEC workers.
The writer is co-founder and director of the Jerusalem Institute for Market Studies, an economic policy think-tank located in Israel.