Reform / Competitive markets need strong frameworks
Competitive markets need strong
frameworks
Matthew Hancock
The financial crisis which began in 2007 didn’t just rupture our banking system.
It also exposed the complacency of uncompetitive, unaffordable governments
throughout the Western world. The model of unconstrained borrowing, evergrowing bank balance sheets, and ever-rising state spending brought the UK its
largest recession in history – larger than in the 1930s – and a painful adjustment
process to ensure we can pay our way in the world. In its wake, we must address
profound questions about how we run our economy, out banking system and our
public services.
State socialism is clearly not the answer to our problems. The 20th century
revealed the planned economy for what it was: one of history’s dead ends –
corrupt, totalitarian and grossly inefficient. As if the collapse of Soviet Communism
in 1989 wasn’t proof enough, the last three decades of market reforms in China
have lifted more people out of grinding poverty than any policy in the history of
the world. It turns out, after a century of experimentation, that there is no better
alternative to capitalism.
But laissez-faire capitalism itself was implicated in the crash. Banks were
allowed to lend without limit because questioning the business model was seen as
always wrong. Within the regulatory system, a deeply ingrained presumption
against exercising judgment meant regulators failed to challenge behaviour, even
when the incentives of the individual and the requirements of the system were at
odds. The prevailing dogma held that private firms must always be right, so banks
ought not to be challenged when their business models were based on reckless
levels of debt. As a result, by 2007 the financial sector held debts worth over six
times UK GDP. Household debt was higher than any G7 country ever. This
overleveraging was in part the consequence of a decade of cheap money. But the
actions of the MPC do not excuse or mitigate the behaviour of banks, who lent
without regard to ability to be repaid, or the regulators who allowed them to
leverage up without limit. If the abundant credit of the boom had been invested in
infrastructure or start-up funding, then we may have been cushioned from the
bust. Instead it merely drove up asset prices, and combined with financial
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Reform / Competitive markets need strong frameworks
innovation to expand trade in complex financial products, while the value of retail
investments like pensions and the FTSE 100 remained flat.
In Britain, under New Labour we experienced an unhappy combination of
both those extremes: a laissez-faire approach to debt coupled with a distinctly
Fabian attitude to box-ticking rules. The FSA placed a disproportionate influence
on “objective”, quantifiable processes to the exclusion of judgment. The number of
pages in the FSA handbook increased from 2,730 in 2001 to 9,283 in 2008, and
yet RBS was able to post the biggest write-down in UK corporate history without
breaking a single one of those rules.
The problems with this approach have not just made themselves felt in the
world of finance. The Fabian aspect of New Labour, aided and abetted by the European
Commission, created a vast superstructure of rights and entitlements, but its laissezfaire tendencies undermined the responsibilities and obligations which should
accompany them. The result was a huge expansion of detailed rules to fill the vacuum.
These stifled enterprise, and caused untold confusion and complexity.
Yet a stable, competitive system needs a strong framework. Both public and
private sectors of the economy require a space in which enterprise and innovation
can flourish, and in which wastefulness and exploitation are unviable. If the old
notion of the public good means anything, it means protecting this space.
This approach can similarly be applied to banking and finance as to public
service reform, particularly in schools.
In financial policy the public good is best served by restoring collective
trust in the value of market institutions, by dealing with the plethora of often
contradictory box-ticking rules and replacing them with strong governance by a
strong authority with the discretion to respond to events.
The stakes could not be higher. Supporters of capitalism must reform the
system to ensure it works for everyone. The state must set the rules to ensure that
the game is both fair and seen to be fair. Allowing the current fear and mistrust of
financial markets to fester empowers the anti-business Left – who can promise
easy regulatory solutions to deep structural problems. Their increasingly shrill
answers threaten to regulate the economy into long term stagnation.
So how do we restore public trust in the banking industry?
Not by rewarding the businesses we approve of with tax breaks, or
punishing those we dislike with higher taxes or excessive regulation, as some have
suggested. It’s both practically impossible and fiscally undesirable for the state to
decide, on a case by case basis, which business practices are good for society and
which are bad. The state’s role instead should be to shrink the space in which bad
behaviour is allowed to flourish.
It is impossible to understate the importance of culture, tellingly defined by
Barclays CEO Bob Diamond as how people behave when nobody’s looking. Culture
is changed by leadership, and defined too by rules as to what is and is not acceptable.
For this reason, we have to think about creating a legal definition of
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Reform / Competitive markets need strong frameworks
financial negligence. Negligence is already defined in terms of driving, medicine,
environmental pollution and food hygiene; the same standards of responsibility
have to apply in financial services. Of course risk-taking is an inherent aspect of
finance, but certain practices which proliferated before the crisis are unacceptable:
sacking risk officers with dissident views, for instance, or misleading investors
about the state of the balance sheets.
Elsewhere I have made a case for a Public Protagonist to strengthen the
role of shareholders in banking. If the management of a major bank proposed a
risky course of action – a highly leveraged acquisition, for instance – the Protagonist
would have the power to call a special shareholder meeting and publically test the
proposals. A CEO’s response to the Public Protagonist’s advice would form an
integral part of any future prosecution.
In this way, and with other measures such as bonus claw-backs, society
will come to see that bankers are not above the law and that socially irresponsible
behaviour will be dealt with. This is our best defence against a creep back towards
defective Left Wing ideology.
But the state’s role in protecting and sustaining the public good should not
be confined to the banking system. In public service reform, getting out of the way
is an equally inadequate response.
The primary role of the state in public services is to ensure stable finances,
which is why fiscal discipline must be at the heart of the modern British state. But
the monolithic top-down provisions of big state Fabianism have failed to deliver
the improvements needed, given the money spent. Instead, to foster innovation
and improvement, we should create a strong framework in which there can be a
wide diversity of public sector service provision. Just as with the banks, we need
to grasp the big picture, and recognise the long term social and economic
consequences of backing off and leaving things as they are.
Nowhere can this be seen more clearly than in education. For the last ten
years, the UK has been tumbling down the OECD’s PISA rankings of educational
attainment, in spite of raised levels of spending under Labour. Just 16 per cent of
GCSE students in 2010 achieved the English Baccalaureate: A* to C grades in the
core academic subjects of English, maths, the sciences, a language and geography
or history. In a 2011 survey, 42 per cent of 500 CBI members reported they were
unhappy with the literacy levels of recent school and college leavers, while over a
third were dissatisfied with numeracy skills.
This has severe implications both for our international competitiveness,
and for the life chances of school leavers.
Clearly the public good is threatened by this decline. With that in mind, the
state has a clear interest in diversifying provision. There are two arguments for
doing so, both of which are applicable to other public services.
First the argument from competitiveness: we on the Right know well that
it’s easy for our opponents to wrongly caricature competition as a vicious survival
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of the fittest, in which the weak and the vulnerable are trodden underfoot.
John Stuart Mill eloquently made the case for diversity of provision in his
argument for free speech in his essay On Liberty. Mill argued that every state had
a direct interest in permitting free speech because it was only through intellectual
competition that the best of ideas could emerge. Unless the dominant assumptions
are constantly tested and questioned by a plurality of ideas, a society cannot
progress. Similarly, in schools we may well have missed out on better forms of
teaching our children because the state has limited change and innovation. Given
more independence, academies will be able to innovate and provide us with a vast
mine of data as to what works best, which can then be applied elsewhere.
As well as the need for innovation, a second powerful argument for
diversity of supply comes from Burke’s “little platoons”: the importance of
institutions into which we are emotionally invested. One of the vital distinctions
between free schools and their LEA-controlled equivalents is that free schools are
an essential part of the community. Formed from local groups, they directly
incentivise parental involvement. Though state-funded, their governance
structure means they cannot be seen as belonging to the state; with their inner
workings not the sole business of the state, but rather the property of the
community. This creates more accountability, and crucially approachability,
than the overly bureaucratic mechanisms of local authorities.
The libertarian doctrine of laissez-faire and the statist instincts of the Left
have failed us – morally and financially. New Labour’s attempt to neutralise their
more destructive properties by synthesising the two was disastrous in the crucial
spheres of financial regulation, economic management and delivery of public
services. A new variation on this theme will not bring us closer to the society we
want. Instead we need to allow and encourage the very human instincts, enterprise
and response to need within strong, clear frameworks that protect the public
good. That way we can build an economy fit for the challenges we face.
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