Tuesday, 29 July 2014

The End Of The Experiment? Part 4

Changing the economic frame/ Making a political difference

“There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things. For the reformer has enemies in all those who profit by the old order, and only lukewarm defenders in all those who would profit by the new order, this lukewarmness arising partly from fear of their adversaries … and partly from the incredulity of mankind, who do not truly believe in anything new until they have had actual experience of it.” ( Machiavelli, The Prince, 1532, Chapter 6)
“For the overriding economic problem discussed in this book, the first necessity is not technical devices but the public acceptance necessary to make them work” (Hirsch, Social Limits to Growth, 1977, conclusion)

It has long been understood that it is politically difficult to introduce a new and untried order of things which upsets the economic status quo. With the slow motion economic failure of the 30 year experiment, it is nevertheless important to ask:  how can we make a difference politically and begin to organise a better world. The answer is not obvious. We have accumulated so many critiques of neo liberalism that, if they were all piled up one on top of another, they would surely by now reach to the moon. And yet, after several decades, we are no closer to defeating neo liberalism.

This disconnect between critical thought and effective action isn’t a problem for everybody. As we have argued in our blog about Thomas Piketty’s Capital, the sales success of that book can be attributed to the way in which it combines fact driven critique of growing wealth and income inequalities with an utopian solution of higher income and wealth taxes. This solution will never be enacted when we live in post democracy where the mass party is no more and the organised working class have been disempowered
But it is a big problem for the team that wrote The End of the Experiment because we wanted to write a book that moved from critique of the thirty year experiment to new political proposals for action and intervention.  Of course we are academic scribblers not political practitioners. But we can break with the dismal TINAF (There is no Alternative Framework) assumption that frames current centre left and centre right politics; and hope that  our arguments can have some performative impact in the next phase of ongoing crisis

In our book, the distinctive form of our critique shapes our concept of the alternative. Because the one centralised, Westminster led dogmatic experiment has failed, we recommend much more diversity of regional and local experiments which provide the basis for discovering answers. Because our critique shows that the generic fix of competition and markets has led to sectoral mismanagement, we recommend a different approach which recognises the heterogeneity of the economy and engages with activity specifics in what we call the foundational economy.

The argument on these points in The End of the Experiment  is dense but it can be simplified and systematised.  The book’s policy argument starts from a contrarian insight about how there is more than one economy. It then focuses on part of the economy by proposing the foundational  economy as an alternative object before proposing chain value and social license as policy principles do which could be developed and articulated through local experiments 

1) The contrarian insight
After thirty years, it is not difficult to see the problems inherent in the current framing of our politico- economic problems in a country like the UK. It is increasingly realised that our economic problems do not have technical solutions with existing management tools. It is widely accepted that the current UK recovery is consumption based, debt fuelled and unsustainably driven by house price rises: if that observation is set in the context of boom and bust over the past thirty years, the implication is that there is no setting of the macro policy levers (fiscal and monetary) which will deliver sustainable UK growth.

The main stream response is denial. The Thatcherite revolution fails because it is incomplete, the answer is more of the same (and please don’t talk about debt based growth). The generic fix of competition and markets is now applied with more force to energy, banking and every other sector; this structural reform is backed by bolt-ons like industrial policy to deal with market failure in the commercialisation of early stage innovation.

This kind of obsessive compulsive behaviour may be increasingly incredible; but it is at the same time difficult to reframe issues and propose an alternative that works. The difficulty relates to habits of thought and organisational peculiarities which are embedded in main stream British politics.

In terms of overall vision, the centre left’s question has always been why can’t we be more like Germany and their difficulty is that they have no policies which would move the British economy away from financialization and onto a more virtuous productive path. Manufacturing output shows no sustained output growth because the aspirations of foreign owned branch firms are limited as are the capabilities of British firms who prefer to compete in sheltered sectors; adding more finance for production or up-skilling the workforce will achieve little without radical changes elsewhere because UK supply chains are constructed around low skill and investment.

As a way of breaking out of this impasse, we turn to the insights of the French historian, Fernand Braudel. First, “there is more than one economy” because the economy is heterogeneous and includes zones that are not competitive. Furthermore, capitalism is as much about monopoly as competition because local monopolies are what many firms want and the state can franchise. These contrarian insights are the basis for our break with main stream thinking.

In the 30 year experiment, the economy was represented as the unitary sphere of competition where all should submit to the imperatives of globalisation; this conceptualisation was reinforced by the aggregation of everything into national income measures with growth and jobs then promoted as the objectives of policy. Against this we argue that a large part of the economy (more than one third) is sheltered from competition; while growth and jobs are socially meaningless objectives when the income gains from growth are captured by the top 10% of households by earnings and because low wage jobs spread welfare dependence

2) Our object is the foundational economy
After recognising the heterogeneity of economic activity, the question is about how to think about the different zones and their interaction. Our focus is on the zone or sphere which we call “the foundational economy”. The foundational has never been an explicit object of policy and (we would argue) has been mismanaged insofar as it has been subjected to the competition and markets fix.

What’s inside the foundational economy? On our calculations, we include the pipe, cable and wireless utilities that deliver water, energy and broadband, transport utilities like rail and bus, food processing and distribution through supermarkets and most of the lower levels of health, education and welfare. Their outputs are mundane goods and services, from processed food to primary education, which lack the glamour or attractiveness found in high tech or knowledge based “key sectors” like aerospace or the creative industries.
The activities inside the zone are diverse in terms of outputs or ownership because the foundational economy produces a bewildering variety of goods and services under private and public ownership. Yet these activities also have a series of shared characteristics which are the basis for our classification.  These goods and services are all foundational because they are necessary to everyday life, consumed by every citizen regardless of income and distributed according to population through branches and networks. They are also typically sheltered and often politically franchised so that the state (through regulation and planning laws) gives the cable tv operator or the big box retailer an effective local monopoly.

When these activities are bracketed together, the foundational economy appears as a large and strategic zone for several reasons. Large because the foundational economy employs one third or more of the UK workforce; strategic because the cost, quality and security of foundational goods and services (such as energy supply and health care) are key determinants of citizen welfare. Indeed foundational activities are funded by a kind of lien on tax revenue and household expenditure; foundational expenditure accounts for 30% on average of weekly consumption in households who have little choice about paying utility bills or buying supermarket groceries.

After a period when low cost provision of many of these goods was taken for granted, the price and security of foundational supply is increasingly an issue. The crisis of foundational supply is related partly to the limits of our small planet and partly to the failed thirty year experiment; thus, our privatized utility operators like BT are investment averse and British infrastructure is increasingly being half-heartedly renewed by billing the customer or taxpayer for investment.

3) Our economic principle is chain value
Our argument on the foundational economy starts from a distinction between two concepts of value (point value and chain value) which is then developed into an argument about how the foundational economy is being mismanaged on point value principles and would be better managed on chain value principles.
Point value means that the measure of success is least cost or highest profit in an individual transaction (or basket of transactions) at a node in an economic chain. Point value is an active and now ubiquitous principle in the calculations of private and public sectors.

It is represented in the public company imperative of shareholder value through quarterly earnings and higher stock price; or in private equity through cashing out by selling a portfolio company to meet the equity investors’ demand for high returns which are levered up with cheap debt. But it is also represented in the public sector response to budget cuts and value for money when, for example, in adult home care the local authority cuts the hourly rate paid to the agency supplying care workers.

Point value has considerable intellectual prestige; because it is in one form materialised in all the post 1930s business school calculations of return which take account of the time value of money; as with discounting to calculate net present value. At ordinary rates of interest, such calculations are socially questionable because they devalue the future by attaching a very low value to returns more than 5 or 7 years away.  Practically also, they are place bound because point value represents a trader mentality which ignores broader social consequences.

Point value is embedded in private business models which then pass problems down the chain as with supermarkets which use their power to capture supplier margins. In the public sector, the problem is that the state gains on one account only to lose on another account. Thus, wage cuts will reduce the cost of providing council services but increase the demands for housing benefit and other kinds of welfare support.  Pervasive point value therefore spreads unsustainability as private and public actors trumpet their point success when supply chains are undermined and the welfare bill spirals out of control.

So our alternative is back to the future with the alternative principle of chain value.  We should recover the idea of value as a stream of benefits for (internal and external) stakeholders over time. Benefits are not only financial and measurable through one master calculation because there are several orders of worth and long term uncertainty requires defensive prudence. This requires a different kind of economic calculus which balances the interests of different stakeholders (rather than privileging the investor); and introduces political objectives around the ideal of connected economies which deliver both the benefits of re-localisation and of national standards and inclusive national networks 

One of the central problems is that much of this calculus about interconnection is not actionable within the current British system and is equally unlikely to be realised through  the forms of decentralisation which are currently on offer. The British way after the 30 year experiment is to dispense with intermediary institutions and combine self-governing operating units with centralised political power which micro manages in an interfering way; hence the decision makers are the PLC board or the Academy School governors subject to interference by Vince Cable or Michael Gove. As for devolution and decentralisation, in the bi partisan view, articulated in the Heseltine and Adonis reports, this is a matter of handing decision making and central money to dominant regional elites with very few questions asked.

4) Our political principle is social license
The operationalization of chain value thus requires not so much more government as a different concept of what nested levels of government are and can do. As well as very much less reliance on governance at operating unit level which always promises much more than it delivers.

We are against the post 1979 concept of business friendly government which has dominated in the period of the thirty year experiment. In this frame, government’s role is facilitative as it creates the space in which the incentives of markets and competition do their work; hence the structural reform agenda of lower taxes, market liberalisation, deregulation and privatisation. The only acceptable forms of local and regional policy are infrastructure and training which make the market work better (and now help create competitive agglomerations); industrial policy is about rectifying market failure in commercialising innovation. 

Against this, we make another back to the future argument which revives the 1930s ideas of US thinkers like Berle about how business and community are in a relation of mutual dependence because all business exists under a social contract whereby the corporation should offers responsible behaviour in return for the privileges which allow market access and secure profit taking. This is especially so in the foundational economy where the privileged business gains a local monopoly on the household spend of an immobile population in communities and user groups

Hence our arguments for social license in the foundational economy with the aim of enforcing the obligations of business to the community (which are much broader than those of customer care). The explicit analogy is with the mining industry where a social license about benefits for the local community is the quid pro quo for the right to exploit immobile natural resources. Social licensing in the foundational economy would impose relevant conditions on specific activities. Thus, councils would be obliged to pay living wages while supermarkets should attend to local sourcing; this would need to be backed by social innovation to change business models.

All this has fierce political pre- conditions in that change through experiments with scope and scale requires decentralisation with intermediate institutions under electoral and civil society pressure for change. But, if we do not have the answer and favour diverse experiments, then regional and local government can begin right away with experiments in areas, like adult care, where resistance to change is weakest. The question is whether regional and local governments, under pressure from civil society, can rise to this challenge and through experiments and “ actual experience” demonstrate the potential of this approach in ways which increase not just “public acceptance” but public demands for change.

Manchester Capitalism

The End Of The Experiment? Part 3

The Foundational Economy: A different starting point

If the exhibits in Part II show that the market experiment had many unpredictable and unanticipated outcomes, how does that register in the UK’s core sectors? ‘The End of the Experiment?’ develops three case examples of ‘foundational economy’ activities that demonstrate what’s gone wrong over the past 30 years and how we could do things differently for better economic and social outcomes.
Our starting point is that is that all markets are embedded in politics and that we currently have a problem with political planning. The cases of i) telecoms and broadband, ii) supermarkets and dairy, and iii) retail banking are services most of us use every day. The cases show the increasing prevalence of ‘point value’ calculations and trader mentalities within large, quasi-monopolies, where cashing out often comes at the expense of national outcomes and social objectives. All reveal different fault-lines in their business models that work against societal interests as well as the limits of a generic ‘competition and markets’ framework.

Let’s follow the money and find the faultlines

The End of the Experiment?’ cases show how, in different ways, we have ended up with socially and economically dysfunctional outcomes. This is unsurprising when much of the foundational economy is dominated by shareholder value driven business models. There are some generic overlaps such as confusion marketing but all in all three cases the key drivers are financial because giant PLCs compete on two dimensions: (1) the product market to win customers; (2) the capital market to generate the narratives and numbers expected by stock market investors.

The former publicly owned BT in its modern guise shows a marked reluctance to invest in a national network of fast broadband. This unsurprising result is the legacy of privatisation where BT demonstrates a preference for distributing dividends - £20 billion distributed since 1984 – and buying back its shares. The outcome is that its super-fast fibre optic broadband terminates at the cabinet adjacent to, rather than on, the premises. The government’s aim of rolling out super-fast broadband nationally meets BT’s corporate requirements, but does it necessarily meet social needs, particularly when the company expect the state to subvent an extension of the network to rural areas?

Supermarkets present themselves as supporters of British farmers, but a point value mindset often harms stakeholders as suppliers are squeezed upstream. In dairy farming the farmers are visible and vocal complainants, but the invisible and silent victims are often the milk processors in the middle of the chain. In the decade since 2001, processors’ share from a litre of milk has declined from 35% to 19% while supermarkets have maintained margins through a form of predatory contractualism.

Retail banks’ rely on the pressure selling of products to customers where the proceeds are applied to cover branch costs. This is a necessity under a shareholder value driven model in the context of free banking. This often results in numerous mis-selling scandals – the fines for which are treated as a basic cost of doing business. The policy response is nearly always to encourage new entrants, without any understanding of either the destructive competition in the product market or the unreasonable capital market demands for high returns on equity which underlie the dysfunctional business model.

Is this the outcome of market competition?

All three cases play out in different ways but all have socially and economically dysfunctional outcomes. All manage to deliver acceptable stock market returns (although some supermarkets are under pressure). But all crucially depend on their supply chain positioning at key pinch points which gives them power over suppliers or customers. The pursuit of ‘point value’ strategies means that position is exploited to extract value immediately at the expense of a stream of benefits over time. Value is maximised at the point of transaction to benefit the shareholder; profits are levered on suppliers and customers without regard to the social/national interest.

The 30-year experiment has above all enshrined generic competition as its mantra. And to varying degrees, with governments of different hues, this is the principle that has underpinned policy. So within this context, how, in such a large portion of the economy, have these PLCs maintained return on equity and profit margins?  Equally, how have PLCs limited the effects of competition when firms are competing amongst themselves inside each sector?

The key features that have prevented the erosion of margins and returns are (a) the companies avoid direct price competition through confusion marketing which is actively used in all three sectors (e.g. bundling to make comparisons difficult); (b) PLCs inside sectors operate using similar business models –often narrated to emphasise differences –that create an opera of stereotyped competition with emphasis on a part e.g. service, plus (c) PLCs using ‘point value’ as a means of exploiting local power relations to take margins off other stakeholders.

There are alternatives but they require vision and framing

The normal treatment of corporate excess and scandal is to claim that it is the result of ‘market failure’ which requires ‘more competition’. These framing devices dominate the rhetoric of Select Committees, policy reports and other outputs. The recommendations are always generic: encourage new entrants, educate consumers, limit monopoly excess. In doing so, the frame narrows our field of the visible and limits our imagination about what alternatives are possible.

The success of this framing has been overwhelming. But there are many other experiments beyond the free market that perhaps meet social and economic need more successfully. These experiments focus on co-operation and co-ordination to rebuild fragile or fragmented supply chains that resulted from the 30 year experiment. They include modest innovations by local authorities in the UK trying to re-glue the supply chain fragments by co-ordinating private sector partners; building agglomerations of expertise and overlapping functions in their area. These experiments also emerge spontaneously in the private sector: for example, Morrison’s vertically integrated meat supply chain secures supply and investment-driven efficiencies. Similarly Tesco’s intervene in the milk supply chain by guaranteeing, via the processors, a minimum price per litre that effectively puts a floor under competition. Alternative forms of ownership may also change the characteristics of competition: municipally owned utilities in the US compete successfully against PLCs, despite operating with quite different priorities. These different examples do not necessarily require central state planning or co-ordination since they involve the rebuilding supply chains from the bottom up.

These are all experiments related to building the foundational economy.

Looking at the three cases in the book it might be easy to conclude that these are just examples of ‘bad company behaviour’. But that would be an alibi and deny the need for something more than just the restatement of more competition and more markets with the usual bolt-ons like industrial policy. But doing something different requires a fundamental reframing of our problems that should include interventions through licensing for social objectives. However, that will require political will not generic fixes for the generic rhetoric of market failure.

Manchester Capitalism

Thursday, 3 July 2014

The End Of The Experiment? Part 2

The free market experiment began with the Thatcher government of 1979 and continued under Major, Blair and Brown. Looking back, many of the changes that occurred in the UK were not well anticipated by the arguments made for markets at that time. Yet despite these undisclosed outcomes, our political classes have yet to consider a 'null hypothesis' result.

The 1980s experiment was premised on a set of visionary promises about what the market could deliver. The vision centred on a critique of the State as a blockage on jobs, growth and competitiveness and a distorter of price signals in a market setting. Drawing on the sentiment, if not the detail, of the Bacon and Eltis thesis, it was argued that the public, non-marketed sector ‘crowded out’ private sector investment and enterprise. Similarly the debate over the public utilities was transformed by an Austrian view that the market would bring the rigour of competition and efficiency of co-ordination to cumbersome public utilities industries. The solution was wholesale de-regulation and privatisation to release entrepreneurial spirit and build an enterprise culture that would benefit ‘the public’ in its multiple identities: as producers, consumers and taxpayers.

The reforms may have had effects, but they were often not the effects that were expected. Surprisingly, public sector job creation increased, both absolutely and relative to private sector job creation under Tory administrations (figure 1). 86.4% of net new jobs created from the beginning of the Thatcher administration to the end of the Major administration came from the public sector. Whilst some of that is explained by the economic cycle, it was mostly the result of a secular decline in manufacturing jobs (over 3m net jobs were lost) which the growth of financial services could not rebalance (only 250k net new jobs were created). By the end of New Labour in 2007 this figure had risen: 4.4m manufacturing jobs had been lost since 1979, with only 330k new financial services jobs created to compensate. What the Conservatives - and later New Labour - discovered was that public sector jobs were a necessary cost, ‘filling in’ for (not crowding out) anaemic private sector job creation and buying in public quiescence at a time of unrest.

Figure 1

Equally unanticipated  was the lack of new entrepreneurial sole traders and SMEs, despite the promise that deregulation extended. From 1992 (when our time series began), the number of full time self-employed workers was virtually flat, until redundancy forced expansion after the 2007 crash. Instead, there was a growth in casualised, insecure low paid jobs: part-time self-employed jobs increased 116%, while part time workers for corporations increased 32% (figure 2). At the same time, large firms failed to show the entrepreneurial flair promised in the discourse of free markets, choosing often to sacrifice high risk/high return activities for modest returns, low risk activities plus scale. The free market experiment, in other words, created an environment where capital satisfices: large companies calcifying around the apparatus of the state, lobbying hard for the release of ever more low return but safe public activities.

Figure 2

This pattern of satisficing was also evident in investment, which always carries risk because it is a gamble on management's strategic and orgranisational competences. The free market experiment promised to stimulate investment, but these problems stubbornly remain. Investment as a % of GDP fell from 17.6% in 1980 to 14.4% in 2013; and the UK continues to have the lowest investment share of GDP among all G7 countries (figure 3).

Figure 3

If the hypothesis that markets would stimulate private sector job growth and investment proved faulty, it equally did not capture unexpected drivers of growth in a more marketised economy. Both Tory and Labour administrations assumed that growth would come from operating efficiencies, competitiveness and specialisation forged within dynamic markets. What they did not anticipate was the importance of credit and asset prices as key sources of growth in a liberalised economy. The push of newly minted credit against real estate assets allowed households to cash out equity gains as income. That income was spent, and GDP rose. It is a staggering fact that housing equity withdrawal was equal to 104.2% of GDP growth under the Thatcher administration and 101.7% of GDP growth under Blair (figure 4). And whilst equity withdrawals were not always spent on items accounted for under GDP measures, its contribution to growth should not be underestimated.

Figure 4

So what were the outcomes? It is clear that the opportunity culture did appear for some: house-flippers, upper income employees in the state subvented sectors, the (subsidised) financial services industry and certain professions all did well. But for many, the disposable income inequalities that emerged put a ceiling on opportunity as income mobility rates fell. By the end of the 1970s the tenth richest households (D10) had five times as much disposable income (before indirect taxes) as the tenth poorest households (D1). By the 2000s the average ratio was almost ten times. These effects were further amplified by the shift from direct to indirect taxes which hit the poor disproportionately: D10 to D1 inequality was 13.4 times on average over the 2000s, up from just over 5 times at the end of the 1970s by this measure (figure 5).

Rising inequalities between households should be understood within a broader context of disenfranchisement as household's lost their stake in GDP growth. At the beginning of the 1980s average disposable household incomes were – effectively – a lien on growth. That changed by the mid-1980s, so that by 2011 (when our series ends) the disposable household income growth of the bottom 90% of households had not kept up with GDP (figure 6). And even the top 10% of households had only just kept pace with GDP growth. Where did this share go? Labour’s pre-tax share of GDP fell 3.5 percentage points from 1979 to 2010 - this was almost identical to the growth of financial corporation gross operating surpluses share of GDP, which increased 2.9 percentage points; although taxes on products and production also claimed a similar increased share of GDP.

Figure 5

Figure 6

These unexpected outcomes may truly surprise us. But surprises are commonplace in all experiments. Learning from those unanticipated results – in this case – seems something that our political classes are less willing to contemplate.

Part 3 will be posted next week...

Manchester Capitalism