Building a responsible capitalism

~ 7508 ~ Building a responsible capitalism ~ Ed Miliband Ed Miliband
Published Fri 25 May 2012
>In this essay for Juncture
Juncture 19.1: Summer 2012

Britain has some world-class businesses. Firms such as Rolls Royce and GlaxoSmithKline create high-quality jobs, train, develop and engage their workforces, invest in their communities and take a long-term view of their role in our society. Our country is also fortunate to have inspiring and dynamic small enterprises. They often emerge directly out of the communities in which they are located. They serve people, create new products and make an invaluable contribution to the dynamism of our national life.

But we do not have enough of these businesses. And we do not currently have an economic order that does anywhere near enough to support and encourage them. During the 1990s and early 2000s, even talking about the fundamental reform of British capitalism was seen as a fringe and old-fashioned activity. That view began to change after the global financial crisis in 2008. The crisis challenged many of the assumptions which had underpinned our economy for a generation. But it is only over the last few months that the question has become part of the mainstream once more.

The emerging debate on the nature of the British economy was the core of my speech to the most recent Labour party conference. The starting point, I suggested, must be to stand back and ask what have we learned from a crisis that brought our economy to its knees, and then to consider what action needs to be taken to avoid it happening again.

The economic crisis we have been living through is, in fact, not just one crisis but two. First, we had the 'loud' crisis. It began with the implosion of financial markets in Wall Street and London, causing a sharp economic contraction that rippled across the globe, triggering recession and unemployment. Second, we have also had a 'quieter' crisis. This is the crisis of living standards of ordinary British families, the majority of whose wages have been stagnating for many years.

Both these crises have their roots in the inability of our economy to generate stable prosperity for the many, at the same time as it has created spectacular rewards for the few. It is a problem that we share with many other countries, and it goes to the heart of the way our economy has functioned since the beginning of the 1980s - and it has led people to question the post-1970s consensus about the extent to which unfettered markets always result in optimal outcomes. It is a problem that requires a fundamental re-examination.

Where do we want to be?

When we reflect on these two crises, it is apparent that Britain needs an economy that is more resilient, more genuinely competitive, more focused on the long term and that people feel is fairer - an economy that works for working people. Not only do we need growth: we need growth that is inclusive and sustainable.

What does this mean in practice?

First, the British economy needs to be balanced differently. The City is one of the leading global financial centres, and it is in Britain's interests that it continues to generate jobs and wealth. However, it is clear that the kinds of returns that were being realised in the City pre-crisis were not sustainable and will never be seen again. We cannot rely on financial services for growth and tax revenue to the extent that we did before. To increase our resilience, Britain needs broader-based growth.

That means a more vibrant and innovative manufacturing sector. While manufacturing as a proportion of GDP has declined since the 1970s, Britain still possesses important areas of comparative advantage in high-skill, high-value advanced manufacturing sectors like aerospace and automotive, pharmaceuticals and low-carbon technology. But a properly rebalanced economy means more than just a bigger manufacturing sector: it means enhancing other areas where Britain has unique strengths, such as our creative industries and professional services sectors.

Second, the British economy needs to focus more on long-term, productive wealth creation than on the predatory, short-term speculation that was at the root of our financial crisis - which involved a small number of people standing to make huge personal gains from taking inappropriate levels of risk, without adequate responsibility for the financial downside. Simply put, short-termism kills responsible capitalism. We need a culture shift in some of our major businesses, with CEOs, boards and shareholders all looking more to the future than demanding an immediate return in each quarterly report.

It also, however, means shifting some of the basic rules that govern our economy. We all know that businesses react to incentives and to the institutions of which they are a part. It is vital, then, that those incentives and institutions do all they can to encourage long-term vision and to discourage short-term expediency. We cannot expect our businesses to take the long-term view when too often the pressures on them are to be short-termist, whether those pressures emanate from the banks or the tax system or the structure of our corporate governance.

Third, the British economy needs to provide both more and better jobs. Factors such as globalisation and technological change mean that the proportion of mid-skill jobs - jobs that offer decent progression routes for school-leavers - has declined significantly in recent years. This has left far too many in our society with jobs that are not rewarding either financially or in terms of their daily experience. Without concerted effort, this is set to be a feature of the labour market for decades to come.

So a more responsible capitalism must mean a different balance between finance and other sectors. It will encourage companies to take a long-term view. And it will offer real, properly rewarding jobs to people across the country.

The challenge of building such an economy cannot be underestimated. There are many great British businesses, people and organisations in society which already wholeheartedly support this transformation. But actually making the change will require us all to work actively together in a way that we currently see all too rarely in British public life.

There are also two important trends that shape the current context. First, the forces of globalisation and rapid technological development mean that many of the external pressures on our economy will tend towards greater inequality. The hollowing out of the middle of the labour market and stagnating living standards for the majority are important symptoms of these changes.

Second, we operate at time of fiscal constraint. This is not simply about a deficit reduction programme over the next few years but is also a longer-term budgetary pressure that comes from having an ageing population. Limited resource means that government will need to find new ways to address the problems we face - and that is why the ideas in this article are not about increasing public spending but focus instead on levers like state-backed investment designed to be fiscally neutral, reforms to corporate governance, regulation to create new markets, and improvements in the way government procures goods within its existing budget. Responsible capitalism is the right agenda for Britain today because it offers the prospect of forging a fairer economy that works for the majority in an era when there is simply less money around.

We all know that markets are the best way known to us to structure an economy and to deliver optimal outcomes for businesses, employees and consumers. But the global financial crisis has altered our understanding of how markets work best. The next Labour government will have to play a more active role in making markets work for working people. In the 1980s, there was a strong belief in unfettered markets, however uncompetitive their practices and whatever their outcomes. In the New Labour years, policies such as the national minimum wage and tax credits showed that we could aspire for social justice while also running a free market economy.

Now, we need to go further. The crisis has reminded us that markets are always shaped by the rules of the game under which capitalism operate. It has also reminded us that governments play a crucial role in forming these rules and can thus play a more active role in shaping a more resilient, competitive, sustainable and fairer economy. This will require action in five key areas.

Reforming our system of finance for SMEs

First, we will need to reform the British system of finance. The great irony is that even as we built up one of the world's greatest financial centres in this country, we neglected our system of finance for British companies, particularly small and medium-sized enterprises (SMEs). For too long, companies have been held back by inadequate access to growth capital. That is a huge problem not just for them but for the British economy as a whole.

In the UK, companies tend to be very reliant on bank finance. But creditworthy SMEs have not been able to access the finance they need because of a lack of competition in the banking sector. In the UK, the largest four banks account for 85 per cent of SMEs' bank accounts. In Germany, only 14 per cent of business loans come from the large commercial banks, while over 60 per cent are accounted for by more than 1,500 local and cooperative banks.

But it is not just about a lack of competition. Governments from economies as diverse as Germany, the US and Singapore have long recognised two factors which conspire against a free flow of bank finance to SMEs. First, it is cheaper for banks to lend to larger businesses because the costs of due diligence are proportionally lower. Second, when times are tough banks are least likely to lend, even though this is when SME access to finance is more important than ever.

Many governments abroad play a far greater role in addressing this funding gap. In the US, the Small Business Administration (SBA) expands access to finance for small businesses by extending guarantees on loans made by private sector banks. And it plays a key role in opening up access to growth capital via its Small Business Investment Company (SBIC) programme, which uses government-guaranteed debt to boost private capital raised by small investment funds. Global giants such as Apple and Intel benefitted from SBIC finance in their early years. Germany too has a state investment bank in the form of KfW (Kreditanstalt f?r Wiederaufbau), which has an express remit to lend to SMEs via commercial and local banks. Both the US and German programmes have existed since the 1950s.

State-catalysed investment need not be expensive. Neither of the US programmes is in the red during normal years. The SBA loan programme covers the cost of any default via a system of upfront charges, and the SBIC programme's losses are more than met by the profit from good investments.

In all of these examples, lending is channelled through private sector actors that bear risk and stand to make gain - be they banks or private investment funds. They are excellent examples of how the energy of the state can be combined with the intelligence of private sector markets.

In contrast, successive British governments have been much more reluctant to get involved in supporting our businesses to access the capital they need to grow. This must change.

I want to see a British Investment Bank supporting Britain's enterprising small businesses that would complement the Green Investment Bank. That would be a big step towards helping entrepreneurs to get finance, and bring us into line with international norms about how to allocate finance to growing SMEs.

Reforming Britain's equity markets

Our problems do not just lie with banking: they also lie with our equity markets. As the respected business academic John Kay highlighted in his independent review, Britain's equity markets have undergone significant change in recent decades. Fifty years ago, most shares were held by individual investors. Now, they are mostly held by a mixture of international investors and UK financial institutions. Professional asset managers have also played an increasingly important role in intermediating between institutions and companies.

However, the interests of asset managers are often out of line with those of the ultimate owners of many shares: members of the public who have invested through their pension funds. People who save into pensions would benefit from a long-term view. They want to maximise the value of companies on the stock market over decades, not months. Yet asset managers are too often rewarded on the basis of how much they can outperform the market average year-to-year, rather than on the extent to which they build long-term performance.

Other factors have compounded this. Quarterly reporting requirements add to the pressure to focus on the short term, and technology has made ever-higher frequency trading possible. This has led business leaders, including McKinsey's Dominic Barton, to criticise the 'quarterly capitalism' of the Anglo-American economies in contrast to the longer-term cultures that characterise countries such as Germany.

The result is that even publicly owned companies that aspire to take a long-term view, like Rolls Royce, are forced to do so in spite of - not with the support of - shareholder pressure. The symptoms of this short-termism can be seen in takeovers which are not always in the interests of long-term shareholders, employees and customers - such as the takeover of Cadbury by Kraft - and in high levels of executive pay, which are too often disconnected from corporate performance.

Prescription is not easy. The operation of equity markets is an area fraught with complexity. While some takeovers may not be in the interests of the company and the wider economy, others are hugely beneficial and an important source of inward investment and innovation. While quarterly reporting can put too much emphasis on the short term, investors want regular information on the companies in which they invest. That is why I have asked Sir George Cox to chair an independent review on the factors impeding long-termism in the UK economy and how we might best encourage the long-term decision-making we need.

Reforming Britain's industrial policy

Greater long-termism is not only needed in the private sector. It is needed in our government too. Since the 1980s, successive governments have been scarred by the experiences of the 1970s, preventing them from taking an active approach to supporting industry. Government has sought to stay out of the economy, rather than be a partner to our most enterprising and innovative businesses. This has put British firms at a stark disadvantage compared to their competitors abroad, and has harmed our economy's ability to generate more inclusive growth.

The simplest ingredient to an effective industrial policy - but one that has by no means always been achieved - must be policy and regulatory certainty. We need to learn from countries like Germany where there is much more stability. If we are asking our businesses to be more long-term in their approach, politics too must meet the challenge.

An active, patriotic industrial policy is not about protectionism. It is about ensuring that growing British companies are able to make it onto the international pitch to compete in the first place. Other countries are more patriotic when it comes to supporting the industries in which they have competitive advantage. The British government is letting down British business. Germany and France are open and proud of their active approach; in the US it is more under the radar, but industrial policy plays just as significant a role.

In many ways, the last Labour government came too late to an intelligent active industrial policy. But when we understood it, it yielded significant results. In the auto industry, Peter Mandelson's initiatives prevented the recession destroying fundamentally healthy British plants - government, unions and management worked together to find alternatives to closures and redundancies. In the future, we must look at the sectors where we have emerging comparative advantage, where our firms can compete successfully against their rivals, and ensure that there are no barriers to Britain competing globally.

There are several important levers available to government, but the best 'industrial policies' are those that harness the power of the market in combination with the energy of government. For example, the government should use intelligent regulation to create new markets, as the Labour government did in the areas of zero-carbon homes, car emission standards and feed-in tariffs.

A more active industrial policy also means employing government's power as the UK's biggest consumer much more inventively to boost jobs, growth and innovation. The US procurement budget for supporting innovation through awarding contracts to hi-tech, innovative companies is 15 times the size of the equivalent programme in the UK, which we introduced while in government. We should learn from the experience of other European countries that have been able to take into account the impact of procurement decisions on the local economic environment within EU law.

It also means using the tax system to reward long-term investment. Labour started on this approach in government with R&D tax credits, the patent box and capital allowances. But there are questions about whether the tax system can be used further to incentivise investment. For example, Singapore has recently introduced a productivity and innovation credit which rewards companies that train staff as well as invest in R&D.

Reforming skills policy

Government of course plays a hugely important role in ensuring young people and graduates gain the skills they need to contribute to the economy. Under Labour, standards in literacy and numeracy improved significantly in our schools, increasing numbers of young people went to university, and more adults gained basic skills.

But while Labour quadrupled the number of apprenticeships in 13 years, much more must be done to improve vocational and technical routes for young people not going to university. We still have fewer apprenticeship places than in countries with a long tradition of successful vocational education. That is why Labour would further expand access by making it a condition that firms winning large government contracts should offer apprenticeships.

We will never reverse the hollowing-out of the labour market if there are not young people with the skills they need to do technician-level jobs.

We also need to think about how employers utilise skills. In previous decades, governments have assumed that if the education system supplies higher levels of skills, the jobs requiring those skills will be created by the market. Yet we currently have a situation where there is a degree of 'skills mismatch' - for example, one-fifth of graduates are in jobs that do not require degrees. The answer is not that we need fewer skills in our economy, but that we need to think about how businesses are supported to improve how they utilise and develop people's skills in the workplace. We should not, of course, be cutting the number of young people able to go to university but instead boosting the number of businesses able to make the most of young graduates. Countries as diverse as Finland, New Zealand and Singapore have focused on this in recent years, for example by subsidising training for managers on skills utilisation. And government should do more to support labour market progression through active labour market policies.

Reforming uncompetitive markets

Competition is a key driver for economic success in any vibrant economy. But some consumer markets have remained too heavily dominated by a few big companies, which presents significant barriers to new challengers entering the market. We need more competition, not less.

I have talked already about this in relation to banking. A lack of competition in energy markets is another example. Just six companies supply more than 99 per cent of consumers' electricity and gas. They also generate two-thirds of the country's electricity. This stops the market from being open. One result is that when wholesale prices go up, so do people's bills. Yet when wholesale prices come down, too often bills do not. This is caused by a lack of transparency in the market and the fact that having just a few large dominant firms means the price is never forced down. The market needs to be opened up to new entrants. Labour is looking at ways to encourage all energy companies to sell the power they generate into an open pool, so that any retailer can buy it, thereby encouraging more competition.

There is also a lack of transparency. Energy bills are now one of the biggest costs that families face, but the complexity of the various tariffs on offer - currently over 400 - means that 80 per cent of people are paying too much for their energy. Elderly customers often find it hardest to shop around and make the market work. That is why a Labour government would ask the energy companies to charge all customers over the age of 75 the cheapest tariff for gas and electricity, enforceable by law.

Beyond the energy market, we need to strengthen consumer rights in other areas where there are imbalances between corporate and consumer power. Strong vested interests are incompatible with our demand for a better British economy. For example, Labour has backed new powers for the Financial Conduct Authority to deal with banks that levy unreasonable overdraft charges. And Ed Mayo, the former chief executive of Consumer Focus, is leading a consumer investigation for the Labour party that will look at new measures to empower consumers - for example, at whether we should introduce a class action framework in the UK that enables consumers to seek redress collectively.

Conclusion

When I talk to business leaders across Britain, they all agree on one point: our country's economy is at a turning point. If the 2008 crash taught us anything, it taught us that our economy requires far-reaching reform. We do not currently have an economy that works for working people. We have been blighted by the two crises I mentioned at the outset: the crisis in our financial sector that led us directly into recession, and the crisis in our living standards that has consistently undermined the security and prosperity of the majority of working families in our country. We need change that tackles these crises head-on.

Bringing about such change requires government to recognise that it has to play a greater role in making markets work to deliver the best possible outcome. The Labour party I lead is changing so that we can once more deliver change for the country. We have challenged some of the assumptions underpinning our economy for the past 30 years and have here set out some ideas for how to build a fairer, more inclusive economy that allows us to pay our way in the world even when there is less money to spend. These ideas are already the subject of a lively and open debate with business leaders, academics, policy experts and, most importantly, the public at large.

But of course if government - while it has an important role to play in learning the lessons of the twin crises - was the only agent for change, a shift towards a more responsible capitalism would be far harder. Labour will deliver change not alone but by building a coalition drawing together business leaders from companies large and small, politicians, social entrepreneurs, investors, employees, consumers, citizens and trade unions. Such coalitions come along rarely in politics but when they do they make real change possible, driving out old orthodoxies and establishing new ways of conducting our lives together. The job of the Labour party - and modern centre-left parties right across the developed world - is therefore not just to put forward some of the ideas that can contribute towards creating a more responsible capitalism. It is to help build the coalition for change that will support and make these changes happen in practice.

 

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