Don’t offer us legal protection

There was a throwaway line by John Kay in his remarks at the TUC’s ‘Beyond Crisis‘ event a couple of weeks ago that didn’t get the attention it deserved: ‘that the financial services industry is by far the most influential political force in modern countries‘. It’s not the sort of language you expect from someone like Kay, despite his fine work on the limits of markets. But further evidence that he might be right followed almost immediately, in the shape of both the pusillanimous Walker Report and the breathtaking Supreme Court decision on banks’ overdraft charges. (To quote an old Goons sketch: Open your wallet and say after me, ‘Help yourself’.) Fortunately John Kay had spelt out his argument in his recent Wincott lecture. Two quotes from the lecture summarise it: first, “prosperity and growth require that entrepreneurial energy should be focussed on the creation of wealth, rather than the appropriation of the wealth of other people,” and second, that, “political freedom is jeopardised by excessive concentrations of economic power”.

The argument that Kay made in the Wincott lecture, helpfully republished by Open Democracy, was that the finance sector was now making most of its money not by productive effort, but by ‘rent seeking‘, a technical term used by economists which broadly means using political power and influence to change the rules to make sure that you are able to appropriate a greater share of resources and rewards. Rent-seeking is inevitable, as Kay observes, but its scale is not; we can have more of it, or less of it.

The ability of a market economy to restrict rent-seeking, its capacity to channel the desire for acquisition into channels that create wealth rather than extract it, depends on measures both to prevent the concentration of economic power and to limit the terms of access to such concentration.

In this, there has been a significant political – and I’d also say cultural – failure in both Britain and America over the past 30 years. Kay has a dry wit, and as he observes, the criteria for qualifying for the unimaginably large state handouts which constituted the bank bailouts were “essentially, that the firm is large, well established, and unsuccessful commercially”. The underlying philosophy which supports the concept of being ‘too big to fail’ is, in essence, rewarding the most able rent-seekers.

Behind that lies the central fact of modern political life – that the financial services industry, and particularly its investment banking arm, has become the most powerful political force in Britain and the United States.  The reasons are clear enough:  the rents available in the financial sector have attracted much of the ablest talent in the two countries and created a generation of financiers who are both smart and wealthy.

Reading some of Kay’s speech,  I was at times reminded of nothing so much as Charles I’s nobles before the English Revolution, plotting to preserve privilege and influence in the face of the challenge from the new merchant class.

An important part of his case is that there has also been a corruption of the idea of what markets are for. Kay points out that markets have three main characteristics:

• ‘prices as signals’: the price mechanism is generally a better guide to resource allocation than central planning;
• ‘markets as a process of discovery’: a chaotic process of experimentation is the means through which a market economy adapts to change; and
• ‘diffusion of political and economic power’.

But in the neoliberal climate which has governed public policy over the past twenty-five years, only the first of these has had any political traction, and with disastrous results for public outcomes (look no further than the electricity supply industry). “Both supporters and critics of the market economy have often confused policies that are pro-business with policies that are pro-market”, says Kay. ” That confusion has both undermined the social and political legitimacy of the market economy.”

Finance as predator

I thought Kay’s speech one of the most effective contributions to the current debate that I’ve seen because it links the political and economic crisis – it reminds us that what we have here is not an economic problem, but a problem of political economy. And once you start looking in this direction, there is quite a lot more to be found. James Robertson’s excellent newsletter pointed me in the direction of a paper by William Black on the damage done by the finance economy to the productive economy. The title sums up the argument: how the servant became a predator. One data point is staggering – that in the US the financial services sector now commands 40% of total profits, whereas forty years ago it took only 2%. (And as Paul Krugman has pointed out, the US economy performed better then than it does now. In fact he had to make the point twice). [Update 13/12: The CRESC alternative report on banking (opens in pdf here) has useful detail on how the financial and political establsihments supported each other in the wake of the crisis.]

Apart from the huge increases in inequality that have resulted from this, the wealth and influence of the big five US banks have prevented reform of the banking sector – ensuring their continued competitive advantage while corrupting political and economic life. James Galbraith has written of The Predator State (reviews here), in response to a challenge from his father shortly before JK’s death:

Today, the signature of modern American capitalism is neither benign competition, nor class struggle, nor an inclusive middle-class utopia. Instead, predation has become the dominant feature—a system wherein the rich have come to feast on decaying systems built for the middle class. The predatory class is not the whole of the wealthy; it may be opposed by many others of similar wealth. But it is the defining feature, the leading force.

It might be comforting to imagine that the scale of feasting is greater in the United States, because of its more plutocratic features, but I’m not sure that we can sit too comfortably in the UK. The entire structure of our public sector and public services, from student loans to local authority services to infrastructure investment has been redesigned to the greater benefit of the finance sector – under both Conservative and Labour governments – over the last twenty five years, whether called ‘private finance initiative’ or ‘public private partnership’. There’s no space here, but no need, to list the long queue of bankers enrolled by New Labour to make recommendations on huge areas of public policy, or the correspondingly short list of public sector workers asked to make recommendations about Cuty governance.

Incumbents and lobbyists

One of the consequences of all of this is that public policy becomes dominated by notions of “market failure” and of “competition policy”, which produces poorer public outcomes, both theoretically (it is too narrow a view) and practically (large corporate beneficiaries can employ better economists and better lawyers). Kay also has some words to say about the media sector, where – similarly – government policy (and proposed legislation) is about rewarding large incumbents who are better at lobbying (an essential rent-seeking skill) rather than enabling innovation.

There is a need for policy, but a market policy, not an industry policy:  But policy aimed at supporting the market, not supporting the industry:  policy towards breaking up the industry, not promoting concentration: policy towards facilitating entry, not conferring artificial advantages on established firms:  policy towards removing distortions of competition, not creating them.

I agree, of course, but am currently pessimistic. Kay’s argument about power and influence needs to be better heard, and better understood, before the current anger about banks and their bonuses can be directed towards change.