EC Consultation on Long-Term Investment - EFFAS Draft Response to Question 2

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Thursday, 23 May 2013 07:57

Published in The Pamphleteers

Written by Con Keating

As you probably know, the European Commission recently launched a consultation on the Green paper on the long-term financing of the European economy. I am currently preparing a submission on behalf of the European Federation of Financial Analysts Societies (EFFAS) addressing the 30 questions included in the consultation. By sharing the draft responses to each question on Long Finance, we welcome questions, comments and criticisms beyond our traditional audience. Please do not hesitate to leave a comment here or on the online community.

Question 2: Do you have a view on the most appropriate definition of long-term financing?

We need to change our culture regarding the long-term and in particular its relationship to the short-term. All too often we still hear that clarion call of short-termism; that the long-term is simply a compounding of lots of short terms, so that the only required focus is to take care of the short term and the long-term will simply derive from it. Most often reflected in the single-minded emphasis on quarterly returns in the stock market and within the fund management industry, this attitude largely misses the point. With such an attitude, would Boeing ever have designed the Jumbo jet? So, the most important aspect of any definition of long-term financing is the definition of long-term.

We can start by establishing a floor in the definition: long-term must mean longer than 20 years (i.e. longer than a generation). We would suggest that there is no real need to establish a ceiling to the definition, because there is none. For example, there should be no end to the period during which motorways and bridges are maintained: and that maintenance requires long-term funding. When the US Interstate Highway System was built under President Eisenhower, the Federal Highway Act included the establishment of a Highway Trust Fund, funded by hypothecated tax receipts on petrol. Such a fund should have no end while there are still cars using the highways but, in an all too typical example of the short-termism that we deplore, the US Congress has repeatedly refused even to tie the tax rate to inflation. Any consideration of the long-term must recognise that there is much in our political system which supports short-termism. This example should highlight the value of a long-term view, and the folly of a short-term one (at least in this instance).

Certain projects of value to the commonwealth (such as hospitals and universities, or roads and bridges) have no maturity date: the long-term for them is forever. They should be funded in a similar manner, and the hypothecation of specific taxes is not the only way. Capital markets have, in the past, been happy to issue and buy undated, perpetual bond issues, and this was not confined just to government issuers (the Canadian Pacific 4% issue springs to mind). Equally some of the players mentioned above, and in particular some charities and many universities and colleges can take particularly long-term positions on the back of particularly long-term views: Balliol College in Oxford is celebrating its 750th anniversary this year (which is a full 220 years older than the world’s oldest bank still in existence). The sources of long-term funding exist, and so does the demand.

We are reminded of the presence of cathedrals and churches that grace so many European cities – the financing, so many centuries ago, of their construction raises more than a passing resemblance to current issues, and perhaps even extends to aspects of institutional organisation. The sales of corrodies (a pension taking the form of board and accommodation) were notable in this regard.

We have emphasised the extreme of what we mean by long-term, and long-term financing, and are fully aware that the supply and demand of long-term funds will be for periods shorter than forever. However, it is important that we not impose any arbitrary constraints on our views. In brief, long-term financing is financing for at least one generation, and with a possible maturity date of forever. We will discuss later some of the intergenerational issues.

In their work, the OECD have associated long-term investment with patient, productive and engaged capital. It is clear that time alone does not define the long-term. We note that the question refers to financing rather than investment, but will draw out some important though broader distinctions.

The patient, productive and engaged attributes are, we believe, symptomatic of the long-term rather than causal or defining. For example, many observers consider mortgage finance to be concerned, inherently, with long-term investment. This is undoubtedly true in the case of new construction; there it meets the OECD productive criterion. However, the majority of mortgage finance is concerned with the purchase of components of the existing stock (previously occupied housing); this is, in the owner-occupied case, the long-term financing of housing consumption rather than housing investment . In many European countries, the consumer attitude to owner-occupied housing is that it is investment, and it is the subject of much speculation. In a consumption context, of course, this is not the case and low rather than high prices are then preferred. We recently heard a variant to this in the context of the UK NEST pensions savings, where the recent rises in stock market prices was welcomed. However, the auto-enrolment system is expected to generate some £11 billion of annual contributions when the system is fully operational; these savers should prefer to buy their investments at low, not high prices. This is also relevant in the context of arguments with respect to intergenerational inequity. We return to this issue later.

This housing finance example raises a question of purpose; in this case, in the use of the financing. We believe there is a similar issue of purpose with respect to the source of the financing. Savings can have many different motivations or sources, from the relatively short-term to the extremely long. This can be from saving for some specific near-term purpose, such as the purchase of a car or holiday, to the extremely long-term of pensions and inheritance bequests on death.

One of the widespread failings of current national statistics is that volumes of savings that are measured and published, but there is little or no discussion of, or data on, the term profile of these savings. This term profile absence is true, also, of the usage of these finances – though the recent estimates of infrastructure and climate change investment demands are a good starting point. We would like to see not just estimates of the volume of savings and investment demand, but also their term structure.

This interest in the term structure is directly relevant to the role and ability of markets and banks to perform the maturity transformation that resolves inter-temporal imbalances between supply and demand. We discuss a related concern with traded equity markets later. Liquidity is a critical issue with any maturity transformation – the ability to refinance when a deposit is called in the case of a bank, and the ability to sell a security at some future time in the case of a market. Financing which relies upon inter-temporal transformation should be expected to be more expensive than financing which does not, precisely because it is reliant upon liquidity conditions, which have a cost.

With this in mind, we should like to propose another (and complementary) method by which we may distinguish the short from the long-term; the source of liquidity from which the contract will derive its performance. Here, we would define the long-term as reliance upon the obligor of the contract as the source of the cash-flow liquidity, both before and at expiration of the contract. By contrast, we would classify reliance upon the market as the source of liquidity as short-term and speculative.

In this view, the purchase of a treasury bill and its retention until maturity would be long-term, as would the purchase of listed equity that is held solely for the collection of dividends. A life insurance policy is non-negotiable and relies upon the life company obligor for performance. A characteristic of the long-term is that income is the dominant concern in performance, which contrasts with the short-term where price behaviour is almost all-important. It is also notable that the high volatility, which characterises short-term behaviour in financial markets, converges slowly to the relatively low volatility of fundamental performance and growth when long-term horizons are considered.

It is as well to remember how low this long-term variability (or risk) has been. The diagram below is reproduced from a recent Bank of England speech. Formally, this is the standard deviation of rolling 30-year periods of annual GDP growth.

It is clear that there are many shades of grey in this liquidity distinction. The speculations of high frequency trading are clearly short-term and the fifty year zero coupon gilt held to maturity is clearly long-term. However, in between, there are many differing degrees of dependency upon obligor versus market sources of liquidity. There are degrees of implicit preference that arise from this source of liquidity approach. The source of liquidity for an industrial enterprise may be entirely independent of the financial markets, sourced entirely in the sales of its products. The source of liquidity for contracts with financial institutions is usually predominantly financial markets. However, the non-negotiability of many consumer financial contracts serves to reduce the dependence of these institutions upon the markets, and incidentally exposes mark to market accounting standards as being inappropriate for these institutions. Here, the risk issue is not whether the instrument can be negotiated or sold to others, but whether the contract can be negotiated with the institution itself, such as deposits called from a bank.

It should also be recognised that financial institutions may add value in manners which are not replicable by an individual. The maturity transformation of banks might be replicated by an individual operating in traded securities; the bank, however, has an advantage with respect to the information it has with respect to its loan customers. However, there are many forms of collective organisation, insurance companies, DB pension schemes and mutual funds, which offer risk-pooling and risk-sharing advantages that are not replicable by an individual. This is the source of ‘financial depth’, and one of its consequences is that, if efficient, it will lower the aggregate need for savings. This suggests that savings targets should be specific to the economy and its financial infrastructure. It also suggests that there should be diversity in the form of ownership of these institutions.

The concept of replication figures prominently in market consistent accounting. Liabilities are replicated by traded assets. This rather begs the question: if an insurance or pension contract can be replicated by traded assets, why do these institutions, insurance companies and pension funds exist at all?

Reliance upon the contract can be seen as ‘patient’ investment. We have some concerns over the ‘engaged’ aspect. We would prefer the concept of committed. Engagement in practice often means no more that lobbying management for higher dividends and immediate performance, with a thinly veiled threat of exit by sale in the market. The long-term investor is committed, for the term of the contract in the case of complete non-negotiability. This is the case in many savings contracts. We shall return later to issues of commitment and the control rights associated with the long-term.

It should be recognised that the long-term is already effectively defined in much regulation. This is most obvious in the case of (long-term) capital gains taxes. The application of preferential rates of taxation with holding term and purpose has been widely utilised within Europe to provide incentives for specific forms of investment. It is not obvious to what extent these incentives have been successful, or whether they have been cost-effective, let alone optimal. There are also many implicit issues within other financial sector regulation, for example: the risk weights applicable to long dated bonds, or even the setting of insurance risk margins from a ‘hedged’ base position within Solvency II.

Finally, we would point out that some long-term pensions and savings entities have already declared their view of the long-term; in Canada, ten years has been chosen, while the Singapore GIC considers the long-term to be 20 years and more.

Read also:

• EC Consultation on Long-Term Investment - EFFAS Draft Response to Question 1

Public Fears, Private Prejudice: Alternative or Complementary Principles of Differentiation

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Friday, 26 April 2013 09:06

Published in The Pamphleteers

Written by rob julian

Many economists and commentators are instinctively pro private sector and anti public sector when considering the solutions to our prolonged recession. With our government debt situation as it is, a cautionary approach is understandable. But here I want to suggest two examples within the larger debates, where what can sometimes come across as intellectual prejudice needs to be backed up more carefully, and where perhaps a more unbiased basis for differentiation would be preferable.

Government Stimulus / Borrowing

Alternative differentiation: Productive verses unproductive debt, rather than public verses private debt.

art of the initial idea for this short essay came from something in Adair Turner's Cass Business School lecture - "Debt, Money and Mephistopheles: How do we Get Out of This Mess?" on 6 February 2013.

Much debate on macro-policy is bedevilled by a failure to be explicit about those two steps of the logic. As a result the same commentators will sometimes:

• assert that we need “ more credit to get the economy going” – making the assumption that this will achieve a predominantly real output rather than price effect
• but warn that stimulating GDP via other means (whether fiscal or monetary) will “drive up inflation” i.e. will have a price rather than output effect
• ... but without specifying why the different balance between a price or output effect will result from the different levers which effect aggregate nominal demand.(p.5)

In other words, Turner is reflecting on the tendency for prejudice to be shown between the means (or “different levers”) of generating greater aggregate demand, even when the mechanism between the means and the benefit of the end result is, to all intense purposes, the same. This observation of Turner's rings true for me, in that I have noticed automatic assumptions being made that government solutions are inflationary and saddle our children with debt, while private solutions are merely “getting the economy going” and a return to healthy levels of investment. These prejudices are often presented as implicitly obvious, but are in fact only partly or not at all backed up by good economic reasoning.

I noticed recently during the Budget coverage on Sky News, that on the banner at the bottom of the screen they had a counter which was clocking up the government's ever-growing debt. This device I thought provided quite a loaded background to the budget debates, and one could imagine Fox News in the US doing the same. It struck me that, given the Chancellors recent 'Help to Buy' proposals, would there be a case for now, and would there have been a case for eight or so years ago, having a similar counter noting the country's total mortgage borrowings.

One rationale for the discriminating mindset of the free marketeers is that private debt usually represents profit making investment, in that firms have seen an opportunity and aim to exploit it for future gain. In contrast, government spending tends to be just a sucking black hole, satisfying present wants, but not contributing anything concrete to future repayment capability. The repayment of the extra business debt can be borne by new profits generated from the investment, but the repayment of the government debt has to come from the freshly squeezed income of future tax payers and businesses. This suggests that the correct prejudice would be to distinguish between debt which contributed to greater output potential in the future, and debt which did not.

But are mortgages productive investments in this respect? A mortgage can be viewed as a productive and rewarding investment on a personal level, in that it saves paying rent and eventually gains a property asset. But on a national scale, a large increase in mortgage borrowing on a slowly growing housing stock, just represents a distribution of money from up-sizers to down-sizers, or between the generations. This obviously is the debate that the policy has sparked. In Britain, one of the biggest silent revolutions over the past decades, has been that a quiet section of middle aged and elderly society are now sitting on small unearned fortunes in house equity, while new buyers struggle to afford a house. For those who ask; where has all the money gone? this is a large part of the answer, … house equity! In terms of being an economically productive investment, one could argue that the section of any extra mortgage borrowing which motivates new house building is real investment, while the rest is just wasted on unproductive and socially divisive asset price inflation. The higher mortgages caused by the later section will not make future tax payers more taxable.

I have left out the potential of government borrowing and spending in general to contribute to a Keynesian multiplier effect on the broader economy, which is a whole other debate. In terms of using government debt finance to spend in non infrastructure areas merely to reflate the economy, perhaps there is an argument for saying this is a viable policy in general during a recession, and the world as a whole does need it. But perhaps Britain's higher than average exposure to the financial services downturn, and subsequent government debt caused by the British bank bailouts on top of the recession, means that Britain should be given a free pass not to join in with any more of this international aggregate demand boosting efforts, and instead should be allowed to free ride on the government stimulus of other countries. Perhaps this underlying recognition that we need stimulus on a global level is what makes the IMF's present attitude towards Britain seem inconsistent with their past country level advice.

In other words, if your finances are as bad as ours are, but you really need to increase economic activity to compensate for a deleveraging and hoarding private sector, you had better make sure your government borrowing is spent on something that will ease repayment in the future. A return to house building in the South-east directly financed by the government is an option I have sympathy for, as that debt would have a very good prospect of paying for itself.

Money Creation

Alternative differentiation: Controlled and appropriate base money expansion, rather than public verses private means.

The central topic of Adair Turner's excellent Cass Business School lecture mentioned above, is the subject of Overt Monetary Finance (OMF), or 'Helicopter Money' to give it its flippant nickname. Turner is all too aware of the prejudiced against public sector interference in general in this area, and against this kind of policy in particular, when he writes:
To print money to finance deficits indeed has the status of a moral sin – a work of the devil – as much as a technical error. … The ability of governments to create money is a potential poison and we rightly seek to limit it within tight disciplines, with independent central banks, self-denying ordinances and clear inflation rate targets.(p.3)

Even when it is effectively proposed, overt money finance is the policy that dare not speak its name. OMF therefore maintains its taboo status – and there are good political economy reasons for why that is so. … The challenge is therefore to take the possibility of OMF out of the taboo box, to consider whether and under what circumstances it can play an appropriate role, but to ensure that we have in place the rules and institutional authorities which would constrain its misuse. … It must also be subject to clearly defined disciplines to guard against political economy risks.(p.31)

Much of the austerity narrative used by the Coalition government relies on the concept of it being constrained by our high government debt level. Introduce the idea that the government could print money, and the being responsible narrative falls apart somewhat. There are probably many people who do indeed believe that it would be helpful for money supply to expand presently, and would have supported lowering interest rates if they had had any further room to drop. So you could ask: if base money supply is growing, does it matter if the cat is black or the cat is white? But many of these same people are wary of crossing the printing money Rubicon, due to a lack of faith in political discipline. Recently, again on a TV news program, when this subject was being discussed, one guest interjected vehemently by saying something like “Oh God, so we should end up printing money like Zimbabwe!” But this I think represents an unreasonable prejudice that is not justified by any evidence of rampant corruption or profligacy to be found, and certainly not within the Bank of England itself.

As Turner recognises, by creating money the government would only be doing in a formal and planned way, what in boom times the banks did in a way which was limited only by the extent of the leveraged boom in finance:
But fractional reserve banks, simultaneously creating private credit and private money, can greatly swell the scale of debt contracts in an economy and introduce maturity transformation. And there is no naturally arising mechanism to ensure that the scale of such majority transformation is optimal. As a result banks can greatly increase the scale of financial and economic stability risks. They can also play an important autonomous role in the creation and destruction of spending power, i.e. of nominal demand, and as a result can generate booms and busts in overall economic activity. (p.11)

In other words, bank creation of money, which can be thought of as their own version of 'debt funded stimulus', systematically over shoots in good times and under shoots in recessions, as Keynes' animal spirits wax and wane. The Bank of England changing interest rates is normally enough to even out this cyclical swing a bit, but at present, when lowering interest rates has run out of steam as a policy, eyes are turning to these other strange and forgotten levers. But right-wingers fear that give the short-termist politicians access to this new lever as a proposed last resort, and they may instead print money for bread and circuses today, and to hell with future price stability. Where as in contrast, at least private sector money creation is more objective, mechanical and derivative of economic activity. But, just because it is derivative of private economic activity, that does not mean that private debt is inherently harmless or without consequence. As Turner states in one of his main conclusions:
If we got into this mess through excess private leverage we should be wary of escape strategies which depend on creating more private debt. (p.40)

Turner's discussion of nominal GDP targets are a clever suggestion to possibly get around the political temptation to misuse an OMF policy, and a clever solution to the all important expectation implications, which are always key to inflation issues. In this approach, nominal GDP targets are set for the future, and if real growth does not materialise, the authorities aim to meet the target with inflation by printing money. When real growth is weak, spare capacities in the economy mean inflationary spirals are unlikely. When real growth returns, the authorities are obliged, in a black and white fashion not susceptible to political fudging or double speak, to take their foot off the gas and park up their helicopters. The degree to which a nominal GDP target is met at a specific time, then becomes a usefully clear measure of a government's, or the Bank of England's competence, ability and integrity.

Turner argues effectively that Japan would have benefited from targeting nominal GDP during the last 15 years. He also introduces comparisons in the way the US and Britain handled post war debt. The 1930s are the period usually evoked in making historical comparisons with today. But as Western countries have kind of learnt that lesson, and as a result in general ALREADY HAVE sunk in the large amounts of government money to try to revive / save their economies (like the WWII spending), perhaps, as Turner hints, it is now the period around the 1950s which are most instructive for today. The 1950's are often considered a golden age for the US despite its WWII debt, so learning from Turner that its debts were “post facto … money financed” (p.27) is significant, and fits in with Turner's inflation rather than deflation biased themes:
Countries such as the UK and the US, which achieved public sector deleveraging after the Second World War, were only able to do so with growth rates of nominal GDP far above current rates (EXHIBIT 23-25). Both rapid real growth rates and inflation rates in excess of interest rates (achieved via effective “financial repression”) were essential to the deleveraging process.(p.16)

Keynes himself was nothing if not agile and unprejudiced in his economic thinking when it came to questions of private verses public solutions. He was also famous for his 'Essays in Persuasion', which sought to stop his contemporary economic generals from fighting the last war, (like inflation today?) or being “the slaves of some defunct economist”. In his discussion to the Macmillan Committee in 1930, in response to the sharp deflation of the period, he had something to say regarding the contemporary recieved wisdom on the subject of money supply, and against the idea of continuing an austerity policy (far more extreme than today's) to reduce domestic real wage costs:
My reading of history is that for centuries their has existed an intense social resistance to any matters of reduction in the level of money incomes. … Throughout history I can only recall two occasions at all comparable to the present one. One was the highly analogous deflation which followed the Napoleonic Wars, … very much like the one we are going through now, was one which brought this country to the verge of revolution, … The other analogous case was the price fall in the middle ages prior to the discovery of America and the influx of precious metals to Europe. The fall of prices was, then, an appalling problem, and it was only mitigated by monetary readjustments. Many of our monarchs rest under unjust imputations of depreciating the currency for their own personal advantage. I am sure they only did it to avoid what they regarded as intolerable wage adjustments. There is no question as to the impoverishment of the world that occurred; and subsequently the High Renaissance and the general process of recovery were based on the accumulation of profit which took place during the period of the rise in prices, lasting about 100 years, which followed on the influx of gold from America. But apart from these two periods I do not think there is anything to prove that it was ever easy to bring about material fall in the level of money incomes. (Keynes, 1981:64)

Finally, interestingly in the lecture Turner reveals that Milton Friedman in his early career proposed the concept of governments never having spending deficits or surpluses, but instead printing and destroying currency in either instance to suit. In parallel, the assumption that needed to go along with this approach was that the ability of private banks to create money would be taken away. What a disconcerting and radical set of ideas this sounds to our 2013 ears. And from Milton Friedman who would later become the darling of Thatcherism and Monetarism!

But Friedman argued in an article in 1948 not only that government deficits should sometimes be financed with fiat money but that they should always be financed in that fashion, with he argued, no useful role for debt finance. (p.3)

Second, however, what both my illustration and Friedman’s proposal assume is that all money is base money, i.e. that there is no private money creation (no “inside money” in Gurley and Shaw’s terms) (Gurley and Shaw 1960). This in turn is because in Friedman’s proposal there are no fractional reserve banks (EXHIBIT 9). [Banks would be made to hold 100% reserves against what they lent out!] In Friedman’s proposal indeed, the absence of fractional reserve banks is not simply an assumption, but an essential element, with Friedman arguing for “a reform of the monetary and banking system to eliminate both the private creation and destruction of money and discretionary control of the growth of money by the central bank ”.(p.7)

When economists of the calibre of Simons, Fisher, Friedman, Keynes and Bernanke have all explicitly argued for a potential role for overt money financed deficits, and done so while believing that the effective control of inflation is central to a well run market economy – we would be unwise to dismiss this policy option out of hand.(p.4)

Note: Interested in economics and economic history, Rob Julian recently wrote an article titled "Keynes on the Slump: A Guide to Keynes' Thoughts During the 1929-32 Crisis, with a Focus on International Relationships and Protection"

References:

1. Adair Turner, "Debt, Money and Mephistopheles: How do we Get Out of This Mess?", Lecture delivered at Cass Business School, 6 February 2013, <
2. The Collected Writings of John Maynard Keynes, Volume XX, Royal Economic Society, 1981.

EC Consultation on Long-Term Investment - EFFAS Draft Response to Question 1

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Wednesday, 22 May 2013 13:02

Published in The Pamphleteers

Written by Con Keating

As you probably know, the European Commission recently launched a consultation on the Green paper on the long-term financing of the European economy. I am currently preparing a submission on behalf of the European Federation of Financial Analysts Societies (EFFAS) addressing the 30 questions included in the consultation. By sharing the draft responses to each question on Long Finance, we welcome questions, comments and criticisms beyond our traditional audience. Please do not hesitate to leave a comment here or on the online community.

Question 1: Do you agree with the analysis set out in the Green Paper (p.4-5) regarding the supply and characteristics of long-term financing?

We do not agree fully with the analysis presented; it is incomplete in a number of aspects. However, we do not believe that an extensive critique is productive, but will point these differences out in our other responses, wherever in our opinion they are material. Our responses are, in the interest of brevity, sketches rather than detailed implementation plans. We are particularly concerned that the paper is single-minded; there are competing demands for capital, notably from households (for housing), together with governments (for investment) and the private sector, over which we would have concerns about potential unintended consequences – particularly over the question of ‘crowding out’.

There is one significant area where we believe the coverage in the analysis is inadequate and it is an area that should be expected to feed into the responses to this consultation. This concerns short-termism and its role in fostering institutional corruption. This is a strand of research emanating from the Edmund Safra Centre for Ethics at Harvard University. The seminal paper is Lawrence Lessig’s “Institutional Corruptions”. In particular, we would draw attention to Malcolm Salter’s recent paper: “Short-Termism At Its Worst: How Short-Termism Invites Corruption… and What to Do About It”.

We quote from the abstract of that paper:
“The central concern is that short-termism discourages long-term investments, threatening the performance of both individual firms and the U.S. economy. I argue, in this paper, that short-termism also invites institutional corruption. Institutional corruption in the present context refers to institutionally supported behaviour that, while not necessarily unlawful, erodes public trust and undermines a company’s legitimate processes, core values, and capacity to achieve espoused goals. Institutional corruption in business typically entails gaming society’s laws and regulations, tolerating conflicts of interest, and persistently violating accepted norms of fairness, among other things.”

Though US-centric, we feel that there are many insights and lessons to be learned from these publications which may transfer to the European context and long-term investment.

References:

1. Lessig,Lawrence - March 15, 2013 - "Institutional Corruptions" - Harvard University - Edmond J. Safra Center for Ethics; Harvard Law School - Edmond J. Safra Working Papers, No. 1
2. Salter, Malcolm S. - April 11, 2013 - “Short-Termism At Its Worst: How Short-Termism Invites Corruption… and What to Do About It” - HBS Negotiations, Organizations and Markets Unit

Is Competition Delivering?

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Wednesday, 24 April 2013 07:08

Published in The Pamphleteers

Written by Chris Yapp

The word compete has two meanings, to strive to win and to take part in a competition. In popular discourse it is interesting how the first definition dominates over the second. To be competitive means to be good enough to take part as much as it means to win at all cost.

When my Dad talked about the Olympics he talked of the ethos of “The joy is to compete, not just win”.

When we talk about “Open Competitive markets” what is the balance we have in mind between these two definitions, and is it right?

Edward de Bono had an interesting example of reductio ad absurdum. Democracy is a good thing; therefore more democracy must be better than less. Carry that on and you end up with a national referendum on what to have for breakfast. Try the same exercise substituting efficiency for democracy and you end up buying each piece of paper individually by competitive tender.

Now try this: “competition is good, therefore more competition must be better than less”.

We have lived in an era of 40 years with the dominance of free market thinking and with it competition.

Regulators are given a duty to promote competition.

Yet over 40 years there is an increasing body of evidence that competition, as currently understood, doesn’t always deliver.

Let’s look at some of the arguments.

Competition is supposed to lower costs, promote innovation, improve service, and improve value for money for the public purse. I can remember that in the early 80s I was told at a think tank meeting that monopolies were immoral and free markets kept the participants honest.

When the utilities were deregulated, the promise was made that in time the need for regulation would diminish as the market took hold. Energy prices would fall and attracting private sector investment would secure continuity of supply.

Competitive markets are the engine of growth and stability. That’s certainly challengeable since 2008.

I don’t want to go through here some of the benefits that have been realised, so this may seem like a bleak analysis, but bear with me.

I’m just about to get my first defined contribution pension. The annuity valuation indicates that I have to live 21 years to get the sum back at 0% interest. The fees eat up much of what I have saved. Indeed costs of the competitive UK pension market are up to 3 times some of our “less competitive” European counterparts. So much for cutting costs!

I spent 75 minutes yesterday on a call centre for a privatised utility trying to report a fault. I don’t believe in naming and shaming so I won’t. It was frankly appalling. In comparison my last contact with HMRC was a delight. Service, what service?

Government IT projects are often described as a disaster waiting to happen, often in my experience unfairly. Yet all of these are procured by open competitive tender. Value for money? Furthermore the contractual mind set in competitive tender has been known to squeeze out, not stimulate innovation, as it’s proven difficult to procure innovation.

As for honesty, can I just say PPI and Horsemeat?

The recent reports on LIBOR have described dysfunctional corporate cultures driven by individually hyper-competitive individuals.

Energy prices have risen and the private sector is demanding large public subsidies to invest in new energy infrastructure. We will be perilously close to the capacity of the national grid around 2015-16 and energy security cannot be guaranteed.

The standard response to all of these is to be blame procurement or regulation. Yet regulation was supposed to diminish over time. The promise was that it was temporary to allow for competition to grow against the privatised giants.

I find it interesting that Michael Gove, a Conservative Education Secretary last year wanted to establish a monopoly for exam boards on the grounds that competition had led to dumbing down and a race to the bottom.

Put like this a mark of gamma and “Could do better” looks generous. In a more balanced piece I would be comfortable with a beta, but not an alpha under any circumstances.

In contrast Europe’s strength in 2G mobile phones that spawned Vodafone was born out of international co-operation. WWW was invented at CERN in an international collaboration.

There is that horrid word “co-opetition”, competing through collaboration that is occasionally used for this phenomenon. This is the difference in Game theory between zero-sum games and win-win.

I’m not arguing to go back to some sunny uplands of the past which never existed. On the contrary, we only progress by tackling difficult and intractable problems.

If we are to secure the benefits of open markets for the long term, then I argue that we need a nuanced debate about the value of competition, not a blind acceptance of it.

I am reminded of a poster in a work place “Flogging will continue till morale improves”.

Is this a case of competition isn’t delivering, what we need is more competition?