21 May 2018

McDonnell’s profit sharing would put Britain on the path to socialist ruin


On yesterday’s Sunday Politics, John McDonnell explained his party’s policy on profit sharing. He proposed that businesses should be required to share profits with workers either in the form of bonuses or share distributions.

He said he wants to “transform the economy” in a way that “radically challenges the system as it now is”. Indeed, he says the “overthrow of Capitalism” is now his “job”. He said his message to investors is “You’ll get a fair rate of return, but we’re not going to be ripped off anymore — simple as that.”

Rates of return are already (to some extent) restricted across a number of economically important sectors — airports, mobile phones, electricity, gas, water, to name just a few. But the restrictions on pricing in those sectors exist because the firms involved are monopolists (or at least have significant market power).

What about if we applied the principle more widely across the economy, as McDonnell seems to want to, restricting profits and prices in all sectors, so investors can make a “fair rate of return” but no more, instead having either to distribute profits to workers or pay excess profit taxes to the state? What would be the economic effects?

Many firms already pay bonuses to staff if the they make higher-than-expected profits, and other firms offer key staff bonuses in the form of shares. Sometimes firms are bought by their workers, either in the form of management buy-outs or sometimes through purchases by the wider workforce. Other firms are automatically owned by their staff. Some are even owned by their consumers.

In a diverse economy there is nothing wrong with having some staff be part-owners of companies or otherwise sharing in the company’s profits. But problems arise if one mandates that all firms should be run that way or attempts to cap returns at some state-set “fair” level.

Capitalism is, by definition, a system with capitalists that are not the managers of enterprises. That investment capital is provided by those not involved in running firms means that firms can secure investment even when none of those seeking to create and run the business has any money of their own. The essential definitive feature of capitalism is that it is a system of opportunity for those without money to have their projects funded.

To object to capitalism is — by definition — to insist that only those who already have money are permitted to start businesses. If all external investment — i.e. investment by those that do not work in a business — is by the state, we call it “state Capitalism”. If all property is held in common and all investment is by The People in common, then The People already have money.

If we do not forbid external investors from putting money into companies (i.e. if we do not “overthrow Capitalism”) but, instead, merely cap their rates of return to a “fair” level, that will not end all investment. But it will mean that only certain sorts of investment occur. In particular, it means an end to high risk investment, where very high rates of return when a project is successful make up for all the losses in other less successful ventures when projects are not successful.

The two most obvious types of high-risk venture are investment in start-ups and investment in failing businesses. If McDonnell’s scheme of restricting all investor profits to a “fair rate of return” were introduced, the automatic result would be less investment in start-ups and failing firms.

That would have fairly clear implications for the sort of economy the UK would have. Over time, the technologies we created domestically would become more and more obsolete. New technologies and new products would come in gradually, but only from abroad and only later than other countries had them. At the same time, it would become rare for investors to seek to turn around failing firms. They would tend simply to be allowed to go bust.

Worthy studies would then tell us that there was an under-provision of investment capital in the UK for new firm start-ups and in failing firms. Such “market failure” in investment would then be seen as a justification for additional state intervention, with the government acting as the main investor in new start-ups and as the bailer out of failing companies. Through this route, more and more of the economy would come into state ownership over time. I don’t need to tell you how this movie ends. You’ve seen it in dozens of failed socialist states all around the world in the past century.

High profits can be the result of monopoly power — sometimes (though not always) caused by misguided protectionist measures, regulatory errors or political influence. Capping the prices and hence profitability of monopolies can make sense, and is already widely done all over the world.

But introducing a general profits cap or general requirement that rates of return only be “fair”, with any excess either distributed to workers or taken by the state, will result in driving investment out of high risk activities, such as new business start-ups or the turning around of failing firms. That in turn will, over time, drag the state into a wider and wider role in the economy. It is not improper that investors who are not workers in firms should be allowed to make high returns from such investment. It is precisely because they can make such returns that those who do not have money of their own to begin with can get funding for their good ideas. That opportunity — that social inclusion, that chance for the poor to get ahead — is the definition of Capitalism.

Andrew Lilico is an economist and political writer.