21 December 2016

We need free markets not a free-for-all


These are disturbing times for those of us who believe in free-market economics. After more than three decades in which the West has been governed by regimes claiming adherence to the principles of the market, the economy is locked into “secular stagnation” and massively in debt – and the public is in the process of repudiating those regimes.

How have things gone so horribly wrong? Have events proved our faith in the virtues of competitive markets to be misplaced?

The reality is that the principles of the free market economy have not failed. Rather, these principles have not been followed. In fact, the regimes that are now being rejected by the voters have never paid more than lip-service to the principles associated with Adam Smith.

There have been two critical departures from these principles. First, governments have failed to break up the domination of key sectors (including electricity, gas, water, phones and the internet) by small numbers of companies.

Second, there has been a failure to enforce honesty and transparency. The principle mechanism of the market – free and fair competition – has therefore failed to operate.

At a time when “capitalism” is being condemned by people who are in fact victims of corporatism, there is a pressing need to restate the case for market economics, distancing it from those who have stolen its language to clothe a creed of selfish cynicism which is now ending in abject failure.

That things have gone wrong is surely undeniable, and is evident in two critical ways.

First, the public across the West are in open revolt against the self-styled “liberal” elites. Though widening inequalities and the sheer arrogance of self-serving regimes have contributed to this anger, a critical motivation is economic.

Real wages have declined steadily, even when measured against official inflation, and even more markedly when set against the cost of essentials – while secured and unsecured household debts are at uncomfortably high levels.

In Britain, for example, real wages have been declining since 2007, and are projected to go on falling throughout an official forecast period which runs to 2021. In the United States, middle-class real incomes have declined, arguably over an even longer period. Italy’s real GDP is now 12 per cent lower than it was in 2007.

At the same time, security of employment has deteriorated, and millions have been pushed into a “precariat” while millions more are now described as “JAMs” (“just about managing”s). This is a track record of failure.

Second, governments and central banks have contrived to run near-zero interest rates for more than seven years. This, too, is evidence of failure, because negative real rates are not consistent with a healthy economy in which investors can earn returns, and provision for retirement can be accumulated.

Again, Britain typifies this malaise. Government continues to borrow heavily, despite sustained “austerity”, while official forecasts link projected growth to an assumed further expansion in household credit.

Immediately after the most recent cut in interest rates, deficits in pension schemes were reported to be £945bn, or more than 50 per cent of GDP.

As well as crippling pension provision, this zero interest rate policy has destroyed returns on capital; created a massive bubble in the value of assets; saddled the world economy with enormous debts; stymied the necessary process of “creative destruction”; and failed to deliver the stimulus which was supposed to push the economy out of secular stagnation.

Between 2000 and 2014, each dollar of nominal global “growth” came at a cost of $2.50 in additional debt. And even this ratio understates the problem, since “growth” has really amounted to nothing more than the spending of borrowed money.

The ratio of borrowing to growth, which was 2.2:1 before the global financial crisis, has been 2.9:1 since then.

The dependency on borrowing has become so absolute that it can, without hyperbole, be stated that the global economy has been transformed into a giant Ponzi scheme – and such systems can only ever end badly.

This is failure on a gargantuan scale. And it presents a stark choice between two possible explanations.

The first is that the implementation of market-based policies has been an abject failure.

The second is that the supposed market-oriented policies of the Western establishment have, in reality, been no such thing.

To resolve this issue, the obvious starting point is with Adam Smith, the Scottish economist rightly regarded as the pioneer interpreter of the market.

It was Smith who stated that competition is the dynamo that drives the economy, not just in goods and services, but in employment and investment as well. He asserted that competition is so important that any departure from it is damaging.

In the story of economics as Smith tells it, the villains are monopolists, cartels, and anyone else seeking to undermine competition. Any such interference, Smith says, is “a conspiracy to defraud the public”.

The incentive for corrupting the market is, Smith says, self-evident. By ensuring best value for customers, competition limits profitability. Accordingly, Smith makes it abundantly clear that markets need to be kept competitive, fair and honest, despite the incentives which promote malign interference. Far from proposing an economic equivalent of an unfettered free-for-all, Smith is an advocate of vigilant regulation, a clear implication being that only the state can provide it.

The Adam Smith whom we meet in his writings – the advocate of competition and avowed enemy of monopoly and other market distortion – becomes a very different, and lesser, figure in the policies advocated by “the neoliberal right”, and followed by governments since the 1980s.

Now he is an inveterate opponent of “the public sector”, a cheerleader for “the private sector”, an advocate of “deregulation”, a believer in minimal government, and the high priest of “law-of-the-jungle” economics.

In plain English, it is simply piffle. Not least because the public sector as we understand it simply did not exist in Smith’s day.

Of course, Smith is not the only victim of the ideological air-brush. Keynes was certainly an advocate of deficit stimulus in adversity, but his matching tenet – that governments should run a surplus if the economy threatens to overheat – is seldom if ever mentioned. In the hands of “semi-Keynesians”, the great man becomes a cardboard cut-out, forever demanding stimulus and unconcerned about the resulting growth in public debt.

Yet it is on the misrepresentation of Smith that the self-serving creed of “neoliberal” economics bases its flimsy case. Though lip-service is paid to competition, the probity required by the real Smith’s concept of the honest and transparent market becomes at best a desirable, but not essential, characteristic. It also follows that deregulation is a public good, and that banks’ managements, not regulators, are the best judges of shareholder interest.

Though the tenets of the falsified Smith can be pulled apart by a first-year student, the attitude prevails that “market forces” are sovereign, bad outcomes for some or many are just the luck of the draw, the future is irrelevant, debt is irrelevant as well, integrity matters little, inequality is “natural” rather than contrived, and profitability is the sole arbiter of effectiveness.

From this nonsense, almost everything else follows. There is no contradiction between promoting consumption and undermining wages, because debt can fill the gap so long as deregulation keeps the taps open. Buying $1 of “growth” with $2.50 (or much more) of new debt is fine, because debt isn’t very important anyway.

Ethics become optional, and corporate misbehaviour, where it cannot be ignored, can be explained away as “miss-selling” (which sounds no more serious than misplacing an umbrella). If penalties really must be meted out, the hapless shareholders can always foot the bill.

One of the most tragic consequences has been the relentless degradation of business ethics. Increasingly, only “the eleventh commandment” (“don’t get caught”) is observed – and even this hardly matters if your influence over the state renders you but all immune to sanction.

Another predictable consequence of “free-for-all” economics is that it has fostered market concentration. Wherever we look in some of the most important sectors of the economy, we see a market concentration that impairs drastically the free choice of customers, and delivers profitability far in excess of competitive market norms. The acceptance of this by government has been a huge betrayal of the principles of the competitive market.

Anyone truly convinced by Adam Smith would long since have demanded that no business in sectors such as energy, utilities and many others should enjoy more than, say, 10 per cent or 15 per cent of the market. Yet many big corporates have more than enough political clout to ensure that the very idea of such “trust-busting” is out of the question.

The public need to be told, therefore, that those who claim to speak loudest for “the market” have in fact been its biggest betrayers. The case needs to be made for competition as the servant of the many, not the hollow slogan of a manipulative minority.

This requires making the case, too, for regulation and for the primacy of ethical behaviour. And emphasising that the system at fault is not “capitalism”, but corporatism.

If this case is not made, we face two distinct risks. The first, less likely, danger is that the current elites survive, perhaps by using ever greater coercion to maintain their power and wealth. The greater danger is that an infuriated public turns instead to the same collectivist philosophy which failed so spectacularly in the Soviet Union and its satellites.

Believers in the principles of the free market should feel not apologetic but angry about the debasement of their beliefs by a self-serving elite. They should side with the public, and explain that the competitive market offers a future far better than the siren call of collectivism, or the tawdry manipulation of corporatism.

It is to be hoped that what emerges from such a backlash is reform that does three things.

First, it must insist on competition, breaking up companies whose market shares are excessive.

Second, it must demand the highest standards of honesty, transparency and accountability in business, reinforcing this with appropriate sanctions.

Third, it must block the “revolving doors” between government and corporate wealth.

If these reforms are made, the competitive market can restore prosperity. If they are not, a far grimmer future looms.

This is an edited version of an article which first appeared here.

Dr Tim Morgan is former head of research at Tullett Prebon.