In Defence Of Capitalism
October 8, 2008
These are dangerous times for capitalism and free markets. In the past few weeks we witnessed an unravelling of the global financial system at a speed so breathtaking that even seasoned financial experts have little certainty as to its eventual implications.
The political class is reeling. How best to balance the need for swift and decisive action to restore stability with concerns at the law of unintended consequences? How to protect depositors and maintain confidence in the markets without protecting and rewarding bankers for reckless risk taking? And how to convey security and certainty to a dismayed public whilst struggling to grasp how this financial turmoil will affect the real economy?
For sure supporters of free markets and globalisation have dealt a sore blow. There is certainly a degree of truth to the notion that we are where we are as a result of untamed greed and we shall have to take stock.
But what we must not do is allow a narrative to develop which heralds the current crisis as the start of a new era of corporatism and ever more restrictive regulation. Capitalism, whilst wounded, has not been discredited. Indeed without the dynamism of free trade and markets, billions across the globe would not be enjoying (in many cases only starting to enjoy) the fruits of innovation, creativity and enterprise.
My constituency houses the City of London; hedge funds and alternative assets in Mayfair and St James; a residential population of wealthy global business folk and a service and entertainment sector in the West End which has blossomed from the disposable incomes of a busy London workforce. Capitalism has thrived here. But Conservatives have never shied from exposing some of the problems caused by this wealth explosion.
Last year, to the dismay of some of my wealthier international constituents, we articulated the importance of an equitable tax system for the non-domiciled in response to a growing sense of despair and resentment from hard-working Londoners. The debate on non-doms followed hot on the heels from that over the preferential tax rates enjoyed by those working in private equity. This was essentially a middle class revolt over the unequal rewards to labour. To their surprise, many highly educated professionals working outside the gilded corridors of the financial services sphere saw themselves losing out as the world became more integrated and interdependent.
It has come as no shock to me, therefore, that many people feel little sympathy for the current plight of the investment banker. For a large proportion of British workers, the growth of the City’s power has simply increased the cost of living and reduced to a wistful dream any prospect of getting on the housing ladder. Now with a culture of two decades of financial services dominating the central London landscape since the 1986 Big Bang, the banking industry (previously keen to keep government interference or regulation to a minimum) asking for a public bailout has quite understandably been met with distaste. In such a climate, I am deeply worried that the centre of gravity of public sentiment on economic and financial matters has in recent weeks moved firmly to the left. The clamour for heavy regulation and government control in the financial services sphere will increase.
So I was very encouraged to see at last week’s Conservative Party Conference David Cameron and George Osborne take a brave stand on this issue. They made clear that whilst irresponsibility in banking must be curbed, populist and rushed measures designed to rein in City excess should be avoided.
In the current climate, it would have been all too easy to play to the gallery, a reckless temptation I fear the Prime Minister has failed to resist. As the Shadow Chancellor rightly pointed out, however, Gordon Brown has no place lecturing the City when he has played such a significant role in shaping the failed regulatory system and racking up colossal government debt whilst hubristically claiming to have ‘ended boom and bust’.
Similarly, whilst it is easy for us all to target bankers as the most obvious recipients of the decade’s boom, we must not forget that the racking up of over £1 trillion of personal debt was the responsibility of the public at large. Nor were the banking fraternity the sole beneficiaries of a house price explosion, which has seen many people accrue more profit from property inflation than they could ever have dreamed of earning over a similar period of time.
It must now be the role of politicians soberly to reflect that this crisis will affect not only the financial services world. The public needs to know that the economy as a whole now stands to be sorely tested in the years ahead as the combination of much diminished liquidity, historically high commodity prices and a weak currency begins to bite.
There is no easy short-term fix and I detect that the public are increasingly receptive to politicians who tell it as it is. We must accept that to a great extent, the housing bubble should be left to deflate. We should reconcile ourselves with the potential loss of some large banking and corporate institutions. At the same time, confidence needs to be restored to our markets through restructuring and recapitalising the financial system and the core of that system sustained – something which will require the determination of a strong government.
Demands for quick-fire solutions and superficially attractive regulation should not be indulged. The Sarbanes-Oxley legislation introduced in the United States after the Enron and Worldcom scandal has taught us two things. First, that recent additional regulation to protect consumers in that country did nothing to stave off the current crisis and second, that in a global economy, business will have no hesitation in relocating if regulation becomes too cumbersome. One positive now being discussed in the City is the possibility of mopping up in the years ahead should other countries, notably the US, be tempted to over-regulate again and further push business our way.
It is worth reflecting at this point that when financial institutions are described as ‘too big to fail’ implicitly we are also recognising they are ‘too big to regulate’ and are ultimately beyond the pale of prudential sanction. Perversely the recent set of defensive megamergers in the financial services world will make this worse since regulation is the strongest barrier to entry to the market. This in-built lack of competition will continue to result in a remuneration regime that means the rewards to investment banking employees are roughly seventeen times that of the general economy. The demand for robustly large balance sheets makes for unregulatable institutions, cushioned from competition and able to charge exorbitant fees.
These new business opportunities will not be welcomed by the public unless we attempt to modify our own regulatory framework and make regulators more proactive and credible. This can be achieved without stifling financial innovation and flair or introducing unnecessary legislation.
Since 1997, we have had a three pronged system which divides responsibility between the Financial Services Authority (FSA), the Bank of England and the Treasury. After a decade of clement economic weather, the first time the system was tested saw the lack of accountability, division and conflict between each institution and the emergence of competition between regulators. Streamlining must now take place – perhaps through the merging of the FSA with the Bank of England – and the disparities between the regulators and the bankers should be evened up. The huge salary differences between the regulators (on civil service grades) and those they pursue mean that the brightest minds are consistently attracted to the banks, outwitting those who seek to check their excesses.
Banks themselves must in the future become more responsible. Huge success-driven bonuses have until now been based largely on short term results. Instead, reward should be pegged to share price performance (I accept this did not prevent the collapse of Lehman Brothers where employees were given generous shareholdings) and longer term profit goals. Furthermore, rules should be introduced to preside over banks’ capital requirements to prevent what risks unravelling into excessive borrowing.
We should also look at the operation of credit agencies, the bodies which rate an organisation’s ability to keep to their agreements, resulting in the advance of many billions of dollars a day. Currently, agencies are paid by the same companies having their credit rated, providing a clear incentive for an agency to produce a favourable result. A better system would see agencies either being paid by those lending the money or a general market levy to ensure neutrality.
It should be kept in mind that whilst mergers facilitated by the government can create short term stability, they are ultimately highly risky. Large banks cannot be allowed to fail and in the event of their faltering, financial meltdown quickly looms. As time passes, we must look to maintain smaller institutions which can keep alive an element of competition in the market place. This will be ever more crucial as consumers and businesses find themselves restricted by the offers available from money lenders.
Finally, the United States looks set to take on the greatest burden in sorting out the current mess. Rather than strive to deal with global financial problems, our focus should remain on sorting out our own house. Painfully, this may mean deepening a huge fiscal deficit but if this is to be done, it has to be vigorously and relentlessly driven down the moment the economy recovers.
A daunting task lies ahead and getting it right means resisting the emotional pressure of a public resentful of the money makers and fearful of what is in store. A large part of that pressure can be mollified if the public is made aware of the danger the wider economy is in, the pitfalls of poor regulation and the collective pain which we may all have to grit our teeth and get through.
Indulging in the bashing of bankers and global capitalism will prove tempting for many – even amongst Conservative Party supporters. As a defender of free markets, free trade and global capitalism, I am willing to bet that whilst government needs to play a crucial role in stabilising and revitalising our confidence-battered economy, it will eventually be hard work, enterprise and freedom in the market place which will ensure our economy thrives once again.