Bill Jamieson: Easy to forget that down follows up

By Bill Jamieson
Published on Sunday 22 January 2012 00:00

SO WHAT are a “better economy” and “socially responsible capitalism”, exactly? Once David Cameron and Ed Miliband have finished flashing their soundbites and defined more accurately what it is they want, how do we get there?

An impossible if not ridiculous task, you may say: capitalism is not just prone to bubble and bust, to crisis and breakdown – it thrives on them. Crisis and recession and depression may be uncomfortable, but that, in its raw, unmediated state, is what critics say it inevitably brings. But to defenders these are the purifying agents of change, the process of “creative destruction”, as Joseph Schumpeter so brilliantly described it, that enables the entrepreneur and the next generation of capitalists to build anew from the rubble of the old.

The business cycle is what comes with capitalism, the heady excesses of exuberance corrected by the sobering arrival of retrenchment and recession. Capitalism is the system that allows the private entrepreneur to adapt, innovate and create to serve a market of consumers free to choose what they wish to buy and allocate their resources accordingly.

The defining characteristic of the business cycle is that the cycle turns. Those peaks and troughs are ultimately self correcting without any state intervention and, indeed, are slower to correct the more that the state interferes. And because it is ultimately driven by the free choice of consumers, this system is both more efficient and more socially preferable to the alternative of central planning and control by an all-powerful and ultimately repressive state.

But Schumpeter also recognised how the Great Depression of the 1930s fundamentally changed American attitudes: the raw capitalism of old and the greed of Wall Street bankers riding roughshod over Main Street America could never be tolerated in a democratic age. The Great Depression fatally undermined the moral case for capitalism: government and the state would come to play an ever greater mediating role. He was right in this, but wrong in his pessimistic ruminations that this would lead eventually to a fully socialised state.

We have struggled since to create the “half-way house”: the kinder, softer, socially responsible, regulated capitalism. Today we are swamped with the wreckage and detritus from the bursting of the financial bubble of three years ago: rising unemployment, a moribund economy, declining real incomes, stagnant to falling house prices, boarded up shops and no sign of recovery.

So how come the mediation model failed? What we have seen is less an unalloyed “crisis of capitalism” as such but a particularly dangerous strain of government-sanctioned debt excesses and an economy fuelled by an unsustainable boom in both state and personal borrowing.

We really thought “we could have it all”. Cheap credit made it so. Or so we thought. A new generation forgot – or was unaware – of the chastening experience of the old. Recessions are the product of this amnesia.

Against this backcloth, little wonder that the detritus of the boom era has come to look ever more intolerable: excessive bank bonuses, the soaring pay of FTSE100 directors, firms going under as bank lending is constrained, and a widening gulf between a wealthy elite and those on low wages or forced out of work altogether.

The policy dilemma now – as it has been for previous generations – is how to fix these excesses without shutting down the entrepreneur, for it is on this efficacious activity that we critically depend for a real recovery – as opposed, that is, to resort to yet higher levels of state borrowing and debt to finance artificial stimulus – and the artifice of mended ways.

But how in all this can we curb those behaviours that most offend us, the galling persistence of bank bonuses and pay excess in top companies?

A marked development over recent decades has been the rise in the power of the managerial elite in companies as the power of shareholders – the owners of the business – to exercise control has diminished. Investment institutions have been too complacent or too powerless to impose sanctions as a company’s share ownership is now globally spread. It was the small shareholder in the 1990s who led the revolt against the pay of Cedric Brown at British Gas. But their numbers and their influence have continued to wane.

Some institutional investors do take corporate social responsibility seriously. But many do not. And UK shareholders as a whole are increasingly being replaced by overseas owners who rarely exercise voting rights. That is why political appeals to shareholder activism are doomed to fail.

Some question the linkage between good corporate governance and long term financial performance. And if there are no rewards for “being good”, why bother?

But you only have to look at the self destruction of companies such as Enron, World Com, the ruinous lending excesses of banks and most recently the crisis within Rupert Murdoch’s media empire to see how the absence of corporate governance can not just affect “the bottom line” of companies but inflict such colossal damage as to prejudice their survival.

What of solutions? Legislative change to enforce ethical behaviour, such as the Bribery Act, is one route. But what of other approaches? Changing attitudes and behaviour to achieve a “better” capitalism may not be quite the lost cause it seems.

Here in Scotland, the Edinburgh University Business School has been working on a Resources Governance Index (RGI). It is the brainchild of former Financial Services Authority professional Professor David Jackman. I caught up with him in Edinburgh last week, and he is convinced that Scotland could develop a comparative advantage in European markets given its reputation for innovation, enterprise and strong management.

It leads the way in renewable technologies, fund management and software design, with Edinburgh a European hub for financial services.

The aim of the RGI is to provide a better picture of the health and effectiveness of companies’ governance across a wide band of measures. It also seeks to reflect how a company fulfils a role in the community and society as a whole. The RGI is drawn from publicly available data and measures compliance with governance codes, the culture within an organisation (salary spreads, treatment of customers and staff) and commitment to the wider community.

If “location, location, location” was the battle cry of the property market, then, in Jackman’s view “reputation, reputation, reputation” should be the compelling reminder to companies that behaviour perceived as unethical can carry a devastating bottom line cost.

Firms that can generate a good standard of ethical behaviour to staff and consumers – the John Lewis Partnership for example – can generate loyalty among customers and become a model for other companies to follow.

Elsewhere, initiatives are under way in the banking sector, while pressure is growing for courses in financial history to become obligatory for bankers. History is indeed a great teacher, but nothing beats the sanction that the cycle itself unfailingly delivers.

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Hamilton2

Sunday, January 22, 2012 at 11:50 AM

Should we encourage the creative destruction of politics?. . . National politics is certainly pushing for its extinction. . . Disregarding checks and balances on finance was the start. It is often said nowadays on investigations into the world's latest economic collapse that no additional rules are necessary, only enforcement of the existing ones.

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Mike ...

Sunday, January 22, 2012 at 11:30 AM

An important and critical absentee from your article is any reference to the role, and efficacy, of market "regulators", whether that be, say the Bank of England, the Financial Services Authority, OFGEM, the EU, etc. etc. The role, and the success or failure, of such "market regulators" deserves not only a mention but some detailed and critical examination in any discussion of market economies.. But in the context of your article on governace, it may be more pertinent, and more interesting, to pose this question. Given the manifest failures of the FSA in regulating RBS, HBOS, Northern Rock et al - and in the aftermath of such failures - were those at the FSA awarded bonuses? Answer - yes. The FSA accounts for the subsequent year year shows that the total paid out in bonuses was just short of £22m, an 11.6 per cent increase on the previous year’s figure of £19.7m. In any market economy, with supposed "market regulators" - Quis custodiet ipsos custodes?

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Willie Boy

Sunday, January 22, 2012 at 02:39 AM

Ah well billyboy, are you telling us that everything will be ok. Britannia will rule the world again, will it?

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