Wednesday, 9 October 2013

Ignoring the Wealth of Nations

When Adam Smith published his economic treatise in 1776 he gave the world a number of defining ideas for wealth creation and preservation.  The first was that regulations on commerce are a menace and counter-productive. Smith’s amazing insight was that a nation’s wealth is really the stream of goods and services that it creates not the gold it accumulates.  Another important idea was that a country’s future income depends upon this capital accumulation (wealth) and that the more that is invested in better productive processes, the more wealth will be created in the future. As an adjunct to this idea people must be confident that their capital will be secure. The countries that prosper are those that grow their capital, manage it well, and protect it. The final theme is of course the “pin factory” and that productive capacity rests on specialisation (the division of labour) and the accumulation of capital that this makes possible.
My thanks to the Adam Smith Institute

In the years that have followed the financial crisis politicians and their economist have had the benefit of these great insight to help them right the problems caused by the great credit explosion of the Noughties.  Simple ideas really: Promote trade and efficient markets, encourage the accumulation of wealth for future investment, ensure the banks are secure and encourage productivity and investment.  You will notice that these broad themes do not encourage:  the printing of money, the expansion of public debt, the destruction of investment appetite and the raising of taxes; common policies that have been applied in the developed world since 2008.
In 1776 the UK was the leading industrial and commercial economy in the world and the benefits of efficient production allowed us to build a secure Empire based on trade and become the wealthiest nation on earth. Today our ability to compete globally is probably the most important influence on our prospects for wealth creation.  The globalisation of markets, capital and production makes it imperative that we are able to keep up in the efficiency race.  A distinction that Smith made was the difference between diligence and efficiency – hard work is good for the soul efficient work is good for the pocket.  Today we call efficiency in production – productivity and although we have come a long way from “the division of labour” in the pin factory the essence of the idea holds good.
Productivity today is a many headed monster requiring efficient production, reasonable cost of capital, technical innovation and importantly efficient markets.  Great enterprises can both succeed (and fail) if these economic characteristics are in place.  Take Kodak – the 5th largest brand in 1998 and now bust, but wow, how our photographic experience has improved!  On a more positive note Google has, in the same period,  has gone from start-up to become the world's third most valuable business – and how our search experience has improved!  At a micro level productivity it is easy to understand:  good news and bad news stories, success and failure, wealth and poverty, Apple and Nokia!
At the macro level everything seems to get blurred and productivity is often used as a “dirty word” – describing the worst kind of exploitation:  child labour, zero hours contracts, off-shoring – or as David Miliband described it “a race to the bottom”!  Miliband is not alone, you won’t find many politicians waving the productivity banner.  There have, of-course been some exceptions notably Mrs Thatcher who made it her mission to make the UK a more efficient country, she achieved this through a single devise – deregulation an important theme in the Wealth of Nations.
She deregulated the labour markets, by tearing up legislation that put the trades unions beyond the law and in precedence to the market for goods and services
She deregulated state monopolies through privatisation of  telephony, energy, transport and utilities
She deregulated the banks destroying the cosy closed shop of merchant banking and Brokers
She deregulated labour markets by lowering taxes on income and benefits (improving incentives for work)
None of these measures cost the tax payer a penny and they were responsible to the rejuvenation of the UK's battered and broken economy.  The legislation was pushed through a breakneck speed in the teeth of a terrible recession and the amazing thing is that she, on the strength of these measures, won three general Elections on the bounce.  However, since 2008 Politicians in the West were quick to blame the bust on poor regulation of the banks and responded into two ways to the financial crisis: Firstly by seeking to kill off the banking sector with regulation and secondly to pour borrowed money into dysfunctional and broken markets.  The experiment in Japan with Abenomics is a classic in this regard.  Shinzo Abe has prioritised his “three arrows” as follows:
First a massive increase in government spending on capital projects
Second a huge injection of quantitative easing to deal with deflation and encourage consumer spending
Third a belated attempt to reduce the deficit (over 200% of GDP) - through sales taxes
There has been no attempt to deal with the underlining problems that have created of long-term declines in productivity, Adam Smith should be spinning in his grave!  There has been no action to restructure markets in banks, labour, publicly controlled industries and business start-ups.  In the same way Europe has bet the farm on austerity and loose monetary policy to solve the problem and it is difficult to know what Obama has been doing – not much by the looks of things!  The urgently required programmes for structural change in the West are non-existent and the resulting declines in productivity remain the biggest threat to our way of life and standards of living.
Focusing a little closer to home, what might we have done in the UK?  There are a number of broken markets that needed and still need attention, my top four are:
  1. The labour market is still poorly structured through taxation and welfare and discourages work for those who can only expect low paid jobs and doesn’t support work for fit and healthy people who want to work into their sixties.  Also the single market for Labour in Europe is ruined by completely different benefits entitlements across Europe - driving migration and misery.
  2. The banking market for commercial loans is concentrated in four banks, two of which are now owned by the government – Lloyds and RBS should have been broken up years ago to create more competition.  Linked to this issue  is the menace of private equity market and the shadow banking which is becoming the greatest value destroyer in the UK
  3. The property market is still too heavily skewed toward ownership rather than rental and this is because of a false market in valuations and “consent for use” – it’s virtually impossible to get authorisation to change office space into homes
  4. Our monopoly infested transport sector needs further deregulation and privatisation

By tackling these structural problems the government could belatedly set a course for growth and prosperity that could last a generation and would see Mr Adam Smith at rest in his grave.

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