Category Archives: Posts

Power sharing

Shareholders don’t really “own” firms, so why do they call the shots?

We all like to read stuff in the papers we agree with, but it’s particularly satisfying to discover an idea that gives intellectual ballast to something you believe instinctively. For me, this was the case with Prem Sikka’s piece on corporate power and funding in yesterday’s Guardian.

British Motor Corporation share certificate from 1959.
A share certificate issued by the British Motor Coporation (forerunner of British Leyland and Rover) in 1959. Should possessing one of these give you dominance over other providers of capital, effort and knowledge?

Prem is professor of accounting at Essex University (stay with me). His point is simple but revolutionary: the idea that shareholders “own” firms is wrong. In fact, shareholders provide only a small fraction of total capital for most large firms – around 5% to 7% for major banks, and less than 50% for almost all FTSE 100 firms. Most capital – including what accountants call “intangible assets”, like knowledge and brand loyalty – comes from other stakeholders, including workers, suppliers, customers and society at large.

Given this, “there is no logical or financial reason to prioritise the interests of shareholders over other stakeholders in large companies,” says Prem. “In an era of universal suffrage, enabling only those with financial interests to elect directors is unsound.”

(This prompted me to dig out the accounts from my own small business. We are by no means a heavily indebted firm but, sure enough, the capital from other people – creditors, the bank and the goodwill of our clients – would probably add up to rather more than I and my business partner have put in.)

Last summer, I wrote a piece asking why, when we have so many models in the public and “third” sectors, we still only have one clapped-out model in the private sector: the shareholder-controlled, profit-maximising corporation. Shareholders are the one stakeholder in a firm whose sole interest is maximising profits in the short-term. And yet we let them run the whole shooting match. I didn’t pick up on Prem’s argument about shareholders not really owning firms and having no moral right to control them, but he’s the professor of accounting, not me.

His solution is “to get rid of shareholder supremacy from company law”. Yes, we need to promote alternatives to the conventional corporate model – mutuals, co-operatives, not-for-profit organisations and the like – but we also need to rethink what a “company” is, and what it’s for.

We might also be able to get rid of the awkward distinction between the “private sector” and the “third” or “not-for-profit” sector. Many small private firms already operate informally on a kind of “third” sector model, with goals other than just maximising profits (I know mine does). This is because of the choices their owners make about what they want to achieve, how they want to live their lives, or simply because they want to treat their workers with respect. No doubt these small businesses are what the serious “entrepreneurs” on Dragon’s Den dismiss as “lifestyle businesses”.

But large firms are locked into this one corporate model which forces them, sooner or later, to behave in the same way – running cartels, rigging prices, avoiding tax and ripping off their workers and customers. It’s only through these “institutional abuses” that companies can meet the inflated profit expectations of the stock market and the equally-inflated salary expectations of their directors, argues Prem.

Like me, Prem believes “the primary purpose of a corporation is to serve society” in whatever way works best. Supporters of the status quo will argue that shareholders’ ruthless pursuit of profit does this by bringing prosperity and creating jobs. But workers and other stakeholders want those things too. Why do we think here-today-gone-tomorrow shareholders, who often have little involvement in the company they’re supposed to “own”, know better than all the people who work in it, depend on it and, just perhaps, actually care what happens to it?

Osborne’s funny money

Only just getting round to this but, in case you missed it, there’s some good work here from Richard Murphy at Tax Research UK, who has recast George Osborne’s personal tax statement (it’s actually nothing of the kind), to show where your money really goes.

Where your money really goes – public spending breakdown by Richard Murphy, Tax Research UK.
Where your money really goes – public spending breakdown by Richard Murphy, Tax Research UK.

Now, you can argue the toss over some of Richard’s methodology, assumptions and so on, but the main point is that it’s ridiculous for Osborne’s “statement” to leave out all the reliefs and allowances given to (mostly wealthy) people and businesses – other taxpayers have to foot the bill for them just as they do for any other sort of benefit. As Richard’s chart shows, these add up to twenty times more than is spent on unemployment benefit.

According to the Treasury, a tax credit paid to a working family counts as welfare spending, but a tax credit given to a billionaire property owner doesn’t count as spending at all. The only reason for the distinction is that Osborne doesn’t want you to know about the latter.

Two other points:

First, most pensions aren’t welfare. State pensions aren’t means tested and people make contributions to them throughout their working lives. It’s called National Insurance.

Second, have Osborne’s figures been cleared by the Office for Budget Responsibility? If not, why not? After all, Osborne made a lot of noise about transparency and independence with fiscal data when he set up the OBR. And should he be allowed to get away with spending public money on this sort of propaganda six months before a general election (or at any time for that matter)?


Economics in the raw

Focus E15 — the young London mums at the sharp end of our economic failure

Some of the 29 Focus E15 mums outside the Carpenter's estate flats in Stratford, east London.The Focus E15 mums, who are campaigning for affordable housing in East London, are back in court this week, after fending off Newham Council’s vindictive attempt to evict them on Friday from the abandoned Carpenter’s estate, a stone’s throw away from the Olympic Park. Here’s Zoe Williams, writing in Saturday’s Guardian, after visiting the “really nice” flats being occupied by these brave young women at the sharp end of London’s housing crisis.

So it’s a constellation: social housing being bought out by private developers, councils trying to divest themselves of what sparse stock they have left, “affordability” criteria bearing no relation to actual affordability, wages that don’t even cover social rents, thousands of homes empty in preparation for the billions their destruction will bring in. It’s pretty plain to everyone except council officials that what looks like a heap of problems is actually one: housing is too expensive. If you try to shoo people from each area as they are priced out by rents, at some point they’re going to mind.

Exactly the point I made (less elegantly) in my post earlier this month: sometimes what looks like a complicated, intractable problem has a simple solution, but the people in power simply don’t want to see it.

Newham Council actually sent people to vandalise the water supply to the Carpenter’s estate in a crude attempt to force the Focus E15 mums to leave. How the bloody hell do we end up  with a Labour council in London’s poorest borough doing something like that? Because politicians and policy makers simply can’t bring themselves to admit that the free market has failed utterly with housing and we need to try something else.  God forbid, we might actually have to go back to what we used to do and let councils do what the market patently cannot.

Economic ideas aren’t abstractions; economics happens to real people. And this really is economics in the raw. Market failure ruins lives, including the lives of people too young to have even heard the word “economics”. This is too important to be left to comfortably salaried academics and City executives to discuss among themselves. That’s why I’ll be at Bow County Court on Thursday to support the Focus E15 mums. I hope you can join me, but if you can’t make it, you can donate a few quid to the cause via their Facebook page.

More houses? Oh, if only it were that simple…

If you can’t explain something, complicate it.

A few years ago, I went into an estate agency in south London to inquire about renting a flat. The agent, a friendly bloke whom I knew quite well, was incredulous. “Are you sure you want to rent? You should buy something,” he said, thrusting a sheaf of property details towards me. “Look, prices are going crazy in the area!”

It only dawned on me afterwards how odd this was. Here was someone trying to sell me something by telling me the price was so high it was “crazy”. The housing market in Britain is now so dysfunctional, we take absurdities like this for granted.

Take the report from the Halifax last month, which found that it costs a family £1,300 a year more to rent an average three-bedroom house than to buy one. What’s more, the gap is getting bigger – rents are rising even faster than house prices.

It probably doesn’t surprise you that renting is more expensive than buying – but it should. After all, renting is supposed to be what you do until you can “afford” to buy.

High rents and unaffordable house prices are a vicious circle from which the market offers no means of escape. High rents drain people’s income making it harder and harder to save a deposit to buy. This keeps demand for rented houses and flats high and keeps rents rising, making saving harder still.

If the market worked properly, house prices would eventually begin to fall as fewer and fewer people could afford them, but this never seems to happen. Whatever the reasons – the overall shortage of housing, the role of houses as investments, the vicissitudes of mortgage finance, sharp practice by estate agents – it’s a truly spectacular market failure.

People within the property “industry” – who usually have a vested interest in sky-high prices – will tell you it’s all very complicated, but in this case the economics really are very simple. There aren’t enough houses, to rent or to buy, in the places where people need or want them. If you’ve read a single convincing argument why this isn’t so, please let me know.

As Paul Krugman points out in a recent blog, sometimes clever people just don’t want to see the simple answer to a problem, especially if it raises awkward questions about what they believe. Mainstream economists and conservative politicians, usually so keen on simple market explanantions for everything, are also quick to hide behind complications when it comes to housing. This is probably so they can avoid having to explain why the market has failed to provide the housing we need.

As this chart shows, neither the private sector nor housing associations have come anywhere near making up the housing shortfall since Mrs Thatcher pulled the plug on council housing more than thirty years ago. Demand for housing has gone through the roof and the response from the private sector has been: bugger all.

But people like George Osborne can’t admit that, so they come up with fiddly, half-baked financial schemes like Help to Buy. Because what we really need is more housing demand, higher prices and more debt underwritten by the taxpayer. That really is crazy.

Sauce for the gander, poison for the flock

Merger mania isn’t good news

Martin Sorrell, the boss of WPP, one of the biggest advertising agencies in the world, gave an interesting interview to the Guardian at the end of August. Sorrel warned that, with all the uncertainty in the world (Syria/Iraq, Russia/Ukraine, the Eurozone stagnation and so on) firms are unwilling to take risks and invest. Instead they are looking to mergers and acquisitions (takeovers to you and me) to grow their businesses.

Although many business people like to cultivate a buccaneering image, most businesses are cautious and risk averse. As health service guru and businessman Roy Lilley, says in an excellent recent blog, “the business of business is the avoidance of risk” . And the bigger the pile of money they’re sitting on, the more cautious they tend to be.

Although a lot of executives seemed to get a thrill out of mergers and takeovers, they are a timid, risk averse strategy for growing a business. It’s less risky to take over an existing firm, especially a successful one, with its existing brands and assets, than risk splurging treasure on the hard work of developing new products or cracking a new market.

This is probably one of the reasons why the global economy, especially in Europe and America, is struggling to get out of second gear, even six years after the great crash. Individual firms may grow through mergers and takeovers, by grabbing a bigger share of the pie, but the size of pie doesn’t grow at all.

In fact, rather the reverse. It’s rare for a merged firm to produce more or employ more people than the firms did when they were separate entities. Product lines shrink, plants close, people get laid off, there is usually a retrenchment to the home country of the dominant partner. And many takeovers are really about taking out a competitor or stripping assets.

Shareholders may do well, at least in the short term, as takeover activity tends to swell share prices. Workers usually suffer, whatever promises are made at the time; many lose their jobs or see their wages and conditions cut. Overall, mergers and takeovers tend to mean lower output, lower investment and fewer jobs.

(We saw this starkly in both the stock market bubble of the 1980s and the dot-com bubble around the turn of the century. On both occasions, frenetic takeover activity drove stock prices through the roof but in comparison economic performance, in terms of output, jobs and incomes, was underwhelming to say the least.)

Takeovers may be right for the firm or firms concerned, but bad for the economy as a whole, especially when everyone’s at it. This is another example of the conflict between individual behaviour and collective outcomes which haunts economics. As long ago as the 1930s, Keynes wrote about the “paradox of thrift”: while it was sensible for individual families to save during hard times, if everyone cut their spending, the times would get harder still. We should all be saving a lot more, but if we all saved, say, another 10% of our income, the economy would collapse like a house of cards.

Once you start seeing these conflicts, it’s hard to stop: it’s obviously sensible for young people to “get a foot on the ladder” and buy their first home as soon as they can. But the more of them do so, the more unaffordable houses become. It’s obviously right for you to take your bright kid out that mediocre local school, but the more people follow suit, the worse the school gets.

The remarkable thing about these vicious circles, with which we’re all familiar, is that mainstream economics ignores them completely. Instead, it asserts that individuals rationally pursuing their own interests will ALWAYS produce the optimum result. There is no such thing as a “collective” interest – just the sum of lots of individual decisions. After all, adding up lots of individual good decisions must produce a good result, right?

The godfather of market economics, Adam Smith, seemed to support this simplistic idea when he wrote in The Wealth of Nations that “what is prudence in the conduct of every private family can scarce be folly in that of a great Kingdom”. It’s also the thinking behind Mrs Thatcher’s famous claim that “there is no such thing as society. There are individual men and women, and there are families.”

It should be easy to see that this can only be true if each individual decision has no effect on anyone else – impossible in any environment in which human beings live together, let alone a highly connected and mutually dependent society like ours.

This idea of isolated individuals going about their business with no impact on each other is one of the central fantasies of what James Meek, in his recent Guardian essay on privatisation, calls the “market belief system”. Market fanatics have to believe it because without it, the whole neo-classical edifice of free market economics crumbles like wet cardboard.

This is really a version of the prisoners dilemma or the fallacy of composition – where what is true of the parts is assumed to be true of the whole. At the theoretical level, this disconnect between microeconmics (the study of the behaviour of people and firms) and macroeconomics (the study of the economies of countries or regions) has never been resolved. But that’s a tale for another day.

GDP: gross delusional propaganda

Ideology determines which economic indicators we’re told to pay attention to.

So the great recession, depression or slump is apparently over, GDP having returned to the level from which it crashed in 2008. That’s enough to satisfy most commentators, even if there are a few curmudgeons like me who point out that GDP per head remains well down on 2008. On average, we’re still more than 5% worse off and 5% less productive than before the crash – there are just more of us than there were six years ago.

Most economists, of course, have long been satisfied. It only takes a single quarter of minuscule growth (0.1% will do, although two quarters of negative growth are required before economists will admit a recession has started) for them to declare a recession over and move on to proselytising about the sunlit uplands which are always just around the corner. It doesn’t matter how many people lost their jobs or how many are still on the dole. It doesn’t matter how much people’s incomes and standards of living have fallen. It doesn’t matter how many firms have gone bust or how much production has been lost. One little tiny uptick in this GDP thingy and everything’s tickety-boo.

This is like a doctor declaring a seriously ill patient completely recovered just because they wake up one morning not feeling any worse.

At first, this just looks like another startling disconnect between the economics profession and the real world the rest of us live and work in. But this is so blatant, it feels more like deliberate manipulation.

Mainstream economists can’t deny that recessions sometimes happen, but want to make them seem as short and as rare as possible. That way they can preserve the illusion that recessions are just blips. The fact that the real-world effects of a recession – basically hardship in various forms – persists long after economists have declared the recession over (and in some cases might never go away) doesn’t matter to them. The recession is over because they say it is and anyone who says different, as usual, is tarred with the “economically illiterate” brush.

As the graph below shows, since the free-marketeers regained control of policy in the UK in 1979, we’ve actually spent quite a long time in recession – at least 13 out of 35 years. That’s quite a big blip.

GDP levels and months since start of recession - sometimes it takes ages to get back to where we were before.
Source: NIESR/FT

Economic concepts and the indicators we’re told are important are ideologically determined. Saying that the recession ended in the fourth quarter of 2009 (or even that it’s all over now, when most people are still feeling its effects) isn’t a statement of scientific fact, it’s a piece of propaganda.

Most mainstream economists are free-market ideologues and will define concepts and choose indicators that make free-market capitalism look better than it really is, however meaningless and remote from reality they are. They are our equivalent to the Soviet officials of yesteryear, solemnly intoning over the factory tannoy endless series of meaningless statistics about the production of tractors or brown shoes.

This is why there is no economic definition of a depression. Mainstream economics just cannot admit that such a thing is possible. The free-market economy is supposed to be self-correcting, quickly adjusting to the blip of recession and returning to growth without any intervention from governments. To admit that Keynes was right all along and the economy can get stuck in a rut, would bring the whole façade crashing down. So the long periods of slow growth or no growth we all know are possible (and have just experienced) are just defined out of existence.

Of course, politicians often connive in this manipulation, because it tends to make their stewardship of economy look better than it really is. This is probably why we use an inflation measure that with every revision (inevitably downward) gets further and further away from measuring anything like the “cost of living” (the CPI is called the government’s “preferred” measure, so what do you expect it to do?). And why we have employment statistics that count being stuck at home on a zero-hours contract waiting for the phone to ring as being just as much “employment” as a real (full-time, permanent) job.

But GDP has become the Daddy of all economic indicators, a sort of catch-all barometer for economic health and a yardstick for comparing economic performance between governments and countries. But it’s a lousy measure of our economic welfare, even in purely material terms.

GDP – or Gross Domestic Product – is an accounting estimate (nothing more) of the market value of all goods and services produced in the country. The fact that GDP is about to be revised significantly to include drug dealing and prostitution (hardly new industries) shows just how arbitrary and abstract a measure it is. It takes no account of population growth, sustainability, debt or how income is distributed among the population. So GDP can be rising quite fast while most people’s standards of living are falling – which is more or less what’s happening now. If we want a simple measure of material welfare as experienced by most people, we’d be better off focusing on median household incomes or even better, median household disposable income (i.e after taxes). That would tell an entirely different story, as the graph below for the US for the last fifty years clearly shows.

GDP per head and median family incomes in the US 1960-2010 (1960=100)

Median family incomes in the US have fallen way behind GDP per head since the late 1970s.
Source: Economic Policy Institute/World Bank

But it would also mean economists having to focus on policies and ideas that address the welfare and lives of ordinary people instead of providing ideological cover for a plutocratic elite whose experience of economic life is completely detached from that of their fellow citizens. Mainstream economists seem to have little or no interest in doing that.

Doubting Thomas

Give Piketty a break – read the book!

Two recent commentaries on Thomas Piketty’s blockbuster, Capital in the 21st Century, caught my attention, if for no other reason than both show signs the writer has actually read the book. While both are broadly sympathetic, they are far from uncritical.

Benjamin Kunkel has a long review in the London Review of Books in which he effectively critiques Piketty from the left. While praising Piketty’s “incomparable array of data” he argues that he pays too much attention to inherited wealth and not enough to wages and growth, and takes issue with the universality of Piketty’s assertion that the return on capital usually exceeds the rate of economic growth. (Kunkel also has some interesting ideas about socialist ownership without monopoly, which I’ll come back to another time.)

Former BBC economics star Steph Flanders’s review in Saturday’s Guardian is more supportive, although she also disputes Piketty’s emphasis on inherited wealth. Flanders’s most interesting point is also picked up by Kunkel: Piketty tends to lump all capital together, regardless of who owns it or to what use it’s put, so that capital accumulation always leads to more inequality. (This seems a bit unfair on Piketty, but I’m only halfway through the book myself, so I’ll reserve judgement.)

Both are worth a lot more of your time than the knee-jerk responses of free market fantasists (try Daniel Hannan or James Pethokoukis), who seem to think just pronouncing Piketty a “Marxist” will encourage everyone to move on (betraying their ignorance of both Marx and Piketty in the process). Most of Piketty’s neo-con critics seem to have done no more than scare themselves shitless about his proposed wealth taxes or just got  lathered up reading commentaries by their right-wing friends (who probably haven’t read it either).

If you’re going to denounce someone’s work at least, like Kunkel and Flanders (or even the highly critical Chris Giles of the FT for that matter), do them the courtesy of reading it or at least trying to understand it. True, it’s a big ask, but I heard somewhere that someone had published a condensed version (approved by Piketty himself). If I can dig out the details, I’ll stick them up here.

Empty vessels

Many British firms are just investment vehicles with nothing inside.

I run a small business. We don’t have a mission statement and we’re not about to write one. But I do sometimes think about what the purpose of our business is. I know it’s not to maximise profits. It might be to make enough profit so my business partner and I can earn a reasonable living. It might be provide us with work we enjoy. Or to work with clients we like and whose aims we respect. Or it might just be a way of dodging the routines and vicissitudes of corporate life.

It’s probably a bit of all of these things and more. We have a variety of purposes and a range of motivations, some of which probably conflict with each other, and the relative weight we give to them probably changes from time to time. I suspect most very small businesses are like this — their purposes directly reflect the lifestyle choices and shifting enthusiasms of their owners and workers.

Large companies, with thousands or millions of anonymous owners, inhabit a different universe. Shareholders demand returns, and increasingly the returns they want are quick ones. Fewer and fewer investors in our hyperactive financial markets are interested in long-term earnings from anything as boring as dividends; they want higher share prices and they want them now. That way they can cash in their winnings double quick and don’t have to stick around for when things go south.

Maximising shareholder value is the only game in town. This means prioritising short-term profits over long-term growth and sustainability, ramping up asset values, constant image makeovers and rebranding exercises, hyping up mediocre or under-developed products and a mania for acquisitions and mergers (since takeover speculation tends to inflate share prices – I will write more on the Anglo-American obsession with takeovers, which many executives seem to see as some sort of virility test.)

The problem of short-termism in British firms has been well recognised, even by business insiders. But I think we’ve gone beyond short-termism. The problem is no longer just that companies think too short-term to achieve their purposes, it’s that they often don’t seem to have any meaningful purposes at all.

If shareholder value is all that counts, then firms are nothing more than financial products – effectively they are all part of the financial services industry which dominates the British economy. Many big British firms seem to be conglomerates of convenience, flashy investment vehicles cobbled together to catch the eye of speculators. It doesn’t seem to matter much to their owners or top executives what they actually do or make.

Writing in the Observer about the phone hacking trial last month, Will Hutton said: “Companies in general, and media companies in particular, must put a sense of purpose at their heart.” Even some business moguls can see the problem. Hutton quoted Elisabeth Murdoch (of all people): “It’s increasingly apparent that the absence of purpose, of a moral language within government, media or business could become one of the most dangerous own goals for capitalism and freedom.”

Good, but looking at the published strategies of FTSE 100 companies is still dispiriting. Capita and Wolseley are two (not untypical) examples. Capita tautologically describes its “business goal” as “building a sustainable business that meets the needs of our stakeholders”. Capita “generates and supports growth” by “targeting growing markets”, “securing organic growth and acquisitions” and “building our capacity and scale”. Capita grows by growing. This is a firm which seems to have no other purpose than to get bigger.

Wolseley, which (I think) has something to do with building materials, has a “vision statement” on it’s website: “Wolseley creates enhanced value for all stakeholders by leveraging the considerable strengths of its individual businesses.” That’s it. At least it’s short, but it’s no more meaningful than Capita’s.

Nothing about what they produces or the services they offers, nothing that shows any pride or interest in the work of their staff, nothing about what the firm aims to do for people or to contribute to society. It’s as if these companies exist in a separate world called “business” and have no relationship at all with the society in which they operate. Simply replacing the word “shareholders” with “stakeholders” doesn’t really cut it.

Does this matter? I think it probably matters a great deal. I have a small hunch this sort of attitude, coming from the top, has something to do with Britain’s notoriously lousy productivity, and a big hunch that it’s behind our rubbish levels of staff engagement. Certainly its hard to see how many workers will be enthused by concepts as remote and meaningless as “leveraging strengths” or “enhancing value”.

The free-market eats itself

Pfizer’s putative takeover of British pharma giant Astra Zeneca exposes yet another intellectual paradox of free market economics. Left to their own devices, firms will always try to takeover other firms or force them out of business. But every takeover (or bankruptcy) by definition reduces competition and choice, which is supposed to be the whole point of the free market in the first place.

It’s always seemed to me that the three top dogmas of free market economics — rational behaviour, perfectly functioning markets and government non-intervention — contradict each other. If companies and firms always act rationally in their own self interest, they will always try to subvert the free market, unless the law stops them (and sometimes not even then). But in a free market, the government is supposed to stand aside. How can this work? Imagine a football match in which all 22 players are determined to commit as many fouls as they can get away with. Then send the referee to the stands.

Free market fundamentalists are always trying to kid us that firms are falling over themselves to "compete" for our custom. They aren't. Occasionally some business people will claim that they “welcome” competition. They don't, or if they do, their shareholders or owners certainly don’t. They don't want competition. They want, if possible, a monopoly, or as close to one as they can get. Is there any example, anywhere in the world, of a joint stock private company willingly giving up its stranglehold over a market? I tried really hard, but I couldn't think of one.

So how can “free” markets ever work perfectly, or even near perfectly, if every firm in the market has an existential urge to make sure they don't? It’s an idea that, as soon as it’s set in motion, destroys itself from the inside out.

As usual, free marketeers have little to say when the weird contradictions in their beliefs come to the surface. Some do admit that enforcing the rules of the free market might be a legitimate role for strong government, but they always seem to cry foul whenever a real government proposes to act — for example by blocking a takeover like Astra Zeneca which, whatever other damage it will do, will definitely reduce choice and competition.

In theory, a real free market government should not allow any takeovers at all, except where the target firm is seriously at risk of failure. But then it wouldn’t be a free market any more, would it?