For many years people in the West have been pointing and laughing about Eastern European state planning and state structures and their hopeless outcomes for consumers. One of the most memorable example was the Stalinist state program that targeted the making of numbers of tractors, but the focus on numbers and a failure to specify that the tractors had to work produced thousands of useless pieces of junk. More recently those in the East have had the opportunity to point and laugh at the failure of Western capitalism, and with derision point specifically to the massive banking debacle and the cost to us all of the banking system.

This polarisation makes for childish fun on both sides, but is not very illuminating about what is wrong with either system. We failed to learn that target driven cultures only deliver what they specify. Large companies and government continue to fall into this trap even though the soviet tractors should have been the last word on the subject. There is also much truth in the fact that banking was a failure of regulation as much as a failure of the ‘capitalist model’ since we in the West don’t exactly have a “free and open competitive market economy”. Over time the state has grown to be an increased proportion of the economy. We have state provision, state planning, regulated and less regulated markets, but do we have any that are completely free and open? And, more importantly, are they a goal anymore? In the context of creating the Big Society, where contribution to social welfare is made by all, what is good about state provision that is worth keeping and what do we know about where the market works well and where it doesn’t?

Over the past 20 years huge sectors of the economy have been privatised and liberalised. This has meant taking departments of state in telecoms, water, and energy and privatising them into corporate entities within a system of state regulation. The steps that have been taken have fostered the development of more open markets and have created competition where there was none. The idea, that with one bound privatisation would lead to competition has been replaced with an understanding that a state monopoly will become a privatised monopoly without further intervention. The western european model is one of a market that is “free-er”, or “free-ish”, and the competition that has been created is in some places intense, but there is also more regulation, or put another way, more state control. Perhaps we are adopting a middle way and achieving a more balanced perspective.

The reality in the UK is that something in the region of 80% of the economy is in the service sector. Agriculture is a limited part of the economy, but a heavily regulated one through the operation of the common agricultural policy. The manufacturing sector is to some extent free and open, in the sense that many barriers to trade have been removed but in many parts of the manufacturing sector there are detailed regulations governing many things. We no longer have western governments owning car companies and making cars. Instead we have an oligopoly with extensive regulation and high barriers to entry. How true is this for other important sectors? We also do continue to have state ownership in many parts of the economy, in: health, education, defense, transport, etc. and the ways in which different countries are organised vary, even in Europe. Setting aside the control of economic activity through state ownership, we have state control through regulation - and we regulate the making of things, even down to the height of car bumpers.

In services we have regulation everywhere, of banking, of insurance, of utilities, of professions, of all types of activity through laws and standards. These are the norm for many markets. At this point the reader may be expecting a diatribe against over-regulation. Many would start to carp on about the need for deregulation and the additional benefits that can be wrought by market forces if only regulation could be removed or the “state rolled-back”. However, we need to look a bit deeper and in this context we really need to have a discussion about motivation and incentives.

The “Foundations” of “The System”.

Some state services work very well. For example, in state provided public services such as defense one of the most remarkable feats of altruism is achieved where people lay down their lives for others. To say that they do this because they are motivated by their compensation, unusual strength of character or unusual mental attitude would clearly be wrong. The armed forces achieves its goals through getting ordinary people to behave in extraordinary ways. It achieves this through a systematic reinforcement of the type of behaviour that is desirable. The ‘management system’ has identified the types of behaviour it wants to reinforce and it encourages and supports that type of behaviour in all that it does. Reinforcement takes many forms, from recognition for bravery through public approval and ceremony; celebrating the sort of socially desirable behaviour through to personal reinforcement of the need to look after others in small teams within the system’s organisational structure. Other public sector services, such as nursing, have been less certain in their execution but their motivation and goals are also altruistic and encourage the members of their profession to help others. Vocations approach motivation in a similar way. Or at least they have in the past and could do so to a greater extent in the future.

In brief, the above identifies one aspect, call it ‘motivation’ that sometimes works well in the state sector. In the private sector things are often assumed to be different since short term profit maximisation is often assumed to be the incentive and motivation and profit the objective of private sector actors, whether individuals or firms. This is returned to below under ‘social outcomes being achieved through private entities and public regulation’.

The Competition law system; driven by the profit motive or the desire to innovate or some of both?

To have a discussion about motivation in competitive markets we need to have a discussion about the cornerstone of the system, that is the competition law system. All too often, in the political world, trite statements are made about the things that markets are good for or not, without understanding the basic drivers of the system. Is the motivation that drives the system the striving for profit or the desire to innovate, or some of both?

Some say that the purpose of competition policy is to ensure that markets work well for consumers, and that open competitive markets, and the competitive process, drives prices toward costs and allows customers to make choices in their own interests with the wider benefit deriving from these effects on suppliers and supply chains and the economy more generally. (This is the basic formulation given by many competition authorities). The argument goes that the profit motive drives the competitive process, and operating through a miriad of small decisions, acts on producers in ways that help them drive for efficiency and the process of competing allows resources to be efficiently allocated across the economy as a whole. Adam Smith poetically described the allocation of resources being distributed by an “invisible hand” in ways that reward those that provide what consumers want.

This piece does not set out to quarrel with the basic benefits of competition law as a process. The system prevents monopolisation and bans price fixing, but that is not the same thing as promoting desirable outcomes. The competitive stimulus can also support innovation and it has also been said that the essence of competitive strategy is differentiation. The need for firms to avoid ruinous price wars and avoid loosing the competitive game is the flip side of the positive motivation that drives people and companies to innovate, to find ways of meeting niche needs, or find ways in which they can differentiate their goods and services over those of others, and to succeed in the face of the competitive threat. Innovation is an outcome but not the only outcome and could be the main goal of competition policy rather than short term price competition, and if it were, the way in which we intervene in markets could be different. When thought of as a potentially beneficial outcome is there a way that this type of outcome can be reinforced? As above with the discussion of where the state works well, there may be something to be learned from the way in which we reinforce and reward socially beneficial behaviour...

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We will post the second part of Tim's analysis next week