We posted the first part of Tim's critique of the interface between market and state in our public services last week. Here he outlines some levers to change the status quo.
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Social outcomes being achieved through private entities and public regulation.
Where competitive markets start and often fail is that the system of regulation they operate within often fails to reinforce the socially beneficial and desirable goals for the individuals and firms in the system. John Kay, Professor of Economics at Said Business school in Oxford has written a series of articles on the perils of the pursuit of short term profits. Banking may be a pure example of a business whose aim is to make money and little else. However, bankers often describe themselves as helping people others achieve their dreams ( in terms of what the money is leant for; the dream home the dream business, rather than the nightmares over levels of debt). When the Goldman's banker said he was ‘doing Gods work' the lack of irony was probably heartfelt. In other sectors the culture of helping others is often a significant motivation for many people, and one that also helps people contribute to the collective pot.
Regulation may contain social objectives but they have not been translated or are not sufficiently reinforced except in a crisis. Recent studies in behavioural economics tells us that people's behaviour is affected by being reminded of behaviour that is desirable. ‘Nudging' people to take the responsible course has been shown to work given the predictably irrational nature of humanity. However, at the heart of the system, competition law assumes profit maximisation and self interest. Competiton policy looks to achieve outcomes that are in the consumer interest through the most efficient provision by market actors pursuing their own self interests. Then again, competition policy may produce outcomes that need to be supported but conflict with socially beneficial outcomes that are not naturally produced through the operation of market forces. For example, environmental damage is a side effect of many efficient manufacturing processes, and, so the thinking goes, without socially beneficial laws requiring curbs on pollution, the market would inevitably give rise to pollution since the impact on the environment is not one of the things that a profit maximising company takes into account, absent legislation in the wider public interest. The P&L account drives the firm to make profit at the expense of others, something economists refer to as an ‘externality'. The environmental damage or social harm is prevented from happening through the application of general legislation.
This inherent conflict may reflect a system that is at war with itself. It inherently sets up the profit maximising firm to be in conflict with regulatory or legislative outcomes that are in the wider public interest. Why does our system do this and can it be refined for the better? The inherent conflict may stem from a misunderstanding of motives. Some firms exist only to make profits. Others marshal their resources to meet customer needs by understanding customers, and motivating their people in ways that inspire effort in making different contributions to meeting those needs. Firms that do this have been identified as “values driven” organisations, the best of which both achieve their missions and make healthy returns for shareholders. ( See for empirical study the book ‘Build to Last' and more recently Obliqity by John Kay). As has been pointed out by these authors and others, short term profit maximisation may destroy value, both for people and shareholders. This may be more true of some companies than others but a simplistic assumption that firms exist to maximise returns may be part of the problem. There may also be something going on within the system of competitive private motivation and the pursuit of profit driven by the P&L and shareholder returns that can be guided toward more socially responsible outcomes. For example, if a manager of a manufacturing plant were knowingly causing pollution and that person ignores the outcome for selfish profit maximising outcomes, at a personal level this requires a socially irresponsible ‘I'm all right jack” type of mentality. We have clearly come a long way from “no man is an island” for this to be the case.
Here lies a critical point; by allowing the socially irresponsible behavior (short term profit maximisation) and then only seeking to control its worst outcomes have we not lost the plot, or worse, could the system of regulation that we have put in place actually contribute to the undesirable outcome? In the example above of pollution from manufacturing process, (given by Anthony Giddens in his book the Third Way), in order to avoid the adverse effects of pollution we have acres of environmental legislation. The theory is that the firm will pursue its profit maximising self interest and comply or face profit debilitating fines and penalties. But the firm that might once have set out to achieve its manufacturing in a responsible way has also been leveled by the system into one that achieves those ends on a playing field set by the rules that promote the wrong behaviour at the outset. Indeed, in such a world, Gordon Gekko can say “greed is good” since everything that he is being told and the system reinforces that type of behaviour.
Issues with the way we go about harnessing and regulating the markets for social purposes.
One example is utility regulation. Here we have often privatised former public departments and formed them into corporate entities that are designed to make profit for their shareholders. This makes some sense if the competitive process is thought to be driven by the profit motive. It is conventional wisdom that that drive is fuelled by both competition and the the structure of markets whether populated by many competitors, or fewer oligopolistic structures etc and financed by shareholders willing to part with capital in return for greater profit. This is based on an assumption that the underlying engine of the market economy is the profit motive.
This is fed and watered by the usual general purpose company, and management is typically motivated to make profit. Stock markets finance the system in the interests of profits flowing to shareholders. As with the example given above about motives at the level of the individual are we also potentially not also confusing outcomes with objectives at the level of the firm? The fact that we can measure outcomes in terms of money is no bad thing, and being good at something can bring financial reward, but is it the reason why people get out of bed every day?
Motivation and Contribution.
Management gurus will often talk about compensation as part of the recognition and reward package available to employees. People are different and many people's motivation and contribution are known to differ in many ways but it is rare to find someone who will say that the only reason they get out of bed every day is just to make money. What people do varies with as many personal goals and ways in which they can think of making contributions. Good management is adept at encouraging people to make those contributions and meeting customers needs' profitably.
Refining the system. Possible future policy approaches.
In returning to the way in which the system works, in line with the latest thinking about encouraging the type of behaviour that is desirable, is there something that can be done within the way we harness the market for public purposes? Could we look carefully at the aims of competition policy? As formulated above, the focus is on consumer benefit which in turn drives innovation to meet customer needs and delivers a dynamic market structure. This leads to a more efficient allocation of resources than a planned outcomes. We know that given half a chance, people will innovate. The question is how to get them to do so in the wider public interest particularly when the assets that they control are general purpose goods or utilities where they could simply sit on top of monopoly and do as little as possible, extracting rent. Perhaps one way of dealing with this is to actively promote the benefits of innovation as a primary goal of the system; reinforcing the positive. Could we shift the focus and refine our approach by explicitly stating that increased innovation is the desired behaviour and outcome?
If the objective of competition law and regulation can be refined, what can be done to improve the way the system works? An early objection to private enterprise running public services was a fundamental political objection to regulation: public ownership was needed because regulation, courts etc could not be trusted to deliver the outcomes that are in the wider public interest. Part of the problem with the court system is that it proceeds slowly to address problems on a case by case basis while systemic issues can be dealt with more quickly through the swifter processes available to well informed decision makers/regulation. The private ownership/public regulation model has not worked well in being swift in identifying and anticipating outcomes and nipping them in the bud. Banking regulation has been found sorely lacking in its ability to gather information and respond in relevant timeframes. There is no doubt that other forms of utility regulation and competition law can move more quickly to reach well founded decisions. And now is the time for reform.
Here the issue in improving regulation is partly the slow speed of the regulatory and court processes. However, any decision making system moves more quickly if the decision makers are well informed and well briefed about the facts and the issues. Initially a series of industry specific regulatory bodies was set up so that expertise could be developed and well informed decisions reached more quickly than the general law would allow. Consolidation of expertise across the UK system would now be one way forward.
At a nuts and bolts level much can be done to improve the way in which regulation is done and what is taken into account and what is thought to be irrelevant. Decisions are based on data and evidence and much data is collected from historical information in long consultation processes. It is also based on presumptions of outcomes. Recently, in dealing with revising its guidelines on market definition, (one of the most central questions for intervention in competition policy), the US Federal Trade Commission has proposed that more forward looking analysis based on more data, evidence and information and less upon presumption and assumption. Some say that this will bring the US system into line with the practice in the EU. Either way it would be helpful to explicitly adopt such an approach. One worry is that more facts will also mean a more fact specific and a less predictable outcome. Predictability and certainty of regulation improves the conditions for investment and a rolling programme of information gathering would address this concern and be sensible for those industries where there are likely market failures. Knowledge and expertise certainly can be improved, whether there is a need for separate agencies, or as many as we have in the UK, is questionable.
In terms of improving the speed of process, a leaf can be taken out of the book of experience from those jurisdictions that allow movements between the private sector and the authorities, which increases knowledge and understanding of the industry concerned. The EU does not do this and that should change.
Maybe another thing to do when trying to run a public utility is to avoid the conflict between the private interest corporate entity governed by external public interest regulation. Much has been done in recent years where entities have been set up for social purposes and those purposes have been written into the company's constitution and statutes of incorporation. When looking at defining the activity of a private entity which is pursuing public interest goals this may be one way of ensuring that private motive and public goals are aligned. Perhaps this could be taken into account in setting up banking entities that provide mortgages to people that are separate from the higher risk activities that some banks undertake?
It is proved beyond any doubt that people are not simply rational profit maximisers. People are happy to do altruistic things, or to create, invent or care for others on many socially beneficial ways. Perhaps the time has come to recognise this in the system we use to regulate markets and to adopt positive reinforcement of the desirable behaviour as not only the goal of policy but also in the way in which policy is put into effect?
Perhaps there is an underlying issue in the combination of public regulation and private sector delivery? After all, if we believe that the state is generally an inefficient vehicle in providing public services why do we persist in using it for governing? Put another way, we know that state as a structure is a weak vehicle but we have done very little about it and now is also the time for simplifying and speeding up the system.
This approach may help to create the "Big Society" idea. The idea of harnessing the profit motive in the public interest is not new. Social purpose was one of the objectives on many British and other entrepreneurs as an explicit goal of their enterprise. We had a big discussion about this here in the UK when Kraft bought Cadbury, with center ground commentators and politicians on all sides looking for ways to ensure that social purpose can endure. Perhaps some of the thinking in this article can help in shaping the way we deal with these issues in the future.
We do have an increasing number of social purpose entities, cooperative societies, and the like and there are stock market investors that are increasingly looking for investments that are not only profitable but socially beneficial. The corporate social responsibility movement has promoted human rights friendly investments and shown that business and social goals can mix well.
If we were to take this thought experiment to its logical conclusion, we would have profitable and socially responsible companies and regulatory authorities that are required to ensure both social policy and profitable outcomes for the industries for which they are responsible. Is this too radical?