December 21, 2017

“Capitalism needs neither propaganda nor apostles”, wrote Ludwig Von Mises, the iconic ‘Austrian school’ economist, in 1947: “Its achievements speak for themselves. Capitalism delivers the goods”.

As the year-end comes into view, our thoughts naturally turn to the future. The challenges facing the UK are considerable, of course – not least because of the government’s fragile House of Commons majority and the questions that raises about Brexit, policymaking in general and Theresa May’s day-to-day political survival.

It is important, though, occasionally to escape the 24-hour news cycle. Columnists and political pundits, in particular, must take time to look beyond the latest political rows and their impact on the parliamentary arithmetic.

At the turn of 2017, as the New Year beckons and we pause for breath, such reflection is particularly important. For questions are now frequently being asked, not only about this or that government policy, but about ‘the system’. Doubts are being raised, more widely and loudly than at any time in my adult life, and often by sensible people, about the future of capitalism itself.

Capitalism works, and is sustainable, when it spreads wealth broadly. That, in turn, means that the market economy secures and is bolstered by widespread popular consent. Yet, with British youngsters struggling to attain living standards enjoyed by their parents, and workers more generally enduring extended real terms pay cuts, capitalism is becoming less popular. For far too many, then, and to recall Von Mises, capitalism is failing to ‘deliver the goods’. Swathes of voters now view the UK economy not so much as capitalist, but corporatist or even cronyist – and with some justification.

Throughout history, the rough edges of capitalism have needed to be smoothed. That will always be true – and it can be done with a humane, properly resourced welfare state. While the UK’s benefit system is patchy, and notoriously tough to reform, it for the most part doing a reasonable job.

But capitalism is also about ensuring a degree of fairness and the spreading of opportunities, not least among the aspirational classes – those working hard, and striving to improve the lot of themselves and their families. This is where the current failure lies.

For almost a decade now since the global financial crisis, access to bank finance – to buy a home or to start and then expand a business – has been severely limited. At the same time, social mobility has gone into reverse. A recent government study found that “a stark social mobility postcode lottery exists in Britain today where the chances of someone from a disadvantaged background succeeding in life is bound to where they live”1.

Some inequality is inevitable under a capitalist system, and UK income inequality has been much exaggerated. But the inequality of wealth – including property and financial assets – has undoubtedly spiraled upwards over recent years (the subject of last week’s Charlie Pickles column). In June 2017, the Resolution Foundation estimated2 that the wealthiest 10% of UK adults now own around half of Britain’s wealth, with the richest 1% controlling no less than 14%. Even this shocking number is surely an underestimate, given the difficulties in identifying the assets of the super-rich.

An unfortunate 15%, by contrast, have no or negative wealth. And while wealth inequality fell during the decade from 1995 to 2005, it has since risen steady, not least since the 2008 global financial crisis, and the subsequent fall in home ownership.

The wealthiest 10% of UK adults now own around half of Britain’s wealth, with the richest 1% controlling no less than 14%
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The total value of wealth across Britain – not just housing, but also private pensions, shares, land and other physical objects – has fully recovered since the 2008 collapse and continued to grow. From £9,900bn before the crisis, UK wealth rose to £11,100bn in 2014, the Resolution Foundation estimates. Rising inequality, though, means that the wealth of the typical ‘median’ adult, lying exactly in the middle of the wealth distribution, has fallen – from £99,000 just before the financial crisis to £84,000. This fall has been driven, in large part, by reductions in property wealth, linked in turn to the narrow distribution of home ownership.

Living and consuming

This was the year when the UK’s housing crisis finally rose to the top of the political agenda – which is where it should be. Britain’s broken housing market is the principal cause of discontent among those who feel ‘the system’ is against them – not least ‘priced-out’ youngsters who, despite holding down good jobs, are unable to buy.

It is generally accepted that the UK needs around 250,000 new homes each year to meet population growth and household formation. The UK’s chronic shortage of homes has been years in the making, as some of us have highlighted, with successive governments failing to ensure enough homes were built.

During the Thatcher era, as council houses were sold under ‘right to buy’ but not replaced, an average of just 190,900 new homes were constructed each year. This fell to 160,800 while John Major was Prime Minister, before dropping again to 156,000 under Tony Blair. Gordon Brown’s short premiership saw annual house-building fall further to 143,400, in the after­math of the 2008 credit crunch, which wiped out many small and medium-sized builders. There was another sharp drop under the coalition government of 2010–15, as new homes per annum fell to just 123,560 on average, the lowest peacetime level since the 1926 General Strike. Over the last 40 years, then, the UK has built around 2-3 million too few homes.

This fundamental lack of supply, coupled with the Bank of England’s ultra-loose monetary policies since 2009, has seen house prices spiral. That has led to the emergence of ‘generation rent’. A decade ago, almost 60% of 25 to 34 year-olds owned their own home. Now it’s well below 40%.

In response to this housing shortage, rather than taking measures to curb prices by ensuring more homes are built, the Conservatives have instead stoked-up the demand side of the market via their ‘Help to Buy’ initiative. The initial error was made in 2013 by then Chancellor George Osborne. His successor Philip Hammond compounded that mistake this year, by further extending the HTB scheme.

Since taking office in 2010, the Tories have also allowed the UK’s oligopolistic house-building industry to amass vast ‘land banks’, delaying the conversion of planning permissions in actual homes, boosting prices and profits by imposing a deliberate house-building go-slow. The campaign group Shelter estimates that no less than one in three homes granted planning permission between 2012 and 2016 has not been built – amounting to 320,000 units. In London, the share of such ‘phantom homes’ is one in two3. Over the same period, the profits of the UK’s five largest house-builders soared by 388%, reaching £3.3bn in 2016. These facts are clear evidence that the UK’s housing market isn’t working.

Average house prices across the UK are now eight times the average wage – a historically high multiple, impossible to finance with a regular mortgage. Even youngsters holding down professional jobs are increasingly ‘priced-out’. That’s why half of first-time buyers depend on ‘the bank of mum and dad’, rising to two thirds in London and the South East – an option available only to some. The UK’s housing market, then, once a source of social mobility and security for those willing to work and save, now generates widespread discontent and anger.

Theresa May’s government has talked tough about ‘fixing the housing market’. But successive announcements throughout 2017 have fallen far short of the radical measures required to address the problem – including genuine sanctions against ‘land-banking’ developers. HTB, in fact, has significantly boosted the profits of large developers – a group of companies that has historically contributed generously to the Conservative Party’s coffers.

While the bulk of the solution to the UK’s housing shortage lies with the private sector, Britain is always going to need a significant and regularly replenished stock of subsidised social housing – another area where successive governments have failed. In response to the Grenfell Towers tragedy, Theresa May announced funding for just 5,000 social units a year for five years – set against a 2m-strong council house waiting list. This was a risible response, as I wrote at the time.

The UK’s broken housing market has been instrumental in convincing a growing number of voters that capitalism is unfair – from low-income workers to high-achieving professionals. Discontent among young and middle-aged adults, linked to their inability to buy a home, largely explains Jeremy Corbyn’s strong showing in the June 2017 election.

The discontent with ‘the system’ goes beyond housing, though, with more and more consumers feeling that businesses in general are ripping them off. Faith in a largely ‘free market’ settlement is increasingly in doubt, according to important research from The Social Market Foundation, published in October 2017. Perceived corporate excesses, such as high profits and prices, are fuelling a growing belief that capitalism is rigged, with the benefits accruing to a small elite at the expense of the ordinary UK households4.

Eight out of ten UK consumer markets – including telecoms, banking and gas and electricity – were ‘concentrated’ in 2016, according to SMF research, dominated by a small number of large companies. Concentration in the telecoms market has increased over the past decade with respect to broadband and mobile telephony. Banking is also more concentrated than before 2008, with the market for current accounts still controlled by just a few players. The household utility market is similarly in the grip of a handful of energy companies. All this results in a range of negative outcomes for UK consumers – including a lack of choice, poorer customer service, lower levels of trust, ‘super-normal’ profits, under-investment and high prices.

It is vital that ‘barriers to entry’ are lowered so these vital consumer markets become more competitive. Too often, onerous regulatory and licencing requirements, encouraged by incumbent firms, deter new entrants. Competition policy also has a tendency to be far too influenced by supplier interests, rather than consumer concerns. When industries are challenged, regulatory changes are typically made only to ‘industry standards’ and ‘voluntary codes’ – non-binding stipulations, that are routinely circumvented.

Eight out of ten UK consumer markets – including telecoms, banking and gas and electricity – were dominated by a small number of large companies.
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Some consumer markets work relatively well. The SMF report highlighted that the rise of discount supermarkets in the UK such as Aldi and Lidl has driven a decline in the concentration of the UK groceries market in recent years. That has generated better outcomes for consumers, even if some suppliers continue to feel badly treated by the large supermarket chains.

When it comes to housing, though, and large corporations such as telecoms companies and banks, consumers increasingly feel they’re getting a raw deal. If markets fail to work well, and capitalism doesn’t ‘deliver’, confidence in our ‘system’ could become endemic – resulting in draconian state interventions, driven by a loss of faith among voters. That would be the wrong outcome for Britain. At their best, free and functioning markets are a driving force of job creation, innovation and prosperity. They expand consumer choice and keep prices low as companies compete to win and keep customers. New ‘challengers’ who enter markets are able to pressure incumbent businesses, pushing them to offer better prices and invest to improve their services.

Yet big companies in the UK and across much of the Western world have become far too powerful. Our political, business and media elites are much too intertwined. Such cosy relationships enfeeble competition policy, further strengthening the might of a small number of corporations. It strikes me that, at some stage, Britain may need the kind of bold anti-trust measures that America reached for in the late nineteenth and early twentieth century – policies championed by Ida Tarbell, the journalist whose name is the title of this column and the subject of the short film I presented for UnHerd.

Systemic dangers

Historically, faith in capitalism has been dented in the aftermath of serious financial crises. This is what happened at the turn of the last century, when successive market collapses and the related ‘Long Depression’ across the US and Europe, roughly from the mid-1870s to the late 1890s, helped to usher in collectivism and ultimately anti-capitalist revolution in some nations – most famously Russia. The Wall Street crash of 1929, and subsequent ‘Great Depression’, also resulted in far more state involvement and public ownership in countries that remained broadly capitalist – a trend that lasted at least until the 1980s.

While the worst of the 2008 financial crisis is over, the global banking system remains precarious and financial markets extremely bloated. After years of quantitative easing, stock prices look extremely over-valued. The US Dow Jones Industrial Average closed at an all-time high over 70 times during 2017 – more than any other year in history. Government bond prices are also in bubble territory, with yields compressed due to years of QE-driven bond buying by central banks including the Federal Reserve and the Bank of England.

The reality is that systemic dangers continue to loom large in both global equity and bond markets – not least in the UK. It is far too complacent to conclude that ‘too big to fail’ has been ended – with the general public rightly sensing that the problem that caused the 2008 crisis is yet to be solved.

“The one big public narrative in this country is… the need to end too big to fail – because that process is not complete,” said Bank of England Governor Mark Carney in September. “Everywhere I go I am asked when I’m going to end too big to fail and the fundamental unfairness,” the Governor remarked.

The Bank of England has made much of the ‘stress tests’ it has conducted on the UK’s big banks – modeling exercises that estimate the ability of these institutions, given their financial reserves, to survive market squalls. It is important to “shed light” and “show that the core of the (UK financial) system is able to withstand very big shocks” says Carney, who in November announced that Britain’s largest seven lenders had all passed.

These stress tests, though, rely on the ‘book value’ of banks’ assets, rather than their more realistic market value. That overstates lenders’ resilience. The Bank of England itself also suffers from an inherent conflict of interest, given that its remit is to maintain the stability of the financial system. That makes it more likely to declare the banking sector ‘safe’, than to point publicly to problems.

Rather than relying on a financial regulator to provide reassurance, it would make far more sense to force big UK banks to become less complex – implementing a full, institutional separation between risky investment banking and commercial banking, for instance, as this column has often argued.

Britain’s banking sector, moreover, remains extremely opaque, with investors unable to gain complete access to balance sheets, so they can assess what is actually going on. That’s why some of our largest banks still have ‘price-to-book’ ratios of less than 1.0 – implying that the market objectively values the business to be worth less than the declared net value of its financial assets. That reveals lingering suspicions that such institutions are not being transparent, harbouring loss-making investments that continue to smoulder, in some disguised form, somewhere on or off their books. This hardly points to a banking sector that is healthy and durable – suggesting that capitalism could yet be dealt another serious blow, in the form of another banking crisis.

It is also worth noting, should another collapse occur, that the UK and other Western governments are now far more indebted than they were in 2007 ­­– meaning they are less able to support moribund banks and other collapsing financial institutions. With interest rates already at rock bottom, the Bank of England also has little or no scope to lower borrowing costs – which are already negative in real (inflation-adjusted) terms.

Every UK recovery from recession over the last century has been associat­ed with a sharp rise in the construction of residential properties – with the exception of the post-2008 re­covery. It is no coincidence, given the slow pace of UK house building over the last decade, that we’re experiencing the longest and slowest economic recovery in British history.
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While pointing out these harsh truths, though, it would be wrong to be too gloomy. The UK economy – despite the near-constant drumbeat of negativity from much of the business press – is bearing up quite well. Growth remains relatively buoyant and, even though sterling has regained much of the ground it lost since the June 2016 Brexit referendum, manufacturers are benefitting from a boom in orders. Britain has also just been judged by Forbes magazine, despite doubts over our EU negotiations, to be have better business prospects in 2018 than any other country in the world – based on ‘technological readiness’, ‘property rights’, ‘inward investment’ and ‘low unemployment’.

While big businesses and many international observers like how the UK economy operates, though, British voters are more sanguine. Many reasonable, liberal-minded people supported Jeremy Corbyn in June 2017 and – and look determined to do so again.

“The government I lead will put fairness and opportunity at the heart of everything we do,” said Theresa May after this year’s election, in a speech that was widely praised. We’ve seen little, though, in the way of concrete policies that will help the ‘just about managing’ families the Prime Minister so rightly identified as being key to her party’s election success.

For my money, the key to keeping Corbyn out of office, and stopping UK capitalism from taking a seriously wrong turn, is the housing market – and, in particularly, creating the right environment to spark a sharp rise in the construction of new homes. Ministers must bring the large, foot-dragging developers to heel, imposing punitive taxes on land-holdings with planning permission that remain undeveloped.

The government should also create powerful Housing Development Corporations – public sector bodies that acquire land and grant themselves planning permission, before selling on plots to private developers, prioritising access to the small and medium-sized firms that will build quickly. The HDCs would use the ‘planning gain’ from the sharp rise in land values once permissions have been granted to fund new schools, hospitals, roads and so on. If housing development means local public infrastructure and services are significantly enhanced, there would be far fewer local objections to new housing.

Every UK recovery from recession over the last century has been associat­ed with a sharp rise in the construction of residential properties – with the exception of the post-2008 re­covery. It is no coincidence, given the slow pace of UK house building over the last decade, that we’re experiencing the longest and slowest economic recovery in British history.

Channels of Progress

‘Capitalism delivers the goods’, wrote Von Mises, some 70 years ago. Yet increasing numbers of UK voters now think otherwise, which is why a hard-left Labour leader inching close to power.

We should take our cue not from Von Mises, but another Austrian economist, Joseph Schumpeter – who was far less complacent about the survival of capitalism. Writing around the same time as Von Mises, Schumpeter provided a sparkling defence of capitalism, pointing famously to the ‘waves of creative destruction’ that occur as entrepreneurs invent and then innovate, cause old ideas, equipment and methods to become obsolete, bringing progress and improved living standards for all.

What’s really hindering UK capitalism is the lack of genuine competition. Too many markets are failing to operate properly – from house building to banking to the supply of telephony, broadband, gas and electricity. These failures, the result of over-concentration and incumbent advantages, are now so considerable, and having such a negative impact on consumers, that there is a rising clamour to upend capitalism as a whole.
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Such a system can only work, though, when there’s a safety net to help the needy – a condition which the UK largely fulfills, even though there will always be ways in which our welfare state and public services can be improved.

What’s really hindering UK capitalism, though, and causing this crisis of confidence, is the lack of genuine competition. Too many markets, across too many UK sectors, are failing to operate properly – from house building to banking to the supply of telephony, broadband, gas and electricity. These failures, the result of over-concentration and incumbent advantages, are now so considerable, and having such a negative impact on consumers, that there is a rising clamour to upend capitalism as a whole.

It was the US economist Mancur Olson who put his finger on the problem we now face, in his 1982 masterpiece ‘The Rise and Decline of Nations’. Building on Schumpter’s work, Olson argued that mature industrial economies, as they develop, become hobbled by ‘vested interests, unwilling and uninterested in change’. That’s the greatest long-term danger to capitalism, in my view, what Olson referred to as ‘the silting up of the channels of economic progress’, by established industry players, who are able to lobby governments, and defend and extend their market dominance by preventing meaningful regulation and reform.

Western capitalism in the twenty-first century, in the UK and elsewhere, is functioning rather less well than it should. Yet, too-big-to-fail banks that extort government bailouts are anathema to free markets. Monopoly corporations that restrict competition and exploit consumers are anathema to free markets.

An oligopolistic house-building sector, deliberately restricting the supply of new homes to keep prices and profits high, is anathema to free markets. Plummeting social mobility is anathema to free markets – undermining the social contract upon which capitalism is built. These trends are increasingly apparent in modern Britain. That’s why the UK’s broad cultural and political acceptance of free markets is now being questioned, bolstering Corbyn’s support.

Capitalism need not lead to ever-rising inequality, providing the right checks and balances are in place. But governments of all shades must constantly face down behaviour that causes systemic instability, and/or involves excessive corporate greed. That’s something which UK politicians from all parties, for some time now, have largely failed to do.

Being pro-market does not always mean being pro big business. In fact, it often means precisely the opposite – as this Tarbell column has previously argued. Unless the Conservative party shows it understands that, and soon, the world’s fifth-largest economy could soon be under the control of a rabble of neo-Marxists.

FOOTNOTES
  1.  “Social mobility in Great Britain: fifth state of the nation report”, Social Mobility Commission, 28 November 2017
  2.   ‘Britain’s increasingly unevenly shared property wealth is driving up inequality after a decade-long fall’, Resolution Foundation, June 2017
  3.  ‘Phantom Homes – Planning Permissions, Completions and Profits’, Shelter Research Briefing, July 2017
  4.  Concentration not competition: the state of UK consumer markets,’ Social Market Foundation, October 2017.