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2010-09-23 09:17:37
Sep 22nd 2010, 14:20 by Buttonwood
VINCE Cable, Britain's business secretary, is getting it in the neck. In a
speech to the Liberal Democrat conference today, he said that
Markets are often irrational or rigged. So I am shining a harsh light into the
murky world of corporate behaviour. Why should good companies be destroyed by
short-term investors looking for a speculative killing, while their accomplices
in the City make fat fees? Why do directors sometimes forget their wider duties
when a cheque is waved before them?
Is this Marxism? Hardly. One of the issues Mr Cable is referring to is the
"agency problem" - that managers do not act in the best interest of
shareholders. From the figures quoted in the Deutsche Bank long-term asset
return study, that is a valid criticism. Earnings per share growth have lagged
GDP growth over the long term. Companies have reduced the payout ratio without
growing earnings sufficiently to compensate. Since the overall remuneration of
executives has grown dramatically faster than GDP over the last forty years, it
is not difficult to see where the money has gone.
Or as that well-known Marxist Warren Buffett remarked
"Too often, executive compensation in the U.S. is ridiculously out of line with
performance. That won't change, moreover, because the deck is stacked against
investors when it comes to the CEO's pay."
The problem of short-term investing is one that has been regularly raised by
businessmen in the past. The average holding period of investors has fallen
dramatically over the last 50 years. But to go back to Buffett, a man who
became rich by investing, he believes the best holding period is forever.
Frantic trading activity just benefits the middlemen in the financial sector.
As for markets being occasionally irrational, we have surely had adequate
evidence of that over the last 10 years. Even the renowned free market advocate
Alan Greenspan confessed in 2008 that
This modern risk-management paradigm held sway for decades. The whole
intellectual edifice, however, collapsed in the summer of last year.
Behavioural finance, the idea that investors are not always rational, is a
flourishing subset of economics. So Mr Cable's remarks hardly represent a call
for the collective ownership of the means of production, distribution and
exchange but standard issues that are debated in the political and academic
mainstream.
Alas, the use of the Marxist terminology betrays a distressing tendency in
modern debate. The recent discussion on this blog of The Spirit Level provoked
one inevitable comment about how those who worry about inequality should
consider the Soviet Union or Cuba or North Korea. But we are not talking about
a choice between modern America and north Korea, but between 2010 America and
1950s America, which had a more equal income distribution, but was fiercely
anti-communist. All western democracies are mixed economies, in which the state
performs some functions and the private sector others. The argument is about
where to draw the line, and it goes back and forth in a process of trial and
error.
The recent crisis ended up with a lot of costly government intervention. We are
now arguing about how to avoid a repeat. One approach is to use the Basle
international accords on bank capital; another is to limit the scope of bank
activities; a third might be to break the big banks up to ensure thay are not
too big to fail. All of this requires government intervention of some sort.
The Economist is in favour of free markets, but both words are important. If
banks are too big to fail, then their cost of capital is implicitly subsidised.
This creates barriers to entry and encourages risk-taking at the taxpayers'
expense; the market is thus not truly free. In an ideal world, we ought to be
able to let banks fail in the same way that we let widget manufacturers fail.
But since bank failures have a devastating economic impact, we need to have
some approach to regulating them. Markets also have externalities, a concept
long established in academia; a chemical company cannot be free to pollute a
river, for example.
To say that any further regulation is socialism, or that any consideration of
inequality is misguided, seems wilfully blind. If banks earn huge profits, and
their traders huge bonuses, only because of an implicit state subsidy, that
seems a legitimate matter of public concern. For those who believe this is the
road to Cuba, one might easily respond that the other camp is on the road to
18th century France, where wealth was concentrated in the hands of a tiny,
hereditary elite. A gross caricature? No more than the Cuba example. After all,
the evidence suggests that social mobility is falling in America and Britain,
probably because the wealthy can gain advantages for their offspring via
private education.
Surely the American dream suggests that all people should have an opportunity
to succeed, despite the circumstances of their birth. This meritocratic model
is not only inspiring but the best way of ensuring economic success. So any
sign that the model is being destroyed requires serious consideration. Using
the Marxist label is as fatuous as bringing Hitler into any political
discussion.