There has been much debate recently about Thomas Piketty’s book “Capital in the Twenty-First Century” which shows the big growth in economic inequality over the years.
Not withstanding recent allegations of data manipulation from the FT and his aggressive response in defence of his numbers, Piketty is now the poster boy for the need for a change in the way global capitalism works.
That’s a reflection of the post GFC landscape and the unevenness that has seen the top 1 and 10 percents reap the benefits of super-low interest rates and quantitative easing while the bottom half is still struggling in many countries around the world to find meaningful and well paid employment.
It is a situation that needs addressing, according to Bank of England Governor Mark Carney who delivered what has to be the most important speech of 2014 about global capitalism, titled “Inclusive capitalism: creating a sense of the systemic“.
Carney takes up Piketty’s cudgel – intentionally or not – and says that unless capitalism is overhauled we face a breakdown in the social fabric of society which allows capitalism to thrive.
Carney introduces the topic by saying:
Inclusive capitalism is fundamentally about delivering a basic social contract comprised of relative equality of outcomes; equality of opportunity; and fairness across generations. Different societies will place different weights on these elements but few would omit any of them.
Carney says that societies aspire to this “trinity of distributive justice, social equity and intergenerational equity for at least three reasons”:
- Increasing evidence relative equality is good for growth
- Inequality is one of the most important determinants of relative happiness and sense of community; and
- Appeal to a fundamental sense of justice
Carney says that the “basic social contract is breaking down” and that now is the time to be “famous or fortunate” as the return across society is incredibly unequal.
Key to Carney’s disquiet about the breakdown in the social contract is his assertion that we need to understand the connection between “values and beliefs in economic life” and that it is these beliefs that “are part of the inherited social capital, which provides the social framework for the free market.”
Looking back but looking forward Carney says that “unchecked market fundamentalism can devour the social capital essential for the long-term dynamism of capitalism itself”.
That’s powerful stuff – he’s saying free markets don’t work -and goes on to drive the point home.
Market fundamentalism – in the form of light-touch regulation, the belief that bubbles cannot be identified and that markets always clear – contributed directly to the financial crisis and the associated erosion of social capital.
Ensuing events have further strained trust in the financial system. Many supposedly rugged markets were revealed to be cosseted.
Carney says that the things that stood out in the world of central banking were the heads-I-win, tails-you-lose approach of the too-big-to-fail banks, the rigging of benchmarks such as Libor and the trend toward algorithmic trading which Michael Lewis recently wrote about in Flash Boys. On the latter topic Carney notes that “equity markets demonstrated a perverse sense of fairness, blatantly favouring the technologically empowered over the retail investor”.
Rebuilding Social Capital
Carney’s prescription for financial reform is to drive reforms that rebuild social capital.
He is clearly taking aim at bankers who favoured themselves for short term gains but he could equally be talking about any company or organisational management when he says that the reforms “need to recognise the tension between pure free market capitalism, which reinforces the primacy of the individual at the expense of the system, and social capital which requires from individuals a broader sense of responsibility for the system. A sense of self must be accompanied by a sense of the systemic.”
Carney highlights that too-big-too-fail was at the heart of the destructive nature of the GFC. “Bankers made enormous sums in the run-up to the crisis and were often well compensated after it hit. In turn, taxpayers picked up the tab for their failures.”
Global regulators have too-big-too-fail institutions in their sights and Carney says that new rules must end “implicit privilege with the full discipline of the market.” Doing so can not only rebuild social capital but increase economic dynamism as well.
Think of it as cutting back the canopy so the undergrowth can thrive.
Carney has set himself some lofty goals and wants to reform markets to make them fairer and more effective and the BoE wants to make “changes to both the hard and soft infrastructure of markets”. In doing so he can remedy “a malaise in corners of finance” and in doing so ensure that market integrity, which “is essential to fair financial capitalism” returns.
Carney highlights that managers and bankers like to have a base salary and then a variable, or bonus component, that is tied to performance. But the perversion of such an approach to income is that it can lead to incentives in the individuals’ interests – not the employer, and certainly not the system.
In Carney’s view the system should move toward a system where “variable remuneration to be clawed back after payment” – so bankers get their full pay including bonuses, and then have to repay the difference on their assessed pay after performance is taken into account. Indeed the BoE has already conducted consultations on such requirements.
That will change behaviours.
In possibly his most ambitious objective in rebuilding modern capitalism Carney wants to build a “sense of vocation and responsibility” in bankers and by extension other business managers.
Financial capitalism is not an end in itself, but a means to promote investment, innovation, growth and prosperity. Banking is fundamentally about intermediation – connecting borrowers and savers in the real economy.
When bankers become detached from end-users, their only reward becomes money.
This reductionist view of the human condition is a poor foundation for ethical financial institutions needed to support long-term prosperity.
Amen to that.
Carney’s speech provides both an explanation for why capitalism went off the rails and how to get it back on track.
Importantly, if you read between the lines, what Carney is saying is that the Invisible Hand doesn’t work and that globally regulators need to legislate and mandate change if capitalism is not about to unwind the great strides since the industrial revolution and hollow out the middle ground in the economy in favour of the wealthy, powerful and lucky.
Business would do well to listen for without Carney’s prescription lay the seeds of capitalisms slow demise. With it, if business listens, is a key message – look after your customers and the system and they will look after you.