We need a dynamic, democratic capitalism

The debate between left and right constrains the development of our political economy leading to stagnation. It’s time for a new agenda focusing on democratising access to land, education and finance

The substance of the recent general election debate does not bode well for the future of our economy and society. Britain’s inability to escape from its long-standing low rates of productivity growth – and the increasing amount of evidence that for the first time since the early 20^th century the younger generation will be poorer than their parents – was largely ignored during the run up to 5 May. Although politicians on both sides have acknowledged that living standards have stagnated with rising inequality, the electorate was merely offered more of the same by the right, while the left focussed on reducing inequality but generally failed to understand the importance of wealth creation. Progress, or the betterment of the human condition, has stalled – which is of great concern, as progress is crucial to the legitimation of our liberal democracy.

There are numerous causes of this reversal of progress, but most are due to a worrying trend that the things we need to drive productivity growth are becoming increasingly out of reach for many firms and workers. Moreover, as globalisation and the development of new technology drives rapid change across the global economy, such low levels of productivity put Britain at a significant disadvantage when it comes to improving our standard of living.

Regression of the British economy

The insufficient development of human capital in the UK has been a major cause of lower productivity growth. Technical skills shortages across the UK has been a consistent theme emanating from British industry, constraining expansion plans.[i] England is the only OECD country where adults aged between 55 and 65 years old perform better than 16-24-year-olds in both literacy and numeracy. There also remains a strong link between family wealth and educational success with access to a high-quality education an aspiration for many poorer sections of society – particularly outside the larger cities.[ii]

When it comes to innovation policy – which is critical in bridging the gap between human capital development and productivity growth – firms are also losing out. The ability of local economic areas to determine their own trajectory through infrastructure investment and support for local clusters is severely curtailed in the UK due to a high degree of centralisation. Furthermore, government departments have not sufficiently embraced innovation programmes to procure inventive solutions to resolve today’s major public service issues.

The financialisation of the economy has fared better in recent decades with a significant improvement in the availability of capital for firms, although much more needs to be done for high-growth, innovative firms whose ability to raise finance is often constrained. However, this financialisation coincided with a reduction in the scrutiny of financial intermediaries. According to one report, the global fund management sector loses around $1.3tn of its clients’ money every year through high fees and poor performance.[iii] Bonuses earned by bankers soared as asset prices rose in the credit boom. In 2007 the UK financial sector bonuses totalled £19bn.[iv] But the profits that permitted this payout were not sustainable. When asset prices collapsed resulting in losses for banks, these bonuses were not paid back. The subsequent banking failures required massive expenditure by government and by the end of 2012, net UK government outlays to the banking sector were £124bn.[v]

Although George Osborne has finally faced up to the fact that the UK faces a major productivity challenge in his report, Fixing the Foundations, his proposals are too timid and piecemeal and, in many areas, there remain huge gaps.[vi] For example, the chancellor has stressed that his planning changes will drive a step change in rates of building. However, there is limited detail on how he will resolve the issue of high land prices that continue to constrain productivity growth.

For the last few decades house prices have been growing faster than wages across the UK. Data also shows that rents have been growing faster than wages and corporate profits over the last 10 years. The Office for Budget Responsibility has estimated that the housing benefit bill will have reached £26bn by 2019 as an ever-increasing number of families find housing unaffordable.[vii] Businesses are finding that they are constantly having to direct resources towards rent rather than investing in R&D or taking on new employees. Recent research shows that rising commercial rent is the main obstacle for firms wanting to expand in the London financial technology cluster.[viii] The process of wealth creation is, therefore, being constrained by the need to pay ever-higher rents before firms can even start to generate value added goods and services.

The dataset assembled by Thomas Piketty shows that rising land and house prices have been largely responsible for increasing inequality over the last three decades.[ix] A further dissection of Piketty’s dataset highlights that the returns from productive wealth, which excludes housing, have risen only weakly relative to income over the last few decades. And, crucially, in the longer run the productive capital/income ratio has not increased at all.[x] Given that governments in most countries tax land and housing at substantially lower rates than income, the owners of land have benefitted most – through no effort of their own – from the productive work of others. In essence, the current economic system discriminates against productive members of society in favour of those who derive income from unproductive wealth. The result of which is lower productivity growth and lower living standards.

Given the central importance of these factors in the way we produce goods and services, it should be of little surprise that productivity growth has slowed and living standards, for large sections of society, have fallen.

The challenge for the electorate today is that there is no solution on offer to resolve these issues from any political party. Such a solution would require an active policy agenda to make markets far more efficient and effective. Contemporary progressive politics still harks backward to the postwar ‘golden era’ where the outcome of the market was accepted as being as good as it gets with redistribution used to improve social justice. Conservative politics uses the same foundation that the outcome of the market is as good as it gets, with just less of the redistribution part. However, the thinkers who promoted the idea of progress during the Enlightenment had a very clear view of how a market-based system should be developed to ensure that it benefitted all of society, not just the few at the top. And it is to these ideas that we need to revisit if we are to navigate a progressive agenda for the future.

Enlightened radicals: Adam Smith and Thomas Paine

Central to Adam Smith’s argument was that the pursuit of commerce required that the inputs into the wealth-creation process should become as widely available as possible. In short, the democratisation of the factors of production. For Smith, this included education to improve the quality of human capital as well as increasing the availability of land for productive purposes. And it was the role of government to ensure that such polices were implemented to democratise these factors. Smith argued that the intensification of commerce through competition would drive prices down, causing real wages for all in society to rise. Smith was aware that this process generated inequality, but as long as everyone in society was benefitting through rising living standards, this inequality was justified. But Smith was also clear that when the majority of society did not benefit, the system would lose its legitimacy. As he argued in the Wealth of Nations: “No society can surely be flourishing and happy, of which the far greater part of the members are poor and miserable. It is but equity besides that they who fed, clothe and lodge the whole body of the people should have such a share of the produce of their own labour as to be themselves tolerably well-fed, clothed and lodged.”

Smith’s radical democratic view of society was at odds with the prevailing conservatism at the time, finding support from a handful of 18^th century revolutionaries. Thomas Paine argued in the Rights of Man that, “If commerce were permitted to act to the universal extent it is capable of it would … produce a revolution in the uncivilized state of governments. The invention of commerce … is the greatest approach towards universal civilization that has yet been made by any means not immediately flowing from moral principles.” Thomas Jefferson promoted this idea too, through the notion of the equality of opportunity. Freedom for Jefferson meant the equality of opportunity to participate in society, with government providing the scaffolding for civil society enabling citizens to gain access to land and education.

Democratising the factors of production

The role of government in a progressive agenda is, therefore, to facilitate the democratisation of the factors of production. This initially meant increasing access to land and education, thereby improving the rate of productivity growth. Smith also raised governance concerns where a firm is controlled by managers rather than the firms’ owners arguing that “negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company”. Clearly, there are many cases where managers are able to build successful companies in the long run without such negligence. However, the recent financial crisis has shown that the propensity for this to happen still exists with significant negative consequences for society. Governments therefore need to institute robust governance arrangements to ensure that managers are more effectively scrutinised by a firm’s owners to safeguard its long-term success.

Through time, it has also become clear that governments need to ensure firms can finance their expansion activities by democratising access to capital. This allows companies to purchase labour, land and capital goods in order to generate value added products and services. Finally, government also has a central role in supporting the process which transforms human capital into productivity growth – or innovation policy. This includes increasing the availability of fundamental and applied scientific research, as well as risky product development in areas central to public policy. Such an innovation policy must also allow local innovation clusters to determine their own trajectory with the decentralisation of decision making for infrastructure investment and local skills provision.

The challenge for this vision of progress – a dynamic democratic capitalism – is that governments of left and right have not sufficiently promoted commerce. Indeed, a variety of public and private vested interests have instead sought to constrain its progress given they have a great deal to lose from the democratisation of capitalism. The historical development of the democratisation of the factors of production shows that progress is not linear – as it requires deliberate action by government – nor is it unidirectional as can be seen by the recent trend of decreasing access to land.

Setting a new agenda

An agenda for progressive capitalism must, therefore, make land more available to households and firms. It also needs to focus on increasing the availability of capital for innovation and growth firms, who will provide the jobs of the future. Such a policy must be supported by access to a high-quality education – particularly of a technical nature – as well as regionalising decision-making, permitting local innovation ecosystems to facilitate the transformation of human capital into productivity growth. Finally, governments must improve governance arrangements to ensure that the long-term success of the firm is not put at risk by managers with a different set of goals.

For too long the debate between the right – who are generally comfortable with the status quo and the left –  who have promoted a redistributive agenda that is also largely based on the status quo – has constrained the development of our political economy resulting in stagnation. Moreover, the continuing transfer of income from the productive members of society to unproductive ones bodes ill for the future. Progressive politicians need to rekindle their 18^th century radicalism and set a new agenda to improve living standards for all in society. A progressive political economy must focus on policies that democratise access to land, education, finance and the process of creative destruction and entrepreneurship, rather than focusing on business as usual or increasingly unrealistic redistribution policies. Making markets work for the benefit of all society and not just the one per cent through democratising capitalism must become central to public policy.

Author: Thomas Aubrey

Thomas Aubrey is senior adviser at Policy Network & Founder, Credit Capital Advisory View all posts by Thomas Aubrey