Monday, 22 May 2017

Mapping & Understanding the Networked Character of Finance

The following is a summary of the “Networks in Finance Workshop” meeting held in Manchester 6-7th December 2016

In December, Adam Leaver and Daniel Tischer from the Alliance Manchester Business School hosted an international workshop on “Networks in Finance” at the University of Manchester. The event brought together both renowned and emerging scholars from different disciplines interested in net-work structures and dynamics within global finance. Despite the considerable diversity of approaches, the presentations shared the assumption that a focus on relationships can help us understand ongoing structural transformations like financialisation or the astonishing re-stabilisation of the industry and its guiding logics after the last financial crisis. “We can only really understand practices and outcomes of finance if we precisely know how it is put together and interconnected”, as Adam put it in his introductory remarks. Social network analysis (SNA) helps us a great deal in this respect since it enables the mapping of actor constellations over time and the connectedness of finance across sectors and borders. Throughout the workshop, three themes emerged: Firstly, the network characteristics in certain sectors of global finance; secondly, the connectedness and activities of particular actors; and finally, financial networks at particular places. This summary covers the various contributions along these themes rather than reporting them chronologically.

Networks in particular financial sectors: CDO, M&A, crowdfunding & CMU
Finance is not a monolithic bloc although our use of this label sometimes might suggest this. It rather is comprised of a variety of sectors, markets, products, actors, and practices that share some common logics but can be structured quite differently. Thus, networks in finance might be best captured by looking at particular sectors. Adam Leaver and Daniel Tischer, for instance, showed how Collateralized Debt Obligations (CDO) are essentially networked products that emerge from a complex set of relations between different actors such as banks, legal advisors, collateral managers, and issuers. The global CDO industry can be analysed as a network that is generally concentrated in few actors and places but allows competition in some functional areas. The technical complexity and opaque-ness of the product serves as an exclusion mechanism and requires smooth, established and repeat-ed interactions between the actors involved. A network analysis of the supply-side of such markets questions the assumption of financial “bubbles” being mostly demand-driven. In their contribution on social network risk, they show how the quotidian careful consensus building among actors involved in the LIBOR fixing scandal as documented in leaked emails is another example of the importance of person-to-person relationships in finance. Not the corruption and misbehaviour part of the story is the most interesting bit but rather the habitual construction of the rules of the game by a close and tight network of insiders. In those constellations, often, common career patterns and alumni networks play a central role. Individuals and individual networks might matter much more in an industry that is often presented as anonymous and technical. And this might not only be the case for well-documented scandals but for the mundane practices within finance in general. This assumption is underpinned by Olivier Godechot´s presentation on team moves in the UK financial sector. Changing companies is happening quite regularly in finance, it maybe is even much more frequent than in other sectors. Godechot shows that also team moves are a significant phenomenon that is supported by specialised head hunting firms. The rationale behind this is keeping the clients and the established working proceedings within the team. Valerie Boussard showed, in the case of Mergers and Acquisition (M&A) services in France, those conventions about interaction and the organisation of transactions are key for the working of finance making it a “social field”. She finds a rise of inter-mediation services and reproduction of hierarchies among actors.

Andrew Leyshon presented a paper on the rather dynamic crowdfunding sector that puts the notion of networks at its core bringing together borrowers and lenders outside of the established financial markets. He questions the perception of crowdfunding being an alternative to mainstream finance. In spite of providing capital for projects that otherwise might not have been funded, it replicates many features of traditional finance like the class, gender, and geographical bias, the encouragement of entrepreneurship, and the reliance on transaction fees. Moreover, traditional actors infiltrate crowdfunding networks as lenders and experts. After all, like in other financial sectors, the most stupid (or least informed) person in the room ends up with the highest risk. Regarding capital markets, Ewald Engelen presented a paper (co-authored by Anna Glasmacher) on the European Commission´s attempt to set up a Capital Markets Union (CMU). He differentiates between a frontstage story presented by the Commission as rationale for CMU (bringing together capital demand and supply more efficiently) and what he identifies as backstage story of this policy, namely providing a new funding tool for big banks and saving securitisation. Thus, a narrative of financial modernisation serves as legitimation strategy for new politics of mass financialisation in the EU. Most interesting from a net-work perspective is the analysis of a contingent interest coalition behind this new regulation consist-ing of the Commission, banking associations, the ECB & the Bank of England, regulators, and institutional investors. This brings to the fore the pressing issue of the industry´s capacity to turn their interests into political projects promoted by state agencies which can be witnessed in various financial sectors and even after the recent crisis.

Relevant actors in financial networks: Organisations & individuals
Turning away from specific markets, another important question raised at the workshop concerned the nodes of networks in finance: Who are the important actors and brokers within those networks and how can we actually measure their influence? In technical terms, SNA measures importance by different degrees of centrality. However, this does not relieve us of the interpretation and theorising work that needs to be done in order to better understand the relationalities in finance and their functions. Sebastian Botzem presented a paper (co-authored by Natalia Besedovsky) that investigates the dynamic development of the global financial elite network drawing on a database including the big players of finance and their connections to other organisations via personal links. They interpret networks mainly as infrastructure for knowledge flows and find that the network becomes bigger and much denser over time and changes its face after the financial crisis. In particular, regulators, international organisations, and the industry itself lose connectivity while private non-profit organisations like think tanks and professional associations move towards the core. This might indicate an increased demand of sense-making, persuasion, and ideational self-assuring after the crisis and signals a renewal of the dominant self-regulatory pattern in financial governance. Jan Fichtner and Eelke Heemskerk also observe an interesting dynamic in the global network of corporate ownership: They trace back the rise of the three big passive index funds (Vanguard, Fidelity, Black Rock) and find that the crisis triggered an unprecedented shift of investment towards those funds that now represent the core of the network. What network analysis does not reveal, however, is how this translates into changes in corporate governance. Anecdotal evidence, however, suggests that index funds show a rather management friendly voting behaviour in shareholder meetings. Similar to the previous paper, SNA is rather limited when it comes to understanding reasons and implications of network change.

Coming back to the individual level, professional experts have been the focus of other workshop contributions. Ronan Palan stressed that asset managers essentially try to disproof the dominant theoretical underpinning of contemporary finance, namely the Efficient Market Hypothesis (EHM). They only can generate higher profits than their competitors if they beat the market (what EHM assumes to be impossible on the long run). Palan concludes that sabotage (operating outside the market) is the only way how higher income can be generated in this sector, making it the rule rather than the exception. In general, finance is a commission-based service economy that by default develops a behaviour that would be less tolerated in other businesses. Yuval Millo pays closer attention to positional struggles of investment advisors within financial networks. He finds that sell-side analysts try to accumulate social capital in order to respond to the increasing questioning of their legitimation. In particular, their reports turn from an informational into a relational device: They are no longer meant to provide knowledge but rather contacts. Thus, reports are written in a way that provokes the read-er and renders a personal meeting more likely. Similar networking efforts under pressure have been observed by David Muzio and James Falconbridge in the case of Italian lawyers who were getting ready to serve the newly financialised economy from the 1990s onwards. In order to keep up with both new legal requirements and Anglo-Saxon competitors, an emerging group of legal experts start-ed to internationalise their careers with Master degrees in New York or London and memberships in international professional associations. Finally, Rasmus Corlin presented joint research with Leonard Seabrooke and Duncan Wigan on professional competition in the governance of global wealth chains. He showed how different professional groups are struggling over influence on the OECD´s BEPS project. Experts who are either well-connected and experienced in different fields (“octopuses”) or who are focused and well-respected within their profession (“arrows”) succeeded.

Financial networks at particular places: The City of London and beyond
A third prominent theme at this workshop was the local dimension of financial networks. Arguably, all networks include places (mostly they are not bound to one place however). Still, in some studies, the local context is more focused on than in others. Those studies also tend to engage more with politics and financial regulation pointing to the fact that finance is essentially a political relation. Many academics are looking at relational and political dynamics at the City of the London. Sarah Hall, for instance analyses the emergence of London as first centre for trade in Chinese currency outside Asia. She argues that political decisions, social relations and power are key to the rise of certain places within global networks. The choice of London was not natural or business-driven but rather an outcome of favourable regulation, high level political contacts, and the reservations against New York. Jonathan Beaverstock presented some scenarios for the City post-Brexit and argued that the future approach to immigration will be crucial for its survival. This is based on the observation that international financial centres heavily compete for transnational labour. Places like Hong Kong and Singapore run quite aggressive global talent programmes and London will need to keep up in order to stay attractive for the transnational financial elite. This creates a challenge for policy-makers since special regulations for the capital are not likely to be popular in the UK.

Moving from London towards overseas tax havens, Richard Murphy suggests the term “secrecy juris-dictions” as new label for offshore financial centres. He argues that tax avoidance and evasion is en-abled through networks deliberately designed to provide secrecy spaces for foreign individuals and corporations. Those networks involve both public and private actors. However, the relations be-tween the actors might be much more important that the nodes themselves. Emmanuel Lazega and Chrystelle Richard looked at the networks of Public Private Partnerships (PPP) in France and showed how the state is an important facilitator of financialisation. The French PPP networks are characterised by a close relation between the state and big business, and by a centrality of banks and other financial actors who try to shift the risk towards the state. Finally, Sheri Markose showed that a net-work perspective can also help to shed light on current economic stagnation and high unemployment in certain US regions. If a production network loses connectivity, it also loses functionality. Also, fi-nance´s ever increasing share of GDP worsens the situation since all the oxygen in the room is sucked up by the financial sector. Therefore, the US economy needs to be rebalanced.

Merits, limits & methodological challenges of social network analysis in finance
In many but not in all workshop contributions, SNA was at the heart of the study, taking into account the various advantages of the network perspective. First and foremost, studying financial networks puts emphasis on agency and actors rather than treating finance as a merely technical, impersonal, and apolitical sphere. This includes awareness to conflicts, power dynamics, social and cultural norms. Network analysis also necessarily entails a process perspective regardless whether or not changes over time are studied. When we look at networks we are asking how exactly outcomes and practices unfold and which actors are involved in shaping them. This fits both the high complexity and dynamism of contemporary finance. While some authors started with the aim to map out a cer-tain networks, hoping to generate new empirical and theoretical insights, others simply decided to add the network perspective to their existing analysis in order to enhance their understanding. Both approaches are perfectly legitimate; their results, however, are not easily to compare.

Anyway, most of the papers combined SNA with other methods like content analyses of interviews and documents or sequence analyses of individual careers. Such triangulation seems to be quite promising since our interest usually does not stop after the mapping of networks. We want to under-stand the relations underpinning finance and their dynamic development. This clearly requires theorising since SNA is merely a descriptive tool. It is worth mentioning, however, that mapping a net-work can be a tricky task given methodological challenges like data availability, comprehensiveness, and reliability. Sources for network data include commercial corporate databases like ORBIS and BoardEx, annual reports, legal product descriptions, leaked communication (like emails), minutes, official registers, social media data (like Linked In and twitter profiles), public biographical information, and interview material. This data often is hard to gather and you rarely can be sure that you have complete information. Relatedly, the boundary question is anything but trivial: Where are the boundaries of a particular network to be drawn and how can this decision being justified? There was also some discussion about how much formalisation is necessary and desirable in the analysis of financial networks and whether more emphasis should be put on the nodes or the relations.

What do we already know and what needs to be investigated further?
The discussions in Manchester both showed how much we already know about networks in finance and revealed many gaps still to be filled. We know that networks, in finance and anywhere else, can be defined as rather small populations of frequently and repeatedly interacting people or organisations shaping outcome and reproducing shared assumptions or ideas. More specifically, networks can serve as infrastructure for power relations, control, knowledge flows, and product proliferation. We know that finance, as any other sphere of society, is constituted by and put into practice through networks. This is particularly true for the complex process of financialisation. Finance might even be inherently networked because it is an intermediary business. It is also to be assumed that networks in finance tend to be more transnational than other networks and that finance is exceptionally highly connected with other sectors (although there are only few comparative studies). What we don´t know exactly is how this connectivity and transnational character have evolved over time. Are con-temporary financial networks denser and more transnational than in previous times? The financialisation literature suggests an increasing connectivity but also a non-linear and variegated development. Which actors were central at certain periods of times? Are there historical patterns that span different financial sectors and regions or are the dynamics more context-specific?

We also know that financial networks develop very dynamically, maybe much more dynamic than other sectors. The reasons and implications of network changes, however, merit further attention. Why and how do certain actors become more central than others? Is it an outcome of deliberate strategies, power resources, or does it happen accidentally? How do networks react to shocks like financial crises? Some of the workshop contributions suggest they might change their form in order to keep their function. But is this true across the board? The workshop papers also suggest that there are considerable differences in the networks in different sectors and places. It is an empirical question whether networks in financialised capitalism tend to harmonise or can easily accommodates sectoral, cultural, or local particularities. One of the most important questions still needs to be investigated further, namely how do relations in financial networks unfold and how we can make sense of them. Maybe a theoretically informed typology of network relations could be helpful in this regard. Of particular interest are relations between public and private actors. How does the financial industry integrate state agencies in their networks and vice versa? How can explain the cognitive capture of regulators? Much more studies on regulatory networks are needed. We also might want to know how networks need to be changed in order to achieve substantial changes in finance and it´s regulation and how this can be achieved.

Conclusion: Towards a common research agenda?
Social network analysis enables the mapping of relations among financial actors and thereby generates a variety of new insights and triggers new questions. In particular, it makes visible hidden connections and changes over time. A network perspective certainly enhances our understanding of the inner workings of global finance. However, it certainly does not replace theorising relations and is more a descriptive than an explanatory tool. The workshop showed that the application of network research to the study of finance can produce much more than fancy network graphs. But it has to be connected with a critical analysis of power dynamics, expertise, and the social and political context of relations within finance in order to present an angle different from mainstream economics. In doing so, the research brought together in Manchester sheds new light on a still growing sector of society and its local and global interconnectedness. This event might lead to further collaborations among the participants. Certainly, it has reinforced an ongoing academic conversation on the important role of networks in finance. It might even have been a first step towards a much needed common re-search agenda on the networked character of global finance.

By Sebastian Moller, University of Bremen

Monday, 3 October 2016

Deutsche Bank: A Vertically Integrated Problem

Recent concerns about Deutsche Bank’s financial position highlight again that banking remains fragile. On Friday Deutsche Bank’s shares fell nearly 9% at the opening bell as investors panicked about news that hedge funds had started to pull business from the company.  This comes off the back of increased concerns about potential writedowns and the vulnerability of its coco bonds at the start of the year.

The immediate trigger for this most recent panic is a $14bn demand by the US Department of Justice to settle allegations related to the mis-selling of mortgage backed securities & CDOs during the 2000s boom. This comes after several other large banks settled similar cases with the DoJ: Bank of America paying a $16.65bn settlement for activities undertaken by it and its subsidiaries including Merril Lynch and Countrywide Financial Corporation, JP Morgan paying $13bn and Citigroup  $7bn. In some cases the fines eventually paid were significantly less than the original sum demanded by the DoJ. There is hope within Deutsche Bank that a similar deal can be struck and a lower amount paid, with recent estimates venturing that the figure could be closer to $3-4bn.

But Deutsche Bank’s bargaining position with the DoJ may be hampered by the specific detail of its activity in RMBS and CDO markets during the boom. Unlike US banks, Deutsche Bank ran a more vertically integrated model of securitization (Exhibit 1) which meant it occupied a different space in the market compared to its competitors. By integrating trustee, listing and other administration functions (which are provided by external parties in most US CDOs) the DoJ will have to consider whether Deutsche Bank’s larger footprint potentially gave it a knowledge advantage.

Exhibit 1: Deutsche Bank entities co-participation in CDOs. Line thickness = #of joint products (values given); size of node = #of CDOs involved with.

To illustrate the point, with the STAtic CDOs that featured heavily in the Senate report on the causes of the financial crisis (373 f. Footnote 1505), either three or four Deutsche Bank entities were usually involved in their structuration: DB’s Irish Deutsche International Corporate Services Ltd., its Cayman Deutsche Bank (Cayman) Ltd., its American Deutsche Bank Securities Inc., Its Luxembourgian Deutsche Bank Luxembourg S.A. and Deutsche Bank (Exhibit 2). These positions were mainly occupied by independent providers in the case of US bank CDOs. Not only that, but Deutsche Bank also sold these services to other market participants (Exhibit 3).

Exhibit 2: Deutsche Bank entities involved in START CDOs 

Exhibit 3: Comparison between Deutsche Bank entities and other major US banks involved in the CDO market

The DoJ will have to consider whether Deutsche Bank’s vertically integrated model gave it access to more information about the quality of the due diligence and thus the underlying collateral in the CDO market. If it believes Deutsche Bank’s structural position meant its employees did know more than their competitors, then - given the febrile context - it might now be financially prudent to consider jail time for the individuals involved rather than fines for the institution. 

Stanley & Tatu.

Sunday, 26 June 2016

Tactics Without Strategy: Brexit And The Politics Of Conceit

With two million Conservative voters seemingly ‘undecided’ last week and Labour voters preponderantly pro-Remain but susceptible to no-shows at the ballot booth, it was tempting to presume before the vote that an event of this magnitude might be decided by something so quintessentially British as the weather. Come Friday morning, it was abundantly clear that was not the case. The gap between Leave and Remain was just under 1.3 million votes, far greater than can be explained by a June downpour. The outcome is humbling.

In due course the referendum defeat will become the textbook reference for political hubris. Cameron’s referendum campaign showed a fundamental underestimation of public mistrust with the political establishment when it committed taxpayers’ money to the production of Remain leaflets. Similarly an appeal to the eminence of its leading voices on the risks of Brexit – prescient though they were – might work when it comes to winning over fearful middle class swing voters in marginal seats, but alienated a large and sceptical cohort who had not done particularly well since the 1990s. This played to Leave’s strengths who were only ever going to run a populist campaign with immigration as the issue ‘the establishment wouldn’t touch’. The more establishment figures Remain wheeled on, the more remote they seemed.  

The referendum loss symbolises Conservative leaders obsession with tactics at the expense of strategy. They built a machine to be elected not govern, perfecting the art of winning small political skirmishes which embrangled them in increasingly intractable commitments. Eventually one intractable position was not going to hold.

So where does the referendum result leave things? Economically, we are in a difficult place. The EU will push for an early exit to reduce uncertainty in other EU countries. The longer negotiations are drawn out, the more turmoil will be inflicted on our major trading partners within the EU - there is a good chance they may move into recession, as seems unavoidable for the UK. It is sadly true that they also must make an example of us or risk giving hope to Leave movements elsewhere. Investment, already weak, will retreat until some certainty returns. This is happening in real time, with huge swathes of construction now put on hold. Financial markets are not as robust as we are led to believe and the £250bn injection promised by the Bank of England - presumably a bid to stave off a prospective wholesale run as bank stocks fell 30% – would seem to support that. We have yet to see the effects of a ratings downgrade and sterling devaluation on the economy. It is doubtful that the devaluation will benefit the export sector radically: in four of the last six major periods of devaluation there has been no impact at all. These are not the conditions under which the politics of optimism thrive.

This takes us to the Leave campaign. The campaign was built on an anti-establishment/anti-intellectual ticket led by an old Etonian and another Oxford graduate. It traded on the conceit that many of the UK’s problems could be solved by ‘taking back control’ – an organising metaphor abstract enough to galvanise a body of voters with quite different perceptions about what this meant. The usual accusations about Leave being ‘old, uneducated people in the North’ have already surfaced but the reality is much more complicated: 43% of ABs voted Leave, for example – that’s a lot of skilled workers and professionals. Similarly, the geography of the Leave vote is split between cosmopolitan centres like London, Bristol, Manchester and Liverpool on the one hand and smaller towns and rural areas on the other. The most important indicator of a Leave voter is value-based according to Ashcroft’s polling data: in other words, we are witnessing the reawakening of a particularly cynical, conservative English authoritarian personality which cuts across class and geography. ‘Taking back control’ in this context signalled a variety of things: release from the EU’s institutional sclerosis and immured power bases; rejection of the neo-liberal grip on policy formation; devolution and an improvement in accountability and sovereignty. But for many it primarily meant control of immigration. And the Leave campaign was happy to let people believe that this was precisely what we were voting for.

The problem now is that this puts Johnson and Gove in precisely the predicament of Cameron and Osborne.  The latter were outmanoeuvred tactically, but it is Johnson and Gove who have the larger strategic quandary. The flipside of the Leave campaign’s amorphousness is that all of its voting tribes will expect their vision of Brexit to be delivered: that is the risk with summonsing ‘end-of-truth-and-reason’ politics. Putting aside the inconceivability of honouring the £350m per week to the NHS pledge, they have a much larger problem regarding immigration. If they opt out of the pledge to stop free movement, as pro-Leave campaigner Daniel Hannan has already indicated, those who voted Leave believing it was a vote to control immigration will feel betrayed.

This is ultimately why I am pessimistic. If you lead a populist, anti-immigrant campaign on an anti-establishment platform, and then support an EFTA model that retains free movement, you will discredit yourself and the democratic process. Add to that a rapidly deteriorating economic climate and the resurgent nationalism you were complicit in stoking, and voters will begin to embrace the extreme right. It will take considerable political skill for Johnson and Gove to manage this next phase should they replace Cameron and Osborne. I am not sure it is within their capabilities. Both have a facility with the blunt instrument of populism, but they do not possess the political guile and sophistication to deal with the subtle intricacies of a perceived volte face in such a febrile climate. Farage, however, does have the necessary nous and aggression to point out their deceit.

Can the Left stop this? They are in a difficult position, not least because we are seeing the working out of the legacy of New Labour - its mishandling of the financial crisis and intransigence towards its heartlands. This instilled a sense of injustice, of powerlessness, of being cut adrift. Atavism fills the space left by the dismantled social and economic institutions that build solidarity and community. The Labour Party were correct to move to the left to reconnect with those communities as voters began to defect to UKIP, but they have the wrong leader to deal with the fight to come. The Labour Party needs a brawler, not a history teacher.

Whoever that might be, they will need to address some of the profoundly reactionary sentiments of their ex ‘core vote’. Anti-immigration is now a deeply ingrained and increasingly animating ideology that will be difficult to reverse. A politics of trust, tolerance and understanding to support vibrant communities of difference is needed. This requires a redistributive politics to fund the rebuilding of the economic and social institutions that embed harmony: better jobs, better public services, better social housing. That may grate with the business elites of London and other cosmopolitan centres, but social dislocation is not good for trade and growth either. As Duncan Weldon has pointed out: capitalism needs social democracy to function. The state now has a duty to stabilise capitalism by acting against the interests of its most vocal proponents and greatest beneficiaries. This is the challenge for Labour.


Tuesday, 5 April 2016

Panama Leaks In The Context Of Austerity

I always thought the austerity rhetoric had something of ‘the spirit of the Blitz’ about it. Austerity (the rhetoric) instilled a sense of togetherness and inclusion in the British public even if austerity (the programme) had a highly uneven impact on different groups, and was largely ineffectual in improving our country’s economic fortunes. In a country steeped in nostalgia for the Second World War, this kind of appeal to mass public sacrifice had a galvanising effect. The British public accepted the idea that some personal short term pain was necessary, even if they privately wanted to see more of that pain passed on to those they deemed less deserving. It conjured images of rationing, of a British public without heed to class distinctions responding stoically to a time of crisis - we were ‘all in it together’, showing our unity and our mettle in times of adversity. Even our cultural artefacts said ‘Keep Calm And Carry On’, before the Hoxtonistas got their hands on them.

It is perhaps because of the success of austerity (the rhetoric) that the Panama leaks are so potentially damaging. The unpalatable situation that confronts the Conservative party this morning is that at the time David Cameron announced the absolute necessity of austerity to UK citizens, his father had employed the services of Mossack Fonseca to avoid making the sacrifices perceived to be the duty of others less well off than himself. Time will tell if Cameron stood to gain personally from this arrangement, but it is now difficult to avoid the sense that we were never all in it together: it was always one rule for the privileged and another for the disabled, the homeless, the council workers, the nurses, the junior doctors and multiple others who were told that there was no alternative and that we all must give up something for the sake of the many. For a party steeped in family and other money, much of which may prove to be mobile, there will be nervousness amongst Tories tonight because that image is potentially toxic.

The British electorate do not like hypocrites and they don’t like to be taken for fools. It was, after all, the hypocrisy of the Back To Basics programme that undid the previous Conservative administration, as revelations about extra-marital affairs, romps and exotic sexual encounters undermined the party’s authority to wag its finger at ordinary people and preach the merits of self-discipline and the sanctity of the family unit. The routine scandals made the party a laughing stock and robbed them of power for nearly a generation. We are now potentially in Back To Basics Mark II. When asked to make sacrifices, we like to think it is not beyond those who stand to lose least proportionately to muck in; particularly when the financial crisis was in large part an elite debacle in the first place. What we learn from the Panama leaks is that for the rich, including allegedly a relative of our leader, even these modest sacrifices were unacceptable.

Cameron has said that this is a private matter, but it cannot be this time. The context of his own austerity rhetoric makes this new revelation unavoidably public. This can’t be handled like the pig-gate affair which was successfully starved of oxygen; his one-line response is of similar intent. Cameron now stands accused of something much worse: he is accused of being a hypocrite and of taking the British public for fools. And that is much more serious politically.


Tuesday, 29 July 2014

The End Of The Experiment? Part 4

Changing the economic frame/ Making a political difference

“There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things. For the reformer has enemies in all those who profit by the old order, and only lukewarm defenders in all those who would profit by the new order, this lukewarmness arising partly from fear of their adversaries … and partly from the incredulity of mankind, who do not truly believe in anything new until they have had actual experience of it.” ( Machiavelli, The Prince, 1532, Chapter 6)
“For the overriding economic problem discussed in this book, the first necessity is not technical devices but the public acceptance necessary to make them work” (Hirsch, Social Limits to Growth, 1977, conclusion)

It has long been understood that it is politically difficult to introduce a new and untried order of things which upsets the economic status quo. With the slow motion economic failure of the 30 year experiment, it is nevertheless important to ask:  how can we make a difference politically and begin to organise a better world. The answer is not obvious. We have accumulated so many critiques of neo liberalism that, if they were all piled up one on top of another, they would surely by now reach to the moon. And yet, after several decades, we are no closer to defeating neo liberalism.

This disconnect between critical thought and effective action isn’t a problem for everybody. As we have argued in our blog about Thomas Piketty’s Capital, the sales success of that book can be attributed to the way in which it combines fact driven critique of growing wealth and income inequalities with an utopian solution of higher income and wealth taxes. This solution will never be enacted when we live in post democracy where the mass party is no more and the organised working class have been disempowered
But it is a big problem for the team that wrote The End of the Experiment because we wanted to write a book that moved from critique of the thirty year experiment to new political proposals for action and intervention.  Of course we are academic scribblers not political practitioners. But we can break with the dismal TINAF (There is no Alternative Framework) assumption that frames current centre left and centre right politics; and hope that  our arguments can have some performative impact in the next phase of ongoing crisis

In our book, the distinctive form of our critique shapes our concept of the alternative. Because the one centralised, Westminster led dogmatic experiment has failed, we recommend much more diversity of regional and local experiments which provide the basis for discovering answers. Because our critique shows that the generic fix of competition and markets has led to sectoral mismanagement, we recommend a different approach which recognises the heterogeneity of the economy and engages with activity specifics in what we call the foundational economy.

The argument on these points in The End of the Experiment  is dense but it can be simplified and systematised.  The book’s policy argument starts from a contrarian insight about how there is more than one economy. It then focuses on part of the economy by proposing the foundational  economy as an alternative object before proposing chain value and social license as policy principles do which could be developed and articulated through local experiments 

1) The contrarian insight
After thirty years, it is not difficult to see the problems inherent in the current framing of our politico- economic problems in a country like the UK. It is increasingly realised that our economic problems do not have technical solutions with existing management tools. It is widely accepted that the current UK recovery is consumption based, debt fuelled and unsustainably driven by house price rises: if that observation is set in the context of boom and bust over the past thirty years, the implication is that there is no setting of the macro policy levers (fiscal and monetary) which will deliver sustainable UK growth.

The main stream response is denial. The Thatcherite revolution fails because it is incomplete, the answer is more of the same (and please don’t talk about debt based growth). The generic fix of competition and markets is now applied with more force to energy, banking and every other sector; this structural reform is backed by bolt-ons like industrial policy to deal with market failure in the commercialisation of early stage innovation.

This kind of obsessive compulsive behaviour may be increasingly incredible; but it is at the same time difficult to reframe issues and propose an alternative that works. The difficulty relates to habits of thought and organisational peculiarities which are embedded in main stream British politics.

In terms of overall vision, the centre left’s question has always been why can’t we be more like Germany and their difficulty is that they have no policies which would move the British economy away from financialization and onto a more virtuous productive path. Manufacturing output shows no sustained output growth because the aspirations of foreign owned branch firms are limited as are the capabilities of British firms who prefer to compete in sheltered sectors; adding more finance for production or up-skilling the workforce will achieve little without radical changes elsewhere because UK supply chains are constructed around low skill and investment.

As a way of breaking out of this impasse, we turn to the insights of the French historian, Fernand Braudel. First, “there is more than one economy” because the economy is heterogeneous and includes zones that are not competitive. Furthermore, capitalism is as much about monopoly as competition because local monopolies are what many firms want and the state can franchise. These contrarian insights are the basis for our break with main stream thinking.

In the 30 year experiment, the economy was represented as the unitary sphere of competition where all should submit to the imperatives of globalisation; this conceptualisation was reinforced by the aggregation of everything into national income measures with growth and jobs then promoted as the objectives of policy. Against this we argue that a large part of the economy (more than one third) is sheltered from competition; while growth and jobs are socially meaningless objectives when the income gains from growth are captured by the top 10% of households by earnings and because low wage jobs spread welfare dependence

2) Our object is the foundational economy
After recognising the heterogeneity of economic activity, the question is about how to think about the different zones and their interaction. Our focus is on the zone or sphere which we call “the foundational economy”. The foundational has never been an explicit object of policy and (we would argue) has been mismanaged insofar as it has been subjected to the competition and markets fix.

What’s inside the foundational economy? On our calculations, we include the pipe, cable and wireless utilities that deliver water, energy and broadband, transport utilities like rail and bus, food processing and distribution through supermarkets and most of the lower levels of health, education and welfare. Their outputs are mundane goods and services, from processed food to primary education, which lack the glamour or attractiveness found in high tech or knowledge based “key sectors” like aerospace or the creative industries.
The activities inside the zone are diverse in terms of outputs or ownership because the foundational economy produces a bewildering variety of goods and services under private and public ownership. Yet these activities also have a series of shared characteristics which are the basis for our classification.  These goods and services are all foundational because they are necessary to everyday life, consumed by every citizen regardless of income and distributed according to population through branches and networks. They are also typically sheltered and often politically franchised so that the state (through regulation and planning laws) gives the cable tv operator or the big box retailer an effective local monopoly.

When these activities are bracketed together, the foundational economy appears as a large and strategic zone for several reasons. Large because the foundational economy employs one third or more of the UK workforce; strategic because the cost, quality and security of foundational goods and services (such as energy supply and health care) are key determinants of citizen welfare. Indeed foundational activities are funded by a kind of lien on tax revenue and household expenditure; foundational expenditure accounts for 30% on average of weekly consumption in households who have little choice about paying utility bills or buying supermarket groceries.

After a period when low cost provision of many of these goods was taken for granted, the price and security of foundational supply is increasingly an issue. The crisis of foundational supply is related partly to the limits of our small planet and partly to the failed thirty year experiment; thus, our privatized utility operators like BT are investment averse and British infrastructure is increasingly being half-heartedly renewed by billing the customer or taxpayer for investment.

3) Our economic principle is chain value
Our argument on the foundational economy starts from a distinction between two concepts of value (point value and chain value) which is then developed into an argument about how the foundational economy is being mismanaged on point value principles and would be better managed on chain value principles.
Point value means that the measure of success is least cost or highest profit in an individual transaction (or basket of transactions) at a node in an economic chain. Point value is an active and now ubiquitous principle in the calculations of private and public sectors.

It is represented in the public company imperative of shareholder value through quarterly earnings and higher stock price; or in private equity through cashing out by selling a portfolio company to meet the equity investors’ demand for high returns which are levered up with cheap debt. But it is also represented in the public sector response to budget cuts and value for money when, for example, in adult home care the local authority cuts the hourly rate paid to the agency supplying care workers.

Point value has considerable intellectual prestige; because it is in one form materialised in all the post 1930s business school calculations of return which take account of the time value of money; as with discounting to calculate net present value. At ordinary rates of interest, such calculations are socially questionable because they devalue the future by attaching a very low value to returns more than 5 or 7 years away.  Practically also, they are place bound because point value represents a trader mentality which ignores broader social consequences.

Point value is embedded in private business models which then pass problems down the chain as with supermarkets which use their power to capture supplier margins. In the public sector, the problem is that the state gains on one account only to lose on another account. Thus, wage cuts will reduce the cost of providing council services but increase the demands for housing benefit and other kinds of welfare support.  Pervasive point value therefore spreads unsustainability as private and public actors trumpet their point success when supply chains are undermined and the welfare bill spirals out of control.

So our alternative is back to the future with the alternative principle of chain value.  We should recover the idea of value as a stream of benefits for (internal and external) stakeholders over time. Benefits are not only financial and measurable through one master calculation because there are several orders of worth and long term uncertainty requires defensive prudence. This requires a different kind of economic calculus which balances the interests of different stakeholders (rather than privileging the investor); and introduces political objectives around the ideal of connected economies which deliver both the benefits of re-localisation and of national standards and inclusive national networks 

One of the central problems is that much of this calculus about interconnection is not actionable within the current British system and is equally unlikely to be realised through  the forms of decentralisation which are currently on offer. The British way after the 30 year experiment is to dispense with intermediary institutions and combine self-governing operating units with centralised political power which micro manages in an interfering way; hence the decision makers are the PLC board or the Academy School governors subject to interference by Vince Cable or Michael Gove. As for devolution and decentralisation, in the bi partisan view, articulated in the Heseltine and Adonis reports, this is a matter of handing decision making and central money to dominant regional elites with very few questions asked.

4) Our political principle is social license
The operationalization of chain value thus requires not so much more government as a different concept of what nested levels of government are and can do. As well as very much less reliance on governance at operating unit level which always promises much more than it delivers.

We are against the post 1979 concept of business friendly government which has dominated in the period of the thirty year experiment. In this frame, government’s role is facilitative as it creates the space in which the incentives of markets and competition do their work; hence the structural reform agenda of lower taxes, market liberalisation, deregulation and privatisation. The only acceptable forms of local and regional policy are infrastructure and training which make the market work better (and now help create competitive agglomerations); industrial policy is about rectifying market failure in commercialising innovation. 

Against this, we make another back to the future argument which revives the 1930s ideas of US thinkers like Berle about how business and community are in a relation of mutual dependence because all business exists under a social contract whereby the corporation should offers responsible behaviour in return for the privileges which allow market access and secure profit taking. This is especially so in the foundational economy where the privileged business gains a local monopoly on the household spend of an immobile population in communities and user groups

Hence our arguments for social license in the foundational economy with the aim of enforcing the obligations of business to the community (which are much broader than those of customer care). The explicit analogy is with the mining industry where a social license about benefits for the local community is the quid pro quo for the right to exploit immobile natural resources. Social licensing in the foundational economy would impose relevant conditions on specific activities. Thus, councils would be obliged to pay living wages while supermarkets should attend to local sourcing; this would need to be backed by social innovation to change business models.

All this has fierce political pre- conditions in that change through experiments with scope and scale requires decentralisation with intermediate institutions under electoral and civil society pressure for change. But, if we do not have the answer and favour diverse experiments, then regional and local government can begin right away with experiments in areas, like adult care, where resistance to change is weakest. The question is whether regional and local governments, under pressure from civil society, can rise to this challenge and through experiments and “ actual experience” demonstrate the potential of this approach in ways which increase not just “public acceptance” but public demands for change.

Manchester Capitalism

The End Of The Experiment? Part 3

The Foundational Economy: A different starting point

If the exhibits in Part II show that the market experiment had many unpredictable and unanticipated outcomes, how does that register in the UK’s core sectors? ‘The End of the Experiment?’ develops three case examples of ‘foundational economy’ activities that demonstrate what’s gone wrong over the past 30 years and how we could do things differently for better economic and social outcomes.
Our starting point is that is that all markets are embedded in politics and that we currently have a problem with political planning. The cases of i) telecoms and broadband, ii) supermarkets and dairy, and iii) retail banking are services most of us use every day. The cases show the increasing prevalence of ‘point value’ calculations and trader mentalities within large, quasi-monopolies, where cashing out often comes at the expense of national outcomes and social objectives. All reveal different fault-lines in their business models that work against societal interests as well as the limits of a generic ‘competition and markets’ framework.

Let’s follow the money and find the faultlines

The End of the Experiment?’ cases show how, in different ways, we have ended up with socially and economically dysfunctional outcomes. This is unsurprising when much of the foundational economy is dominated by shareholder value driven business models. There are some generic overlaps such as confusion marketing but all in all three cases the key drivers are financial because giant PLCs compete on two dimensions: (1) the product market to win customers; (2) the capital market to generate the narratives and numbers expected by stock market investors.

The former publicly owned BT in its modern guise shows a marked reluctance to invest in a national network of fast broadband. This unsurprising result is the legacy of privatisation where BT demonstrates a preference for distributing dividends - £20 billion distributed since 1984 – and buying back its shares. The outcome is that its super-fast fibre optic broadband terminates at the cabinet adjacent to, rather than on, the premises. The government’s aim of rolling out super-fast broadband nationally meets BT’s corporate requirements, but does it necessarily meet social needs, particularly when the company expect the state to subvent an extension of the network to rural areas?

Supermarkets present themselves as supporters of British farmers, but a point value mindset often harms stakeholders as suppliers are squeezed upstream. In dairy farming the farmers are visible and vocal complainants, but the invisible and silent victims are often the milk processors in the middle of the chain. In the decade since 2001, processors’ share from a litre of milk has declined from 35% to 19% while supermarkets have maintained margins through a form of predatory contractualism.

Retail banks’ rely on the pressure selling of products to customers where the proceeds are applied to cover branch costs. This is a necessity under a shareholder value driven model in the context of free banking. This often results in numerous mis-selling scandals – the fines for which are treated as a basic cost of doing business. The policy response is nearly always to encourage new entrants, without any understanding of either the destructive competition in the product market or the unreasonable capital market demands for high returns on equity which underlie the dysfunctional business model.

Is this the outcome of market competition?

All three cases play out in different ways but all have socially and economically dysfunctional outcomes. All manage to deliver acceptable stock market returns (although some supermarkets are under pressure). But all crucially depend on their supply chain positioning at key pinch points which gives them power over suppliers or customers. The pursuit of ‘point value’ strategies means that position is exploited to extract value immediately at the expense of a stream of benefits over time. Value is maximised at the point of transaction to benefit the shareholder; profits are levered on suppliers and customers without regard to the social/national interest.

The 30-year experiment has above all enshrined generic competition as its mantra. And to varying degrees, with governments of different hues, this is the principle that has underpinned policy. So within this context, how, in such a large portion of the economy, have these PLCs maintained return on equity and profit margins?  Equally, how have PLCs limited the effects of competition when firms are competing amongst themselves inside each sector?

The key features that have prevented the erosion of margins and returns are (a) the companies avoid direct price competition through confusion marketing which is actively used in all three sectors (e.g. bundling to make comparisons difficult); (b) PLCs inside sectors operate using similar business models –often narrated to emphasise differences –that create an opera of stereotyped competition with emphasis on a part e.g. service, plus (c) PLCs using ‘point value’ as a means of exploiting local power relations to take margins off other stakeholders.

There are alternatives but they require vision and framing

The normal treatment of corporate excess and scandal is to claim that it is the result of ‘market failure’ which requires ‘more competition’. These framing devices dominate the rhetoric of Select Committees, policy reports and other outputs. The recommendations are always generic: encourage new entrants, educate consumers, limit monopoly excess. In doing so, the frame narrows our field of the visible and limits our imagination about what alternatives are possible.

The success of this framing has been overwhelming. But there are many other experiments beyond the free market that perhaps meet social and economic need more successfully. These experiments focus on co-operation and co-ordination to rebuild fragile or fragmented supply chains that resulted from the 30 year experiment. They include modest innovations by local authorities in the UK trying to re-glue the supply chain fragments by co-ordinating private sector partners; building agglomerations of expertise and overlapping functions in their area. These experiments also emerge spontaneously in the private sector: for example, Morrison’s vertically integrated meat supply chain secures supply and investment-driven efficiencies. Similarly Tesco’s intervene in the milk supply chain by guaranteeing, via the processors, a minimum price per litre that effectively puts a floor under competition. Alternative forms of ownership may also change the characteristics of competition: municipally owned utilities in the US compete successfully against PLCs, despite operating with quite different priorities. These different examples do not necessarily require central state planning or co-ordination since they involve the rebuilding supply chains from the bottom up.

These are all experiments related to building the foundational economy.

Looking at the three cases in the book it might be easy to conclude that these are just examples of ‘bad company behaviour’. But that would be an alibi and deny the need for something more than just the restatement of more competition and more markets with the usual bolt-ons like industrial policy. But doing something different requires a fundamental reframing of our problems that should include interventions through licensing for social objectives. However, that will require political will not generic fixes for the generic rhetoric of market failure.

Manchester Capitalism