#55. Where pragmatism meets vision

WHY THE RIGHT ARE WRONG ABOUT GEORGE OSBORNE’S LIVING WAGE

In an era when so much of each budget is “briefed” in advance, it can be difficult for a Chancellor to pull a really unexpected rabbit out of the hat. However, George Osborne certainly accomplished this when he introduced the “national living wage” in the first Conservative budget for almost two decades.

Though this initiative will raise the incomes of millions of working people, and will enable big reductions in benefits spending, its greatest significance lies elsewhere. At a stroke, Mr Osborne has ditched the low-wage, low-quality model, determining instead that Britain must compete primarily on quality, not price. As such, he has created a wholly new agenda for business and government. He is profoundly right to do so, but follow-up will be vital.

Mr Osborne would have expected, of course, that the official opposition would be rendered almost speechless by such a bold move. He will have anticipated, too, that employers in some low-wage industries would be furious. What might have taken him more by surprise is the vitriolic response of some supporters of free market economics. These opponents argue that wages must be allowed to find their own level, and that it is folly for the state to interfere in the market place.

Those of us who applaud the logic of the Chancellor’s bold move must question the consistency of these ideologues. Does their opposition to interference mean that they would repeal, too, the laws which interfere with the activities of trades unions? If so, then collective bargaining would bring in higher wages, though in a much messier way than Mr Osborne has done. If, on the other hand, these opponents wish to extend freedoms to employers whilst denying them to workers, their inconsistency surely strips them of credibility.

Aside from the need for consistency, there are three things that these opponents of the living wage seem not to understand. The first of these is the real nature of market capitalism. The second is the fundamentally correct economic calculation that inspires Mr Osborne’s thinking. The third is the scope of the further reforms that will need to follow if the Chancellor’s bold strategy is to succeed.

The intellectual problem that confounds and confuses the extreme advocates of laissez-faire is that a functioning capitalist economy is not a free-for-all, and nor is it the economic equivalent of the law of the jungle. Rather, capitalism works best when it promotes free competition in a context of transparency and probity. If the state simply withdrew, capitalism would soon destroy itself, first because large firms would gobble up or destroy their smaller competitors, thus putting an end to competition. Under a “law of the jungle” version of liberalism, transparency and probity, too, would quickly go by the board. Anyone doubting this need look no further than a banking sector that has been as short of probity as it has been of competition.

In short, the true capitalist economy requires a vigilant state, ready to defend a market-place in which competition is free, fair, honest and transparent, and is not undermined by concentration.

In addition to this reasoned understanding of capitalism, Mr Osborne’s wage policy is informed by an appreciation of where the British economy has, for many years, been going wrong.

A current account deficit of close to 6% of GDP, and a consequent need to borrow £100bn annually (and rising) from abroad, is one indicator that the model is not working. Another is the sheer quantum of debt that Britain’s government and households have taken on since the turn of the century. Public debt keeps rising – albeit at a gradually decelerating rate – whilst OBR statistics indicate that household debt is on a strong upwards trajectory.

These are not signs of success.

An economy that relies on capital infusions from abroad, and that keeps going ever further into debt, is an economy in need of a re-think. This is what George Osborne has done.

What he also needs to do is to explain why.

There is a central inconsistency at the heart of what can be called “the corporatist recipe” for the economy. Ideally, many corporates would like to see a combination of low wages and high consumption. Unfortunately, and as Henry Ford famously understood, a low-earning worker cannot be a big-spending consumer as well, unless, of course, he borrows the difference.

This glaring inconsistency has driven households deeply into debt. It has contributed mightily to the public debt, too, because it obliges government to pay ever-escalating amounts of “in-work” benefits (such as tax credits) to bring household incomes up to acceptable levels.

In other words, many employers are in the business of unloading part of their labour cost on to the taxpayer. It would be interesting to know how the laissez-faire fundamentalists square this subsidy with their philosophy of a small state.

Moreover, the case against the living wage defies not just logic but experience as well. The idea that countries become prosperous by winning a “race to the bottom” in labour rates would imply that low-wage countries like Ghana and Somalia would be more successful than Germany or Switzerland, something which we know to be nonsense. Britain can never make itself a cheaper labour market than countries like Ghana and, even if it could, it would drastically undermine demand by doing so.

Assuming that we are competing with Germany rather than with Ghana, the key to success is the quality of our goods and services, not their price. Many emerging economies produce cars that are cheaper than a Mercedes Benz, but this has not robbed the Stuttgart giant of its market. Indian-owned Jaguar Land Rover has succeeded on the basis of quality, not price. The relationship between wages, skills and productivity hinges very much on the competitive edge conferred by perceived quality. A sweatshop economy is not a productive one.

What this means is that George Osborne is surely right to drive Britain in the direction of high wages, robust demand based on income rather than debt, enhanced skills and productivity, and a competitive edge founded on quality, not cheapness.

To succeed in this, he will need to change mind-sets, so that companies grasp the need to produce the best service that they can, rather than (as is so often the case) the poorest service that their “terms and conditions” let them get away with.

So the next requirement is to raise ethical standards of customer service at the same time as increasing the real wages of people who are, by definition, not just workers but consumers as well. This means enhancing consumer protection, and rebuilding the premium provided by reputation.

But perhaps laissez faire purists will be against that, too?

Explanatory note:

Since George Osborne presented his ground-breaking budget, its key innovation – the introduction of the national living wage – has received much media coverage.

Unfortunately, most of this coverage has focussed on fiscal effects and political implications.

In fact, the greatest significance of this policy lies in starting a fundamental change in the British economic model. In order to emphasise this highly important point, this article has appeared today on CapX.

23 thoughts on “#55. Where pragmatism meets vision

  1. I think you’ve failed to account for the merger between corporations and state to the advantage of both. In reality, a company could never grow big enough based on it’s own merits to “gobble up” every other smaller company, in our world they do this by employing government to set corporate rules in their favour, penalising or hampering the growth of new business and competition. They also use their easy access to capital markets and links with finance to support growing and managing ever increasing amounts of debt to fund increasingly less profitable business ventures. If a government provided a level playing field (i.e, they stayed out of the way and simply policed the upholding of law) then in my opinion you would find that the bigger the company, the more unstable and less competitive it becomes, and new companies would come in and take market share with their fresher, better ideas and approaches. The net result? A more efficient market and better deal for consumers.

    From a philosophical perspective, the “law of the jungle” as you put it does apply well. Does nature require governments to “manage” natural ecosystems? Of course not. It is a dynamic system of competing forces, just like a market place. As such, the free market works best when their is little or no interference from government/the state. Yes, it is a uncaring place and those who do not heed caveat emptor will be punished financially, but it will be efficient and sustainable.

    In today’s world, we are seeing bigger and bigger governments and corporations working together to essentially, centrally plan and economy. It is becoming clearer and clearer that this does not work for tax payers who are being increasingly priced out of decent standard of living. Surely, common sense (if nothing else) dictates that the answer is not more government….

    • The relationship between corporates and the state isn’t mentioned here, but I have covered it at length as part of a four-part series (starting here) on the evils of corporatism. I think where we differ is that I regard the state as an integral guardian of the market economy, whilst fully accepting that the state’s power for good can equally be a power for bad. We’ve seen the latter all too often – for instance, rescuing the bankers whilst rescuing the banks, and allowing fraud to be treated as just “miss-selling”.

      Big companies might become complacent, and vulnerable to smaller insurgent competitors with less state intervention – but what about dirty tricks?

      Here, though, Osborne has clearly done something that the big corporates don’t like, which I see as positive. They will mount a hugely-financed campaign to stay in the EU, by the way.

      My belief is that, without state vigilance, incumbent corporates would create barriers to entry, not least by using concentrated pricing power to eliminate competitors – which, incidentally, is what happened to Phones4you. What if, in order to fend off new competitors, big companies combine in a price war, incurring short-term losses to fund predatory pricing, losses to be more than recouped once smaller rivals have been destroyed? Ironically – given his status as an icon of neo-cons – Adam Smith’s greatest strictures were reserved for monopolies and oligopolies.

      I’m certainly not in favour of big government – but better government might be a different matter……

  2. Tim,
    I agree with all you say except question whether the Osborne “strategy” actually exists .It would be nice to think so ; but he could have been purely driven by the cost to the state of in work benefits which obviously he would like to eliminate :so lets shift them onto the businesses .
    It begs the question as to why he didn’t do it before !?

    best Peter

    • That is indeed a big question, Peter. But the balance of the evidence does, to me, suggest a strategy. What he’s done prevents UK businesses from competing on cheapness alone, and the Treasury must – ? – be aware that this has huge implications for the economy, not just for public spending. (Or, if they don’t understand this, they are stupid).

      This – strategy or no strategy? – is a debate that we need to have.

    • I work out on the R&D coalface in biotechnology. My current employer is based in San Francisco and is absolutely on fire – this is not an accident! The senior management are all scientists with good business heads, with both an understanding of big themes and crucially an absolutely obsessive attention to details to ensure the whole machine is moving in the right direction (their direction), on time and on plan, if it is not they are ruthless in making it work or ditching the project! Also being in with the detail they maintain a connection with those doing the work – they know what people are doing, who is doing what and listen to what they have to say – and other than guiding they generally leave them to do what they do best.

      Having worked for most of the worlds largest pharma including the UK’s finest, I honestly think the biggest gap we have is at the top – there is just no comparison. They can wheedle and schmooze, and slick and slide their way into the chummy circle, but once there they are totally lost! Many seem totally devoid of the skills and mindset needed. Talking of Jaguar I am from “round that way” and as a child many of my older neighbors complained bitterly about the incompetence of the senior management in the dead and dying manufacturing industry (“not fit to run the fish and chip shop!”). There is this stuffy we know best hierarchical attitude (sometimes outright hostility) to the workforce that to my mind dislocates them from the ongoing activities of their companies.

      Anyway I am just tired and ranting 🙂

    • You must be a mind-reader! – I have been pondering an article on management, which is a long-standing British weakness, I believe. The turnaround in the UK car industry results partly from investment but mainly from Indian, Japanese and German ownership. Britain has always been brilliant at inventing things but poor about bringing new products to commerciality.

      It’s interesting that corporates are keen on bringing in labour from abroad, but this stops at the boardroom door. If the same “market forces” ideology was extended from the shop-floor to the management floor, we could bring in some brilliant managers from India, Japan and Germany – not only better but cheaper, no doubt!

      I don’t know why we have this long-standing weakness, but two culprits come to mind – education, and our “status”- or “class-consciousness”.

      This applies to the public sector corporates, too – mainly because failing managers seem impossible to dislodge.

    • It’s a cartel. Just look at the renumeration. Cartels need smashing…

  3. I too am suspicious that this was anything more than a way of muting his opponents, allowing him the freedom to continue cutting back on welfare spending without drawing the harshest criticism from child poverty action groups and the like. What many people are forgetting is that the majority of jobs “created” since 2008, on closer inspection turn out to be people becoming self employed. According to the ONS between 2008 and August 2014, the UK percentage increase in self-employment was the third largest across the European Union and now stands at the highest rate in forty years. In that same period, the median income from self-employment dropped by 22%. It doesn’t take a genius to see what’s happened here: the euphemistic “welfare reform” has rendered claiming unemployment benefit unfeasible as a stop-loss strategy for those finding themselves without a salary and many have washed up trying to scrape together a living as some sort of sole trader, only possible thanks to the tax credit system. There is a large vulnerable group of families for whom the living wage will mean nothing.

    • This is the big issue, clearly – has George O a strategy, or is this just a fix for the escalating cost of tax credits? And, what happens to those without full-time employment?

      On the former, we’ll soon know – if this isn’t a strategy, there won’t be the necessary follow-through. I’m an optimist on this – not because this government has done a good job (over defence and foreign policy it’s been inept), but because I do think GO is pretty good. We do need to remember the state of the economy when he took over in 2010.

  4. I may be way off the mark here but when I think of benefits, payment protection insurance, pension freedom and so on I hear the sounds of helicopter blades and money being shovelled. Perhaps what I can hear now is George parking the thing up for the time being.

    • Indeed. There’s a lot of different stuff happening – UK banking debt has shrunk hugely (which might mean the UK banking sector is shrinking too). There’s been no more QE for a long time, though there seems no prospect of interest rates rising for a long time either. We remain hugely exposed to any global crisis….

    • And in the case of pension freedoms an expectation in increased tax revenues as people fail to realise the tax implications of withdrawing too much money from their pension pot too fast.

    • Yes, pensions freedom could boost the tax take. Pensions freedom is an interesting sidelight on psychology. There is also mounting evidence of fraud.

  5. His master stroke would be to elimnate the Marxists in the department of education and close it down. Our young people are woefully educated – let charity registered institutions flourish to do a proper job!

    • Quite so. I’m biased here, having been in the last year-group to go through a grammar school, which was superb, then seeing it become a pretty unpleasant comprehensive.

      I’m not sure I share your faith in charities generally, where I think tougher regulation is called for.

      I also note that Michael Gove’s reforms seem to have hit a brick wall put up by the educational establishment.

  6. Ending non-dom status was a crucial and welcome change. Regardless of the money raised, it was necessary to close this loophole.

    • Absolutely! Many opinion-formers in the US hate our non-dom system. One called London “the global capital of dirty money”. This got much worse when an official was photographed holding (idiot!) a document suggesting we didn’t want sanctions over Ukraine if it would cost us Russian money – an NYT columnist called this ‘stabbing the US in the back’. It doesn’t help that Americans, Germans etc cannot really take advantage of it, only people from Russia, the Middle East etc.. And some British citizens actually manage to claim non-dom tax status….

      Then, 24% of world offshore money is held in UK overseas territories, which doesn’t help Britain’s image either – even before we consider the behaviour of some UK-based banks. Overall, the whole thing looks very grubby.

      So I’m extremely pleased that we’re eliminating it.

      Moreover, the idea that attracting the wealthy to London helps the economy is a bit doubtful. If people come to Britain to invest, that’s great, but not if they just use Britain as a tax haven.

    • Depends why they’re overpaid. One of the problems of corporatism is that executives are under little or no shareholder scrutiny. This is compounded by some big institutional shareholders, voting shares which actually belonging to clients whose money they manage, and these institutions sometimes have bosses who are themselves very well remunerated. So it is a sort of freemasonry. We saw this in the US over Enron, when it emerged (though many of us had long known of this) that non-exec directors are often execs of other corporates, so part of the corporatist web. What we need in the first instance is greater transparency and shareholder activism.

      But this issue isn’t limited to corporate execs – and I don’t know what we do about highly paid sports and media stars…..

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