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How not to run an economy:
Government as a Corporation

When financial markets become a measure of the well-being of an economy, what are the consequences in the real world

Every news broadcast you hear gives you news on how the 'markets' are doing, but what are these markets? The FTSE100, the CAC40 and the Dow Jones Industrial Average are just indexes of the few largest companies floated on the stock exchanges of London, Paris and New York respectively. This means we've managed to narrow down our impression of the 'market', or indeed or whole economy, to the performance of the largest 100 or so companies which are floated on certain stock markets and considered in various indexes. Much like a corporation looks to its stock price as a primary measure of performance, we see these indexes as measurements of how well our economies are doing. Therefore record rises in the FTSE is good, whereas large falls are bad. There is no measurement of the performance of smaller companies, even though they employ the vast majority of the population and, along with government itself, create the bulk of the wealth of a country. Government policy has become skewed in favour of the large over the small, private over public. This may sound like nonsense, but looking at certain case studies reveals both the truth of this idea and some of the disastrous consequences of such a mind-set.

Take retail as the first example. Napoleon, 200 years ago, jeered the English for being a nation of shopkeepers. If you walk down any town High Street today, however, you will be astonished by the ubiquitousness of certain chain shops, which are present throughout the country. Independent newsagents have been taken over by nationwide chains such as WH Smith; clothing is all provided by the same one or two companies - although the shop names may be different, the owners (principally Arcadia group) are the same; while independent grocers, butchers, bakers (and candlestick-makers) have vanished under swathes of supermarkets. In fact, there are only 4 supermarket chains of note in the UK, a number considered more than adequate for effective competition (between themselves - independent retailers are often subjected to anti-competitive practices by the supermarkets, but that is largely ignored) by the rotten Competition Commission. The largest of these chains is one of the most powerful retailers in the world, Tesco, although in the following tale you could substitute that name for Wal-Mart in the US, Carrefour in France etc.

Great excitement usually accompanies the opening of a supermarket in an area. There are (unfulfilled) promises of a great number of jobs to follow, as well as pomp and circumstance (the British royal family opens hundreds of supermarkets every year) combined with large discounts on the opening day. Tesco has been allowed to diversify so much that you now see massive supermarkets on the edge of town, combined with much smaller convenience stores in town centres. They are often given financial and planning aid by local councils, which could take the form of reduced council tax for premises (especially car parks) and fast-tracked planning processes. In the meantime, local businesses who are in direct competition with the supermarket get none of this assistance. Differences between big and small retailers don't end there though. A locally-owned business will generally employ family members or a small number of local employees. As the workers and the owners know each other, they will generally be on speaking terms and probably the employees will earn a living wage. Especially if the company is doing well, it makes sense for all that some profits are shared between the owner and workforce in order to keep them happy and in a reasonable state of well-being. That money will then be largely spent by those people buying goods or services in their village or town, ensuring that money will largely be kept within the community. If the money comes from outsiders, the shop helps to bring in capital to a local economy. Supermarket chains, however, pool the profits from all their stores to pay as dividends to share-holders at the end of the financial year. Thus the money from the local economy leaves the town and is passed upwards to the institutional (or just very wealthy) shareholders. In such a way, publicly floated companies act as wealth vacuum cleaners in the area they situate their stores. The profits are rarely shared with the employees (many of whom earn minimum wage), but rather go to enrich the already wealthy. Why do these companies get preferential treatment? Because their profits are measured on the stock exchanges, whereas local profits are not.

Another way that government has been seen to favour stock market profits above the provision of services is through the privatisation of utilities. In the late 1980s, all the water boards in the UK were privatised by the Thatcher government. The idea being that private is better than public, full stop. There was a lot of opposition to this, but after winning the 1987 election the Conservative government (erroneously) believed they had been given a mandate to perform such huge alterations to the economy in the name of increased investment and efficiency gains (sound familiar?). By their very nature, water companies are local monopolies because the water that comes out of your tap originates from the watershed in which you live. Water isn't transported from one region to another, except in times of crisis, so must be locally sourced. In order that water companies are socially and economically responsible, however, regulatory bodies were set-up to ensure water quality, environmental standards and prices. The pricing body, Ofwat, dictates how much a water company can charge for provision of services. This must take into account costs of investment, maintenance and profits. Since privatisation, one part of this equation has grown significantly compared with the other two: the profits of the company. To 1997, profits grew by 147%, on the back of 30-40% real-term increases in the amount paid by consumers for water and sewerage. As water rates (the cost of water delivery) are set by the regulator according to predictions made by the company as to expenses for the upcoming period, when the company outperforms these targets, the amount of profit that can be paid over a period will be higher than predicted, and thus increase the share price. This means water companies have no incentive whatsoever to be truthful as to their cost projections, and in fact overestimates are desirable so that higher profits can be made at the expense of the consumer. Once again, government action has led to the enrichment of shareholders to the detriment of the population as a whole.

One further example of this mentality can be seen in the fashion for Public-Private-Partnerships (PPP) or Private-Finance-Initiatives (PFI). Many schools and hospitals were funded in this way during the 1990s and early 2000s. In theory it's a good idea. Private companies make investments in infrastructure, and then make that money back over a period of thirty years or so by charging for rent and services (cleaning, maintenance) to the local authority which uses the premises. Not only do private companies 'take the risk' of borrowing money for building public infrastructure, they also make efficiency savings because they're a private company. With a little bit of thought, however, that rationale disappears. What risk is there in building a new school? It will be used as a school for the next thirty years at least, and if the school wants to relocate within the period of the deal, the PFI contract will stipulate against get out clauses, meaning there is no risk whatsoever. The total amount invested in new infrastructure in Britain totals 11.4 billion, which will cost the UK tax payer around 70 billion over the length of the contracts (the last of which ends in 2049). What kind of efficiency gain does this bring? It's certainly very expensive! What's more, the re-nationalisation of NetworkRail, the company that owns and maintains the rail tracks of the UK, shows that sometimes things even work better under public ownership. Following a spate of accidents for which PFI contractors Jarvis and Balfour Beatty admitted partial responsibility, culminating in the fatal Hatfield and Potters Bar rail crashes, the track company was renationalised and maintenance was taken 'in-house', a situation which has led to far fewer accidents at lower costs. Under the public sector! It seems to blow the idea that private is better than public is a 'set-in-stone' rule of economics.

Our obsession with the stock market has all the attributes of Enron's disastrous failure - whereby the stock price became more important than their actual, real business. While politicians are happy to overspend on pet projects which enhance the FTSE100 at the expense of the tax payer, to make money available to prop-up large, publicly limited banks while cutting funding on (non-PFI) social services, and while we let them get away with this blatant corruption, nothing can be expected to change. Until we realise the depth of our current economic crisis, solutions will be meaningless.

Adam R. Mathews, Utrecht, 22 January 2012

This article is part of the series How not to run an Economy.

How not to run an Economy

"What choice do we have?" It's a common refrain these days; while the economic cracks in the system have been proliferating and widening, the explanations are generally seen as incomplete, and the solutions as little more than useless. In order to build a better economy and reform the system, we need a better understanding of the fundamental causes of the pickle we find ourselves in. This series addresses a number of such topics, including governments' favouring of big over small enterprises and the increased financialisation, largely through debt, of our world. The aim is to create an awareness whereby precise solutions can be proposed and worked upon, because answering the question 'what can we do?' cannot be done in a single two line soundbite.

The second article in this series looks at the reasons that governments favour big business over small, and the local consequences of this ideology.

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Also in the series

Part 5: Industrial Rise and Decline
The Black Country led the world into industrial prowess and then economic decline - what does it tell us about today's world?

Part 4: Utilities and Resources
Rising dependence on gas and ballooning prices are not a path towards a sustainable energy policy

Part 3: Growth and Debt
To cover our huge debts we have to grow our economies, but for how long will that be physically possible?

Part 1: Ownership
How does the ownership of our most powerful companies affect our communities and our economy as a whole?

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