Tuesday, 27 September 2011

Should government reward 'good' businesses?

By Robert Peston on the BBC
A happier, more cohesive society would be filled with businesses that offer rich and fulfilling employment, don't pollute, don't impose big risks on taxpayers, pay taxes that more than cover their net drain on social resources, train the younger generation for life in an uncertain economic world, and so on.

It's a lovely ideal that the market hasn't delivered, because the market doesn't always reward those businesses that do good things, or penalise businesses that do bad things.

To put it in highfalutin' economic terms, there are plenty of externalities generated by companies: these are the various impacts that companies have on society and the economy that aren't captured by the pricing mechanism.

That is one reason why we have government, to deal with those externalities. Right now, for example, the current government is amending the tax system to impose bigger penalties on large emitters of carbon dioxide. And it has already imposed a special levy on banks, because of its view that the financial risks taken by banks impose a potential cost on taxpayers, for which the banks have not been paying.

These judgements about the good and bad that companies do are never simple to make or uncontroversial. Think about the threats that heavy energy users and banks have been making about jobs going abroad if the special tax burdens they face aren't lifted.

In recent times, governments have tended to penalise negative externalities - like pollution - while ignoring positive externalities. And the reason is largely to do with history: providing state rewards for businesses that are deemed to be good is felt to be uncomfortably close to the failed industrial policies of the 1960s and 1970s of picking so-called winners.

So should government play a more active role in rewarding the good that companies do, while also imposing new penalties on a wider number of bad effects?

The Labour leader appears to think so. Here is an extract from the official briefing notes for the speech he is to make later today at his party's annual conference:

"Ed Miliband will call for radical changes in the way businesses are rewarded to create a something for something deal in our economy.

"He will challenge the idea that all businesses are the same and will call for rewards and incentives linked to the long-term value they create and the wealth they build.

"He will say businesses which secure governments contracts will be required to offer young people apprenticeships. And he will open up the prospect of major reforms to the tax and regulation system to create incentives for companies that make a wider contribution to the economy, e.g. through long-term investment or building skills."

In concrete terms, what he means is "Rolls-Royce good, Southern Cross bad".

He wants to support companies that win large export orders, collaborate with universities to develop valuable intellectual property and provide highly skilled manufacturing jobs in Britain (like Rolls). And he wants to penalise those that place big financial bets, where the winnings (if any) are restricted to a few well-heeled owners, and losses fall on innocent bystanders.

Which is all very well, except that it is hard to create general rules that define all the good businesses and all the bad businesses in a fair and accurate way.

For example, even if a Labour government wished to discriminate against businesses owned by private equity, on the basis that it believed they were more likely to invest too little in training and R&D, that would not necessarily have spared the residents of Southern Cross's care homes from heartache and anxiety - because it was listed on the stock market at the time that it collapsed.

What is more, not all private equity businesses take the kind of extreme financial risks that Southern Cross took when it was owned by private equity. And if your bugbear happens to be another species of debt-financed institution, the hedge funds, don't forget that some of them have been more effective than regulators at spotting dangerous bubbles in markets.

Also, judgements about the merits of businesses and business leaders are subject to change. So for example I understand that in an early version of his speech, Ed Miliband was going to say that it was wrong of the last Labour government to reward Sir Fred Goodwin - widely seen as responsible for the calamitous near-failure of Royal Bank of Scotland - with a knighthood (he may yet say this).

But this is to forget that until Royal Bank of Scotland became obsessed with growing bigger and bigger from 2005 or so and onwards, Goodwin was widely seen as one of the more talented British business leaders - who had overseen a highly effective and long overdue modernisation of NatWest's systems and network.

Which is why Mr Miliband will - I am sure - resist the temptation to argue that ministers should reward or punish companies, with special grants or exceptional taxes, on a case by case basis.

That would almost certainly be the road to industrial desertification and corruption.

Does that mean there is nothing government can do to encourage sustainable long term wealth creation?

Well, there is evidence that the tax rewards accruing to debt finance have encouraged banks, property companies, hedge funds and private-equity businesses to take dangerous risks, while discouraging long-term investment as opposed to short-term asset trading, and also shrinking tax revenues paid by the corporate and financial sectors.

This was an argument that George Osborne, the chancellor, took seriously in opposition, but seems to have subsequently discarded - although the Independent Commission on Banking recently flagged up the tax advantages of so-called leverage or borrowing as a contributor to the lethal explosion in the growth of banks' balance sheets relative to their capital resources.

So finding a way to enhance the rewards of equity-financed investment, and reduce the rewards of debt-financed investment, could go some way to reducing the most toxic of externalities afflicting our economy - namely an urge to borrow that has foisted record debts on the British economy and hobbled its ability to grow.

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