Think welfare spending is spiralling out of control? You're wrong

Britain's welfare spending is actually about average, while claims that it is wasteful should be seriously challenged

• 
• • Ha-Joon Chang
  • The Guardian, Friday 28 March 2014

Labour support for the welfare bill lies in the fact it 'exempts “cyclical” spending, such as unemployment benefit'. Photograph: Matt Cardy/Getty Images

With Labour voting for the government's bill to cap welfare spending, the debate on the welfare state has taken a decisively wrong turn. The issue is not the cap itself, its level, or even its design. The problem lies in the very way in which the welfare state is understood.

Even if one accepts the need for the cap, there are many problems with the way in which it is designed. Many people have rightly pointed out that the capping scheme is not as "recession proof" as it is portrayed. One defence of the bill offered by the government – and accepted by Labour as the key justification for its support – is that it exempts "cyclical" spending, such as unemployment benefit (now given the Orwellian name jobseekers' allowance). But there are other elements of welfare spending that increase in economic downturns that won't be exempt. For example, recessions may increase the need for disability benefit because more people are incapacitated due to the psychological and physical impact of unemployment, poor diet, and lack of heating.

The need for disability benefit can also be increased by an ageing population, which is one of the structural factors that are not recognised by the bill and drive up the costs of certain elements of welfare spending. It has also been pointed out that capping could be a false economy because it may increase the demands for other public services, such as education and social services, that are not covered by the bill.

Important though these criticisms are, the biggest issue is the very way in which the "problem" of the British welfare state has been defined and understood. The cap is based on the view that the UK needs "to prevent welfare costs spiralling out of control", given the wasteful nature of such spending. This is not backed up by the evidence.

The British, having supposedly invented the modern welfare state (a debatable proposition), have the mistaken notion that they have an exceptionally generous welfare state, as evidenced by the widespread worries about "welfare scrounging" and "welfare tourism". However, measured by public social spending (eg income support, pensions, health) as a proportion of GDP, Britain's is not much bigger than the OECD average; 24.1% against 22.1% as of 2009. And the OECD includes among its 34 members a dozen or so relatively poor economies – Mexico, Chile, Turkey, Estonia and Slovakia, for example – where the welfare state is much smaller for various reasons (eg younger population, weaker parties of the left).

Even when it comes to income support for the working-age population – the element targeted by the new bill – the UK is not a particularly generous place. In 2007 it spent 4.5% of GDP for the purpose. This was only slightly above the OECD average (3.9%) and way below other rich European economies: the figures were 7.2% for Belgium, 7% for Denmark, 6% for Finland and 5.6% for Sweden.

And it is not even as if the need for social spending goes away if you reduce the welfare state. For many British supporters of a smaller welfare state the role model is the US, which has a very small welfare state (considering its level of income), accounting for only 19.2% of GDP as of 2009. However, it has a huge level of private spending on social expenditure, especially medical insurance and private pensions, which is equivalent to 10.2% of GDP. This means that, at 29.4%, the US has total social spending that is almost as high as that of Finland, which spends 30.7% of GDP on it (29.4% public and 1.3% private). Moreover, if the cost is "spiralling out of control" anywhere, it is in the largely private US healthcare system, thanks to over-treatment of patients, rising insurance premiums and soaring legal costs.

Most importantly, the view that social spending is wasteful needs to be seriously challenged. The frequently used argument against the welfare state is that it reduces economic growth by making the poor workshy and the rich reduce their wealth creation, given the tax burden involved.

However, there is no general correlation between the size of the welfare state and the growth performance of an economy. To cite a rather striking example, despite having a welfare state that is 50% bigger than that of the US (29.4% of GDP as against 19.2% of GDP in the US, in 2009), Finland has grown much faster. Between 1960 and 2010 Finland's average annual per capita income growth rate was 2.7%, against 2% for the US. This means that during this period US income rose 2.7 times while Finland's rose by 3.8 times.

The point is that the welfare state – if well designed and coordinated with labour market policies to re-train people and get them back into work – can encourage people to be more accepting of change, thereby promoting growth. Firms in countries such as Finland and Sweden can introduce new technologies faster than their US competitors because, knowing that unemployment need not mean penury and long-term joblessness, their workers do not resist these changes strongly.

Most American workforces are not organised and thus incapable of resisting technological changes that create unemployment – but the minority that are organised, such as the automobile workers, resist them tooth and nail because they know that if they lose their jobs, they will not even be able to afford to go to hospital, and will find it extremely difficult to get back into the labour market at the same level.

The British debate on the welfare state needs to be recast. The false premise that the country has a particularly generous welfare state whose cost is spiralling out of control needs to be abandoned. The structural factors driving up welfare costs, such as ageing, should be accepted – rather than denied and so putting undue pressure on other elements of social services.

Above all, the debate should be redirected into reforming the welfare state in a way that promotes structural change and economic growth.

This is no recovery, this is a bubble – and it will burst

Stock market bubbles of historic proportions are developing in the US and UK markets. With policymakers unwilling to introduce tough regulation, we're heading for trouble

• 
• • Ha-Joon Chang
  • The Guardian, Monday 24 February 2014 18.00 GMT

'Share prices are high mainly thanks to quantitative easing not because of the strength of the underlying real economy.' Photograph: David Levene for the Guardian

According to the stock market, the UK economy is in a boom. Not just any old boom, but a historic one. On 28 October 2013, the FTSE 100 index hit 6,734, breaching the level achieved at the height of the economic boom before the 2008 global financial crisis (that was 6,730, recorded in October 2007).

Since then, it has had ups and downs, but on 21 February 2014 the FTSE 100 climbed to a new height of 6,838. At this rate, it may soon surpass the highest ever level reached since the index began in 1984 – that was 6,930, recorded in December 1999, during the heady days of the dotcom bubble.

The current levels of share prices are extraordinary considering the UK economy has not yet recovered the ground lost since the 2008 crash; per capita income in the UK today is still lower than it was in 2007. And let us not forget that share prices back in 2007 were themselves definitely in bubble territory of the first order.

The situation is even more worrying in the US. In March 2013, the Standard & Poor 500 stock market index reached the highest ever level, surpassing the 2007 peak (which was higher than the peak during the dotcom boom), despite the fact that the country's per capita income had not yet recovered to its 2007 level. Since then, the index has risen about 20%, although the US per capita income has not increased even by 2% during the same period. This is definitely the biggest stock market bubble in modern history.

Even more extraordinary than the inflated prices is that, unlike in the two previous share price booms, no one is offering a plausible narrative explaining why the evidently unsustainable levels of share prices are actually justified.

During the dotcom bubble, the predominant view was that the new information technology was about to completely revolutionise our economies for good. Given this, it was argued, stock markets would keep rising (possibly forever) and reach unprecedented levels. The title of the book, Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market, published in the autumn of 1999 when the Dow Jones index was not even 10,000, very well sums up the spirit of the time.

Similarly, in the runup to the 2008 crisis, inflated asset prices were justified in terms of the supposed progresses in financial innovation and in the techniques of economic policy.

It was argued that financial innovation – manifested in the alphabet soup of derivatives and structured financial assets, such as MBS, CDO, and CDS – had vastly improved the ability of financial markets to "price" risk correctly, eliminating the possibility of irrational bubbles. On this belief, at the height of the US housing market bubble in 2005, both Alan Greenspan (the then chairman of the Federal Reserve Board) and Ben Bernanke (the then chairman of the Council of Economic Advisers to the President and later Greenspan's successor) publicly denied the existence of a housing market bubble – perhaps except for some "froth" in a few localities, according to Greenspan.

At the same time, better economic theory – and thus better techniques of economic policy – was argued to have allowed policymakers to iron out those few wrinkles that markets themselves cannot eliminate. Robert Lucas, the leading free-market economist and winner of the 1995 Nobel prize in economics, proudly declared in 2003 that "the problem of depression prevention has been solved". In 2004, Ben Bernanke (yes, it's him again) argued that, probably thanks to better theory of monetary policy, the world had entered the era of "great moderation", in which the volatility of prices and outputs is minimised.

This time around, no one is offering a new narrative justifying the new bubbles because, well, there isn't any plausible story. Those stories that are generated to encourage the share price to climb to the next level have been decidedly unambitious in scale and ephemeral in nature: higher-than-expected growth rates or number of new jobs created; brighter-than-expected outlook in Japan, China, or wherever; the arrival of the "super-dove" Janet Yellen as the new chair of the Fed; or, indeed, anything else that may suggest the world is not going to end tomorrow.

Few stock market investors really believe in these stories. Most investors know that current levels of share prices are unsustainable; it is said that George Soros has already started betting against the US stock market. They are aware that share prices are high mainly because of the huge amount of money sloshing around thanks to quantitative easing (QE), not because of the strength of the underlying real economy. This is why they react so nervously to any slight sign that QE may be wound down on a significant scale.

However, stock market investors pretend to believe – or even have to pretend to believe – in those feeble and ephemeral stories because they need those stories to justify (to themselves and their clients) staying in the stock market, given the low returns everywhere else.

The result, unfortunately, is that stock market bubbles of historic proportion are developing in the US and the UK, the two most important stock markets in the world, threatening to create yet another financial crash. One obvious way of dealing with these bubbles is to take the excessive liquidity that is inflating them out of the system through a combination of tighter monetary policy and better financial regulation against stock market speculation (such as a ban on shorting or restrictions on high-frequency trading). Of course, the danger here is that these policies may prick the bubble and create a mess.

In the longer run, however, the best way to deal with these bubbles is to revive the real economy; after all, "bubble" is a relative concept and even a very high price can be justified if it is based on a strong economy. This will require a more sustainable increase in consumption based on rising wages rather than debts, greater productive investments that will expand the economy's ability to produce, and the introduction of financial regulation that will make banks lend more to productive enterprises than to consumers. Unfortunately, these are exactly the things that the current policymakers in the US and the UK don't want to do.

We are heading for trouble.

The banking industry's biggest problem isn't bonuses or market share

The only way to make the sector pursue long-term viability instead of short-term greed is to change the rules of the game

• 
• • Ha-Joon Chang
  • The Guardian, Wednesday 22 January 2014

‘The fact that the political class, including Miliband himself, cannot even imagine state-owned banks ditching the business model that caused this crisis is a testimony to the power of the financial industry lobby.’ Photograph: Stefan Rousseau/PA

Last Friday, in another of those agenda-setting speeches for which he has rightly become famous, Ed Miliband took on the biggest of what he describes as "the broken markets" in the UK economy – the financial market.

Taking his "cost of living crisis" theme to another level, the Labour leader emphasised that the issue is not just about oligopolistic firms fleecing their customers; it is also about the lack of jobs with decent wages that can support decent standards of living. The problem with the British banking industry, Miliband pointed out, is not just about the concentration of financial power in the personal account market, but also in the business loan market.

According to Miliband's analysis, the dominant banks are not lending enough to small and medium-sized enterprises because they form a cosy oligopoly (controlling 85% of small business lending) that does not want to take any risk; enterprise loans are inherently riskier than mortgage and personal loans. Given that small businesses create most jobs in the UK (as they do in all countries), lack of finance for them is limiting the creation of decent jobs. The solution, he argued, is to introduce more competition into the small business lending market by capping the share of individual banks.

This proposal has caused much controversy. However, one thing is certain: it is going to be slow-acting. It may be years before proper "challenger" banks emerge, given the time necessary for the review by the Competition and Markets Authority – which takes over the roles of the Competition Commission and Office of Fair Trading from April – and for the process of selling branches.

But there is a quicker and simpler solution to this problem. It is for the government to use its ownership of two of the big four banks, RBS and Lloyds, to direct more lending to small businesses. Thanks to the bailout following the 2008 financial crisis, RBS is 81% owned by the government. This means it can tell RBS what to do. It also owns 33% of Lloyds, and while this does not give it a total control over the bank, it is well above what is normally considered a "controlling stake" in an enterprise.

Now, if you can basically tell two of the four largest banks what to do – say, to increase lending to small businesses – why go through the rigmarole of calculating their market shares and forcing them (and the other two) to sell off some of their branches?

The usual refrain is that Westminster cannot make RBS and Lloyds do things differently because, in order to survive, these banks need to behave like other competitors: generating as much profit and paying their staff as much.

This argument may be right if the existing business model of British banks and other financial companies is fine. But it is not. It is a business model that has caused the biggest financial crisis in 70 years and created imbalances and inequalities that threaten the future viability of the British economy. The fact that the political class, including Miliband himself, cannot even imagine state-owned banks ditching such a model is a testimony to the power of the financial industry lobby.

From the day when RBS and Lloyds were bailed out, the Labour government was at pains to emphasise it would run them along the same lines as before nationalisation. The only thing for which Labour and, subsequently, the coalition government have used the government's dominant shareholding position has been to restrain bonuses. But this is really missing the point.

The problem with bonuses in the financial industry is not about their levels – if someone makes a huge contribution to the economy, he or she should be richly rewarded. The main problem is that these bonuses are given to people for doing the wrong things well – things that harm the economy in order to enrich the shareholders, the top managers of banks and other financial firms.

So the real question is how we make banks and other financial firms pursue the right goals, rather than how much people should be paid, whether in bonuses or salaries. And the only way to make them pursue different goals from those they pursue now is to change the rules of the game.

Unfortunately, few regulations have been introduced since the crisis that have materially changed the goals of financial companies. The result has been "business as usual".

All those complex and risky financial products that were at the centre of the 2008 financial crisis – such as mortgage-backed securities, collateralised debt obligations, credit default swaps and other financial derivatives – are back in vogue again.

The credit rating agencies, whose incompetence and cynicism in rating those financial products has become legendary after the crisis, are still operating in the same way.

Thanks to Help to Buy, the mortgage-lending market is nearly back to its old self. Now you can get loans that are 95% equal to the value of the house – not quite the 125% you could get before the crisis, but nearly there.

In the absence of measures to encourage longer-term shareholding – for instance, by granting more votes or tax advantages – short term-oriented shareholders are still reigning supreme, putting pressures on banks to generate short-term profits, whatever the consequences.

The main problem with the British financial industry is not the level of bonus, or even the concentration in the banking sector; it is that the industry is pursuing goals that are detrimental to the long-term economic viability of the country, in the process enriching only a tiny minority and sapping human and financial resources from the rest of the economy.

Unless those goals are changed through better regulation, the industry will remain harmful to the rest of the economy, whatever we do about bonuses and market concentration.

There's a new jobs crisis – we need to focus on the quality of life at work

British workers face low wages, but are also being hurt by job insecurity, stress and the demand of long hours

• 
• • Ha-Joon Chang
  • The Guardian, Sunday 22 December 2013 20.30 GMT

David Cameron addresses workers at a factory in Britain. ‘The dominant free-market ideology has convinced Britons that consumption is the ultimate goal of life, and that their work is only a means to gaining the income to buy the goods and services to derive pleasure from.’ Photograph: Stefan Rousseau/AFP/Getty Images

With economic growth now picking up and unemployment inching its way downwards, things are beginning to look up for Britain's economy. Except that it does not seem that way to most people.

David Cameron may be in denial, but most people in Britain are experiencing a "cost of living crisis", as Labour puts it. Growth in nominal wages has failed to keep up with the rise in prices. With real wages predicted by the Office for Budget Responsibility not to recover to the pre-crisis level until 2018, we are literally in for a "lost decade" for wage earners in Britain.

Worse, the crisis for British wage-earners is much more than the cost of living. It is a work crisis too. Take unemployment. For most people this results in a loss of dignity, from the feeling of no longer being a useful member of society. When combined with economic hardship, this loss makes the jobless more likely to suffer depression and even to take their own lives, as starkly shown by Sanjay Basu and David Stuckler in The Body Economic. There is even some evidence, published in the British Medical Journal, thatout of work people become more prone to heart diseases. Unemployment literally costs human lives.

On this account British workers have been doing badly since the financial crisis began. Though the unemployment rate has fallen, it still stands at 7.4%. Most people find this rate acceptable, if regrettable – but that is only because they've been taught to believe that full employment is impossible. We may not be able to go back to the mid-1960s and the mid-70s, when the jobless rate was between 1% and 2%, but a rate much lower than today's is possible, if we had different economic policies.

There is also the issue of job security. The feeling of insecurity is inimical to our sense of wellbeing, as it causes anxiety and stress, which harms our physical and mental health. It is no surprise then that, according to some surveys, workers across the world value job security more highly than wages.

On this account too, British workers have been doing very poorly. The rise in the number of zero-hours contracts is only the most extreme manifestation of increasing insecurity for the workforce. The 2010 European Social Survey revealed that a third of British workers feared losing their jobs – giving Britain, together with Ireland, the highest sense of job insecurity in Europe.

Then there's the issue of the quality of work. Even if you are getting the same real wage – which most British workers are not – wellbeing is reduced if your work becomes less palatable. It may have become more strenuous because, say, the company has just turned up the speed of the conveyor belt in the factory, as happened to Charlie Chaplin in Modern Times. Or the stress level may have increased because the company reduced your control over your work, as Amazon did when it decided to attach GPS machines to its warehouse staff.

Whatever form it takes, any deterioration in the quality of work can harm the worker's wellbeing. And this is what has been happening to many employees in Britain.

The European Social Survey also revealed that a quarter of British workers have had to do less interesting work. The 2012 Skills and Employment Survey revealed that British employees are now working with much greater intensity than before the crisis; the proportions of jobs requiring high pressure, high speed and hard work all rose significantly from 2006.

And then there is the issue of commuting. Britons spend more hours travelling to and from work than any other workforce in Europe. But to make thing worse, the quality of the commute has been deteriorating. The failure to invest in transport has meant more crowded and more frequently disrupted journeys in many regions of the country. Recent surveys have also revealed that more and more people are working while they commute, at least in part to cope with increased workload.

Once we take into account all these dimensions, it becomes evident that the "cost of living crisis" is only one – albeit important – part of a broader problem that is afflicting most people in Britain.

Despite the graveness of the situation, this wider crisis – perhaps we can call it the "general living crisis" – is not seriously discussed because over the last few decades we have come to neglect work as a serious issue.

During this period, most Britons have come to see themselves mainly – or even solely – as consumers, rather than workers. The dominant free-market ideology has convinced them that consumption is the ultimate goal of life, and that their work is only a means to gaining the income to buy the goods and services to derive pleasure from. At the same time, the decline of the trade union movement has made many people believe that being a "worker" is something of an anachronism.

As a result, policies are narrowly focused on generating higher income, while any suggestion that we spend money on making jobs more secure and work less stressful, if it is ever made, is dismissed as naive. Yet this neglect of work-related life is absurd when most adults of working age devote more than half their waking hours to their jobs – especially if we include the time spent in commuting and, increasingly, out-of-hours work. We simply cannot ignore this when judging how well we are doing.

If we are to deal with the "general living crisis" we need to radically change our perspectives on what is a good life. We need to accept that consumption is not the end goal of our life, and stop measuring our wellbeing simply on the basis of earnings. We need to explicitly take the quality of our work-related life into account in judging our wellbeing. Let's start taking work seriously.

Orthodox economists have failed their own market test

Students are demanding alternatives to a free-market dogma with a disastrous record. That's something we all need

• 
• • Seumas Milne
  • The Guardian, Wednesday 20 November 2013 21.00 GMT

Ha-Joon Chang, one of the last surviving independent economists at Keynes's Cambridge: 'The supporters of neoclassical economics have an almost religious mentality.' Photograph: Sean Smith for the Guardian

From any rational point of view, orthodox economics is in serious trouble. Its champions not only failed to foresee the greatest crash for 80 years, but insisted such crises were a thing of the past. More than that, some of its leading lights played a key role in designing the disastrous financial derivatives that helped trigger the meltdown in the first place.

Plenty were paid propagandists for the banks and hedge funds that tipped us off their speculative cliff. Acclaimed figures in a discipline that claims to be scientific hailed a"great moderation" of market volatility in the runup to an explosion of unprecedented volatility. Others, such as the Nobel prizewinner Robert Lucas, insisted that economics had solved the "central problem of depression prevention".

Any other profession that had proved so spectacularly wrong and caused such devastation would surely be in disgrace. You might even imagine the free-market economists who dominate our universities and advise governments and banks would be rethinking their theories and considering alternatives.

After all, the large majority of economists who predicted the crisis rejected the dominant neoclassical thinking: from Dean Baker and Steve Keen to Ann Pettifor, Paul Krugman and David Harvey. Whether Keynesians, post-Keynesians or Marxists, none accepted the neoliberal ideology that had held sway for 30 years; and all understood that, contrary to orthodoxy, deregulated markets don't tend towards equilibrium but deepen the economy's tendency to systemic crisis.

Alan Greenspan, the former chairman of the US Federal Reserve and high priest of deregulation, at least had the honesty to admit his view of the world had been proved "not right". The same cannot be said for others. Eugene Fama, architect of the "efficient markets hypothesis" underpinning financial deregulation, concedes he doesn't know what "causes recessions" – but insists his theory has been vindicated anyway. Most mainstream economists have carried on as if nothing had happened.

Many of their students, though, have had enough. A revolt against the orthodoxy has been smouldering for years and now seems to have gone critical. Fed up with parallel universe theories that have little to say about the world they're interested in, students at Manchester University have set up a post-crash economics society with 800 members, demanding an end to monolithic neoclassical courses and the introduction of a pluralist curriculum.

They want other schools of economic thought taught in parallel, from Keynesian to more radical theories – with a better record on predicting and connecting with the real world economy – along with green and feminist economics. The campaign is spreading fast: to Cambridge, Essex, the London School of Economics and a dozen other campuses, and linking up with university groups in France, Germany, Slovenia and Chile.

As one of the Manchester society's founders, Zach Ward-Perkins, explains, he and a fellow student agreed after a year of orthodoxy: "There must be more to it than this." Neoclassical economics is after all built on a conception of the economy as the sum of the atomised actions of millions of utility-maximising individuals, where markets are stable, information is perfect, capital and labour are equals – and the trade cycle is bolted on as an afterthought.

But even if it struggles to say anything meaningful about crises, inequality or ownership, the mathematical modelling erected on its half-baked intellectual foundations give it a veneer of scientific rigour, valued by students aiming for well-paid City jobs. Neoclassical economics has also provided the underpinning for the diet of deregulated markets, privatisation, low taxes on the wealthy and free trade we were told for 30 years was now the only route to prosperity.

Its supporters have an "almost religious mentality", as Ha-Joon Chang – one of the last surviving independent economists at Keynes's Cambridge – puts it. Although claiming to favour competition, the neoclassicals won't tolerate any themselves. Forty years ago,most economics departments were Keynesian and neoclassical economics was derided. That all changed with the Thatcher and Reagan ascendancy.

In institutions supposed to foster debate, non-neoclassical economists have been systematically purged from economics faculties. Some have found refuge in business schools, development studies and geography departments. In the US, corporate funding has been key. In Britain, peer review through the "research excellence framework" – which allocates public research funding – has been the main mechanism for the ideological cleansing of economics.

Paradoxically, the sharp increase in student fees and the marketisation of higher education is creating a pressure point for students out to overturn this intellectual monoculture. The free marketeers are now being market-tested, and the customers don't want their product. Some mainstream academics realise that they may have to compromise, and have been colonising a Soros-funded project to overhaul the curriculum, hoping to limit the scale of change.

But change it must. The free-market orthodoxy of the past three decades not only helped create the crisis we're living through, but gave credibility to policies that have led to slower growth, deeper inequality, greater insecurity and environmental degradation all over the world. Its continued dominance after the crash, like the neoliberal model it underpins, is about power not credibility. If we are to escape this crisis, both will have to go.

Why do private-sector zealots choose to ignore the countless ways public money underpins daily life?

OWEN JONES 

Wednesday 13 November 2013

Free market capitalism is a con. The state is the backbone of modern British capitalism

 

 

Clutch your mobile phone close to your bosom, stroke it tenderly, and praise the Fairy Godmother of Free Market Capitalism that you’re not walking around with an obscene brick stuck to your ear, a breadstick aerial reaching towards the heavens. “Imagine what telephones would look like if the public sector had been entrusted with designing and making them,” as an opinion piece in theTelegraph had it this week, reflecting views widely held on the Right. “The smartphone revolution would probably be at least another couple of decades away.”

One tiny little flaw with this dystopic piece of counter-factualism: er, the public sector was entrusted with doing just that. Economics professor Mariana Mazzucato’s The Entrepreneurial State shows how – to take just one example – the Apple iPhone brings together a dazzling array of state-funded innovations: like the touchscreen display, microelectronics, and the global positioning system.

The governing ideology of this country is that it is the entrepreneurial private sector that drives human progress. The state is a bureaucratic mess of red tape that just gets in the way. But free market capitalism is a con, a myth. The state is the very backbone of modern British capitalism.

It begins with the state’s protection of property rights, which needs a costly legal system to protect. Patent law prevents companies having their products ripped off by rivals, and limited liability and insolvency law encourages investment by preventing shareholders being made personally liable for debts. As the economist Ha-Joon Chang has pointed out, in the early days of capitalism a businessperson would have to sell all their earthly possessions if they fell into ruinous debt, even facing the prospect of the debtors’ prison.

The state spends billions of pounds a year on research and development that directly benefits business: no wonder the CBI applauds “additional spending on research and innovation” that attracts business investment. Businesses depend on the billions the state lavishes on infrastructure, too. The CBI routinely demands more and more public dosh is thrown at roads and airport expansion. Our taxpayer-subsidised privatised railway network is a classic example of how our modern economic system works. The government splashes out several times more money than in the days of British Rail.

Recently, the House of Commons’ Public Accounts Committee denounced the Government for throwing a £1.2bn subsidy at British Telecom for building rural broadband. Fossil-fuel industries are granted effective subsidies, too, with generous tax allowances, and by leaving the state to deal with the costly environmental damage they inflict. A recent environmental committee of MPs found that nuclear power gets an annual subsidy worth £2.3bn, and arms exports benefit from government subsidies worth £890m a year.

Who do businesses depend on to train their workers? State-funded education, of course, and indeed there are those who advocate letting for-profit companies take over schools, which would mean taxpayers’ money subsidising shareholders rather than looking after children.

Many companies pay poverty wages, leaving the state to subsidise them with billions of pounds of tax credits, housing benefits and other in-work benefits. Businesses are even increasingly benefiting from free labour with the rise of so-called workfare, where they pay nothing to shelf-stackers and other workers, leaving the taxpayer to pay out derisory benefits instead.

Privatisation has proved a generous subsidy of the private sector, too, with £1 in every £3 of government spending on public spending going straight to profiteers. Like G4S, for example, which failed to provide the security personnel for the Olympics, leaving the state to come to the rescue. Or take PFI, where private contractors are paid to build schools and hospitals and lease them back to the state. The actual worth of the completed projects was £54.7 billion, but the taxpayer is projected to pay them £310 billion when it finally pays them off. And then there’s the financial system that all businesses depend on. It wasn’t free-market dogma that saved the banks: it was, of course, the state.

Free-market triumphalism is endemic among the British elite, but rarely challenged. It’s time to start exposing it for the sham it is. They demonise the state, but they are dependent on it. Perhaps they should be a bit more grateful.  

Decent wages or a breadline economy: it's a no-brainer

The hostility that greeted Ed Miliband's ideas about increasing pay epitomises everything that's wrong with British business

• 
• • Ha-Joon Chang
  • The Guardian, Thursday 7 November 2013 20.31 GMT

Labour leader Ed Miliband delivers a speech on Labour's plans to tackle low pay, at Battersea Power Station in London. Photograph: Stefan Rousseau/PA

Ed Miliband's speech at Battersea power station in London on Tuesday this week attracted a lot of attention. Not least because of the Labour leader's own choice of battleground for the 2015 election, the debate has focused on his ideas about wages: his proposal to raise minimum wages in sectors such as finance, and to provide tax breaks for firms that pay living wages.

The reactions have been predictable. Many people are up in arms against the very idea that the government may "artificially" raise wages through market intervention. Many, including a former adviser to Tony Blair, solemnly warn that this will create unemployment and hurt British companies – or, to be more precise, companies that operate in Britain, as so few are owned by British citizens nowadays.

A typical reaction came from John Cridland, the director general of the CBI, who said in a BBC interview that employers "pay what they can afford to pay, depending on the income they get from the consumers". In this short sentence, Cridland – befitting his status as the spokesman for British business – has unwittingly managed to epitomise what is wrong with British business today.

To begin with, the argument shows the disingenuousness with which many large British companies describe themselves as helpless prisoners of market forces. It implies that the incomes companies get from their consumers are beyond their control, because they cannot charge their customers more than their competitors do.

But many companies do in fact have significant influence over what they charge (known technically as "market power"). It may be because they face little competition, like the railway companies. They may, like the payday loan companies, be dealing with poor customers in desperate situations. It may even be that they actively collude, like the big banks in the Libor scandal, or act in concert, like the energy companies in their recent price rises. Whatever the reason, it is simply not true that these companies have to take whatever customers give them.

So at least companies with market power are perfectly capable of paying their workers more by charging customers more, if they so wanted – except that they don't. Many are busy using the profits from overcharging customers to give big pay rises to their CEOs and give away money to their shareholders. Between 2001 and 2010, the top 86 UK companies included in the Europe 350 index distributed 88% of their profits to shareholders through dividends and share buybacks. Naturally, there is no money left for the workers.

More problematic than this misrepresentation of big business is Cridland's view – shared by many in business, government and media – that British companies cannot "afford" to pay higher wages. The subtext is that British companies have to compete with companies from low-wage countries like China, so British workers should feel lucky they are not paid even less, to match Chinese wages. In this view, whatever causes wages to rise needs to be abolished or at least seriously weakened: trade unions, health and safety regulations (the new whipping boy of the Tory right) or employers' national insurance contributions.

In the short term it may be true that raising wages hurts competitiveness, especially if you are a small company with no market power. However, even in this case the effects of higher wages may be offset by savings from reduced staff turnover and the improved efficiency of happier workers – as Miliband rightly pointed out.

In the long run, however, companies and countries should not be afraid of higher wages. If anything, higher wages are signs of success. They are proof that you are more productive than your competitors, so nations and enterprises should strive to pay higher wages in the long run.

Workers in German car factories are paid about 30 times more than their Chinese counterparts, and twice what their American "competitors" get. Despite that, German car companies more than match their Chinese and even US rivals.

One thing that enables German companies to stay ahead of the game is that Germany as a country has invested heavily in technical education and training, making its workers individually more productive than their foreign counterparts. A more important reason, however, is that German workers benefit from more productive technologies as a result of the investments that German companies have made in advanced machinery and research and development. It is exactly because British companies have not made similar investments that they "cannot afford" to pay their workers good wages.

The low-wage strategy so beloved of the British business elite – or what Miliband called the "race to the bottom" – has no future. If Britain is aiming to compete with China in terms of wages, it will have to lower them by 85%. It is doubtful whether this can be achieved even if it engineers a 30-year recession and installs the harshest military dictatorship. Worse, once it had reduced its wages to the Chinese level, it would have to contend with Vietnam, where wages are one-quarter those of China's. After dealing with Vietnam, Britain would have to face down the Ethiopias and Burundis of this world, with wages one-third that of Vietnam's, or less. Countries like Britain can never win that game.

Does Britain want to go back to Victorian times or, looking forward, become like some Middle East oil states, where a small wealthy minority is served by poorly paid workers with zero-hour contracts and minimal rights? Or does it want to reform its economic system so that its companies and government invest in raising productivity – and thus enable its workers to have decent wages, job security, and well-protected rights?

The choice seems like a no-brainer. Unfortunately, large sections of the British business and political establishment do not see it that way.