01 Oct 2010

(by Bruce Lyons) “Competition is central to my pro market, pro business, agenda.” So wrote the new UK Business Secretary. Yet he had business leaders, including , jumping up and down with rage. Should this be a surprise? And more importantly, how should we interpret what Mr Cable said?

Vince Cable was making a highly political speech at his party conference last week. As the Lib Dem member of the coalition government with the highest profile job, he was always going to use emotive language to rouse the troops, many of whom are deeply concerned about being junior partners in alliance with the Conservatives. The language elsewhere in the speech may have been emotive, but was his economic analysis right?

It is worth quoting two key passages. The first draws on Adam Smith’s ever-relevant insights on business incentives to form cartels and to exclude rivals. :

“Capitalism takes no prisoners and kills competition where it can, as Adam Smith explained over 200 years ago. I want to protect consumers and keep prices down and provide a level playing field for small business, so we must be vigilant right across the economy – whether in the old industries of economies textbooks or the newer privatised utilities and cosy magic circles in auditing, law or investment banking. Competition is central to my pro market, pro business, agenda.”

Maybe talking about capitalism ‘killing’ competition has the rhetorical twang of Karl Marx, but every business school teaches business strategy to soften the sharp discipline of competition. Of course business people would rather they had weak rivals so they can glean easy profits and a . This is why we need a strong competition policy. A second passage in his speech ramps up the emotions to a more fevered pitch:

“And the principle of responsible ownership should apply across the business world. We need successful business. But let me be quite clear. The Government’s agenda is not one of laissez-faire. Markets are often irrational or rigged. So I am shining a harsh light into the murky world of corporate behaviour. Why should good companies be destroyed by short-term investors looking for a speculative killing, while their accomplices in the City make fat fees? Why do directors sometimes forget their wider duties when a cheque is waved before them?”

I am not sure about the concept of an ‘irrational market’. Rationality can apply to individuals and their collective action in firms, but the market is where supply meets demand. A market has no separate intellect that can be irrational. I think Mr Cable means that the outcomes of market processes do not always get close to the desirable properties that are so compelling to most economists in the absence of market power (‘rigged’ markets?) and other distortions. He focuses on the distortions created by ‘short-term investors’, City ‘fat cats’ and directors looking after their personal interests. What he should be talking about here is not ‘market irrationality’ but Corporate Governance. How is it that the shareholders of banks, in particular, allowed their boards of directors to make such huge mistakes that resulted in their shares becoming worthless? Why is it that remuneration committees allow executives to pursue objectives that are against the interests of the owners of the firm? Answers to these questions may go some way to understanding also why investors become ‘short-term’.

Yes, some of Vince Cable’s language may have been a little intemperate, but he has put his finger on what is necessary to make the market economy work: strong competition policy; and good corporate governance. It remains to be seen whether he will keep these objectives to the fore in the current frenzy of cuts and ‘reform’ of regulatory institutions.