Saturday, 21 November 2009

Hostile corporate takeovers - time to reform the rules

The attempted takeover of Cadbury by the American multinational conglomerate Kraft has not, unsurprisingly, been greeted with universal cheering throughout the country. Workers at Cadbury are now anxious about possible job losses, and politicians are worried about the relocation of those jobs to outside the UK and the political fall-out that might then ensue. After all, in 1993 Kraft took over another prominent English chocolatier, Terry's of York, and look what happened subsequently. In 2005 it closed the factory in York and moved the majority of its production to eastern Europe. The questions many are now asking are: will the same thing happen with Cadbury? And if so, what can be done to prevent it?

The neo-liberal proponents of unregulated free-market economics would doubtless argue that corporate mergers and acquisitions are all just a part of life under globalisation, that the benefits of such takeovers outweigh the disadvantages, and that the ownership of any one individual company does not really matter in the grand scheme of things. However, the current Director-General of the Confederation of British Industry (CBI), Richard Lambert, clearly thinks it does matter. So much so that he wants to see restrictions in the voting rights of shareholders who have owned their shares for less than six months. This restriction appears to be targeted at hedge funds which, it is claimed, have now acquired over 12% of Cadbury shares, presumably on the basis that they expect the share offer by Kraft to be increased. However, hedge funds are only doing what most market investors and speculators have done countless times before over the years. I know because I was one of them.

Back in 1992 I bought shares in Midland Bank when it was being lined up as a takeover target by HSBC. At the time the market speculation was that a counter bid would be made by Lloyds and so the share price could only go higher. It did. So you can hardly blame hedge funds or speculators for trying to cash in on what looked like a one way bet.

The problem here is not the speculation. Even if the rules on share ownership were changed to limit voting rights for short-term traders, speculators and hedge funds would still bet on the likely outcome of any takeover battle. The real problem is actually the whole issue of corporate takeovers, and in particular the destructive impact that the threat of a hostile takeover can have on the long term stability of a publicly quoted company. Unfortunately this is a problem that corporate leaders like Richard Lambert either tiptoe around, or completely fail to address; yet it is one of the most economically damaging issues facing this country, and is fundamental to addressing the numerous shortcomings of current corporate governance.

My principal objection to corporate takeovers is not that they play into the hands of speculators; it is that they are fundamentally anticompetitive and therefore, rather than being the natural bedfellows of neo-liberal economic thinking, actually distort the free markets that neo-liberals are forever proselytising. The reasoning behind this view is fairly easy to outline.

If a company takes over one of its competitors, it effectively increases its market share without having to work for it through comparative advantage. This process therefore represents an easy and lazy way for a company to appear to be increasing its profits without having to grow endogenously. Consequently, it does nothing to increase market competition and will actually act against the interests of the consumer by reducing choice and increasing prices. In fact from the perspective of the consumer, the merger process is no different in its outcome from that of a price-fixing cartel. Yet as both British Airways and the UK construction industry have recently found to their cost, such price-fixing cartels are illegal. Takeovers, on the other hand, are not. Nor do mergers and acquisitions do anything to significantly increase the GDP of the country. These, though, are not the only problems with mergers and acquisitions.

One of the most insidious consequences of the current takeover rules is the effect that the threat of takeover has on the long term stability of a particular company and its ability to plan investment in the medium or long term. In order to fend off potential predators, vulnerable companies are scared into maximising their share price on a day-by-day basis by paying ever higher dividends at the expense of future investment. So instead of investing in future research and development, money is haemorrhaged from the company to placate short-term investors. Nowhere is this more apparent than in the UK which, with its liberal takeover rules, also has one of the worst records for investment in industrial R&D of all the major economies.

Moreover, there is also a growing trend for companies that merged in the past to de-merge at a later date. As a case in point you need look no further than the company at the centre of this recent takeover controversy: Cadbury. Last year Cadbury was de-merged from Cadbury Schweppes after the two entities had enjoyed nearly forty years together, and acquired numerous other acquisitions over that period. Yet other mergers are less long-lasting. The acquisition of Imperial Tobacco by Hanson lasted barely ten years, for example.

The suspicion therefore remains that this seemingly never-ending cycle of corporate merging and de-merging may often be about as economically productive as a dog chasing its own tail. This poses some obvious questions in regard to the real shareholder benefits that can accrue from them in the longer term. If both companies in a merger and de-merger eventually end up back more or less where they were originally, who really benefits from the entire process, other than a few management consultants, merchant bankers and corporate lawyers who are generally at the heart of the whole process, and often responsible for driving much of it?

Then there is the other big driver of takeovers - debt. This is best exemplified by the tactic of the leveraged buyout (LBO) that is often associated with the takeovers made by private equity funds. In this respect the proposed takeover of Cadbury by Kraft is another prime example of how the creation of debt can be used to acquire a target company. Yet, with a debt-to-pretax profit ratio of 3.6, Kraft is already heavily leveraged. This highlights some of the inherent dangers that can arise from LBOs, and you only have to look back at some of the biggest LBOs of the 1980s to realise the scale of the problems that can arise. Given what has happened more recently, however, how can it be considered beneficial for the economy as a whole for both it and its largest companies to be saddled with unnecessary debt? After all, haven't we just seen the consequence of such practices? Nor does this growth in debt help the wider society as the interest on it is usually offset against any profits, thereby reducing the company's tax burden and thereby the government's income.

The final criticism that can be levelled at takeovers is that they are bad for free enterprise. In extremis, they result in the formation of oligopolies and quasi-monopolies. In crude terms, they are nothing more than a form of corporate cannibalism. The proponents of takeovers claim that hostile takeovers, or the threat of them, are a way of keeping management on their toes and ultimately removing poorly performing executives. But isn't that what shareholders are supposed to do? If it requires the executives of one company to purge those of another, then that merely proves that shareholders cannot ultimately hold the executives of either company to account. Executives are in effect beyond the reach of those they claim to be beholden to. That is not just an argument in favour of reforming takeover rules, but also one in favour of reforming the entire basis of corporate governance.

So, given the numerous negative impacts of takeovers on the wider economy, perhaps the question the likes of Richard Lambert should be asking is; how should we reform the rules that govern takeovers?

The first step should be to outlaw hostile takeovers, once and for all. That would then allow companies the relative luxury of being able to plan their future investment without forever looking over their shoulder to see which corporate predator was preparing to strike. It would also attract companies to the London Stock Exchange (LSE) as the LSE would then be perceived as a safe haven from corporate attack. If we are to champion greater competition and stability in our economy, however, I believe we need to go further.

As well as outlawing hostile takeovers, we should also be looking to reduce the burden of debt on public companies. That means vetoing all takeovers where a significant proportion of the finance for the takeover is provided by the creation of additional debt.

The low visibility of the Competition Commission (CC) in the area of corporate regulation in the UK is a testament to its current weakness, and an over-compensation within government towards light touch regulation. We should be setting more stringent limits on the definition of quasi-monopolies that not only outlaw hostile takeovers, but also prevent any agreed takeover between companies if the market share of either company, or the combined company, in any sector of its business, exceeds a predefined limit. For the sake of argument, I would set that limit at 10%. This is in contrast to the current regulations where the market share required for a significant lessening of competition (SLC) is not explicitly or objectively defined. This could mean that some judgements of the CC may appear to the outside observer to be too subjective in their basis, and therefore potentially prone to political pressure or bias.

In summary, the current policy towards corporate takeovers does little more than pander to corporate executive machismo, and contributes little to improving growth in GDP. Too many takeover battles are played out as gladiatorial combat at boardroom level, with the heads of the losing companies served up as trophies. It is also worth noting the scale of these mergers and acquisitions in the UK. When the FTSE 100 Share Index was introduced on the 3rd of January 1984 it was set at a level of 1000.0 while the total market capitalisation of all the 100 companies listed was barely in excess of £100bn. Twenty-five years later the FTSE 100 stood at 4434.17 while its market capitalisation stood at £1083bn. So while the FTSE 100 had risen by a factor of 4.4, its market capitalisation rose by a factor of 10. The different between those two numbers is, in a large part, down to mergers and acquisitions.

Saturday, 31 October 2009

House price inflation part 2 - a solution

The thorny issue of house prices is once again back on the political agenda, or at least it is outside of Downing Street and the Westminster bubble.

Yesterday Rob Williams raised the problem once more on the Compass website. Now while I agree with much of his comment, there are a couple of criticisms I would make.

Firstly, while it is true that house prices are going up again, I don't believe this is predominantly a result of City bonuses, Russian oligarchs or the Cameron bounce. While these factors may have a strong effect in London, elsewhere there are other factors at play. Those are the reduction in the size of deposits that the banks are demanding for each mortgage issued, and the low interest rates that they are currently charging. As I pointed out in this blog last week, this fall in deposits has coincided with rising prices. I do not consider that a coincidence.

This issue of mortgage deposits now brings me to my second criticism. Rob has articulated the problem of house price inflation nicely, but like many before him, has failed to provide a definitive solution to it. Yet find a solution we must. It is no use saying something must be done unless you know what should be done. Unfortunately there are too many economists and political commentators who claim that either nothing can be done, or that the market should be left alone and allowed to correct itself, without intervention, whatever the economic cost. Needless to say it is partly this neo-liberal belief in intelligent markets that got us into this current mess in the first place.

Personally, I would argue that the only positive thing that can be said about the concept of intelligent markets is that they are probably more intelligent than some of the people that believe in them. Quite frankly, to claim that markets are intelligent is about as rational as claiming that gravity is intelligent, or that a bowl of water is intelligent because its surface is always flat and so that means that the water must always be capable of finding its own level.

The truth is that the surface of a bowl of water is flat because of the laws of thermodynamics. Markets find their own level because of the economic laws of supply and demand and competitive advantage. There is no intelligence involved in either, except by those that seek to understand and scientifically quantify the behaviour of each system, or by those that seek to intervene in the behaviour of each. And if we can intervene in the behaviour of natural water systems for our own social and economic benefit (such as by damming rivers and building reservoirs), then by the same token we should also be allowed to intervene in economic systems to improve their social impact.

So, the question remains: how should we intervene in the housing market?

As I again pointed out last week, house price inflation can only be brought under control if the sources of imbalance in supply and demand are tackled. So while many are arguing for increased house-building to increase housing supply, I would argue that that cannot solve the problem in the short term. Nor can it ever respond quickly enough to sufficiently dampen the oscillatory boom and bust cycle. What is needed is a lever that can be pulled that would have a smooth, rapid and proportionate impact on the housing market by reducing demand. Traditionally that lever has been interest rates, but this usually has an adverse affect on business investment, employment and the wider economy. A far better approach would be to regulate bank lending more strictly, and there are essentially three ways that this could be done.

The first would be for the Bank of England (BoE) to set an annual quota for total mortgage lending that would go up or down depending on whether house prices went down or up. This quota would then be divided amongst the various lenders. There are, however, a couple of problems with this approach. The first is that it requires the BoE to interfere in the lending policies of individual banks. This would not be popular, it could be very bureaucratic, and it might be difficult for the BoE to always be seen to be even-handedly in its treatment of different banks. The second problem is that some of those banks might also be less than even-handed in deciding which of their customers they choose to grant mortgages to, and which are sent to the back of the queue (where they will probably remain indefinitely). You don’t need to be a rocket scientist to work out which customers will be first in the queue and which will be last.

A better solution would be to set a fixed limit on the loan-to-earnings ratio for each mortgage applicant. Unfortunately this is one of the two mechanisms Lord Myners specifically ruled out a couple of weeks ago. Why? Who knows?

The third option, and the second proposal Lord Myners discounted, is setting fixed limits on the loan-to-value ratio for every mortgage. In my opinion this is probably the policy that would yield the greatest number of economic benefits.

The easiest way to implement such a policy is by introducing the concept of a Minimum Mortgage Deposit (MMD). This would be the fraction of the value of the house that the buyer must provide in cash that cannot be covered by the mortgage itself. This threshold should be set by the Bank of England’s Monetary Policy Committee (MPC) at the same time as they set base rates. The base rates will continue to control the CPI rate of inflation; the MMD will control house price inflation. A target for house price inflation should be set for the BoE by the Government, just as the target for CPI currently is, but the BoE will then be responsible for meeting this target using MMD. This is the first virtue of this policy. Its mode of operation is almost identical to the already proven mechanism by which CPI inflation is controlled.

For its part, the Bank of England should report annually to Parliament on the state of the housing market, and recommend what it regards as the optimum value for MMD under the current economic climate, and how many new houses need to be built (and where) in order to achieve this in the medium term.

The beauty of this system is that it includes a separation of powers between two potentially antagonistic institutions, the Bank of England and the Government. Each can impose demands on the other, but neither will be able to have control over the parameters under which they themselves are being asked to operate. The BoE has no control over what the house price inflation target will be, and the Government will be told how many houses to build in order to keep the the MMD threshold at an appropriate and acceptable level. Therefore neither can corrupt the system nor damage long term economic stability for their own short-term self-interest. The benefits will also extend beyond the confines of the property market.

This policy, unlike the loan-to-income approach, will force potential house buyers to save before they can buy. In the past that has been futile because house price inflation always meant that the deposit required would rise faster than most people’s capacity to save for it. The 125% mortgage was then introduced to overcome this, but actually made things worse. If house prices are stabilised first, the panic-induced dash to buy will no longer be there. The increased savings will decrease consumer debt, increase the country’s national saving ratio and help recapitalise the banks. With mortgage lending then effectively capped, banks will have more cash to lend to business. Therefore business loans will be more plentiful and cheaper. With housing no longer being the vehicle of choice for investors and speculators, money will flow more freely to other areas, such as the FTSE100 which has stagnated whilst house prices have boomed. That cannot be pure coincidence can it? After all, why would you invest in the stock market with a typical yield of 4%-10% when you can invest in a (seemingly) less risky asset (i.e. housing) that is generating yields that are two or three times as much?

The other advantages of the MMD policy are that it is easy to implement. Most of the necessary powers, people and institutions are already in place. The BoE MPC is already set up and could easily expand its role to cover MMD. Indices for average house prices are already measured by the Land Registry (and also by several banks and building societies). The FSA already has powers to regulate financial services and consumer products, and could therefore monitor the compliance of the banks. Moreover, the FSA has already suggested possibly abolishing 125% and 100% mortgages, so the precedent for this new policy has already been set, except of course that the FSA has now backed down over this approach. Perhaps that is because setting the precise limits on bank lending is not, or should not be, within the remit of the FSA. The FSA is in effect a financial police force. Its role should be to police the activities of financial institutions, not to set monetary and fiscal policies. Those roles should remain with The Treasury and the BoE.

So this policy also has the added bonus of reinforcing the separation of powers between the BoE and the FSA. While this separation of power and responsibility has been the source of much criticism during this financial crisis, it is not a criticism I share. Having two competing institutions does not necessarily mean that there will be cracks in the regulatory framework where no-one takes responsibility. If those two institutions are programmed to compete aggressively with each other for greater regulatory power then that will not happen. Such an outcome, though, depends on the exercising of strong leadership underpinned by positive political support, so any failure of regulation is ultimately the result of either a failure of leadership in the FSA and BoE, or a lack of political will from the Government.

Inevitably some people will look at these proposals and declare that the requirement for mortgage deposits will be impossible to sell to the electorate, because people have become accustomed to getting mortgages on demand. This may be true, but there are a couple of ways to overcome this problem.

The first is to allow banks to lend low value mortgages without large deposits, but only for much smaller loans-to-earnings ratios (say less than 1:3) with the BoE MPC also setting the value of this floating limit on the same monthly basis as they would for MMD and interest rates. Such mortgages would also be suitable for those who wish to re-mortgage when moving home. In effect they would be using existing equity in a property as a form of deposit. If buyers require larger mortgages with higher loans-to-earnings ratios (1:4 or 1:5) then deposits should be required on those mortgages. This has the added bonus in that it introduces an element of choice and diversity into the mortgage market.

The second solution is to introduce the policy gradually. If this is done then most people won't notice the change. For example we could introduce the policy now with the MMD rate set at 5% and it would make no difference to lending practices because currently virtually all mortgages require much larger deposits. If MMD were to subsequently vary by about 1% per year, then once again most people wouldn't really notice.

Ultimately all that is required is for this policy to become reality is for the Government to give the green light, to set the target rate for house price inflation (I would suggest keeping it between the CPI inflation rate and the average growth in earnings), and give the FSA some bigger sticks to beat bad banks with (e.g. fines, increased capital adequacy ratios). Other than that it is a question of timing, and I suspect we may need to wait for the economic recovery to occur first, in order to let all the fallout from the last crash get purged from the system, before it will be possible politically to implement such a measure. However, sooner or later, implement it we must.

Friday, 23 October 2009

The real issue is house prices, not bank regulation.

This week the FSA published proposals to increase and improve the regulation of mortgage loans, principally by banning self-certification mortgages where applicants were not required to provide any proof of income. At the same time much of the wider political discussion has been about more general regulation of the banking industry. Unfortunately, both this strategy of the SFA and the wider discussion seem to me a bit weak at best. They are both based on the flawed assumption that the current economic crisis was caused by the reckless behaviour of banks and bankers, when in fact it was at least partly caused by an unregulated house price bubble that, together with the securitisation of debt, encouraged bad lending practices. To suggest otherwise is to put the cart before the horse. Banks like Northern Rock, HBOS and RBS did not collapse or require government intervention because they indulged in the reckless trading of derivatives. The problem was they borrowed in order to lend into an inflated property market, and it was the rate of inflation of that market that encouraged them to borrow so excessively.

The issue is this. Fundamentally, there are two distinct problems that need to be solved, not one. These problems are the risky lending practices of banks as they sought to inflate their profits, and the boom in house prices that both underpinned those policies, and was driven to even greater extremes by them. In this chicken and egg world, it is both of these failures that need to be addressed. Unfortunately our politicians and regulators so far only seem interested in tackling the first of these. They are only interested in saving the banks and the financial system while appearing quite happy for laissez faire free-market ideology to go on unchecked in the rest of the economy, and particularly in the housing market. This is partly because in doing so such actions reinforce the current received wisdom that all the current economic woes are the fault of nasty, greedy bankers, and not the way banks and bankers were (or were not) regulated, because obviously if it were the latter then politicians would also have to share in the blame, and that would never do.

So, one year on from the collapse of Lehman Brothers and the almost complete nationalisation of Scottish banking, and it seems it is not only bankers who have learnt nothing from the experience. Listening to the latest proposals from the FSA on the regulation of mortgages, it is clear that most politicians and regulators still haven’t got it either. What is worrying about the latest FSA announcement is not so much the proposals that are being advocated: it is the total disregard for the ones that were omitted. Fundamentally, though, it is about the complete failure to even acknowledge the elephant in the room that still no-one will talk about. That elephant is house price inflation and how to control it. The conventional wisdom is that such control is beyond the power of governments or regulators. I disagree. I believe it is both possible and essential that this rampant source of inflation is killed off once and for all time if we are ever to return to sustainable economic growth, or if Gordon Brown’s dream of no more boom and bust is ever to be realised. Moreover, I will demonstrate precisely how it can be done.

This antipathy towards controlling house price inflation also highlights the hypocracy of our politicians and leading economic thinkers. If economic stability is so critical to ensuring long-term economic prosperity, and if the control of inflation is so critical to maintaining economic stability, why is the control of house price inflation not sought with equal enthusiasm? After all, was it not the housing boom that ultimately caused our current economic problems? And it’s not the first time such a boom has been the cause of recession in this country, is it? So, unless we do something to change things, it won’t be the last either. So why the reluctance amongst so many politicians to do anything to change things?

Maybe the obvious answer is that there were too many vested interests in politics, business and the media that were benefiting from the boom, or at least thought they were. And with so many MPs using their second home allowance to play the property market themselves, perhaps it is understandable that there was little appetite amongst many of them to kill the goose that was (temporarily) laying the golden egg for the privileged few. Yet in 1997 we were told that things would be different. As Gordon Brown stated in his first budget speech as Chancellor: “I will not allow house prices to get out of control and put at risk the sustainability of the recovery”.
The mistake Gordon Brown made was the same one that many others continue to make. He tried to counter house price inflation through taxation. In 1997 he reduced mortgage tax relief and raised stamp duty. Unfortunately neither measure had any effect. Nor could they, because the plain fact is that you do not dissuade people from speculative behaviour merely by taxing a proportion of the profits of that speculation. That is why stamp duty doesn’t work, nor capital gains tax, nor a land value tax. In order to control inflation in house prices you have to get back to fundamentals and control supply and demand.

Many on the Left have been advocating house building as a solution, particularly the building of more social housing. While this supply-side approach would have many benefits, it is also very slow to implement. On average it takes between three and five years for a house to get built, so a supply-side solution will always lag behind the market and will always be playing catch-up. When the market turns, the change will be exacerbated and the boom and bust cycle maintained.

The only viable solution is to control demand. Traditionally governments have done this using interest rates with some limited success, but this approach also damages the wider economy, particularly with regard to business investment. What is needed is a lever that the State can pull that only affects the number of potential house-buyers. That lever is the one that controls the supply of mortgages. If you control this, you ultimately control the number of buyers in the market. Unfortunately, the Government and the FSA have just rejected the two measures that would do just that. As Lord Myners said last week, “...we’re not going to have a mandatory limit on loans to value or loans to income but rather a prudential limit...

Yet it is only these policies of either a manditory limit on loans-to-value or loans-to-income that can ever work. They can, after all, be defined and quantified objectively within a legal framework. How do you define and quantify prudence? More importantly, however, by setting changeable limits on what people can borrow for a mortgage you can adjust those limits and thereby adjust the qualifying criteria for mortgages as economic circumstances change.

As the deposit required for a mortgage goes up, the number of people who can summon up such a deposit will decline until the balance between buyers and sellers shifts in favour of the remaining buyers. Therefore the price of housing will eventually stop rising and begin to fall. Similarly, if the criterion is the ratio of earnings to mortgage value, reducing the ratio removes lower income applicants from the bidding process for each house and also reduces the eventual sale price. Thus both mechanisms should result in lower house prices and a control of inflation in that sector of the economy.

No doubt the naysayers will ask, how do you know such a policy would work? Where is your evidence? Has it ever been applied anywhere?

Well the answer is yes, right here, right now.

Why do you think house prices have crashed over the last two years?
  • Was it because of higher interest rates? No!
  • Was it because of higher tax rates? No!
  • Was it because of increasing supply of houses? No!
  • Was it because of a shortage of potential buyers? No!
  • Was it because of a shortage of mortgages? Not exactly.
It was because the banks raised the deposits that prospective buyers needed to provide in order to qualify for a mortgage. A year ago this deposit was so large that most prospective buyers were forced out of the market. The result was that house prices crashed. Now, though, those deposits have fallen from over 20% last year to as little as 5% in some cases this month. And the result? Well over the last six months house prices have been on the rise once more as the buyers have returned. If that isn’t convincing what more evidence do you need?

The problem is that all this has happened by accident, or at least in a haphazard and totally indeterminate manner. Yet it needn’t be so. All that is required is for the Government to give the Bank of England (or some other independent financial authority) the power to set these deposit levels on a monthly basis, in much the same way as Bank of England interest base rates are currently set, and then house prices can be brought under control once and for all.

So if this Labour government is truly interested in delivering economic stability and a fairer society then it must commit itself to the control of house price inflation. Without such a commitment any housing policy it tries to implement in the future will at best be no more than mere palliative care, and any economic policy will ultimately be wrecked on the same rocks that scuttled the last policy.

Saturday, 10 October 2009

Is it time for a new business model for Royal Mail?

The latest strike vote by the CWU workers at the Royal Mail is sending a clear message that all is not well within that organisation.

Royal Mail is a business in trouble. It has some of the lowest staff morale, one of the highest strike rates, and one of the highest rates of staff turnover of any company in the country. The unions and workers appear to have no confidence or respect for the management, and given the damage these disputes do to Royal Mail in business terms, many of them seem to have very little sense of personal investment in Royal Mail either. Maybe that is part of the problem, and so should be seen as part of the solution?

The traditional solution for ailing nationalised industries is privatisation. However, there is a lingering worry that this would actually hasten the demise of the service the Royal Mail currently provides, not improve it. The universal service would be unlikely to survive the pressure to maximise corporate profits, and experience shows that any guarantees to the contrary given before flotation rarely survive the test of time, or a change of government.

Privatisation will also leave Royal Mail workers hopelessly exposed to the downward pressure on wages from the free market. Given the nature of its business, which will always involve large numbers of postmen and women delivering thousands of letters by hand each day, Royal Mail workers are always going to be amongst the lowest paid in the economy, and increasing deregulation and competition in the industry will continually reduce their collective bargaining power.

On the other hand, continued nationalisation leaves the Royal Mail umbilically tied to the current short-term political and financial interests of the Government. If history shows us anything it is that the Government is a bad owner of business. Its attention span is too short-term, and it is more interested in squeezing cash out of businesses to fund other services than allowing those businesses to invest for the future.

So, if nationalisation doesn’t work, and privatisation is a disaster-in-waiting, what third way is there?

It seems to me that all the problems at Royal Mail are indicative of an organisation where the workers feel undervalued, powerless, and marginalised. One way to change that would be to give the workers a greater sense of ownership of the company. The answer could be to turn the Royal Mail into a cooperative partnership along the same lines as the John Lewis Partnership (JLP).

The John Lewis Partnership is a cooperative venture that was set up in the interests of its workers (or partners) by its owner, John Spedan Lewis over an extended period from 1920 to 1950. The company is run by a tripartite system of company Chairman, Partnership Board and Partnership Council. The Council is directly elected by the workers based on constituencies. Each constituency is based around one store, or a group of stores, or part of the business, and returns one member. The Council then elects five members to the Partnership Board, with the Chairman nominating another five, and two external non-executives also being appointed. The Chairman and Board run the business, but are accountable to the Council, i.e. the workers.

As in most companies, the Chairman and Partnership Board take the day-to-day business decisions and decide what proportion of the annual profits should be reinvested in the business. But unlike PLCs, the rest of the profit is paid to the workers as bonuses in proportion to their salary and not to rentier shareholders. At the John Lewis Partnership these bonuses typically range from about 8% of salary in poor years, to over 25% of salary in good ones. For people on low incomes such large lump sums would be welcome windfalls and could provide enormous financial opportunities. In addition there are other corporate benefits such as pension provision and leisure discounts. The other major area where JLP differs from most private sector companies is in its commitment to social responsibility and local communities, a commitment that is enshrined in its constitution.

The positive consequences of this arrangement are that JLP has a much lower turnover of staff than most of its main competitors, better staff morale and good industrial relations. It is also renowned for its customer service and tends to be more resilient at weathering recession. And at a time when excessive executive pay is constantly in the headlines, JLP also rewards its senior managers less extravagantly in comparison to its shop floor workers than is the case for most of its competitors. In short, JLP has all the positive attributes that the Royal Mail currently lacks.

It seems to me that the business structure and employee demographic of JLP and the Royal Mail are very similar. So applying the business structure of JLP to the Royal Mail should be straight-forward, and should result in a new postal service without most of the problems that afflict the current one.

So why not turn the Royal Mail into a partnership, with each sorting office electing one member to its Partnership Council?

Under such a scenario the Royal Mail would become an independent company, but with no shareholders, only stakeholder workers. The management would be appointed by a board that is answerable to, and elected by, the workers. The benefits for the Royal Mail of this arrangement would be:

  • the company would be independent of government and so able to take its own long-term financial decisions.
  • It would give the workers a greater say over the way the organisation was managed and run, and a greater sense of ownership of any changes to working practices that need to be implemented.
  • The workers would reap the rewards that accrue from the sacrifices and compromises that they need to make. That would be a powerful incentive for workers to embrace business change, rather than continuing to resist it.
  • Industrial relations, service quality and reliability should all improve.

The benefit to the Government would be that it would no longer be responsible for the Royal Mail pension fund deficit, nor for overseeing the business. In return for the Government relinquishing its ownership rights, the Royal Mail could pay the Government a fixed annual dividend (let’s say 25% of the total staff bonus fund) but the Government would have no voting rights accompanying this dividend. The new Royal Mail constitution should commit the company to maintaining the current universal service and an external regulator should set the price of the standard second class stamp as this is the area in which the Royal Mail has the greatest monopoly. All other pricing should be left to the management of the Royal Mail.

The strategic position of Royal Mail means that most other businesses in this country are dependent upon it by using its services. Royal Mail is therefore critical to the economic prosperity of this country, and this means that the mail service that it provides must be reliable and adaptive to the needs of its customers.

The current policy of many on the Left including Compass is to keep the Royal Mail in public ownership. As I have also argued elsewhere, I do not believe this is viable in the long term, and sooner or later a Conservative government will pluck up the political courage to either privatise the Royal Mail through flotation, or sell it off completely to a competitor. The JLP solution has the added advantage that it would protect the Royal Mail from such a fate in perpetuity as well as leading to a better quality of service and better employment conditions for the workers.

Sunday, 4 October 2009

AV or not AV? That is the question. Or is it?

When Gordon Brown announced in his speech to the Labour Party Conference last week that a referendum on the alternative vote (AV) electoral system would be held after the next election (if Labour won), did he really mean AV? Or was the term simply a lazy shorthand for all possible flavours of AV+ (AV plus top-up seats to increase the proportionality) with the exact composition to be decided on later? Or more worryingly, was it another exercise in triangulation designed to kill off any real prospect of reform?

If it was the last of these then I can understand the anger of people like Neal Lawson of Compass who wanted the referendum to coincide with the next General Election. However, the problem with that strategy is that the issue of proportional representation (PR) could become subordinate to the other main issues at the election. Then there is the other problem of double jeopardy. Either scenario for a referendum will mean that two separate electoral hurdles must be overcome before electoral reform can become a reality. With four possible permutations available (YY, YN, NY, and NN) but only one (YY i.e. Yes to a Labour government and Yes to voting reform) that will actually deliver change, the odds are not good. So was that part of Gordon's cunning plan?

The issue of PR in our electoral system has long been a controversial one, particularly for those on the political Left. Maybe it is because some on the far left were never really true democrats in the first place, and only ever saw democracy as a means to an end, not an end in itself. For them it was about the acquisition, appropriation and maintenance of the reins of power, albeit for what they perceived to be the common good or the liberation of the working class. That position, however, is no longer tenable, if it ever was.

21st century Britain is crying out for a modern democratic system. You only have to look at the disaffection of many voters, and the lack of any real policy differences between the main parties to see that the current electoral system reduces the amount of pluralism within politics, rather than increasing it. It places 90% of electoral power in the hands of 10% of voters in the 100 most marginal constituencies and effectively disenfrachises most of the rest. It is therefore not fit for purpose, and is most certainly not democratic.

It is against that background that many of us in the Labour Party have long been waiting for Gordon Brown to take the initiative in this area. So when he finally broke cover, the relative modesty of his proposed reforms has left many of us underwhelmed. However, much of the criticism regarding Gordon's announcement and of AV in general has been about its perceived lack of proportionality. So while Simon Heffer writing in The Daily Telegraph thinks (wrongly) that AV is a form of proportional representation (PR), many others such as Neal Lawson and Mark Thompson at Left Foot Forward dislike it because it is more disproportionate than the current First Past The Post (FPTP) system. Meanwhile, back at The Daily Telegraph, Janet Daley seems to hate AV because she thinks the Tories would never be able to win under it (as incidently does Heffer given his apparent paranoia over the "threat to put a centre-Left coalition in power for perhaps decades to come"). Of course the point both Daley and Heffer fail to acknowledge is that if the Tories can't win under AV or PR (even in coalition) it is probably because more than 50% of the electorate hate them. In which case they don't deserve to be in power in the future just as they probably didn't for much of the recent past either.

The reality is that the proportionality or fairness of AV+ depends fundamentally on the number of top-up seats that are included. The greater the number, the greater will be the proportionality, at least for the three main parties. The argument that is then presented to counter this is that top-ups give too much power to the party leaders in their appointment, but this is another red herring. If the top-up candidates are selected from the highest placed runners-up in each constituency and ranked in priority based on their proportion of the first preference vote, only the voters can ultimately decide which candidates get chosen for the top-up seats, not the party leaders.

The advantages of AV+ are that it means that each candidate needs to garner the support of over 50% of the electorate relative to his/her nearest rival in order to win. So fewer constituencies will be safe seats and almost everyone's vote will count towards the final decision. This should help to increase voter turnout and improve the democratic credentials, support and legitimacy of whichever candidate is selected. However, there are three other important factors that most people tend to overlook when considering the merits of any type of electoral reform.

Firstly, you cannot judge the merits of a proposed electoral change for the House of Commons (HoC) without considering how such a change interacts with the electoral process for the upper chamber (assuming we ever get one). The two bodies should be designed to work in unison, with each complementing the other and each compensating for the deficiencies of the other, not merely reproducing the political balance or composition of each other. A bicameral system only serves any real purpose if it introduces a separation of power or powers, and creates constitutional checks and balances. If each of the two arms of the legislature is a carbon copy of the other then all you are doing is adding extra cost for no additional benefit.

Secondly, people wrongly assume that if electoral reform is implemented everything else will stay the same, that the constituency boundaries will be the same and the amount of tactical voting will be unchanged. Neither of these are true. If the voting system changes then the Boundary Commission will inevitably change the size, shape and demographic of the constituencies in order to make the outcome of any election fairer. People's voting strategies will then be influenced by both of these changes as they seek to maximise the impact of their vote.

Finally there is the elephant in the room that no politician will talk about. That elephant is the Parliament Act of 1911 and its 1949 amendments that give the House of Commons ultimate supremacy over the upper chamber. It's justification is the greater democratic legitimacy of the elected House of Commons (HoC) over the unelected House of Lords (HoL). But if the HoL is reformed into a democratic chamber elected by PR using the list system, and the HoC remains with FPTP or merely changes to AV or AV+, how can the Parliament Act continue to be justified? The reformed HoL will have at the very least equal democratic legitimacy, and so should have equal power and status. Unfortunately, many MPs will never countenance such a transfer of power, and presumably neither will many of them countenance any real electoral reform either. In that respect these MPs demonstrate their true anti-democratic credentials.

Perhaps the most worrying aspect of Brown's speech, though, was the one reform that was glaring by its omission. What exactly is the Government's policy on House of Lords reform? Until we know that everything else must be put on hold?

It is clear that real electoral reform requires a reform of both Houses of Parliament and of the constitutional settlement under which they operate. AV+ has many attractive attributes in this respect.
It maintains the constituency link for most MPs as in FPTP. This will also help maintain the independence of local parties and their candidate selection.
It means every vote will count in many more constituencies, so voter turnout should increase, and there will be more marginals.
Marginal constituencies will be as attractive as safe seats to the winning candidate(s) because these constituencies will return two candidates, not one.
It is more likely than PR to generate a House of Commons with a parliamentary majority for one of the major parties, and therefore avoid the constitutional messiness of ever changing coalitions.

But AV+ also has a number of drawbacks:
It is still not truly proportional. A party will probably still end up governing with less than 50% of the popular vote.
It still disadvantages the small parties.
It fails to address the West Lothian question.

However all these drawbacks could all be compensated for with a reformed HoL elected on the list system. In such a chamber it is unlikely that any one party would ever achieve a majority of votes or seats. Therefore a coalition between the dominant party in the Lower House (i.e. HoC) and other smaller parties in the Upper House (i.e. HoL) would be necessary, provided of course that the Lower House could not steam-roller its legislation through using the Parliament Act. That is why the Parliament Act must eventually be repealed.

The constitutional settlement that I have arrived at could also be enhanced with a number of other refinements.
Disenfranchising voters in Scotland, Wales and Northern Ireland from one of the two Houses (personally I favour the Upper House) effectively nullifies the West Lothian question.
PR for the Upper House is more amenable for fixed term parliaments.
Mid-term elections to the Upper House would increase democratic accountability. I would elect a third of members every two years.
Term limits of six years for the Upper House would increase the independence of MPs and decrease the power of the party whips and the executive.

So, Gordon, if you really are committed to electoral reform I expect to see much of the above in the next Labour manifesto. After all, what have you got left to lose?