It’s not just the finance industry — there are scandals as far as the eye can see
And so it did.
And here we are like Keynes’s contemporaries in 1918. Keen to return to the set-up we know got us into this mess. In the midst of the financial services royal commission, scandals stretch as far as the eye can see. They are rife in finance, of course, but are also evident in the way professionals — from the commanding heights of academia to policy-makers and opinion leaders — have failed to move beyond a vision of reform that was already stale at its zenith in the 1980s and 90s. After the global financial crisis, that vision stands today bereft and becalmed, increasingly irrelevant in today’s financialised, professionalised, digitised world.
Trauma, intellectual growth and reform
The postwar reforms were profound, giving us a generation of unmatched prosperity. But there’s also a more recent time when we turned our back on the bad old days. In response to the recessions of 1975 and 1982, and after prime minister Malcolm Fraser’s feints towards economic liberalisation, the Hawke and Keating governments turned “economic rationalism” — as it was then called — into a comprehensive program to refurbish our economic institutions.
In each case reform was built on new understandings that had originated in the academy. Where the Keynesian revolution had underpinned postwar reform, post-1960s reform was founded on a cluster of ideas. They included George Stigler’s critique of “regulatory capture,” Milton Friedman’s popularising of proposals for unbundling of delivery from the financing of government services (using vouchers and income-contingent loans, for instance), and Ronald Coase’s idea of reassigning property rights to achieve specific objectives (think pollution permits and spectrum auctions).
All these men were University of Chicago economists favouring greater reliance on markets. But they thought of these ideas as technocratic rather than ideological. Many of them — like income-contingent student loans and the liberalisation of airlines, tariffs and agricultural subsidies — had egalitarian implications and were supported by many from the centre left to the centre right.
The institutional refurbishment following the second world war lasted twenty-five-odd years. But it was only a few years before the Hawke-era reforms atrophied into a reductive formula under which change that looked more rather than less “market-based” was preferred on principle. This might reflect the lobbying power of business even with centre-left governments. But it was also the product of faltering intellectual progress in the academy and the political class’s wider failure of imagination and empathy for the people for whom they ostensibly govern.
Supporting greater “market orientation” worked well when it involved dismantling the detritus of eight decades of policy-making by deal-doing. Tariffs, agricultural subsidies and regulated shopping hours were slashed and government-sanctioned cartels in the airline industry broken up.
Reform also inspired some well-conceived new policies that could be achieved with the stroke of the pen, as when we more tightly targeted family payments around need. (Not all notable Australian policy successes followed this formula, and they showed Australian policy-makers at their best. They included programs to divert people from residential aged care — via Home and Community Care — and more sophisticated ways of partnering with communities through such initiatives as the AIDS strategy and Landcare.)
But relying on a summary aesthetic of greater “market orientation” was no way to reform sectors — utilities and finance, for instance — in which market failure is pervasive. There, as Mark Twain once put it, it’s not what you don’t know that does the damage. It’s what you know for sure that just ain’t so. Looking back, the landscape is strewn with disasters.
In infrastructure and utilities, monopoly problems abound, so regulation remains inevitable and new rent-seeking pathologies lie in wait for those unpicking the old ones. Here, our reform efforts brought forth overpriced tollways, energy, desalination plants, airports and airport carparks, and governments selling buildings they owned only to rent them back at vastly higher ongoing cost. And that was just the opening salvo of a lurch towards crony capitalism, as the insiders who engineered the changes parachuted into careers lobbying their successors on behalf of the beneficiaries of their reforms. In the process, we’ve seen massive overinvestment in electricity transmission and, until recently, underinvestment in other infrastructure.
That’s before we even get to finance.
Here’s a marvellous passage in which the Financial Times’s Martin Wolf introduces finance as “a jungle inhabited by wild beasts”:
[T]he purchasers of promises will know that the sellers normally know much more than they do about their prospects. The name for this is “asymmetric information.” They will also know that those who have no intention of keeping their word will always make more attractive promises than those who do. This is “adverse selection.” They will know that even those who are inclined to be honest may be tempted… not to keep their promises. The source of this is “moral hazard.” The answer to adverse selection and moral hazard… is to collect more information. But this too has a drawback: “free-riding”… [T]hose who have made no investment in collecting [information] can benefit from the costly efforts of those who have… That will, in turn, reduce the incentive to invest in such information, thereby making markets subject to the vagaries of “rational ignorance.” If the ignorant follow those they deem to be better informed, there will be “herding.” Finally, where uncertainty is pervasive and inescapable — who, for example, knows the chances of nuclear terrorism or the economic impact of the internet? — the herds are likely both to blow and ultimately to burst “bubbles.”
Are you feeling lucky?
And that’s before allowing for the special status of the public–private partnership that is banking. Here, commercial banks resell basic banking services they access exclusively from the government-provided central bank that, as lender of last resort, effectively guarantees their liquidity. Oh, and if that isn’t enough, governments first guarantee them, as the Rudd government did over one panicked weekend in 2008, or, failing that, simply hand over money to keep the show on the road.
Bank of England governor Mervyn King describes this diabolically bad set-up as the worst “of all the alternatives.” We’ve duct-taped it back together: a little more capital adequacy here, tighter prudential standards there. Global debt is now $164 trillion, or 225 per cent of global gross domestic product, 12 per cent higher than its last peak in 2009. The banking system, both nationally and internationally, remains structurally unstable, just as it was before the crisis, amplifies the economic cycle, just as it did before the crisis, and will blow up again, drawing taxpayers back into its maw.
The road not taken
All this is a microcosm of a wider and longstanding intellectual complacency. In the sixty years since they were first articulated, there’s been little replenishment of the first generation of reform ideas I quoted above. And so our policy-makers and opinion leaders wing it against a backdrop in which two caricatured abstractions — “free markets” and “government intervention” — fight it out. This dichotomy feels compelling. It gets our ideological juices going and can fuel a thousand Twitter storms. But it makes little sense.
The standard view among economists, and more informally among the public, is this. Markets provide private goods like cookies, cars and cameras, while governments provide public goods shared by all, like roads, rubbish removal and regulation. That’s a good start, but it’s a lousy conclusion. It ignores how profoundly individual and collective endeavour are enmeshed.
And that’s before considering something that economists have largely ignored since Adam Smith founded his whole view of society on it — the dialectic of individual endeavour within the collective bonds of culture. The very language in which I’m addressing you is a public good that is owned — to the extent the term makes any sense — collectively. So are any number of other aspects of its transmission to you, from the open-source software powering so much of the internet and its epiphenomena to the internet itself.
In areas like education, health, aged care, finance, research, legal services and cultural industries like the arts, and in networks like media, transport, energy, telecommunications and other infrastructure, and in city planning, output is better thought of as the joint product of competitive and collective (collaborative and regulatory) activity. Each sector requires the evolution of quite different institutions in which public and private, competitive and collaborative considerations concatenate at every level from high policy down to workplaces.
And we’ve barely started on the project of trying to shed intellectual light on these issues in ways that might cash-out in practical improvements to the way our institutions work. We might have begun decades ago, if we’d understood reform as refurbishing the institutions of the mixed economy.
THE SCANDAL OF ROYAL COMMISSIONS THEMSELVES, AND BEYOND…
Let’s start with the scandal of the royal commission itself. A Productivity Commission inquiry costs three or four million dollars — a figure that might double or quintuple if we include the costs of outside participants in the inquiry. The PC actually has discovery powers not unlike a royal commission’s, though it’s never used them and it wouldn’t be the appropriate specialist body for searching out and pursuing wrongdoing. But it provides an indicative benchmark on the costs of a good look around. So too does the recent inquiry into the public service, which at around $10 million seems excessive to me but is similar.
Though I would expect its policy conclusions to be meagre — it is focused on misbehaviour — the royal commission is budgeted to cost government $57.5 million. Each of the major banks is spending around that on their favoured big law firm. Then there’s external PR, lobbying, day-to-day “issues management,” crisis and/or strategic issues management, and so on.
Add to this substantial in-house expenditure on all these items. Smaller firms would be spending less, but there are many more of them — in banking, funds management and financial advice. Consistent with the adage “never let a good deed go unpunished,” the industry super funds have also been drawn in, their solid investment returns and relative lack of scandals putting the big end of town to shame.
So half a billion dollars seems like a safe underestimate of the total cost of this exercise. Much of it goes on massively inflated salaries to top lawyers — think ten to fifteen thousand dollars a day. But more goes on sheer inefficiency. The legal system has virtually no regard for directing lawyers’ efforts to where they’re most valuable. So the commission sends out trawling requests for all records of all misconduct. This has at least uncovered lots of bad things, though many had already been reported to authorities and then kept quiet.
Still, this approach is prodigiously wasteful in other legal proceedings for reasons we’ll discuss shortly. Sure enough, ASIC’s gun-shyness in pursuing corporate wrongdoing arises partly from this wastefulness. It blew $20 million in legal costs going after OneTel and $30 million going after Andrew “Twiggy” Forrest. $30 million! Presumably total costs, including Twiggy’s, exceeded this figure handsomely. But looking at the case notes, and even allowing for the inevitability of “gold plating” some processes when one is pursuing the potential wrongdoing of the wealthy, this is an extraordinary amount to determine a legal question. Oscar Wilde once described fox-hunting as the unspeakable in pursuit of the uneatable. Here we’ve sent in the irredeemable in pursuit of the insatiable.
Why we might have expected better: the professions
One theme of the economic reform playbook from the University of Chicago was the way the professions are just one genteel instance of Adam Smith’s famous line, “People of the same trade seldom meet… even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices.”
This should figure in any list of the unfinished business of economic reform. Policy reform has been all over this question in vocational training, with “competency based” training and certification. Reform in the professions does figure in the list of unfinished reforms Gary Banks compiled as chair of the Productivity Commission. But how often do we see high-profile champions of reform highlight the issue?
And if it were to be taken seriously, there’d be so much more to successful reform than simple deregulation of barriers to entry. At both macro and micro levels, professions typically exert a huge influence on the demand for their services. The lawyers representing each side in a case effectively dominate legal procedure and will gold plate each stage of the process to an extraordinary degree. (Ask Twiggy Forrest or his adversary, ASIC.) Likewise, in the country where the market is least constrained by government acting as “informed purchaser” of health services for the community — the United States — health spending has surged to being half as large again as the health sectors of comparable countries, with worse health outcomes.
I’ve only highlighted financial aspects of reforming the professions. Making them truly responsive to our needs is a bigger prize. Imagine a market in which you might be able to find medicos, lawyers, investment advisers and managers in the way you can assess which restaurant suits you on TripAdvisor. Throw in consumer advocates, found in the same way, who help you navigate the maze of professional services to best meet your needs.
The analogy with TripAdvisor is facile, of course; and nor could the idea be dictated in a learned journal. It could only succeed if pursued iteratively, building the institutions in situ with co-design and dialogue between practitioners, their clients and disinterested experts guiding experiments to build better practice. The ideal is well expressed by businessperson Charlie Munger: “A seamless web of deserved trust.” Where have we heard that, or anything like it, in the endless debates on “reform”?
An information age for spin doctors and conmen
Commentators on the royal commission have been shocked, shocked that AMP sought amendments to Ernst and Young’s reports. But what else would you expect? We might be taken aback by the frequency, regularity and flagrancy of AMP’s entreaties. But who really believes that firms aren’t heavily invested in getting what they want from those they hire to perform “independent” analysis? This applies to auditing, which should be a truly fundamental public good, its purpose being to ensure that the connections between the different parts of our immensely complex economy are based on financial reality.
The constraint that stops auditors spinning any old pack of lies — the way those advertising patent medicines did in the nineteenth century — is that auditors wanting to remain in business must conform to professional standards. But that leaves plenty of wiggle room, and so increasing effort and resources go into “stretching the envelope,” to use a tellingly recent expression.
This is just one small example of how an information supply chain gets subtly perverted. Within governments, the same thing happens endlessly. We’ve set it up that way. All manner of “impact analyses,” from regulatory to environmental, are performed or commissioned by the very agencies whose impact is under review. Auditors are chosen by the firms they audit the world over, and the Australian approach of having agencies complete “regulatory impact analyses” in defence of the regulations they are promoting is offered as typifying best practice within the OECD.
Even this is the tip of a very large iceberg. Far more shockingly than AMP’s clumsy mishandling of the optics of “independence,” the utterly corrupted markets for information in nineteenth-century patent medicine markets have been replaced by much subtler corruption that steadily worsens as traditional professional standards give way to the intensifying pursuit of revenue and other institutional imperatives. Driven by various factors, not least academics’ and learned journals’ competition to “publish or perish” and their resulting lack of interest in “null” results and replication, published results are full of bogus findings. As they say in the trade, “if you torture the data enough, it will confess.”
Scholars recently found that only 11 per cent of pre-clinical cancer studies could be replicated. John Ioannidis, a leading scholar in the field, came to this devastating conclusion: “Overall, not only are most research findings false, but, furthermore, most of the true findings are not useful.” Incredibly, the process by which research then feeds into the proving up of drugs for human use is likewise tangled in similar conflicts. Researchers’ funding depends on the favour of drug companies and widespread suppression of “unsuccessful trials.”
Once drugs are on the market, their marketing is further compromised by conflicts of interest. And so the dominant treatments for vexing and chronic conditions, from anxiety and depression to the short attention span of children, are marginally efficacious drugs while less easily privatised and possibly more efficacious social cures go largely unfunded and unexplored. This is worst in the United States, which tolerates more advertising and more aggressive drug marketing than other developed countries. One result is the opioid epidemic, which has now given the United States the extraordinary distinction of being the first country since records were kept ever to experience peacetime falls in life expectancy for large socially mainstream demographic groups.
Gary Banks’s list suggested removing restrictions on the ownership of pharmacies, but made no mention of any of this.
MICROECONOMIC REFORM FOR THE INFORMATION AGE
These issues concern the arteries of our information economy. Yet, compared with the set-piece reform talking points driven by business — the state of the budget, over-regulation, restrictive workplace practices and tax — and the obligatory warnings against backsliding on trade protection, they’re largely absent in our reform conversation. They’re nowhere to be found in the endless op-eds and “summits,” where the tall poppies of the Lucky Country bemoan declining productivity growth, and canvass the favours that might be done them while they lament the pervasive lack of leadership.
If we’re to rise to the challenge, we’ll have to ditch all the barracking for “free markets” or “intervention.” When markets work, they do so miraculously by harnessing the information distributed throughout society. Yet they also corrupt information flows wherever one side has better information than another — say, about the shoddy product they’re selling. So solutions to these problems must be pragmatic hybrids of competition and collaboration — accessing and leveraging local knowledge while minimising conflicts of interest throughout the production chain.
Around the Western world “information policy” is mostly stuck in early prototype. Thus, governments issue crude edicts with little care for their effectiveness. In finance, for instance, mandated product disclosure statements for investments cost the economy billions annually, but go virtually unread. Meanwhile, as the scandals about financial “advice” surge from time to time, new regulation is developed. But it always resembles a PR makeover rather than serious policy action. Some corrupt limbs are jettisoned so the rotten body — the corrupt business model — can live on.
Both investment “advisers” and mortgage brokers are now subject to extensive and costly regulation, including the usual mandatory disclosure of commission payments. But it’s all built around the existing model and its fundamental deception — that they’re “advisers.” Regulation now requires practitioners to provide formal written “advice” to their clients — generally adapted from master scripts spewed forth from software marketed to the industry as “sales technology.” Salespeople still play their well-rehearsed role as their clients’ fiduciaries (though most still lack even a university degree) but now as government-approved professionals.
This fecklessness is reinforced by academia’s disciplinary values. There’s a vast literature on the economics of information. But it’s nigh-on impossible to get these issues into the obligatory formal mathematical models required in academic publishing without ruthless abstraction down to ideal types. This is an unpromising hunting ground for new hybrid institutions in which competition and collaboration would be structured in some new and promising way. Recall that none of the ideas I cited from the Chicago School came from formal modelling. Rather, they came from empirical investigation, helpful reframing of problems or institutions, and pragmatic insights, or what a software coder would call “hacks.”
Note that in our discussion of the travesties of regulating financial advisers, we’ve not even got to the main game, which must surely involve surfacing which advisers are providing the best advice and structuring a market that helps consumers find them. One likely prospect would be improving the transparency with which professional reputations are made. But if we simply impose this from the outside, as we’ve done with NAPLAN testing for instance, what’s made transparent will probably be the wrong thing, and even if it isn’t, it will still be vitiated by gaming and buck-passing. Professions and industries must be closely involved in, but should not dominate the building of, standards against which they’ll be judged, while we ensure that those standards represent the interests of users.
We should be asking how we could build institutions to get important information to people in ways they can use. We already know the recent on-time departure rates for airlines, for instance, and the workers’ compensation premiums of firms, which offer a good proxy for workplace safety. What kinds of institutions would build routines to bring this and other relevant information to the attention of those who need it — buyers of airline tickets and prospective employees respectively — when they need it? We could begin without cumbersome regulatory edicts — with groups of industry and user representatives developing disclosure standards — and with governments and other civil society institutions using their convening power to forge greater regard for the collective public good (the standard) so competition between providers is actually in pursuit of something of value. We’d talk and experiment our way to better information flows and better lives. Isn’t this better than ideological barracking for “free markets” or “intervention”?
Wither post-reform renewal?
Meanwhile, the internet is reconfiguring the ecology of public and private goods. Digital artefacts, like language, are potential public goods — available for endless, costless reuse. You’ve probably heard of the “free-rider problem,” which can kill off improvements like new drugs because the scope for using others’ ideas without paying undercuts the original incentive to develop them. The problem is real enough in some areas, and it’s why governments subsidise research and development and protect intellectual property. But the “free-rider opportunity,” where existing cultural artefacts — like words and ideas — spread for everyone’s benefit, has always been more important. That we’ve never heard the expression is a testament to how biased towards private interests our discourse really is. When it comes to sharing, the vested interests driving public debate are vastly more preoccupied with preventing it from undermining private profit than with optimising the immense and increasing opportunities and advantages it offers.
Be that as it may, with the advent of the internet, the free-rider opportunity is burgeoning as a slew of new public goods are privately provided. They include open-source software, blogs and Wikipedia, where people generate digital artefacts to satisfy their own desires and then throw them open for digital sharing to work its magic. And public goods privately provided for profit are also burgeoning. Google and Facebook could have marketed their products behind a paywall to monetise more of the value they generated. But in those cases, as with so many others, the free-rider opportunity afforded by the internet now so overwhelms the free-rider problem that monetising a small fraction of a public good via advertising has made their owners vastly richer than they’d have been if they’d obsessed about free riders, as our policy debate does, and provided their services as private goods for a fee.
The internet has certainly given the entrepreneurs of the world plenty to be getting on with. Government policy-makers not so much. I’ve suggested a whole class of digital public goods delivered by public–private partnership, and as chair of Innovation Australia I presented them to scores of officers senior and junior from the federal Departments of Innovation, Treasury and Communications. We’ve had a major innovation statement since then in which I participated at senior levels. No one disagreed with the ideas. Several found them exciting or inspiring. But they never took hold — even to be ultimately rejected further up the line. In the jaded discourse of our post-reform world, they could never be more than innocent entertainment. It’s so much easier just turning out the same old, same old.
Back to where we started
Since before the finance industry royal commission was announced, the Productivity Commission has been conducting a major inquiry into intensifying competition in finance. My submission proposed a small “hack” that could make a big difference: a slight gloss on an old idea of “competitive neutrality.”
Indeed, my proposal “completes” the idea of competitive neutrality, putting it on an ideological level playing field, as it were. Since we’ve taken so seriously the idea that, if they compete with private firms, government enterprises should compete on a “level playing field,” shouldn’t we also take the converse idea seriously — that where governments have substantial investments in providing services exclusively to some group, they should provide them on an unsubsidised basis to all comers?
This would see governments opening up the superannuation services they provide for their employees to all comers. It would also see the utility banking products central banks provide to commercial banks — products like savings and payment accounts with the government — opened up to the general public online.
The PC’s draft report on finance dealt with competitive neutrality in banking with the silence of a holy order. With others taking interest — from Martin Wolf to the Greens (who adopted it, quickly topped and tailed for political consumption) — the PC’s final report broke its silence. Not to engage with the issues, but to shoo them away. They think it’s a bad idea. And here’s the thing. Maybe they’re right. Policy is a difficult game with more moving parts than anyone can feel confident about. But if we’re to get even a glimmering that we’re reasoning our way to a decision rather than having our prejudices do all the work, the PC needs to weigh the pros and cons conscientiously.
But that’s not how the game has worked in Australian economic debate for a long while. Instead, the PC points to some untoward possibilities. It doesn’t suggest how likely they are, how bad they’d be or what might be done if they happened. Nor does it weigh those concerns against possible benefits. Rather than engage with a new idea that goes (however slightly) against the grain, it simply gainsays it as John Cleese does in Monty Python’s classic argument sketch. My proposal got the five-minute argument. But we’ve been getting the full half hour for decades.
As Thomas Paine once observed, “We have it in our power to begin the world over again.” There’s certainly lots to be thought about after the good, the bad and the ugly of thirty-odd years of reform and economic and social development in the age of the internet. But when the royal commission hands down its report and the vested interests of finance are at their weakest point, the intellectual work to get us beyond a bit more tinkering won’t have been done.
Nothing ventured, nothing gained. •