Reproduced from today’s Mandarin
Around the world, finance is a major policy problem driven ultimately by the ease with which insiders can advantage themselves (sometimes illegally, but mostly legally) against outsiders — the mug punters who must pay for financial services. It’s ironic that these problems have burgeoned in the wake of a generation of policy-making that putatively paid increasing deference to economic expertise.
Still, had we taken one principle from the economic reformers’ playbook seriously, we’d have finessed lot of the problems we’ve encountered. Margins in two of our most inefficient industries — banking and wealth management — could be cut substantially, in the case of wealth management by well over 50 per cent.
This would involve using the principle of competitive neutrality not just as a shield for business against unfair government competition, but as a sword, guaranteeing all-comers unsubsidised access to the financial services governments already provide a favoured few — as they provide central banking to banks and superannuation to public servants.
As the dust settles on economic reform, how much have successes been confined to ‘stroke of the pen’ reform — where we swept away the detritus of the political deal-making of the Australian settlement — for instance in tariffs, the two airline policy, the regulation of shopping hours? We were also successful where a singular idea could be implemented with the stroke of a pen within existing systems — as in the case of HECS or the Child Support Agency.
Where we reformed government involvement in the economy that was there to solve inherent ‘market failures’, we’ve done much less well. In infrastructure and utilities, monopoly and asymmetric information problems abound, regulation remains inevitable and new rent-seeking political pathologies lie in wait for those unpicking the old ones. Here our reform efforts brought forth excessively priced energy, tollways, airports, desalination plants and financial tricks many of which saw governments paying more for what they already had, as occurred with the sale and lease-back of government offices. To this day, policy-making and private investment in energy, infrastructure and telecommunications are mired in short-termism, dysfunction and crisis.
There are also rich professional ecosystems in which governments play a major role as funders, regulators and/or service deliverers in health, education and legal and other human services. Has reform improved performance here? It’s pretty unclear. And in areas like regulation and reducing red tape things seem to have deteriorated, notwithstanding three decades of ‘regulation review’. It’s unsurprising in such circumstances that the public’s faith in the governing classes continues its long slide.
Then there’s finance, which in many ways is a special case. Warming to his theme that the financial system is a “pyramid of promises”, here’s a purple passage from Financial Times correspondent, Martin Wolf:
“[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”.”1
This brief tour de force continues with a new paragraph beginning “Finance is a jungle inhabited by wild beasts.” Are you feeling lucky?
In such circumstances, crude favouritism for the private or the public sector has been what one might have expected — a recipe for failure. We should assume more humbly, that our task is to evolve institutions of the mixed economy in which the public and private, the competitive and the collaborative, play to their strengths and bolster the others’ weaknesses to address the myriad issues they encounter more fully on their merits.
We’ve barely begun this process of articulating post-ideological reform. But embracing competitive neutrality as a sword, not just a shield, provides a powerful ‘policy hack’ with which to begin.2
Australia coined the expression “competitive neutrality”3 at the summit of our reform prowess in the mid-1990s — alone among the more aggressive Anglophone liberalisers in coupling economic reform with economic equity. But it was always confined to the notion of constraining government to compete fairly, rather than drawing more fully on government’s potential to outperform profit-seeking firms in the presence of serious market failure.4
In this regard, competition should be regarded as ‘fair’ and presumptively efficiency-enhancing whenever public provision is offered at prices that reflect underlying resource costs. In finance, possible advantages government agencies may enjoy include:
- The directness of their relationship with the fundamental architecture of the monetary, financial and tax systems;5
- The public’s greater trust in the integrity of services provided by government;
- The lesser extent to which senior executives have hitherto been able to exploit their positions as insiders to extract rents from others;
- The tendency for government-backed firms to be substantial players in their markets and so the access this gives them to scale economies.6
Banking has been built on competitive non-neutrality. First, commercial banks receive basic banking services from the central bank which are inaccessible to citizens. Second, the commercial banks — who ‘retail’ and upsell to their customers the basic banking services of payments and savings initially ‘wholesaled’ by the central bank — are themselves advantaged against other businesses which cannot themselves directly access those services.
And yet, since at least the advent of the internet, we’ve been able to cost-effectively end this non-neutrality by allowing all-comers access to central bank services to save money in central bank accounts, be rewarded at the overnight cash rate and use those accounts to pay others.
Indeed central banks have ‘retailed’ their services to the public since the Bank of England’s dominance in banknote issue was legislated in 1844. Remarkably, there’s been no hint of something analogous online.
Ending this non-neutrality would be disruptive, but in precisely the way that competitive neutrality was disruptive when used as a shield for business against unfair competition from government agencies. It helped move our economy towards a healthier division of labour between publicly and privately provided services.
As I’ve outlined in several publications,7 allowing central banks to provide unsubsidised basic banking services to all who sought them would generate large gains. Since my initial publication in this area, Bank of England research has argued that, coupled with the issuance of digital currency, central banking for all could add 3% to GDP — a remarkably large number.8 Much of the gain comes from the revenue accruing to government from money creation, something which is generated in my model with central bank lending against super-collateralised assets.
Superannuation and funds management
The principle of competitive neutrality would also offer a useful means by which the excessive margins in the provision of superannuation services could be tackled. Given the resources governments invest in account and funds management to support public servants’ superannuation, those services should be available to all those wishing access to them.
Naturally, Australians’ right to have others managing their money should be preserved, but the public sector has been a better wealth manager than most alternatives. As the Grattan Institute’s Jim Minifie observed in 2015, “public sector funds as a group have achieved the highest average net returns over the 14 years to 2013”. Their average annual returns exceeded those of the entire APRA-regulated superannuation industry by 1.1 percentage points, industry funds by 0.6 percentage points, and retail funds by 2.2 percentage points per year over that period.9
With $2 trillion in super and a sizeable chunk of wealth management outside superannuation, there are vast sums at stake, not to mention the peace of mind for Australians whose compulsory super was initially at the convenience of their employer — and/or their union — which was then revised through successive regulatory palavers of ‘super-choice’ (are you feeling lucky?) and then MySuper and default funds.
Service delivery and market design
Since the reform bug hit in the 1980s, policy-makers have felt comfortable addressing policy problems with a degree of abstraction via market design. The pre-reform approach — this is a problem that’s not being addressed, so government should step in and address it directly — is now exercised as a last resort if policy-makers can overcome their distaste for ‘picking winners’. Certainly, we should consider sophisticated market design if we think it will be superior. But policy problems should be solved on their merits.
Since the Harper Review into competition policy, we’ve been seeking to maximise competition and contracting out in government-funded human services delivery as if it was an end in itself. As I’ve argued elsewhere, contracting out should rather be one amongst many instruments for optimising the outcomes that governments must vouchsafe — in social policy, health, mental health, employment services, education and family support to name a few areas.
New principles of competitive neutrality
In short, what is being proposed here would:
- Use already existing institutions and infrastructure in such a way as to wrest greater productivity from them and efficiency for the economy.
- Achieve its objective simply by enabling government agencies to compete in the marketplace on their merits rather than by preventing or impeding competing private service providers.
- Involve no subsidies — though through the growth dividend it generated it could be expected to improve government budgets.
- Respect the important principle that government agencies’ commercial dealings should be at arm’s length from the government of the day.
Seeking to learn from the mistakes of the past — of the pre-reform and reform periods alike — policy-making ‘on the merits’ can begin, though it should not end with the presumption that, in the absence of compelling reasons to the contrary, competitive neutrality should be pursued not just as a shield but also as a sword.
This essay is developed from Nicholas Gruen’s Submission to the PC inquiry into competition in the financial system.
1. Wolf, M., 2008. Fixing Global Finance, The Johns Hopkins University Press, pp 13-4.↩
2. By ‘hack’ I mean what Wikipedia means when it refers to a ‘life hack’ as a “trick, shortcut, skill, or novelty method that increases productivity and efficiency.↩
3. OECD Working Party on State Ownership and Privatisation Practices, 2013. “Competitive Neutrality: National Practices in Partner and Accession Countries”, OECD, Paris. Accessed on 25th Sept 2017 at http://www.oecd.org/officialdocuments/publicdisplaydocumentpdf/?cote=DAF/CA/SOPP(2013)1/FINAL&docLanguage=En.↩
4. The ‘founding document’ outlined the purpose of competitive neutrality “to remove resource allocation distortions arising out of public ownership of significant business activities and to improve competitive processes.” Yet this was to occur asymmetrically:
Competitive neutrality requires that government business activities should not enjoy net competitive advantages over their private sector competitors simply by virtue of public sector ownership.
Treasury, 1999. Commonwealth Competitive Neutrality Policy Statement, 1 April agreed to in June 1996, downloaded on 25th Sept 2017 at http://archive.treasury.gov.au/documents/275/PDF/cnps.pdf.↩
5. In fact the entire financial structure of a modern economy is built on government provided architecture from the specification of the monetary unit, the provision of central banking, the setting of monetary policy and the financing of government, including through the selling of bonds. Thus for instance central bank notes offer lower transactions costs and risks on users than private bank notes. Likewise government financing of income contingent student debt is more efficient than private financing because of government’s greater capacity to integrate their lending into the tax system with all this means for the efficiency of enforcing payments and surveillance of income.↩
6. Moreover where scale economies are substantial they may also compromise the vigour of competition in the private sector.↩
7. Gruen, N, 2014. “Central banking for all: a modest proposal for radical reform”, Nesta, accessed on 25th Sept at http://www.nesta.org.uk/publications/central-banking-all-modest-case-radical-reform
Gruen, N. 2016. “Why Central Banks Should Offer Bank Accounts to Everyone: Central banking disrupted for the 21st century”, Evonomics, December, accessed on 25th Sept at http://evonomics.com/central-banks-for-everyone-nicholas-gruen/.
Gruen, N. 2017. “Making the reserve a people’s bank” The Saturday Paper, April 15 – 21, Edition No. 152, accessed on 25th Sept on https://www.thesaturdaypaper.com.au/opinion/topic/2017/04/15/making-the-reserve-bank-peoples-bank/14921784004504.↩
8. John Barrdear and Michael Kumhof, 2016. “The macroeconomics of central bank issued digital currencies”, Staff Working Paper No. 605, Bank of England accessed on 25th Sept at http://www.bankofengland.co.uk/research/Documents/workingpapers/2016/swp605.pdf.↩
9. Minifie, J. 2015. “Super savings”, Grattan Institute, Melbourne, April accessed on 25th Sept at https://grattan.edu.au/wp-content/uploads/2015/04/821-super-savings2.pdf. The latest numbers from APRA suggest that this record remains in tact see APRA, 2017. Quarterly Superannuation Performance June 2017 (Issued 22 August 2017) accessed on 25th Sept at http://www.apra.gov.au/Super/Publications/Documents/2017QSP201706.pdf.↩