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How public and private bureaucracies stifle innovation

My Times column on the rent-seeking crony-capitalists who stifle innovation:

While the world economy continues to grow at more than 3 per cent a year, mature economies, from Europe to Japan, are coagulating, unable to push economic growth above sluggish. The reason is that we have more and more vested interests against innovation in the private as well as the public sector.

Continuing prosperity depends on enough people putting money and effort into what the economist Joseph Schumpeter called creative destruction. The normal state of human affairs is what The jurist Sir Henry Maine called a “status” society, in which income is assigned to individuals by authority. The shift to a “contract” society, in which people negotiate their own rewards, was an aberration and it’s fading. I am writing this from Amsterdam and am reminded we caught the idea off the Dutch, whose impudent prosperity so annoyed the ultimate status king, Louis XIV.

In most western economies, it is once again more rewarding to invest your time and effort in extracting nuggets of status wealth, rather than creating new contract wealth, and it has got worse since the great recession, as zombie firms kept alive by low interest rates prevent the recycling of capital into new ideas. A new book by two economists, Brink Lindsey and Steven Teles, called The Captured Economy: How the Powerful Enrich Themselves, Slow Down Growth, and Increase Inequality, argues that “rent-seeking” behaviour — the technical term for extracting nuggets — explains the slow growth and rising inequality in the US.

They make the case that, in four areas, there is ever more opportunity to live off “rents” from artificial scarcity created by government regulation: financial services, intellectual property, occupational licensing and land use planning: “The rents enjoyed through government favouritism not only misallocate resources in the short term but they also discourage dynamism and growth over the long term.”

Here, too, hidden subsidies ensure that financial services are a lucrative closed shop; patents and copyrights reward the entertainment and pharmaceutical industries with monopolies known as blockbusters; occupational licensing gives those with requisite letters after their name ever more monopoly earning power; and planning laws drive up the prices of properties. Such rent seeking redistributes wealth regressively — that is to say, upwards — by creating barriers to entry and rewarding the haves at the expense of the have-nots. True, the tax and benefit system then redistributes income back downwards just enough to prevent post-tax income inequality from rising. But government is taking back from the rich in tax that which it has given to them in monopoly.

[Thomas Babington Macaulay MP summarised an early attempt to extend copyright in a debate thus: “The principle of copyright is this. It is a tax on readers for the purpose of giving a bounty to writers. The tax is an exceedingly bad one; it is a tax on one of the most innocent and most salutary of human pleasures; and never let us forget, that a tax on innocent pleasures is a premium on vicious pleasures.” A correspondent sends me the following details of this appalling saga: “Someone noted that there is a divergence in copyright term in the European Union. All the then member states protect works for the life of the author plus fifty years while West Germany alone protects works for the life of the author plus seventy years. Immediately the copyright publishers suggested this as something in need of harmonisation. But instead of harmonising down to the norm, all the member states were lobbied to harmonise up to the unique German standard. As a result, Adolf Hitler’s “Mein Kampf” which was going out of copyright in 1995 was suddenly revived and protected as a copyrighted work throughout the European Union. Gilbert and Sullivan operettas whose copyright had been controlled by the stultifying hand of the D’Oyly Carte Opera Company found themselves in a position to once again stop anyone else performing Gilbert and Sullivan works or creating anything based upon them. It is not surprising that, following a brief flowering of new creativity when the Gilbert and Sullivan copyrights initially expired (e.g. Joseph Papp’s production of Pirates on Broadway and the West End stage), since their revival by the European Union harmonisation legislation their use have become effectively moribund. A generation of young people are growing up without knowing anything about Gilbert and Sullivan – an art form which, it can be argued, gave birth to the modern American and British musical theatre.”]

As for occupational licensing, Professor Len Shackleton of the University of Buckingham argues that it is mostly a racket to exploit consumers. After centuries of farriers shoeing horses, uniquely in Europe in 1975 a private members bill gave the Farriers Registration Council the right to prosecute those who shod horses without its qualification.

Then there are energy prices. Lobbying by renewable energy interests has resulted in a system in which hefty additions are made to people’s energy bills to reward investors in wind, solar and even carbon dioxide-belching biomass plants. The rewards go mostly to the rich; the costs fall disproportionately on the poor, for whom energy bills are a big part of their budgets.

An example of how crony capitalism stifles innovation: Dyson found that the EU energy levels standards for vacuum cleaners were rigged in favour of German manufacturers. The European courts rebuffed Dyson’s attempts to challenge the rules, but Dyson won on appeal and then used freedom of information requests to uncover examples of correspondence between a group of German manufacturers and the EU, while representations by European consumer groups were ignored.

So deeply have most businesses become embedded in government cronyism that it is hard to draw the line between private, public and charitable entities these days. Is BAE Systems or Carillion really a private enterprise any more than Oxford University, Oxfam, Oxfordshire county council or the NHS? All are heavily dependent on government contracts, favours or subsidies; all are closely regulated; all have well-paid senior managers extracting rent with little risk, and thickets of middle-ranking bureaucrats incentivised to resist change. Disruptive start-ups are rare as pandas; the vast majority work for corporate brontosaurs.

Capitalism and the free market are opposites, not synonyms. Some in the Tory party grasp this. Launching Freer, a new initiative to remind the party of the importance of freedom, two new MPs, Luke Graham and Lee Rowley, not only lambast fossilised socialism and anachronistic unions, but also boardrooms “peppered with oligarchical and monopolist cartels”.

One of the most insightful books of recent years was The Innovation Illusion by Fredrik Erixon and Björn Weigel, which argues that big companies increasingly spend their profits not on innovation but on share buybacks and other “rents”. Far from swashbuckling enterprise, much big business is “increasingly hesitant to invest and innovate”. Like Kodak and Nokia they resist having to reinvent themselves even unto death. Microsoft “was too afraid of destroying the value of Windows” to go where software was heading.

As a result, globalisation, far from being a spur to change, is an increasingly conservative force. “In several sectors, the growing influence of large and global firms has increasingly had the effect of slowing down market dynamism and reducing the spirit of corporate experimentation”.

The real cause of Trump-Brexit disaffection is not too much change, but too little. We need to “radically reduce the restrictive effect of precautionary regulation” and promote a new regulatory culture based on permissionless innovation, Erixon and Weigel say. “Western economies have developed a near obsession with precautions that simply cannot be married to a culture of experimentation”. Amen.


By Matt Ridley | Tagged:  rational-optimist  the-times