Poor Competition In Personal and #SME Banking (and What the CMA Plans To Do About It)

The Competition and Markets Authority has been investigating the state of competition for personal and small business bank customers, and the results are pretty shocking. The full report is here, the summary of findings here and the possible remedies are here.

We have until 20 November to comment on the findings and remedies (email retailbanking@cma.gsi.gov.uk). The CMA's provisional decision on remedies is due in February 2016 and the final report in April 2016.

Most glaring is the fact that 99.9% of all UK businesses are small - over 5 million of them - and the vast majority of them are sole traders. Yet small businesses do not benefit from most of the customer protection and other measures aimed at improving services and increasing competition for personal customers.

You would also think banks would do more to look after small businesses, given they are responsible for at least 5 million self-employed roles, and most new jobs come from that sector. But only 60% of SMEs survive beyond three years and only 40% make it past the five year mark. It's true that no job is for life, anymore, but poor financial services must surely be a factor in such high business death rates.

More has to be done to help this sector thrive. Have your say! 

The P2P Jobs Market

The UK has an army of 4.6 million self-employed people, according to the Office of National Statistics - the largest it's been since we began recording such figures 40 years ago. That's 15% of the UK workforce. Even more significant is that 732,000 of the 1.1m people who have found work since early 2008 are self-employed. Fewer people have been leaving self-employment for employee roles over the past five years than used to be the case. Perhaps that's because of the recession. But over that period numerous services have emerged to support self-employment, and it seems possible that we'll see an even greater shift towards that way of working in the future.

So, who are the self-employed, and how do they find work?

The largest increase in self-employment since 2008 has been among 'managers, directors and senior officials'. But, hey, every self-employed person might claim to be a manager. So it's more noteworthy that the top 3 self-employed roles of 2014 have been building trades, cab drivers/chauffeurs and carpenters. The figures also show that professional and technical occupations are heavily represented.

How do these people find work?

No doubt word of mouth has a lot to do with it. But we've also seen a rise in the number of online marketplaces that match self-employed people with those who need work done. Indeed, TaskRabbit, a leading US marketplace, chose London as testing ground for a more automated model that it later rolled out in the US to replace its initial manual auction service. While TaskRabbit currently seems to cover the broadest range of services, there are many other such marketplaces in the UK, such as RatedPeople, Trustatrader, MyHammer, MyBuilder, TradeAdvisor, Checkatrade and so on. Note that Amazon has launched a 'local services' offering in the US, which suggests it may one day do so here.

The prevalence of cab drivers amongst the self-employed may help explain the growing number of taxi apps and car-share services.

Meanwhile, SchoolofEverything (a client of mine from 2007, on the back of my experience of P2P lending), enables anyone to make money from giving lessons in almost anything you could think of (...no, not that).

At any rate, the growth in both the number of self-employed people and the services that help them find work, suggests that self-employment could be an even more popular model in the future. The rise of the P2P economy?

Innovation Is Vital For Growth, Not Just Cost-Cutting

There's a lot of concern about how to grow the UK economy. Some have pointed to banks and the public sector as 'the enemies of growth' because they are 'extractive', rather than inclusive 'facilitators'. Government spending is too high, as are taxes, and there's a concern that national public sector pay awards have 'crowded-out' private employers. Banks are not lending. 

But there's much more to this, of course. 

Clearly even the generous private credit available during the noughties merely went on houses and consumer spending, rather than building sustainable and globally competitive businesses, especially in the regions. As Steve Randy Waldman of Interfluidity recently explained in the context of southern Europe's troubles, it's the poor allocation of capital, not lack of finance or high labour costs, that causes "an incapacity to produce tradable goods and services in sufficient quantity." Governments aren't alone in their ability to waste money and other resources.

How do these things fit together?

Experience shows that countries whose governments try to spend more than 30 - 35% of their overall output (GDP) gradually produce less and less. That's because governments impose taxes to pay for spending (and borrowing), and tax is a 'deadweight cost' or economic inefficiency. As output declines, the government receives less and less tax so ultimately must spend less on public services. Those services then start to break down. Eventually, everyone speaks Greek. UK government spending is about 50% of GDP. Yet tax receipts have averaged around 38 per cent of GDP over the last twenty years and have never exceeded 40%. The UK government can a funding gap (deficit) of up to 2.5% of GDP before it becomes a 'structural deficit' - an albatross around the country's neck that takes a special effort to remove - George Osborne's current challenge. By contrast, the Australian and Swiss governments spend around 35% of GDP (source: OECD, IEA, p. 47).

On a regional basis, the UK picture gets worse. Public spending in London and the South East has remained under 40% of regional GDP. But public spending equates to 45% of regional production in the East, and a whacking 70% of what the North East produces. Public spending in England is cruising at 50% of national output, while in Scotland it's at 60% and in Wales and Northern Ireland the good citizens are dragging around a millstone of government expenditure equal to 80% of their GDP  (source: HM Treasury, hat tip IEA, p. 57).

So, if you live somewhere outside London and the South East your community has a choice. Either you ask the government to start spending a hell of a lot less on you. Or you make sure the region produces enough so that government spending only represents about one third of your output. Pick neither and you'll αρχίσουν να μιλούν ελληνικά.

It's possible that high public sector pay rates make both of these tasks harder - it means the government is spending more (on its staff), and it's more expensive for businesses to hire the staff they need, so they charge higher prices and their products are are less competitive.  Public sector pay is mainly agreed centrally, in national pay awards. Those who work in more expensive places than the average, like London, get paid a bit more. But employees who work in places where it's cheaper to live than average don't get paid less. So their communities will find it harder to keep government spending in the right proportion to what their community produces.

But this does not necessarily mean labour costs are the main reason for some regions being more competitive than others. Steve Randy Waldman, of Interfluidity, argues that competitiveness is about capital much more than labour:

"... to the degree that unit labor cost statistics capture what they claim to capture ... European workers, North and South, have come to earn roughly equal pay for equal product. Southern European workers do earn less overall, simply because they produce fewer or lower-value goods and services than their Northern neighbors. [But] unit labor costs are not the problem at all: it is the scale of aggregate output. And what determines the scale of aggregate output? Is it the laziness of workers? No, of course not. We all know that when residents of poor countries emigrate to rich ones, the same weak bodies and flawed characters that produce very little at home suddenly explode into economic vigor. The difference is “capital depth”, broadly construed to include all the physical equipment, business organization, public infrastructure, and governance that collude to enable two small hands and a broken mind to accomplish outsize things. Workers’ pay level is not the problem in Southern Europe [or, say, UK regions]. It is deficiencies in the arrangement of capital, again broadly construed, that have left Greece and Spain unable to produce value in sufficient quantity to compete with their neighbors."

 As a result, Steve suggests: 

1. "If Southern Europe lacks competitiveness, the part of the cost structure that needs to be reformed has to do with rents paid to capital rather than the sticky wages of workers; and

2. "The European periphery was rendered uncompetitive by toxic patterns of capital allocation." For this he cites Arnold Kling's recent paper for the Adam Smith Institute, which concluded:

"...economic progress involves creating new patterns of [sustainable] specialization and trade [PSST]. When new opportunities suddenly emerge, there can be periods in which high productivity growth in industries with relatively inelastic demand creates a surplus of workers. It takes time for entrepreneurs to discover new ways to exploit specialization and comparative advantage, and it takes time for the labour force to adapt to new skill requirements. These real adjustments are needed in order to restore full employment."

In short, the UK and each of its regions needs to foster self-employment and entrepreneurship, by creating an environment in which it's easy to start and grow new businesses. Removing the difference between public and private sector pay may help incentivise public sector workers to move to the private sector - as could laying off more public sector workers. The necessity to find new work may be the mother of invention, after all. But that doesn't remove the ultimate need to focus on fostering the process of creating new businesses for those workers to join.

Image from NE Generation.

 

Role of The Entrepreneur

I recently made the point that, instead of looking to the state for our personal wellbeing, the buck stops with each of us personally - whether as voters, taxpayers or whatever - to ensure the wellbeing of others. Some basic, inevitable economic constraints mean the state simply can't do that job for us on any sustainable basis. This is also the difference between an entitlement culture in which we behave as passive victims of our institutions, and an empowerment culture, in which we seize control of those relationships. Ultimately, the state can only serve as a facilitator, enabling each of us to meet our fundamental personal obligation through private enterprise.

But how can we meet those obligations? Which business activities will be the winners of tomorrow? And how can the state help?

Peter Urwin's "Self-employment, Small Firms and Enterprise" very helpfully explains the role of self-employment, with and without employees, as our primary source of "genuine entrepreneurial insight". Big corporations are of little use here. Businesses don't start big. Entrepreneurs start out self-employed, either with or without staff. Yet, picking winning business ideas is impossible: while "entrepreneurship is crucial for economic growth... we have no idea where it will come from - not even in the most general terms." As a result, the best that we - and government - can do is to ensure "a climate in which enterpreneurship can thrive".

Peter lays out some interesting stat's for the UK:

• over half of all new businesses won't exist in 5 years time - yet this is no bad thing: serial entrepreneurship seems to have a greater influence on success than academic qualifications;

• you're more likely to be self-employed if you have dependents under the age of 16;

• about 20% of males who are active in the labour market are self-employed (42% of those aged 65+);

• there is no obvious impediment to being self-employed, and people who struggle for various reasons to fit the big firm mould tend to be self-employed or work for small firms;

• small firms are easy to start, but face impediments to growth through tax and regulation, such as taking on employees - in the UK, only 6% of new firms create over half of all new jobs.

• in particular, "the costs of compliance... are regressive, as there are economies of scale in tax compliance... product market regulation and employment protection legislation". These costs have remained constant despite efforts to eliminate red tape. However, these costs don't prevent people starting up or remaining self-employed with no employees, they inhibit expansion.

It's suggested that there's a distinction between being self-employed for tax planning purposes, and being self-employed for 'genuine' enterpreneurial reason. But if it's impossible to pick who among the self-employed will be successful, then I don't see how you can reliably make this distinction, except with hindsight. Step one to starting your own business is to become self-employed. Perhaps you take that initial step for cynical tax planning reasons, or maybe with a view to figuring out what sort of business you might start. In either case a bigger business could emerge, with lots of employees. Life's what happens to you while you're making plans. The motives are pretty meaningless.

However, Peter rightly points out that there's little room for entrepreneurial activity in large firms - even if self-employed people with the "skills of entrepreneurship" are involved. Those skills essentially being to provide "the central concept around which the firm is initially constituted" and "to unearth the unknown unknowns." I've worked in two start-ups, both of which are still running after 10 and 7 years respectively, and various large firms. Once a bunch of people unite around any business plan it becomes tough to change. Add more years and more people and the job gets harder.

So it's laughable to see big corporate executives and entrepreneurs lumped into the same category, as Luke Johnson recently explained, though the CEOs still at the helm of the companies they created are in a category of their own. This latter group also prove the case for a lack of demand for genuine entrepreneurial skill in big corporations. It's the original vision of the founder that rules, and competing strategic visions aren't welcome. In fact, it's not uncommon for a business to oust its founder only to welcome him back to rescue the ship from doom (e.g. Steve Jobs).

Ultimately, Peter is to be applauded for essentially recommending that small firms should be allowed to retain all their staff as self-employed individuals. This would allow for the rapid expansion of a business around an entrepreneurial concept as it emerges, rather than straining its resources and strangling it in red tape before it has a chance to discover whether the concept will 'fly'. Of course, firms could still choose to offer employment to staff where that is necessary in order to compete in the labour market. But given the healthy, inevitable failure of most small firms within 5 years, and the inability to predict the winners, it seems pointless to require all of them to grind through the cost and admin involved in creating and maintaining the employment relationship.