Social leadership – a people friendly ideology
by Garry WeavenGarry Weaven, the Chair of Industry Funds Management recently addressed the “Crunch Time” conference of progressive think-tanks dealing with Australia’s policy future. This is an edited version of Garry’s address with his permission.
In the course of my career I have usually been engaged in writing and speaking on specific issues. However, this forum and this topic give us the opportunity to re-think or re-state our core beliefs about the purpose and orientation of public policy. That has led me to the title of this address:
Government involves intervention into and regulation of private behaviour. Its purpose of course depends on who is doing the governing. It follows that democratic government is socialist by nature in that all voices must be heard, all interests balanced, and the maximum well-being of the society as a whole pursued as the ultimate goal.
Socialism has become a pejorative term because the regimes that have typically adopted the socialism brand have been unmitigated disasters. Certainly socialist theory has embraced spurious assumptions and breathtaking naivety and is often simply outdated, but mainly the brand has been trashed by misappropriation. After all, even Hitler raised the banner of “National Socialism” to market his particular brand of paranoid fascism. In fact time and time again we have witnessed regimes that, while embracing the central socialist tenet of public ownership and control of the means of production, simultaneously embrace every conceivable anti-social characteristic.
Chief amongst these has been the absence of democracy and the use of censorship and intimidation of the populace. This has simply demonstrated the axiom that power corrupts and absolute power corrupts absolutely and has sometimes been extended to its logical extreme of extermination of sections of the populace.
Other excess baggage typical of socialist regimes has included a proclivity to define public ownership and control as centralised state ownership and control and to doggedly ignore the workings of economic market forces instead of using those forces to foster social outcomes. Not only were political and cultural ideas not allowed to compete, economic ideas and organisational structures were not able to compete, the corollary of which is that inefficient economic units could survive as long as the regime survived. Little wonder then that to paraphrase John Le Carre, the knight of Soviet socialism was ultimately dead inside its armour.
Social leadership
By contrast, a sound Social Leadership ideology would readily embrace market forces. For instance, it would readily recognise that market prices need to operate as a free expression of a society’s preferences and should act as a signal to producers; and it would recognise that interest rates as the price of capital have an important role to play in the allocation of resources to their optimal social use.
Social Leadership requires the recognition simultaneously that governments need to intervene to ensure that market imperfections are minimised so there can be clear signals and that markets left to their own device, are not a sufficient mechanism for delivering a society’s well-being.
Of course some will disparage social leadership as an elitist concept. Others advocate that government should be minimal because they can do best for themselves with minimal government. But I think that social leadership is an imperative for a society to thrive in a global economy.
In particular, a Social Leadership ideology must comprehend that:
- Even a perfectly operating market does not guarantee a fair distribution of income, wealth or work.
- Fair distribution is essential to social cohesion and social cohesion is essential to the long term advancement of social well-being.
- A consequence of private ownership and control of the means of production is that social leadership is required in order to co-ordinate certain activities which are beyond the capacity of the market to co-ordinate efficiently and in an appropriate time frame. This is especially the case in respect to ensuring that economic development is put on an environmentally sustainable footing.
- Democratic governments have a right and responsibility to promote and preserve ideas, practices and organisations on other than economic grounds. The major responsibility being the promotion of democracy itself and its attendant values of equality, fairness and tolerance. This responsibility is increased the freer and stronger is the society’s economic organisation.
The global financial crisis has of course re-opened, in a very abrupt way, the debate over the desirable extent of public ownership and control. The Social Leadership Ideology requires only a utilitarian definition such as: “A sufficient degree of public ownership, control and influence over the means of production, service provision, information acquisition and education to deliver maximum social well-being on a sustainable basis”.
This definition of course begs the question of how much is enough but it is clear from my earlier comments regarding intelligent use of market forces that I am more in the quality rather than quantity, and leadership rather than dominance, camp when it comes to government intervention.
Models of development
The last 25 years has seen the rapid decline of traditional socialist/communist models for economic development. The so-called “end of ideology” has been linked to the triumph of market capitalism which, in tandem with an unprecedented growth in scientific knowledge and technological innovation has produced rapid global economic expansion and relative abundance (at least in the developed world). This has been associated with explosive consumerisation, the “choice” mantra, and a dominant role for marketing in an attempt to keep pace with the rapidly expanding productive capacity of the world economy. In more recent years this sustained boom has produced a massive increase in credit and debt leverage and a burgeoning financial services sector with its increasing layers of intermediation between borrowers and lenders and between investors and enterprises.
The end result of all this marketing, credit growth and intermediation is firstly excess and then crisis.
Credit has grown rapidly for a number of reasons. Firstly, an extended period of rapid economic growth, wealth creation and technological advances gives rise to the notion that it is both possible and reasonable to bring material advancement forward in time through borrowing. Secondly, increased indebtedness of working people acts to mask for an extended period of time, the gross inequalities in material advancement within a society and between societies. This means it is popular with both consumers and government, as well as vendors.
Thirdly, the creation of large economic surpluses results in a massive expansion of the financial sector which can then create a multiple expansion of credit through the magic of the banking system, which is founded on confidence, and through sophisticated marketing. Fourthly, a permissive global monetary policy combined with sustained economic growth gives rise to the ability to enhance investment returns (for a time) by maximising the debt leverage of assets, that is, a higher IRR is produced simply by increasing the debt carried by an asset or enterprise. This ultimately leads to the displacement of entrepreneurs and managers by financial engineers. But of course leverage has a reverse multiplier effect once expected returns fall below interest rates.
The scale and degree of financial intermediation and its associated sales and marketing has been a significant factor in the GFC because it has disguised fundamental risk and has been relatively unregulated. The immediate source of the GFC was of course the U.S. sub-prime mortgage market. Here we had people being sold loans usually by mortgage brokers who were paid upfront sales commissions or by an incentivised sales force whose incentives in turn are ultimately linked to senior management incentives which are often short term but very lucrative and therefore powerful.
What is produced is a fundamental disconnect. That is, the broker’s incentive is completely disconnected with the interests of either the borrower or the lender, so long as the loan gets sold. The broker is not particularly interested in whether the loan can be afforded by the borrower or repaid to the lender. The bank management interests are also often largely disconnected from the long term interests of shareholders. Once the loans are made another sales commission driven intermediary packages loans together and on-sells them to another financial institution allegedly de-risked because they are now a diversified package. This institution might in turn structure them, along with other “asset” packages into a new investment product perhaps adding another layer of debt leverage (and certainly another layer of fees) along the way. No-one has fundamentally audited the original loans to see whether they really do represent an appropriate ratio to the value of the underlying assets. The U.S. home lending market was almost entirely financed by this securitisation process, the Australian market less so.
I have campaigned for twenty years for an end to up-front and trail commissions on Australian superannuation products.
But they are so endemic to the distribution of retail super and self-managed funds that the opposition and inertia are tremendous. We do not even have an unequivocal law that requires licensed financial planners and accountants to act in the best interests of their clients so they continually detract enormous value from national superannuation savings by refusing to recommend the best performing funds, simply because those funds do not pay commissions.
Similarly, I look at some fund managers in the infrastructure investment space who were able to out-bid their rivals for assets because their intention was not necessarily to hold long term assets but rather to transfer most of the risk to a listed fund and then continue to earn management fees because the ASX (which is itself a privately owned listed company) has no decent rules regarding shareholders’ ability to remove a manager.
These funds frequently borrowed in order to pay dividends. In fact they sometimes geared at four levels – the assets are leveraged to 90% or more, the investment vehicle may be leveraged, the manager is leveraged and then the principal shareholders in the management company borrow against their shares. In the short term this financial leverage can boost the fund’s rate of return but of course it proves disastrous once expected returns fall below interest rates or a credit crunch makes re-financing difficult.
In some cases, a perfect circle of conflict of interest, misinformation and intermediation may be created.
Take for example a financial advisory firm which first of all receives a bank mortgage brokering commission for selling a client a loan secured by the client’s property. The advisor then takes some of the surplus funds of the loan and directs it into its own or a related party investment product, foe exaple, a unit trust or super fund. This product may in fact simply be a packaging of an existing funds management product of the original bank which then pays an ongoing commission to the advisor for as long as those funds remain in place. This can amount to tens of thousands of dollars over the life of a product like superannuation. And of course the original bank or other product provider derive ongoing fees for an extended period.
In some parts of the property market such dealer groups have all but replaced traditional real estate agents by posing as financial advisors rather than sales agents. For example, in the development of new retirement villages or off the plan apartment blocks, it has become common for upfront commissions of 6% to 12% to be paid to these groups by developers anxious to get pre-sales up to a level where the banks will finance the development.
I have taken the time to give these examples simply to point out how large and obvious are the opportunities for constructive re-regulation by a government that chooses a social leadership path. And these are also areas where the total quantum of regulation could actually be reduced in favour of better and better-motivated regulation. This brings me back to the change imperative and the political and social choices which now confront us as a direct result of the GFC. This crisis presents both a threat and an opportunity.
On the one hand the threat of regression as establishments dig in and convince politicians and the populace that bold change is too risky, that traditional monetary and fiscal responses and corporate bail-outs are sufficient leadership. That addressing climate change unacceptably threatens jobs. Politicians respond with populist regulations and pump-prime by stimulating consumption. Nationalism and protectionism re-emerge. The long payback of all the public indebtedness ensures stagnation (maybe stagflation) and stultification and an atmosphere of conflict, both internally and internationally, is engendered.
On the other hand is the opportunity for social leadership, for moving on from the notion that markets self-regulate in the national interest. This requires envisioning of the sort of society we aim for, it requires modern re-regulation, it requires stimulating investment in the infrastructure for a better future, it requires insistence on and strategies to promote corporate responsibility, and can produce a sense or rebirth and growth.
A social leadership agenda
The first requirement is that political leaders must convince the populace that they can lead effectively and must obtain a clear mandate for change. This is not easy given the empowerment by fear given to established vested interests. The need for change and a clear way forward must be enunciated.
One obvious means for addressing simultaneously the case for fundamental change and the need to generate new jobs is a robust response to addressing climate change. It is estimated that the introduction of the Renewable Energy Targets proposed law requiring 20% renewable energy by 2020 will by itself directly result in more than $20 billion of new private sector investment over the next few years. Much of this is necessary simply to allow for growth in demand for power. Much more will need to be done to bring about a significant reversal of Australia’s currently growing carbon emissions. This will be necessary not simply to play our part as a citizen of the world but also to demonstrate that we are an appropriate and responsible trading partner as the consequences of climate change begin to affect nations and they turn their protectionist instincts against imports from high carbon-emitting countries.
Many other opportunities exist for enhancing our economic and social infrastructure and putting it on a sustainable footing which also address the immediate imperative of sustaining employment. These opportunities include enhancement of public transport systems and rail freight networks, water and waste recycling opportunities and overhauling irrigation infrastructure, building out the energy grid and of course the broadband telecommunications network as well as addressing growing needs in affordable housing, health and aged care and education.
But the task will far exceed the capacity of government balance sheets alone to finance, which raises the issue of how best to attract private sector investment. Currently the share market and banking system is unlikely to be able to support traditional means of funding such projects to any significant degree and in any case these methods have often been marked by excessive intermediation and fee taking and sometimes sub-optimal ownership solutions. On the other hand superannuation funds are no longer in the position of having vast free cash flow in search of scarce infrastructure deal flow. For example, IFM’s clients in Australia are overweight in infrastructure investment precisely because portfolios have held up well compared to the general market. And the GFC is resulting in a large array of attractive investment opportunities world-wide. So governments will need to find ways to more directly connect with super funds and use their own balance sheets to de-risk projects and leverage partnerships while ensuring that the public interest shares in any upside to returns.
Industry super funds (including public sector funds) are judged on their investment returns, but as they are mass-member organisations embracing millions of working people they are at least conscious of the critical importance of a robust labour market and the fact that the interests of their members and the public interest are not very different concepts.
A further opportunity for social leadership is in relation to the advocacy and establishment of decent measurements for national development rather than enslavement to the idea that living standards can only really be measured by GDP per head and that progress depends on the GDP growth rate. For example, how crazy is it that if I am forced to commute for longer and longer each day from my distant dormitory suburb spending more and more on fuel and encroaching more and more on the natural environment this will be measured as a boost to my living standard. Similarly, what a failure of social leadership it would be if the only effective response to the threat of job losses was the exhortation to buy more “stuff”. Clearly we need to wholeheartedly embrace the triple bottom line approach to measurement of success – that is, social, environmental and economic – at the national level, the corporate level and at a community level. We need to be committed to the idea that over-regulation can only be successfully avoided if we consciously use the market to deliver agreed objectives rather than allowing the market to set all objectives.
And social leadership also requires the conscious advocacy of sharing. Sharing of wealth and income on a socially agreed basis that fully acknowledges the need for financial incentive but rejects the idea that the market solution to income distribution is somehow ethically connected, and especially rejects the notion that corporate clubs disconnected from their ultimate owners can set their own standards for personal income relativity.
But we also must do better to ensure social leadership in the sharing of work both in the sense of ensuring that society fulfils its obligation to provide people with a meaningful livelihood, and in the sense of expecting its citizens to contribute meaningfully to the society’s wellbeing. If we can only address the issue of good access to jobs by running an inflationary fiscal policy, fostering rampant consumerism or closing ourselves off from the world, then clearly we are failing the test of social leadership. At the international level the social leadership philosophy requires advancement of free and fair trade and finally, in a world where conflict ultimately means nuclear and biological warfare, the advancement of peace and disarmament.
In the U.S. and Australia and some other countries, the early responses to the change imperative presented by the GFC have been encouraging from a social leadership perspective but by no means unequivocal. And the challenges and pressures that lie ahead remain daunting. I am reasonably confident that the collective global actions being taken will enable the worst to be avoided but far less sanguine that we will fully seize the opportunity for change that we really can believe in.
Reference: Capitalism Beyond the Crisis, Amartya Sen, The New York Review, March 26 2009.
Source: Australian Options, Issue 57, Winter 2009, pp. 7-11.