ONLY COMPETITION CAN SAFEGUARD FREE MARKETS / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( HIGHLY RECOMMENDED READING )

Only competition can safeguard free markets

By Maurice Saatchi

Published: November 25 2009 21:56

As the financial crisis unfolded, those who trusted most strongly in free markets watched in dismay and bewilderment. They struggled to understand how competition could possibly lead to a situation where, as President Barack Obama put it, “only the state had the resources to rescue the situation”.

It is for these true believers that questions are being tabled on Thursday for Treasury ministers in both houses of parliament – in the Commons by Michael Fallon, a Conservative member of the Treasury select committee, and in the Lords by me. What, we ask, was the UK market share of the top five companies in the following financial services: retail banking, corporate banking, mortgages, insurance and re-insurance, government bond issuance, foreign exchange, and credit swaps and derivatives?

The UK government owns two banks and regulates all banks. Yet in spite of having at its disposal the power of legislation and such eminent bodies as the Financial Services Authority, the Competition Commission and the Office of Fair Trading, it appears not to know the answer. Estimates range from 80 per cent to 100 per cent, which means that competition is almost over in these markets.

Why is this so important? Because in free markets, competition is the keystone of the arch. Take it away and the edifice crumbles. According to the theory, in a free market, millions vote in a perpetual referendum on the countless products and services on offer. To win support, rivals try to outdo each other and better products and services emerge. In this way, the self-interest of rational individuals brings the best outcome for all.

Unfortunately, it has not worked out quite like that. After 100 years of competition, the record seems to show that Marx was right – the end result of competition is the end of competition.

Marx foresaw constant internecine warfare among capitalists, resulting in fewer and fewer controlling vaster and vaster empires. Any current description of the financial services sector can validate that.

To solve this problem, some cling to the hope that “institutional shareholders” will take more responsibility for the management of these organisations. But that can never happen. These shareholders will never want to get too close to the companies they own, for example by putting their own representatives on to the boards of directors. If they did, they would be exposed to insider dealing legislation. That would restrict their flexibility to deal in shares at the drop of a hat, which would breach their “fiduciary duty” to achieve maximum returns for their investors.

Others put their faith in regulation. They hope that monopolies, oligopolies and cartels can be controlled by government. This was what led Margaret Thatcher to put new regulators – Ofwat, Oftel, Ofcom, Ofgen – in charge of the newly privatised utilities, and Gordon Brown to create a Financial Services Authority to monitor the banks, brokers, insurers, etc.

But the cartels proved far too clever for the regulators. In each case, they have a ready scapegoat – the government. When the state recently asked a bank it owns to “get the bank lending again”, the negative response was that the state also required the bank to meet its capital adequacy ratios, which must take precedence. So it is that banks cannot cut borrowing costs because the government wants them to improve their balance sheets; water companies cannot cut prices because the government wants them to invest in infrastructure; and electricity companies cannot lower prices because the government wants them to invest in renewable energy.

A sell-off of assets owned by Lloyds and Royal Bank of Scotland may eventually restore some competition to the banking market. Yet so far, the UK government’s response to the financial debacle has been restricted to regulatory review. It assures us that the International Accounting Standards Board (IASB) has been charged by the Financial Stability Board (FSB) and the Group of 20 to review its standards and, as a result, is proposing new consolidation rules. It has said that, in addition, the Committee of European Banking Supervisors (CEBS) and the Financial Services Authority (FSA) are seeking greater disclosures on the impact of the crisis. All have concluded that this is an area that needs to be addressed on an international basis rather than by the UK alone – a journey that makes the long grass look like a putting green.

We are all touched by romantic faith in the wisdom of bodies such as the IASB, the FSB, the CEBS, the FSA and so on. All their measures are worthy and will help, but they are not enough. Regulatory responses do not deal with the basic problem identified in our question to the ministers – five companies controlling 80 per cent of an industry without anyone noticing is an accident waiting to happen.

Lord Saatchi is chairman of the Centre for Policy Studies

Copyright The Financial Times Limited 2009