No more market failure: the economic case for nationalisation

While labour's manifesto has often been deemed radical, its economic policies would be far better at addressing the flaws in the current system. 

Peter Kennedy
9 June 2017

Labour leader Jeremy Corbyn campaigning in West Kirby. Andy Miah/Flickr. Some rights reserved.Yesterday’s general election saw the Labour Party make significant gains across the country and robbed the Conservatives of their parliamentary majority. This was in no small part due to the transformational nature of Labour’s manifesto. Where Labour’s proposals were fully costed, not a single pound sign managed to sneak its way into the Tory equivalent.

Corbyn’s Labour outlined measures which would begin to get to grips with some of the country’s core economic troubles. The unveiling of the manifesto precipitated an immediate jump in opinion polls, helping cut the Tory lead to single digits. Yesterday’s electoral swing in Labour’s favour can be taken as a clear sign large sections of the British public are desperately seeking an alternative to a failed economic orthodoxy.

 During an election campaign political debate inevitably heightens in intensity. We’re more likely than ever to discuss politics with friends, family and colleagues who may usually prefer to stay off the topic. It’s hard to argue about economics with your nan in the heat of the moment. If Gary at work says the government can’t keep ‘spending on the country’s credit card’, it’s hard to counter such a fatuous argument with a pithy one liner.

As any progressive will be painfully aware, decades of ideologically motivated misinformation have led to a shockingly poor understanding of basic economics amongst the general public. Proponents of ‘free-market’ capitalism (a misnomer of the highest order) have successfully overseen the popular dissemination of a kind of ‘common sense’ economics. All debt is ‘bad’ debt, government run industries and enterprises are inefficient, and higher wages will always lead to run-away inflation.

This makes for great politics, but has a tenuous basis in economic reality at best. Such a narrative has succeeded by re-writing twentieth century political and economic history to emphasise the failures of economic intervention by governments and minimises the colossal failures of the private sector.

Andrew Simms and Stephen Reid highlight myriad market failures, which can be found across all sectors of the economy. From the NHS to publicly run railways, government provided services often prove themselves more efficient than their privately run equivalents at home and abroad. The US based Commonwealth Fund recently ranked the NHS as the best health service for efficiency and quality of outcomes (this despite a decade of underfunding).

The widespread belief in private sector efficiency is an ideologically constructed myth mobilised politically with the intention to ensure certain sections of society have greater say and control over the economy and its fruits.

Large and small businesses alike rely on government in direct and indirect ways. Whether it be direct subsidies and tax breaks, or policing and educating the population which consumes their goods and services. In many instances, what appear to be innovative businesses are merely monopolies reliant on government funded research & development for their success. Companies such as Apple and Google have made massive profits off the back of technologies developed by tax-payer funded R&D (often emanating from the US Department of Defence). GPS, voice recognition/Siri, the Internet, touchscreen displays are all examples of technological innovations by government, later utilised by corporations for profit.

In response to the abject failure of the market, Labour has committed itself to nationalising Britain’s water and railway systems. So deep is the ideological hold of free-market fundamentalism, that such a policy strikes many as archaic and regressive, regardless of the fact this is the presently the most economically rational option available, as the privatisation of natural monopolies such as water has lead to major inefficiencies and sky-rocketing prices.

The privatisation of natural monopolies such as water has lead to major inefficiencies and sky-rocketing prices.

Before answering how the nationalisation programme would be paid for, it’s helpful to understand why nationalisation of industries can be good for the economy and the public which rely on the services they provide.

Natural Monopolies

Many key industries nationalised following the Second World War were natural monopolies. The most efficient number of firms providing the service is one. This is because fixed costs (business costs — such as water pipes — are constant, no matter how much of the good is produced) are so high, there is no sense in having any competition. A private natural monopoly could easily exploit its power and set higher prices for consumers.

Yet under Britain’s privatised water system, water bills have risen by 64%, compared to a 28% rise in average earnings over the past decade. In Scotland where the water industry has remained in public hands, there have been no price rises. Consumers living in a given area have no choice but to have their water provided by the single company controlling the local supply. Instead of fostering market competition, privatising water supplies has led to the creation of private monopolies (if living in South-East England, I can’t decide to take my custom to a provider in the North-East, for obvious reasons). Government control of natural monopoly prevents this exploitation of monopoly power and the massive inefficiencies it often leads to.

As of 2010, more than 3.3 billion litres of treated water (20% of the nation’s supply at the time) were lost through leaking pipes in England and Wales. This lost water would otherwise have met the needs of 21.5 million people.

Government control of natural monopoly prevents this exploitation of monopoly power and the massive inefficiencies it often leads to.

Externalities —These are the consequences of industrial or commercial activity affecting other parties, without this being reflected by market price. Think of the pollution every VolksWagen car produces, which is not reflected in the company’s share price. Instead the cost of these externalities are borne by society in terms of dealing with the health effects of pollution, upkeep of roads and environmental degradation caused by VolksWagen cars. VolksWagen faces no liability for any of these costs, or ‘externalities’.

Many nationalised industries have significant positive externalities. For example, public transport plays a key role in reducing pollution and congestion. A private firm would ignore the positive externalities, but a government run public transport system could invest in public transport to help improve the economic infrastructure.

Private companies controlling rail routes are legally obliged to focus their efforts on generating as much profit as possible for their shareholders. The level of profit gained often does not correlate with the quality and conditions of the service provided. This has resulted in crowded trains, ancient rolling stock and massive price hikes.

One in three commuters into London were forced to stand for the duration of their journeys in 2016. The Department for Transport also revealed 35 per cent of commuters on services arriving into Blackfriars have been made to stand and almost a third of commuters have been unable to find a seat on trains into stations including Waterloo, Fenchurch Street and Moorgate. The figures show that 94,279 people arriving into London stations between 8am and 9am have to stand, up from 26 per cent in 2011.

These worsening conditions despite the price of a single ticket from London to Manchester having gone up by 208%, up from £50 in 1995 to £154 today. This equates to a price rise more than three times the rate of inflation.

Not only are taxpayers lumped with way above-inflation price rises, but are also expected to subsidise operators on most lines, to the tune of billions of pounds.

90% of investment in the railways in recent years has been through Network Rail and comes mainly from taxpayer funded or government underwritten borrowing. So dependent are private providers on government welfare, the railways have seen a 300% increase in public subsidy since privatisation in the 1990s.

Yet despite these subsidies to under-write operating costs, ever increasing sums of money have a tendency to magically appear for chief executive remuneration. After overseeing the company’s receipt of the lowest ranking of any rail operator in Britain in the summer of 2016 following cancellations and strikes, Southern Rail chief executive Charles Horton was paid £495,000. As is so often the case in the private sector, failure is richly rewarded.

Welfare Issues

Some industries play a key role in the welfare of consumers and citizens. For example, gas and water can be considered necessities for basic living standards and not luxuries. Government provision means that needy groups can be looked after and provided with basic necessities.

40,000 elderly people in the sixth richest nation on earth die due to inadequate heating every winter.

Every winter the UK experiences what are euphemistically referred to as 40,000 ‘excess deaths’ amongst the elderly, due to inability to pay for heating. That translates into one older person dying every seven minutes throughout the winter, purely because they cannot heat their home sufficiently. The same thing does not happen in Scandinavian countries which experience much longer and colder winters.

The UK energy market is dominated by ‘the big six’ energy firms. Whilst 40,000 elderly people die each year due to the rising cost of energy, the company’s profits have risen tenfold since 2007 — collectively ‘earning’ £1bn in profits per year by 2013. The average annual cost of a typical dual fuel bill has risen 45% since 2007.

Labour have proposed the creation of a government energy company to compete with private providers. The government provider will be better placed to ensure vulnerable groups are provisioned for through the use of caps and subsidies. The alternative to such an eminently sensible option is to continue to allow a ‘market failure’ in the form of tens of thousands of needless deaths each and every year.

Industrial Relations

Labour unions often favour nationalisation because they feel they may be better treated by the government — rather than a profit maximising monopoly.

Since the dawn of the neoliberal counter-revolution (our present era of mass privatisation, anti-union climate and financial chicanery in The City of London), there has been a concerted attack on the ability of British trade unions to defend their members’ pay and conditions. Anti-union offensives have come in the form of state violence, as witnessed during the miner’s strike and the imposition of stringent anti-union legislation.

Income inequality was at its lowest in Britain during the 1970s, when the number of workers covered by collective bargaining agreements reached its peak. As Susan Hayter of the International Labour Organization highlights, Countries where a higher percentage of employees have collectively determined wages are also those with lower wage inequality. The opposite also holds true. Countries where fewer workers are covered by collective bargaining tend to have higher wage inequality.

In both Belgium and France, inequality is significantly lower than the UK, even though union membership differs greatly (relatively high in Belgium, very low in France). What both nations’ workers enjoy is the greater coverage by collective bargaining agreements."Mandatory wage bargaining would be far easier and perhaps actively encouraged in state owned industries. A reversal of anti-union laws introduced during the Thatcher government and mostly upheld by New Labour will be critical in any attempt to shift power from capital, in favour of workers. Employees would be better positioned to demand improvements in pay and conditions, bargaining collectively as part of their constituent union and protected by law.

Yet if unions have greater say in the economy, won’t they just demand higher wages, leading to higher prices and ultimately, inflation?

The short answer is, no.

Rising Wages and Inflation

Rising real wages mean an increase in living standards and gives consumers greater purchasing power. In the past decade, many economies such as US and UK have witnessed stagnant wage growth. At present, a rise would be a welcome boost to living standards.

A rising real wage will also enable an improvement in public finances. This is because higher wages will lead to higher income tax receipts, higher VAT receipts and therefore enable a reduction in government borrowing. This is partly due to drive increased consumer spending — a major component of aggregate demand and further economic growth.

At the current time, UK growth could be greatly curtailed by any further fall in real wages. Real hourly wages have dropped by 10% in the UK, second worst in the OECD only to Greece.

Rising real wages usually corresponds with a fall in unemployment. With positive wage growth and rising spending, more demand exists in the economy and firms respond by employing more workers.

If productivity growth is 3% a year (due to improved technology, better management practices, worker enthusiasm) then a firm can afford to pay a real wage increase of 3%. The productivity growth pays for the wage increases. In this case, we can see rising wages without inflationary pressures. Labour costs are rising, but overall costs are staying the same.

This kind of wage increase is sustainable.

Rising real wages arising from increased productivity are generally beneficial to the economy. They enable higher living standards, increased tax revenue — without potential costs of inflation and uncompetitiveness.

Real wage inflation only becomes a problem if it is financed by pushing up prices and diminishing firm profit margins. This kind of wage inflation tends to be unsustainable and could lead to an inflationary boom and decline in competitiveness.

Government Investment

And so we come to the second question often faced by those who support or propose policies which increase government involvement in the economy:

“But How Will It All Be Paid For?!”

The UK economy is currently suffering from chronic underinvestment. More than a third of UK businesses thought they had underinvested during the past five years. A fifth of all firms have experienced constraints on access to credit which have reduced investment. Investment has lagged since the financial crisis.

The private sector’s lack of confidence to invest has been compounded by central government’s abject failure to lead the way. UK government investment, the key underlying driver of per-capita growth in the economy, has entered a prolonged slump despite the unprecedented persistence of near-zero real interest rates. At the same time, the government has relied on consumption to drive economic growth. This has led to substantial household borrowing, which relies on riskier funding from abroad, while government investment has fallen and stagnated since the Conservatives entered government in 2010.

Astoundingly, this has taken place at the exact time when the cost of government borrowing has been at historic lows, including at times negative nominal interest rates on debt financing. Until recently, the UK has had the option of borrowing to finance long-term productive investment at the extremely low rate of 1.5% interest.

There is strong evidence to suggest that returns generated on well-managed, carefully selected public investment projects are significantly higher than their financing costs. By boosting economic growth, this offers the Government the opportunity to capture the returns and service its debt through a mix of direct charges and levies and higher general tax revenues.

The Organisation for Economic Cooperation and Development (OECD) (PDF) suggests that an annual investment of 3.5 per cent of GDP into infrastructure is necessary in developed countries to prevent growth being undermined.

Not only does increased investment mean increased growth, but since the Second World War, high points in net public sector investment have coincided with large current account surpluses. The fastest, most efficient and socially equitable means by which to reduce the deficit in government current spending, would be through a public investment programme.

To put it simply, over the past seven years the UK government has had access to what could be classed as near ‘free money’ (investors willing to buy UK government debt, for very little in return) to invest in productive industry. It has been a policy choice not to invest in roads, schools, hospitals, railways, airports and more at historically low rates of borrowing. Every passenger, patient, student, driver, consumer is feeling the effects of such an economically disastrous decision.

An alternative

Labour's policy programme could only be described as radical if viewed within the strict bounds of British economic discourse prevalent since Margaret Thatcher’s tenure as Prime Minister. For over thirty years now British citizens have been serving the needs of the economy, rather than the other way round.

The policies Labour took to the country limited themselves to mostly mild reforms of the most egregious market failures and inefficiencies outlined in this article. Breaking up energy cartels and private monopolies is only a starting point from which to further democratise the economy.

The ideology of privatisation at any cost has failed even by its own logic, unable as it is to provide economic stability and strong growth. Britain therefore requires a rational economic programme, which emphasis human well-being and flourishing over profitable gain for an increasingly small section of society.

If Labour can build on last night's result and generate greater support for an economic alternative founded on hope and rational economic thinking, we have a real chance creating a more just and economically equitable society.

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