Giving away the banks is fraught with danger
7 March 2011
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Over at the Adam Smith Institute, Dr. Eamonn Butler criticises Stephen Williams’ proposals to give away the Government’s shares in RBS and Lloyds to each and every person in the country. As Eamonn notes, this form of privatisation proved disastrous in post-communist Russia, where citizens sold their shares too cheaply to oligarchs with deep pockets. Even if they hang onto the shares, Eamonn doubts that they would become the interested shareholders that would ensure good governance of the company, as is surely desired.
I agree with him, but I also see two further problems with this proposal.
Firstly, each shareholder would own such a small fraction of the company (about 0.00000014 per cent of RBS and 0.0000007 per cent of Lloyds, I calculate) that their influence on decisions would be minimal, rendering their presence at an AGM or the time spent filling in the voting forms meaningless.
The second issue is one of fairness. The debt for the banks does not, as people often claim, fall on each and every one of us equally. It actually falls on each of us in proportion to how much tax we pay. Those who pay more tax are already in the frame for more of the bill. Giving the shares equally to all is a deliberate act of redistribution that does nothing to ease the national debt, which is £66 billion higher as a result of these two interventions alone.
If the shares are sold and the money used to pay down the national debt, each citizen would be relieved of debt in proportion to how much of that debt they were expected to pay in the first place. That seems a much fairer way of going about it. The alternative is to give the money away to the citizens, and tax the hell out of them down the line to recover that £66 billion (and the other trillion, of course). That hardly seems like a sensible approach.
I agree with him, but I also see two further problems with this proposal.
Firstly, each shareholder would own such a small fraction of the company (about 0.00000014 per cent of RBS and 0.0000007 per cent of Lloyds, I calculate) that their influence on decisions would be minimal, rendering their presence at an AGM or the time spent filling in the voting forms meaningless.
The second issue is one of fairness. The debt for the banks does not, as people often claim, fall on each and every one of us equally. It actually falls on each of us in proportion to how much tax we pay. Those who pay more tax are already in the frame for more of the bill. Giving the shares equally to all is a deliberate act of redistribution that does nothing to ease the national debt, which is £66 billion higher as a result of these two interventions alone.
If the shares are sold and the money used to pay down the national debt, each citizen would be relieved of debt in proportion to how much of that debt they were expected to pay in the first place. That seems a much fairer way of going about it. The alternative is to give the money away to the citizens, and tax the hell out of them down the line to recover that £66 billion (and the other trillion, of course). That hardly seems like a sensible approach.
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Over at Lib Dem Voice there is a summary of the proposals along with a positive assessment of it.
I have commented further on why it would be a bad idea.
However, one distinction that the author suggests there which I (and I think Eamonn) had missed is that, according to the author, “A floor would be set so the shares could not be sold until they had passed the price paid by the government and individuals would only keep any gains made above that floor price” – i.e. the government would still recover the costs of the bail-out.
I still don’t think that it is a good idea, and I question how this could be achieved without huge and costly bureaucracy, but it does slightly change things, perhaps.
Tom, I must congratulate you. Not only have you reiterated some of the fallacious or irrelevant arguments advanced by Eamonn Butler at the ASI, but you’ve managed to come up with two completely new ones of your own. You have indeed surpassed yourself.
Firstly, the failure of this form of privatization in Russia was not due to any intrinsic flaws in the basic idea, but down to the total lack of a functioning market economy under which it was attempted. It failed, not because of a lack of “interested owners”, but because there was no established trading mechanism for the shares once they were issued. The shares were issued into an economy without a properly functioning stock market. Hence there was no market into which the small shareholder could sell or buy, there was no liquidity, no competition and anti-monopoly laws, and there was no national price-setting mechanism or trading platform that allowed those shareholders to know the true value of the shares that they had been given. Which is why those small shareholders represented rich pickings for the oligarchs. None of this applies to the UK, fortunately.
Eamonn’s second criticism based on the concept of “interested owners” also fails to stand up to serious scrutiny. The vast majority of those that bought shares under the Thatcher government’s privatization schemes sold them within a couple of years. So clearly they weren’t “interested owners” either. Yet this is the model both you and Eamonn Butler appear to favour. The alternative of selling the banks directly to institutional shareholders is scarcely much better given the atrocious record of many fund managers in holding directors to account at company AGMs etc. So are these fund managers really “interested owners”?
However, your attempt to criticise this proposal because of the low level of voting influence that would be accorded to each shareholder really does take the biscuit. Even if each shareholder only owns 0.00000014 per cent of RBS, that is one share in every 700 million, they have more voting power than the average Indian citizen. So are you going to campaign to abolish democracy in India next? And why stop there? The average American only has about twice the voting power of a future RBS shareholder.
Finally, we come to your final issue of fairness. Here you wrongly assume that the only people who are paying for the financial bailout are those that pay taxes. So you argue that the wealthiest will pay the most. Not so. What about all those (mainly on low incomes) who have seen their incomes reduced and their costs rise as a result of the recession and the austerity measures? Add these factors together and I would argue that they complement each other. So an equal share distribution is indeed fairer. What is not fair is to sell off RBS shares at a discount (as happened with BT and other flotations) so that large windfall profits result for those that can afford the shares (i.e. the rich), with the poor being excluded from the stock market feeding frenzy once again. Now that is an exercise in redistribution: from the poor to the rich!
I suppose pension funds and other institutional investors would be able to afford to buy the shares and thus potentially earn so-called ‘windfall’ profits. But wouldn’t that benefit most of the population, not just ‘the rich’? I seem to remember that under the Thatcher government’s privatisations, the number of shares one could apply for was strictly limited — so much so, in fact, that personally I didn’t think it was even worth the trouble applying.
Despite my previous comment, I believe there are a couple of dangers with this proposal. Given that this is supposed to be an economics forum, I would have thought a few others might have spotted them.
 
The first is that giving the shares away does nothing immediately to reduce the government debt. That will only happen gradually as each voter sells his shares and spends the proceeds. The resulting increase in economic activity will raise government tax revenues. But would it raise as much money for the government as would be forthcoming if the government had sold the shares instead of giving them away? And how quickly would the Treasury get to receive this additional tax revenue?
 
The real danger though is inflation. Giving away bank shares is in effect like a large tax cut. Most voters will sell their shares fairly quickly and spend the proceeds. The inevitable result will be a surge in consumer spending that could drive up inflation and/or fuel a spike in asset prices. These are the real potential dangers that I can foresee.
Despite what I wrote in my first comment here, I do actually think that there could be a couple of hidden dangers with this proposal, though not the ones outlined by Tom Papworth and Eamonn Butler. Given that this is supposed to be an economics forum, though, I would have thought that a few other commentators might have spotted them first.
The first potential problem is that giving the shares away does nothing immediately to reduce the government debt. That will only happen gradually as each voter sells his shares and spends the proceeds. The resulting increase in economic activity will raise government tax revenues. But would it raise as much money for the government as would be forthcoming if the government had sold the shares instead of giving them away? And how quickly would the Treasury receive this additional tax revenue? In short, is this proposal in the best interests of the Treasury in the long term, or could another strategy generate a better return?
The greater danger though could be inflation. Giving away bank shares is in effect like offering voters a large tax cut. Most voters will sell their shares fairly quickly and spend the proceeds. The inevitable result will be a surge in consumer spending that could drive up inflation and/or fuel a spike in asset prices. These are the real potential dangers of this proposal that I can foresee. Injecting up to £20bn into the economy very rapidly cannot be without consequences.
@Cantab83: “one share in every 700 million, they have more voting power than the average Indian citizen. So are you going to campaign to abolish democracy in India next?”
I’ll ignore your obvious attempt to extrapolate my argument to the point where I appear not to be advocating tyranny and focus on the flawed logic behind it.
India has 675 million (that’s less than 700m, and so gives them more voting power, but anyway…) and yet in the 2009 elections barely half of them voted (57 per cent). This despite the fact that India’s government dominates the Indian economy and provides roads, healthcare and education among other essential servcies.
By comparrison, each UK citizen would have a stake in the banks that equalled just 4% of the national median wage. It is hardly likely, then, that many would devote much effort to reading annual company reports and making informed choices about voting.
“you wrongly assume that the only people who are paying for the financial bailout are those that pay taxes… What about all those (mainly on low incomes) who have seen their incomes reduced and their costs rise as a result of the recession and the austerity measures? …”
Here you are conflating the recession with the bank bailouts. Like the Wall Street Crash and the Great Depression, the banking crisis was the first blow in, but not the cause of, the recession. The £68 billion given to Lloyds TSB and RBS didn’t cause the recession or the ensuing austerity; indeed, at current levels they represent just 7 per cent of total government debt. The recession was the result of bad economic policy by the Labour government: notably, running a deficit since 2000 while stoking a credit crisis.
I agree that it is the poorerst who will have to pay for the recession and some of the austerity measures (the latter cut both ways: lower benefits and higher taxes) but the cost of the bank bailouts, which were paid for by government borrowing, will have to be paid for by taxes on future taxpayers.
“What is not fair is to sell off RBS shares at a discount”
Certainly not. And nobody is suggesting that. But then, that’s not the first straw man you’ve introduced today, is it?
Whether or not it’s a sensible or effective way of repaying national debt I think is the elephant in the room on the economics. The politics though are brilliant for the Liberal Democrats. It’s easily understood, sounds like prizes for everyone, and few will care if the state gets the best bang for their buck, outside the Treasury.
Another downside might be making the firm impossible to takeover if it is failing. Unless the value does return to the level of cap, shares cannot be sold. A failure markedly more likely if the board face the requirement to run the equivalent of national referenda on dozens of political mandates from campaign groups at each AGM, and bottom-line focused staff, of the kind that increase shareholder value, don’t want to work in a people’s bank.
I don’t think we can avoid the politics of privatisation so I do not necessarily suggest that the bank is only sold to the highest bidder. However, the issue of voting is important and the comparison with India entirely bogus. Most countries use democracy because there is not a better, peaceful way of changing a government. The ownership and corporate governance structures of firms evolve in a competitive marketplace so that, in a given situation, an effective approach to corporate governance is used. Highly dispersed ownership may have some advantages but it has one particularly large disadvantage and that is the difficulty of holding management to account. Sometimes (eg in the case of mutuals in the past) this led to managers growing the business too much and hoarding rather than distributing profits. In other situations it could lead to wreckless gambling with shareholders’ money. By all means, give some RBS shares away but we should have sufficient that are floated in such a way that the highest bidders can buy the shares and ownership and governance structures that truly add value are developed.
@ Andy Mayer: “Another downside might be making the firm impossible to takeover if it is failing.”
If a company is failing then surely it would be more likely to be due to a failure of management than a failure of ownership, wouldn’t it? So why is the best remedy then to change the owners of the company and not the management? Arguing that it’s all the fault of feckless shareholders does not stand up to any sort of serious scrutiny as far as I can see.
Of course we all know that it is the management that is to blame if a company under-performs. How do we know? Because the managements of these companies are forever telling us it is so. Every time they try to justify their massive salaries and bonuses they do so on the basis that it is they, and they alone, who are responsible for the excellent performance of their companies. The necessary corollary to this ideological viewpoint is that they then must be entirely responsible for any corporate failures as well.
However, if the only way to remove the management is via a takeover, then it is tantamount to admitting that the owners (they being the shareholders) have no control over the company they supposedly own. It is an admission that shareholder democracy has failed, and that the board of directors is, in effect, operating outwith any form of external control or accountability.
All takeovers are therefore either an admission of a failure of corporate governance (i.e. the impotence of shareholder owners and their inability to rein in the excesses of senior managers), or the failure of free markets to preserve competition (i.e. a tendency towards monopolies). Takeovers are a form of corporate cannibalism, as I have explained on my blog. Therefore they are anathema to free markets and act entirely contrary to the interests of consumers and customers alike. They reduce choice and competition in much the same way that a cartel would. If the proponents of free market capitalism were really true to their beliefs, then they would all vigorously oppose all corporate takeovers on principle.
As for the point about the effect that the price cap on share trading would have on corporate governance, this is a bit of a red herring. For a start it is predicated on the erroneous belief that only the threat of takeover ensures that companies operate in the interests of their shareholder. If that were true then cooperatives such as the John Lewis Partnership should not have thrived in the way that they have, should they?