Annual Economics Lecture, Saturday 31st January 2015
Dr Peter Bowman, Head of Economics
We live in interesting but uncertain times. In the economy a sense of instability continues to pervade. The crash of 2008 has not been followed by any fundamental reforms or substantial change and we still live in its shadow. A heavy burden of indebtedness, probably worse in the private sector than in the public sector and the pervasiveness of the doctrine of austerity has made recovery slow and painful.
Meanwhile there is a growing suspicion that conventional economics is not the best voice to listen to find out how to make the world a better place. A growing number of economics students are demanding reform of their university curriculum. They are saying that it should at least be widened to include views other than just the orthodox one and there should be a more critical approach so that the basic assumptions and models should be carefully examined rather than just being passively accepted and applied.
Data on the growing inequality between rich and poor continues to act as an indicator that there are fundamental problems with our present arrangements. Oxfam’s recent report carried the headline statistic that 1% of humanity have now managed to acquire 50% of our collective wealth, so what is left for everyone is becoming less and less adequate. Inequality of wealth owned or of income is not necessarily inherently unjust, but when the distribution of wealth becomes so unbalanced that it leads to deprivation for so many then that it can no longer be acceptable. Here in the School we would take these imbalances as symptomatic of underlying injustices. They may well be deep-seated, issues that we have lived with for so long they have become entrenched in the way the way the economy works. Issues as simple as access to land and natural resources.
However with these concerns it is also easy to overlook the immense progress that has taken place, particularly over the last seventy years in raising general standards of living, in the technical innovations we all enjoy and in the increased health provision and longevity we appreciate.
The question posed for this lecture is how can the economy work for the benefit of all?
The approach of our Economics course is to give some simple propositions.
The first is that Economic Life is governed by law. By this is meant natural laws, laws that are inherent in the nature of things, and particularly the laws governing the relations between people in society. The task, the duty even of the economist is to discover and formulate these. The challenge for the legislators, policymakers and CEO’s of the institutions that are the main players in the economy is then to formulate rules and regulations so, as far as possible, they are in accord with these natural laws.
The second proposition we give is that justice implies a fair portion of knowledge, happiness, health and freedom for everyone. This gives a simple criterion to judge the suitability of a particular policy.
Our third proposition follows from a basic analysis that the fundamental activity in economics is the application of work, purposeful human endeavor to land, the free provision of nature. From this it follows that: everyone has the same essential need for access to nature’s material and for access to land.
The intention behind this lecture was to try to give a sense of what the application of these simple propositions might mean in practice by offering examples of what could be taken as endeavours to let these propositions operate.
In the end, out of the various possibilities, two were settled on to be presented in some detail on the basis that real example are multi-faceted and offer many fascinating lessons of what actually happens in real situations.
The first example relates to the provision of direct access to land. It concerns the land reforms that took place in East Asia after the Second World War, sometimes known as the land to the tillerprogramme. It is very evident that Japan and its two former colonies, Taiwan and South Korea, have undergone very rapid and substantial economic growth since that time bringing considerable material benefits to their people, and spread in a relatively even-handed way. Some thirty years later similar developments began to take place on mainland China.
It is also significant to note that when the Asian crisis came in 1997 it was these countries that were least adversely affected, their economies showing a robustness that was not evident in the South East Asian countries such as Thailand, Indonesia, Malaysia and the Philipines which had not undergone land reform. Although the economies of these countries had previously appeared to be showing healthy growth when the crunch came it became apparent that the development that had taken place was superficial and lacking in resilience.
In practice effective land reform is one of the most difficult transformations to achieve because those who are in power are almost always those who control the land. So to yield up the land amounts to yielding up power and it is rare for anyone to do that willingly. One of the participants in this story described the process as like negotiating with a tiger for its skin.
However the situation in Japan and its former colonies in 1946 offered a rare opportunity for constructive land redistribution to be put in place. The territory was under occupation by the allied forces, principally those of the United States. The landowning class that had close associations with the military had effectively been overthrown.
For a number of reasons the situation in Japan was precarious and needed firm action. There was a simple need to feed the population, most of which at this time was still rural, but domestic agriculture had become quite inefficient. Economically there was a need to get the country back on its feet. Probably the biggest fear was of communism taking over. One large close neighbor, Russia had already succumbed and another, namely China was now in the throws of revolution.
The Allied forces occupying Japan were commanded by Douglas MacArthur. He was indifferent about land reform as were many other Americans. Property rights had a sanctity that they were reluctant to disturb, and re-distribution smacked of the very socialism which the Americans were aiming to protect the Japanese from.
At this point Wolf Ladejinsky appeared on the scene. The man who became the main driver of reform was born in Western Ukraine. He fled to the US after the Bolshevik Revolution and so carried with him a very clear idea of how important land ownership was and what would happen if the communists took over.
Ladejinsky had studied economics at Columbia University but had also gained a lot of experience of Asian farming methods through fieldwork. He acquired a very strong reputation as someone who derived his understanding from going in on the ground and gaining experience first hand of actual conditions of the rural workforce.
He was very clear about the importance of land tenure: “the foundation of the social structure,” he said, “must stand or fall in the countryside, and so the peasant and his aspirations must be put at the centre of the piece.”
Ladejinksy was seconded to Japan as Mac Arthur’s Aid.
The situation in rural Japan at that time was that agricultural production was stagnating. Between the wars tenanted land had steadily increased from 20% to 50% of the total. 70% of farmers were tenants handing over up to two thirds of their produce as rent over to the landlord.
Farms in Japan and in East Asia generally are mostly quite small, only a few acres in size. There were a large number of small, often absentee landlords each owning a few of these plots rented out to tenants.
It was clear to anyone with a working knowledge of the system that using a free market approach to stimulate production simply would not work. As population rose and pressure on land increased rents would go up making margins tighter for tenants. Any small farmer who wished to invest to increase productivity would need to borrow and the only people who had money to borrow from were the landlords. They were only too keen to lend, but had an interest in the loan not being repaid since then they could claim the land that had been used as collateral and so increase their holdings. Given that their rents were large and growing, the landlords had no real incentive themselves to invest in capital inputs that increased productivity.
Ladejinksy was convinced that a radical policy of land redistribution was required and convinced MacArthur of this. The Japanese government was requested to pass its own legislation. The following instruction was sent:
In order that the Imperial Japanese Government shall remove economic obstacles to the revival and strengthening of democratic tendencies, establish respect for the dignity of man, and destroy the economic bondage that has enslaved the Japanese farmer to centuries of feudal oppression, the Japanese Imperial Government is directed to take measures to ensure that those who till the soil of Japan shall have more equal opportunity to enjoy the fruits of their labour. The Japanese Government is therefore ordered to submit to this Headquarters on or before 15th March 1946 a programme of rural land reform.
There are strong echoes in this proclamation of the Communist Party’s famous land to the tillers edict in China and it is interesting to note that both ends of the political spectrum recognized that land reform was the only way forward.
The first draft of the legislation was rejected by the allies as being too weak and full of loopholes, not surprising given the representation of the landlords in the parliament. A second, more robust version was then passed and accepted by the allies. Much of the technical work for the legislation had been undertaken by Ladejinsky and his team.
The arrangement was that any absentee landlord with more than a certain area of land had to sell off the excess to the government. [The original legislation had a 5 hectare limit but this was decreased to 3. The effect of the change was that the number of landlords included in the reform rose from 100,000 to over 1 million]. Such was the need for detailed practical knowledge. The sale price was very low and was paid for in fixed interest government bonds whose value was soon inflated away to almost nothing. The tenants were then able to buy the farms they had been working from the government on generous terms.
Most of the re-distribution took place peacefully and by negotiation in the villages rather than being imposed from the top or with the violence that had taken place in China. This was a characteristic of the way Ladjinsky worked.
The very fact that the land reform was imposed from outside was a powerful factor in making the transition a peaceful and orderly one. To quote an observer: “Tenants could take over the land, not with the light of revolution in their eyes but half-apologetically as if it hurt them more than it hurt their landlords, for the cause was not in themselves but in a law for which they bore no responsibility.”
The scale of the operation was huge. 6 million acres, around one third of the total farmland changed hands. By 1950 around 90% of farmland was owned by the farmers that worked it. Around 4 million families gained by the reform and around 2 million lost out.
Under Ladejinksy’ s direction similar reforms were later carried out in Taiwan with even more dramatic effects and also, after more substantial resistance, (and a War) in South Korea.
The effect of the reform was to produce a very great shift in what in the economics course we call the conditions at the point of interaction. The people were the same, the land was the same, but changing the conditions had a huge and liberating effect.
There was a major transformation in the economic and social landscape. Of very great significance was the change in the status of the farmers themselves. They had been freed and were now empowered to act independently and responsibly. They were in a position to enjoy the full fruits of their labour. There was much greater equality. Farmers once liable to be evicted for voicing their opinions learned to take charge of village affairs..
In terms of output, increases in yields were dramatic. Over ten years they went up by around 50% in Japan and were even greater in Taiwan reaching 75%.
Note, there was considerable wisdom of encouraging the small-scale labour-intensive agriculture rather than moving to large scale capital intensive cultivation. This would have been more labour efficient and provided profits for the operators but what have meant thousands, if not millions of small farmers being thrown off the land.
As previously mentioned, most of the farms in East Asia are quite small by western standards, just a few acres in area. To the western mind the operation might appear more akin to large scale gardening than agriculture. Although it is very labour intensive in terms of output per acre this is highly efficient, much more so than large-scale mechanized process.
Even crops normally associated with large plantations such as bananas, sugar cane and rubber, have been found to give higher yields per acre from these small family farms than from large plantations.
The farmers were not just left to themselves. Government invested in the infrastructure needed to support this type of development and many subsidies and grants were offered. Relatively low-interest credit was offered through village co-operatives.
This healthy situation in agriculture had several advantages for the economy as a whole. Soon the farmers were producing surpluses which they were eager to make use of to improve their standard of living. This in turn created the opportunity for small businesses to spring up to meet these demands. Many entrepreneuring farmers set up enterprises on a part time basis, borrowing against their land to obtain the capital they needed and keeping their farms running as an insurance policy.
A number of what later became large international corporations started out by cutting their teeth on the domestic rural market. Think about the little Honda 50 cc engines used to motorise bicycles or the Toyota pickup truck designed to operate on rough unpaved rural roads.
For the country as a whole having surplus agricultural produce reduced the need to import food or even give rise to exports providing much needed foreign currency which was then available for importing capital goods that could be used in the development of manufacturing industry.
Once industrialization started to develop and workers began to migrate from the farms to the cities the system of small family farms also provided a social safety net. Work in the factories could be insecure. In bad times when workers were laid off they could simply return to the family farms to both contribute and be provided for.
So there is an example of the application of the proposition that everyone has the same essential need for access to nature’s material and for access to land. It also an example of the implementation of a bold and radical policy which brought about increased prosperity for millions in the short term but also provided a firm foundation for future development and even if not perfect in its execution carries the sense of being driven by an intention to provide economic arrangements that worked for the benefit of all.
As a post script it is only right to add that although the land reforms did provide firm foundations for later development of manufacturing an unintended consequence was the establishment of a market in land, particularly urban land in Japan. The fundamental right of access to land had been recognized but the corresponding obligation to return to the community the benefits received from enjoying advantageous locations was less clearly understood. In due course Japan paid a heavy price for this omission. As requirements for land for urban development pressed land speculation set in. Many growing corporations began to build up land-based assets. When Japan’s crisis came around 1990 land values rocketed before crashing very heavily leaving the country in a state that is has yet to fully recover from.
The second example is about banking.
Following the financial crisis of 2008-9 much deliberation and debate has been undertaken concerning the banking sector, its excesses, its corruption, its failings and what could be done to improve the situation. There have been various calls for increased regulation and also for fundamental reform.
The idea here is to take a different approach and rather than looks at what is wrong and how it can be made better to take an example of good practice, to look at a particular bank which operates in a very different way to most other banks, with very different outcomes.
Not long after the crash a long-standing member of the economics faculty here (David Nicholls ) who had spent his professional life in banking wrote and presented a paper entitled “Back to Banking Basics.” David referred back to his own experience in the days before de-regulation when banking was a profession with dignity that required integrity, good judgment discretion and prudence. It now seems a million miles away from the reports we have of our present banking culture.
Is it possible to bring about a restoration of values and how might that be done? The next example is given to provide an answer to that question.
Svenska Handelsbanken is one of the major Swedish Banks. It is also one of the biggest twenty five banks in Europe. It first began to stand out as different from the rest after the Swedish banking crisis of 1991 when it emerged as the only Bank in that country not to require Government assistance. In the crash of 2008 it also showed remarkable resilience. Whereas the British banks RBS and Lloyds saw their share price drop by 90% and 75% respectively and both required government bailouts for Handelsbank there was just a small drop of 5%, and no need for government assistance. It soon made a rapid recovery and has been steadily increasing its market share ever since.
One reason this bank is not well-known is that it does not advertise. That in itself says something about the status of the institution. Its way of working is not well understood by its rivals who describe it as “odd” “old-fashioned” or even “losing it”. Also because most of its employees, once they join the bank, tend to stay and recruitment for senior positions is from within the bank there is not much flow of personnel between the bank and its competitors.
The bank was founded in 1871. There is not much to say about its first hundred years other than that it was quite successful and grew quite steadily absorbing other smaller banks to become one of the top four in Sweden. The big change came about in 1970. After a substantial period of poor performance the bank reached crisis point and to resolve the situation it appointed a new CEO, one Jan Wallander.
The new leader set about fundamentally changing the ethos of the bank and the way it operated almost literally turning it upside down. It is not easy to find out much about the man himself, in some respects that does not matter because what he achieved speaks for itself. His background was in research rather than business. He was clearly strong-minded and also regarded as a little eccentric.
A flavor of his way of thinking can be gleaned from the translation of the titles of one of his publications: “With human nature, not against it.”
This carries the sense of being in accord with natural law, particularly the natural law governing the relations between people in society.
Wallander diagnosed that the problems the bank had got into were due to its highly centralized structure, and in particular the way almost all the lending decisions were being passed back to the head office. He set about reversing the arrangement by embarking on a radical process of de-centralisation. It was more than just a re-structuring. Unlike other CEO’s who wanted to make their bank the biggest in the world Wallander’s intention was to make this bank the best in the world.
The central philosophy of the reformed institution was that “the branch is the bank”. Thus major responsibility was devolved in a very significant way down to the branches. As well as a change of organization it was a fundamental change of ethos. The customer became the main focus of attention. Each was allocated to a particular member of staff. Decisions on loans were now made by the branch. They had a qualitative as well as than a quantitative aspect and were based on the managerss knowing their customers and local environment well and that was done by building strong relationships.
One could say this was a return to banking basics. Some call it affectionately the Captain Mainwaring approach to banking.
The branches’ responsibility was not limited just to loan decisions. They also had freedom to decide on pricing, for example the interest rates on loans, there was no one size fits all policy imposed from above. Decisions on advertising such as sponsoring and also recruitment all lay with the branch. With the arrival of internet banking the Handelsbank response was to provide each branch with its own website and so not compromise the relations with customers.
Each branch is highly localized. They are only allowed to take on customers in their own geographical area. This was known as the church tower principle.
As the business turned to being driven entirely from the branches’ contact with customers this meant no central policy or targets were set from the top. The main constraint set by the bank as a whole was, as far as possible, to limit risk as to the issuance of new loans and that in turn was regulated by the judgment of the branch managers working on a case by case basis. This was almost the exact opposite of the bank’s previous way of operating and the convention for most other major banks.
The success of the whole operation depended fundamentally on having the right people in place. Large loans would be referred to regional and head office for review but the final decision was still based primarily on the judgment of the manager in contact with the potential lender.
Another means of oversight was to engender competition between branches by monitoring them closely and publishing the outcomes. However the basis of the comparison was not profit but prudence, the avoidance of bad loans was counted as more important than anything else.
The transition was not necessarily easy and Wallander had to show considerable resolve in making senior managers let go of their perceived hold on power and move away from the idea that policies had to be imposed from the top and decisions always passed back up to the top of the management structure.
Such a de-centralised arrangement can only grow organically with new branches opening one at a time. This can only happen if the region has the right cultural fit and if a suitable manager can be found who both knows the region well and has empathy with the bank’s philosophy. For example since the 1980s there has been a steady expansion in the UK the number of branches steadily rising towards 200. Growth within new branches is generally steady and organic. There are no specific targets to meet but growth takes place naturally as experience is built up.
What about remuneration? Does, the bank pay bonuses? No. Why not? The de-centralised arrangements, particularly the way genuine responsibility falls on the branch employees combined with the strong and rewarding relationships with customers provides a high degree of job satisfaction. This produces a sense of enjoying the work for its own sake rather than as a means to large financial rewards. The staff value their contribution. Good individual performance is in due course rewarded with promotion and strong overall performance of the company as a whole is rewarded by additional collective payments into the bank’s pension fund, which individual’s receive a share of when they retire.
With so much responsibility devolved to the branches and no centrally imposed policies the attitude of senior management is described as one of stewardship rather than absolute ownership. Under the direction of the present CEO Par Boman a foremer branch manager who rose through the ranks and steered the bank through the 2008 crisis the general direction has actually to become more conservative and more risk averse, they would say more purely Handelsbanken. For example the bank no longer deals with finance companies, their treasury department no longer takes part in propriety trading, (i.e. attempting to make profits for itself rather than just dealing with customer investments). They have kept out of investing in emerging markets even though these offer potentially very high returns. They also keep very high capital ratios based on what they would actually need to survive a crisis rather than the minimum they can get away with.
The ethos of the bank does not mean that it is not interested in profit. This remains an important driver for the company but rather than setting goals the aim is to always make a profit that compares favorably with their main competitors.
To undertake and maintain what some would see as unconventional, whilst others would see as a very traditional approach, required a certain steadfastness on the part of Wallander but in time an institutional memory has been established that helps to maintain the ethos. This is assisted by the way staff tend stay and retain experience within the organization.
Maintaining the approach also requires taking a firm stance with the investors. They need to be listened to but the actions taken have to be in the best interest of the bank rather than the short term interest of shareholders.
Maintaining this steady and single minded approach means that the banks fortunes are counter cyclical. In the good times before the crisis when rival banks were expanding rapidly and becoming risk averse Handelsbank’s market share contracted and its profits started to look comparatively low but when the down turn set in their very carful choice of loans stood them in good stead and they remained in a healthy condition to move forward and let their market share increase. There was plenty of opportunity for new business in the UK.
Behind the specific arrangements is a sense that within the organization there is an understanding of the proper function of banking and a strength to organize the institution around this. Conditions have been set so the bank prospers in a steady way, it enables its customers to prosper and the employees have the satisfaction of offering fulfilling and rewarding service.
That may be quite a detailed account but there seem to be many lesson to learn.
Here is an example of an institution that changed from the inside. By so–doing and remaining true to its ideals it avoided the catastrophe experienced by others in the sector the outcome of which were then imposed on the rest of the economy.
It also shows the power of a single-minded individual to bring about change for the better and hold to it.
It gives a sense of a more natural way of engaging in banking which is for the benefit of all – not just the employees, customers, and investors but the rest of society which is protected from the follies of excess.
So, to conclude, what are the proposals for directing an economy that can work for the benefit of all?
The first is for the economist to discover and formulate the natural laws that govern the relations between people in society, laws which, if followed would enable the economy to work for the common good.
The second is the restoration of economics to being an ethical subject which values values, one for which justice is a major consideration.
Thirdly, the need to establish as the basis of the economic system justly governed access of all people to the land and all the other gifts our Maker has provided us with.