Anthony Hilton was certainly right to call my comment about the government’s proposed green investment bank “waspish” in the Evening Standard yesterday. He also suggested that it was unfair. Perhaps it was; it was certainly unanalytical, so let’s have a bit more analysis now.
The argument goes that the private sector struggles to raise long-term investment capital and so the public sector has to help. If one looks at the history of the railways, the roads in many countries, the development of electricity, telecommunications and the internet, I don’t think that argument is true. There is a brilliant discussion of this in one of the IEA’s unsung but still excellent publications railway.com.
What probably happens is that we see things that we (as intelligent individuals, journalists, academics, politicians and civil servants) think should be done, the private sector does not do them and so we think there is a market failure. The market failing to provide is not a market failure, however. It may simply be the case that the risks are so great that the private sector is not willing to put its capital to work on such projects because the distribution of potential payoffs does not justify the risks. Capital is scarce, it has other uses: interest rates and capital markets are pretty good at coordinating preferences and directing capital to its best home. Just because it does not go where clever people think it should go does not mean the market has failed.
But let us assume that there is a problem here. Can it be resolved by an investment bank with the government in partnership? I would argue “no”. This new bank will put at risk the capital of people who have not freely chosen to put their capital at risk (taxpayers in general). Decisions as to where that capital will be directed will be taken (or at least influenced) by civil servants and politicians. Anthony Hilton argues that the risks are shared and therefore diminished by state involvement. In fact, the risks are not diminished, they are transferred to a group of people who are forced to carry them: risks are already well shared in capital markets, potentially around hundreds of millions of people on an international basis.
In fact, state involvement will make the risks even greater. The history of state sponsorship for capital-intensive projects is a disaster. Two things go wrong when the state is involved. Projects are determined by what economists call “public choice” (that is the decisions of politicians and bureaucrats courting public opinion and furthering their own interests and prejudices) with only the discipline of a quinquennial election fought on a huge range of issues to keep them in line. Not only will the wrong projects be chosen but they will also be inefficiently executed because market disciplines (represented by people choosing to put their own capital at risk and buying and selling securities according to their beliefs about value) will be diluted. The fact that the early projects involve windmills and so on, when almost all economists suggest that more carbon could be saved much more efficiently through home insulation (encouraged by VAT on domestic fuel), does not bode well.
But what of Anthony Hilton’s suggestion that the industry wants it? This makes me even more worried. What did Anthony Hilton make of the banking industry in the US wanting the risks of the mortgage industry to be partially underwritten by taxpayers and wanting the state to provide capital for the troubled banks? From my reading of his columns, he wants this situation to come to an end as soon as possible. This is not because the market is always right but because state intervention will make it more likely that the market will get it wrong – as happened in banking. The history of state-sponsored long-term investment projects is no better than that of state-underwritten mortgage markets.
I should add as a coda that the identification (ex post) of particular government projects that have worked is not evidence that a general stategy of government direction of investment capital will work. If we have enough state backed projects, the odd one is bound to pay off. The question is, a priori, does the market (with all its incentives for efficiency and the use of dispersed information) or the state allocate scarce capital best? In my view, it is no contest. What the state should do, in my view, is provide a proper stable framework of law and regulation so that long-term investment projects can be made by the private sector with less political risk. I am afraid that recent interventions by politicians in the regulation of the privatised utilities have undermined private sector confidence in the long term. This does not bode well for the operation of this new interventionist mechanism.