Scottish Referendum Shows Governments Must Decentralize

Several years into the most serious structural crisis of modern history, it is apparent that there are still a number of flaws, in both the current national and global economic system, that need to be addressed if the West is to resume stable and meaningful economic growth.

We have already stressed and analysed various aspects of this matter in a previous article*, and now the misleading debate between a Yes or No, for Scotland’s independence, has caused us to revisit our analysis.

We assert that these matters are related. We believe that, both sides of the Scottish divide are animated by same goals and objectives, which could be brought to life by an effective revival of both local economies, with a more decentralized economic and political approach.

Since the crisis, the increasing trend towards a further strengthening of oligopolies in all major sectors, have detracted from a real return to stability. This has been fuelled by an excessive and distorted centralization of Europe’s national economies, and by an increased defection from free market competition. The even more centralised imposition of restrictive public spending policies has further depressed consumer demand, and any possibility of a recovery.

This has resulted in a worrying consolidation of companies and a concentration of economic power in all sectors most notably, and most worryingly for the health of the SME sector, in banking.  The crisis’ main culprit, the banking system, is still failing to perform its necessary capital intermediation function to the real economy, preventing a recovery, and also obstructing more open competition.

It is our contention that one flaw that has received less publicity than it ought, surrounds the ability of western governments to revive a ‘local economy approach’; its necessary efforts to decentralize activities, and to develop both economic and political activities in a more evenly distributed way, over our territorial boundaries and localities.

In a world that is inevitably interconnected, yet wishes to follow a democratic process, this appears the real main driver behind the discontent, and subsequent requests for succession, in Scotland, and in other regions like: the Spanish Basque or Cataluña areas, the Corsican island, or in the spirit that made popular the Italian Northern League, and many other analogous regional separatist movements.

Much of the common ground amongst nationalists, however, is the remote nature of highly centralised government, remote both geographically and culturally. The problem of remote government soon becomes seen as rule by “others”, and characterised as an economic and cultural imperialism. Such imperialism may be tolerated when times are good, and the economy thriving, but soon become intolerable when mixed with economic failure.

As a result of the Scottish referendum, which produced a  near 45% vote for independence, (that would have resulted in an independent Scotland leaving both the UK and the EU), we saw  the importance people place on local issues and local democracy. The problems of over centralised government in the UK, where the votes of the 85% English majority overwhelm the votes of voters in Scotland, Wales and Northern Ireland, yet where each of these countries have their own distinct local challenges both economically and politically, are echoed and indeed magnified across the EU. In the EU, economies share less commonality than those of the UK countries, and their peoples less common history, and less uniformity in culture and values.

What is also notable in both cases is the careless and often condescending attitude of over centralised governments to local political movements that give voice to local issues. Rather than recognise the need for dialogue and change to create both a more robust economy and to address local issues. In Scotland versus Westminster, this centred on issues such as the choice of the local demos over levels and structures of social housing, schooling, health services and taxation. The recognition and willingness of Westminster to recognise the validity of such issues as matters for local decision-making came very late in the day.

In the UK versus Brussels, we are seeing much the same attitudes by central government in Brussels replayed back to Westminster. The failure of central economic policy to stimulate local economies across much of central and southern Europe has created an exodus of about 250,000 people a year into the UK, most notably to the south eastern region of the UK already the most densely populated part of Europe. The problems and costs both social and financial of building the support infrastructure in terms of social housing, schools, hospitals, roads, railways, water, electricity and gas supply, are substantial and seen as desperately wasteful when the infrastructure already exists in the less densely populated countries from where the immigration originates. Free movement of peoples within the EU, was a policy devised to make prosperous and efficient economies more so, not as a bail out mechanism for failed economic policies.

What policies does the EU require to stave off its day of reckoning with local democracy?

As with the UK it must act on several fronts simultaneously. It must recognise that local issues are real, need to be dealt with by the local demos, that is most affected by such issues, and it must find the way to fit such choices within a greater regional political economic framework. It must also create the basis for economic growth that will relieve the economic pressures that aggravate the social issues.

On this latter economic front, the prolonged structural crisis confirmed that the main engine of growth/employment, at a micro-economic level, is represented by the activities of SMEs.

Yet, SME activities can thrive only if a competitive level playing field is established and access to capital made available.

Currently, however, economic activity is strongly biased in favour of a few large oligopolies, controlled by a few players, influencing governments and all too often avoiding taxes. SMEs on the other hand lack effective incentives and access to capital to develop their businesses whilst having the extra economic burden of having to pay their taxes.  The ability of SMEs to contribute to employment, capital formation and economic growth, is directly correlated to the creation of a level playing field.

This issue is we believe especially important in the context of a growth strategy for the UK, for the EU and indeed the West in general.

Will the results of the Scottish referendum force the government to act in this direction?

In our previous article*, we highlighted the importance of resolving the growing “disconnection” between the control of corporations, (and other entities) exercised by both management, and owners. In that article, not only did we aim to find solutions to the agency problems, but we also looked at issues to do with the differing objectives of professional investors, as owners of public companies, versus the objectives of owners of private companies.

This point is vital since it appears that these professional investors, dimensionally large and detached, fail to match their interests with those of society as a whole.

That debate was pointing to the creation of a specific set of policy and governance reforms to avoid the system failure. We reiterated that: “Capitalism without owners will fail”. We also added that any nation, without the active contribution of its local economies and communities, would also undoubtedly fail.

The policy and governance reforms outlined in our previous work went disregarded. We are now suffering the consequences of deep structural faults: a huge compression of the investment time horizon towards an extreme short term bias, aggravated by the role that tax planning now plays in what has become a major capital misallocation process by large companies. This problem is in turn aggravated by the problems of the banking system which results in capital no longer flowing to where it is most productively used to create future jobs and wealth, the SME sector.

These twin problems constitute a major barrier to capital formation and economic growth. They distort the value of enterprises; reduce the availability of capital and the ability and opportunity to use it. They also ignite permanent instability, as the financial system with its inability to allocate capital to productive enterprise creates a vicious spiral of excess savings chasing speculative opportunities creating volatile asset prices and new “asset bubbles”.

Perhaps the most vivid illustration of this problem is that according to William Lazonick, a scholar at the University of Massachusetts Lowell, the top 449 companies in the S&P500 spent on buying back their own shares and on dividends some 91% of their net income between 2003 and 2012.**

The various QE launched by the FED, the ECB, and the Bank of England, claim to soften this malicious time horizon distortion. Yet, our contention is, that in order to be effective, they should be accompanied by a proper set of systemic policy and governance actions to favour the local economy.

Whilst the re-regulation of capitalism on a global scale, is arduous to implement, this does not stop any one country from tackling the problem. Developing policies that create a level playing field between SMEs and large companies, should encourage SME companies to grow.

It is relatively easy to identify policy changes which the UK might implement and what their effects might be, as most of the policy instruments necessary to support the growth in private companies, are under the control of the UK and regional government agencies.

Firstly, fixing the imbalance of powers between centre and periphery, allowing local agencies to respond to local needs in both infrastructure development and application of the planning system, to encourage local enterprises to develop and grow.

Secondly, there needs to be a major rebalancing of commercial, political and tax policies away from encouraging the growth of oligopolies, and favouring a variety of multiple players, to resolve our economies lack of growth.

The benefits of a more distributed and balanced territorial approach, and a decentralized development of social and economic policies, would increase economic activity, and accommodate the social tensions now aggravated by the current economic malaise.

The Scottish divide should be taken as both a warning and a learning opportunity for the UK and EU. The decentralisation of social and economic policy is vital to the continued health and indeed existence of these central institutions. It is not a threat, it is a last opportunity for them both.

A version of this article will be available on the on the Global Policy Institute and Long Finance Journal.

Brandon Davies is the Chairman and CEO of Ltd and a member of the Financial Markets Group at the London School of Economics

Carlo Resta is a Senior Research Fellow at the Global Policy Institute:

* CSFI “Capitalism without owners will fail: A policymaker’s guide to reform”, Nov 2002

** See “The short-sighted US buyback boom” by Edward Luce FT 27 Sept 2014.

2 Responses to "Scottish Referendum Shows Governments Must Decentralize"

  1. Exchangeman   October 3, 2014 at 1:42 pm

    Some comments to this excellen article.
    The restrictions imposed by the global requlatory reforms are making virtually impossible the development of SMEs in the financial sector and specifically in banking. The barrier to entry is way too high. In the wake of the 2008 crisis there wasan opportunity to estblish a new governance framework and robust and sound principles of risk management. However, the political imperative obfuscated what the real reasons of the crisis were and precluded the implementation of measures that would have helped the recovery and insulated the system from excessive and unjustified risk-taking.What we have ended up with is more regulation that is penalizing SMEs and consumers while being ineffective at reducing risk.

  2. Exchangeman   October 3, 2014 at 1:43 pm

    And another thing…
    This state of affairs has created an oligopoly of banks, propped up by the state with taxpayers money. This oligolopy is proving very efficient at stifling innovation, bleeding customers and keeping the competition of SMEs out.
    The regulators on their part, are proving themselves more adept at being a politifcal tool rather than serving the interests of savers and investors.
    Proof of this are the 30+ applications for new banking licenses that have been languishing with the FCA for the past two years. The UK has one of the most developed financial sectors in the world and yet only ONE new banking license has been granted in the last 100 years (Metro bank). So much for financial innovation, competition and free markets.