Much as I think that a Corbyn led government would be an epic disaster – both for investors and citizens – I don’t want to give the impression that all the ideas coming from Labour and the Left are as crazy as their leaders’ foreign policy. There are the odd few smart ideas kicking around especially around lifetime learning and decentralisation. Even within economic policy – the bastion of the ultra Marxist McDonell – there are some interesting ideas kicking around. In particular hats off to Phillip Aldrick at The Times who has done an excellent job of highlighting the influence of one of Labour’s few, remaining City-based advisers – Graham Turner of GFC Economics.
I strongly suggest reading Turner’s report for the Labour Party on financing investment – it was released back in June and is available online at http://www.gfceconomics.com/wp-content/uploads/2018/06/Financing-investment-final-report-combined.pdf
There are lots I don’t agree with this in this weighty missive, with perhaps my biggest fear being quango overreach. In order to support the suggested new industrial strategy, we’ll see a blizzard of new initiatives and organisations brought into being. The chart below from later in the report nicely sums up what I think could be a bureaucratic nightmare of conflicting policy objectives and reporting lines.
The report also takes aim at the dividend preferences of UK listed business, rightly pointing out that many (usually large) companies choose to focus a large chunk of their cash flows at shareholders. I bloody well hope so, is all I’d say. How on earth do we expect to help finance our future pension funds?
There’s also this slightly odd idea going around that dividends are bad, but capex is always good. Much depends on the lifecycle of the business. It is indeed inspired lunacy for fast growth businesses – such as Amazon for instance – to pay out vast sums of cash via dividends and ignore capex. But many businesses are much more mature and frankly, they’d struggle to come up with any sensible ways of deploying spare cash, except perhaps on utterly daft M and A. Also if investors do invest in these mature businesses, it is not unreasonable for them to expect a return on their capital. All things being equal, many of these well-established businesses won’t offer huge capital gains (no re-rating likely here) but the dividends do represent a form of total shareholder return. One last point. Big businesses frequently have so much cash that they can sustain BOTH high capex AND dividends and buybacks. Apple is a great business but it can easily afford to pay out huge amounts on capex and support share buybacks and dividends. It is not an either/or.
The report does go on though to make some strong observations, not least that the UK is vulnerable in the great Tech strategy race. We have some great small businesses doing wonderful tech but too few really big, world-beating enterprises. When we do nurture these world beaters, too many get sold on to foreign owners. Free market enthusiasts don’t seem bothered by this offshoring of ownership, assuming the rest of the world plays by proper free market rules. They don’t. Most of our other major competitors operate on a very uneven playing field and we somehow expect to thrive by ignoring this reality.
More broadly the report makes what I think is a very powerful argument in favour of some form of industrial strategy. The free market right says that all industrial strategy is bad and the government should stay away from it. But again, this ignores reality. The UK government constantly intervenes already in many marketplaces, sometimes with explicit objectives. Take Help to Buy, which is an egregious example of blatant government intervention. It bolsters private sector balance sheets and deliberately encourages one particular model of housing development. It is, for all intents and purposes, industrial strategy. And a big and expensive one to boot.
Another example, ably demonstrated in Financing Investment report – bank lending. What really struck home reading this report is that we have a set of macro-prudential regulatory policies which deliberately encourage lending to commercial property by banks. I can see why banks do it. It is less risky because if nothing else the lender can grab the assets and then work them out via a fairly liquid, broad market in real assets. If I was a bank, forced to be prudent and careful, I’d lend to commercial property as much as I could.
Better SME funding is a real priority for boosting productivity
But there is a downside to this regulatory intervention – a funding gap for SMEs. Even the few SMEs that do get loans are then forced to provide real assets as a backing for the loan. This lending bias towards real assets such as commercial property which could well have an impact on our low levels of productivity.
And it’s that word – productivity – on which we need to focus. Only this week, for instance, we saw the release of the IPPR Commission on economic Justice – Prosperity and Justice – that rightly I think calls on the government to focus strategy and policy on improving productivity. I think there’s much to be said for investigating opening up the remit to the Bank of England and encouraging it to target higher levels of productivity, just as the US Fed openly targets unemployment levels. We need some very intensive work on boosting productivity levels and I’m fairly certain that we’ll discover that boosting investment in technology – and cutting back on investment in commercial property – will prove to be one answer amongst many.
Which brings me back to how we boost investment and lending to the UK’s SME sector, and build our own version of the Mittelstand. The report boasts an excellent section at the end on the importance of fintech innovation, which rightly points out the new tech giants may have a huge competitive advantage in lending to fast growing small businesses – Paypal and Amazon are already hard at work in this area.
The report suggests a blizzard of initiatives and centrally controlled policies and institutions. I have some sympathy with the idea of a National Infrastructure Bank, at proper arms length from the Treasury but I’m also wary of overreach. My instinct is that such an institution needs to emerge more organically from the existing stew of institutions. One issue for instance in SME lending is origination. Currently, too many alternative SME lenders are dependent commercial finance brokers – who are, in my humble opinion, of very, very variable quality. We need new forms of loan origination which aren’t dependent on these finance brokers. Enter the RBS and its (diminishing) network of local bank branches. Let’s keep RBS in the public sector, and reshape it into the National Investment Bank with Natwest as its retail sub. All those branches on the high street could then act as a new origination channel. We might even merge the British Business Bank into said entity.
Get really tough on late payers
And talking of the BB, another simple, organic move might be to address the pressing issue of sub mid-market lending. There are many businesses – our versions of mittelstanders – who seek debt and equity funding in the £1m to £25m bracket. These are helped by the BBB but its reach and capital base would be vastly increased if we licensed a new generation of listed Business Development Corporations, built on the US BDC model. These could source investor capital and then target these sub mid-market lenders ignored by the scale PE players.
Another organic idea is to focus on late payment. This is a real issue with many SMEs in the UK and in my experience, the very worst offenders are the big multi nationals. If we could improve cashflow generation for SMEs that would be an enormous move forward for the UK. The time for bland statements and codes of practise are over.
We need real action. If the government can (arbitrarily) set a minimum wage and a maximum consumer interest rate, why not be even more ambitious for SMEs. Let’s set a national interest charge for all invoices more than 30 days late. It would start at 1% per day and then rise to 3% per day for those 90 days or more. Crucially this charge would only apply to businesses with more than 1000 employees. These usurious interest rates would swiftly solve the problem. Any sensible FD would switch to sub 30 day payment terms overnight. As for policing, we’d let any private sector invoice funder levy the charge. Overnight we’d solve the problem instantly.
But all these are small changes and don’t I think address the big problem with SME lending – which is that it is damned risky. I sit on the board of a fund that lends to smaller businesses and I can attest to what I call the 1/5 or 1/10 fear. In sum, in a bad recession, one year of bad debts could easily overwhelm five years of a positive business cycle (or 10 years as is more recently the case). Bad debts and defaults are akin to a tsunami in a recession, destroying all the good work of the previous years. As a result, many investors have a sensible fear of deploying capital into the space. It also helps explain why the big banks are – rationally – nervous about lending.
Ignoring this default risk is a recipe for disaster, so we need some new thinking. Investors need to have some confidence that during the bad years, they won’t get utterly killed by the markets. My observation is that Government’s around the world already offer credit guarantee schemes for exporters and for mortgage lending to householders. Lets’ introduce credit guarantee insurance for SME lenders. A state entity could underwrite bundles of loans and their defaults and late payment. Investors opt in to the scheme and pay a 1% annual fee to the fund. In recession they can hand the bad debts back to the guarantee corporation who can then work out the SME debts in an intelligent fashion. This last point is really important – we need a mix of creative destruction and anti-deflationary zeal. So, in the depths of a recession we shouldn’t be closing down lost of zombie firms, deepening the debt deflation cycle. But once out of the recession, the guarantee corporation could then bring in PE firms to help aggressively reorganise the zombie businesses and cut out the deadwood that are holding back productivity improvements.
So, in sum, there’s lots of work that can be done to boost SME lending, cut back on real estate lending and improve productivity. It just needs a more ambitious active government, willing to listen to markets and think big. What it doesn’t need are a bunch of Marxists masquerading as social democrats, determined to destroy the capitalist system in some vain quest for a democratic socialist nirvana that will never exist.
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