Bootle on 'the morality of markets'

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Economic guru Roger Bootle's advice on how to steer the British economy away from trouble is refreshingly jargon-free.

"Public spending cuts and efficiency savings - aim to use the money saved there to lower taxes," he told me when we met in his elegantly-decorated office in Victoria.

"There's a more immediate issue of how we deal with the credibility of the government in relation to debt.

"If I were chancellor, I would go for some measures which would bear down on the size of the debt immediately.

"In essence, we should relax about the debt and allow income growth to do the job for us.

"Twice before, we've achieved this after fighting existential wars, the first again Napoleon and the second against Hitler.

"In neither case, by the way, did we deal with this by imposing draconian increases in taxation.

"How we dealt with it was by constraining the growth of public spending below the growth of the economy and letting economic growth produce the tax revenue."

Meltdown warnings

Bootle's new book, The Trouble With Markets, is published today.

It has been rightly praised by critics as insightful and definitive.

His scholarly yet accessible analysis of last year's financial meltdown identifies a series of factors that caused the crisis.

He argues that as well as restricting the activities of financial markets we have to put morals and the idea of public purpose back in business.

Bootle heads up Capital Economics, a macro economic research consultancy.

Everyone from large banks to boutique property investors subscribe to their publications.

He is also a columnist for the Daily Telegraph, an economic adviser to Deloitte and a specialist adviser to the Commons Treasury committee.

Bootle's previous book, Money for Nothing, correctly anticipated the financial crisis – so I begin by asking who else was predicting last year's crash.

He says his Telegraph colleague Jeff Randall and Lib Dem Treasury spokesman Vince Cable "certainly saw a lot of it coming and saw the dangers arising from the explosion of debt".

"A lot of people were worried about the international imbalances.

"I don't think anyone that I can recall really picked up on the vulnerability and weakness of the banking system."

Which begs the question of how so many highly-intelligent people, among them the "armies of risk managers" employed by the banks and the so-called regulators, got themselves into this mess.

Human nature

Bootle's response has as much to say about human nature as financial models.

"The answer is that it is convenient and helpful and positive for everyone to be taken in.

"The time lags between something developing into a bubble and the eventual burst are pretty long.

"So if you're a commentator, an analyst, a regulator or whatever, if you're on the other side (of the argument) you have to go through a very long, uncomfortable period seeming not just wrong but ridiculous and antisocial.

"I know because I've been in that sort of position myself when I called the housing bubble burst too early. I know what it's like and I was right in the end, but boy it was some time coming.

"I think you have to understand the importance of ideas. At its essence I'm arguing in the book that the primary failure was an intellectual one, in understanding just how dangerously wrong markets can get it.

"Around all these people's complacency was a fundamental belief that actually the market can't really be that wrong.

"So if these absurd instruments are being developed then that must be useful, if their price is shooting up to some extraordinary level, that must be a true reflection of reality.

"That was the prevailing view."

The bubble effect

Bootle heaps praise on the work of Canadian-American economist John Galbraith, whose studies of the 1929 economic crash he "admires greatly".

"He said that a lot of people think that in a bubble like this you've got a few mad speculators.

"People are looking on and thinking 'God look at those characters driving up the price'.

"It's not that at all. If it was as simple as that the bubble could never get going.

"What actually happens is that everyone is taken in.

"The regulators, the accountants, the politicians, the central bankers, everyone is taken in and in the process they get blinded to fundamental reality.

"And by the way, professional standards of scrutiny and criticism slacken.

"That's what he said about the 1920s. It is there in print.

"He was absolutely, completely right and in my view the same thing happened here."

Bootle argues that sub prime alone did not cause the 2008 crash.

He describes it in The Trouble With Markets as "an egregious manifestation of a much more widespread phenomenon of excessive lending".

He is talking not just about the spike in personal debt but the "compression of risk standards".

Bootle cautions against the idea that if only sub prime had been prevented from getting out of control all would have been fine.

"If you look at just about any risk instrument you care to name, whether it's corporate bonds, lending to an emerging market, governments, second and third tier property, primary properties, it's all the same.

"It's a tremendous embrace of risk or squeezed returns."

G20 and China

Despite this, Bootle remains positive about capitalism as a concept, but does not hold out much hope that an international structure touted by the world's political leaders will have the desire effect.

"I suppose I'm stuck between optimism and pessimism on this, but if push came to shove I guess I sort of believe that eventually something will be hammered out."

He praises the Chinese, "who are absolutely critical to this question and have been so impressive over the last five to 10 years with their grasp and the way they've managed China".

China's economic transformation continues to entrance the West, but what next? Is Africa set to become the next land of consumers?

Bootle patiently explains "that is not the right way of looking at it at all".

"There are two things going on.

"One is the replacement of domestic manufacturing. So the things in question have to be imported rather than produced domestically.

"But of course the whole world can't do that itself, someone's got to produce it.

"The second thing that's been going on is simply the fact that as countries get richer, people tend to want to spend their money proportionately less on goods and more on services.

"So, apart from the import and export thing, as societies get richer you get the share in manufacturing falling and the share of services rising and that's really the dominant feature in all this.

"What I think will happen is that the relative importance of manufacturing in the Chinese economy will tend to fall, but if the Chinese people are given resources and encouragement to spend then there would be a lot more Chinese production for the Chinese market.

"Chinese production of both goods and services - that's where the job generation will come from, rather than selling things to us in the West."

Money and morals

In The Trouble With Markets, Bootle argues that capitalism has an "absolutely fundamental" moral dimension.

The Victorians illustrate that the Wall Street view of "greed is good" has not always been the model for capitalists.

"They were interesting because this is the period supposedly of rampant self-interest and competition, but also what comes out of the period is tremendous sense of social solidarity, morality, ethics, values.

"In this country of course you've had so many successful industrialists and entrepreneurs who were devoutly Christian and humanitarian in their interests," says Bootle, thinking specifically of the Quakers.

"Capitalism virtually collapsed and imploded in the interwar period," he explains.

"You had a catastrophic period in the 1930s in America, from which it was rescued by the war.

"You had fascism in Europe accompanied by huge war production.

"You had war and crypto-fascism in militaries in Asia producing some central demand for resources.

"What came out of it was that determination that we weren't going back to anything quite like that.

"So we then had a system of managed capitalism in which the state occupied a leading role

"And then came along Reagan and Thatcher to challenge all that.

"They said 'let's go back to the pure period of the 19th century'.

"In conclusion my view is that the market was made for man and not man for the market, by which I mean that you've got to see man and society in its entirety.

"The market is part of that, achieving something for human beings and for human society, and you can't conceive of human society without concepts of justice, fairness, duty, responsibility, all these things.

"So to have at the heart of this a great monster built solely on self-interest and greed is a complete total contradiction.

"It's interesting; it seems to me that the textbook models of these things are unbelievably crude.

"Imagine that there's just sort of self-interest, capitalism at one end and communitarian conduct and communism at the other end.

"Well, there isn't.

"You've only got to look at the colonies of Western Europe to see what a mixture there's been and the different roles that the state plays in countries as diverse as Hong Kong, Singapore, Korea or Taiwan.

"And yet these have all been in some sense nominally capitalist but capitalist in a very different way, and the state has conceived its role differently."

Financial regulation

For Bootle, the future will be capitalist, "but that doesn't mean to say that the state just withers away."

Which brings us back to the need for regulation, specifically the Financial Services Authority.

Bootle says he does not know if it will survive, indeed he is stunned the regulator continues to thrive.

"I do find it extraordinary that in an organisation that absolutely completely and utterly failed, it's hard to find a single good word to say about them, actually could end up with more status than power.

"It's quite bizarre, really bizarre."

For Bootle, the key question is not whether the FSA should survive or fold but defining the appropriate role of regulation.

The bigger the regulator and more active it is, the less effective it will be, he argues.

"We'll get these vast rulebooks which no one reads or understands, like so many of these things that don't actually hit the spot, they'll progressively be something that you just sort nod to and nod through and don't take seriously.

"We want something simpler and clearer that allows maximum scope for the markets."

As Labour and the Conservative parties present themselves as best to lead Britain into economic recovery, it can be hard to discern how long that recovery will take and how bad things will get.

Bootle describes his take on the current situation as unorthodox".

"There are two problems really which mustn't get mixed up; one is public spending and the other is public debt.

"The level of public spending is too high from an efficiency point of view, that is to say that under this government huge amounts of money have been wasted, public sector pay has got too high, we've got too many of these wretched diversity awareness co-ordinators doing useless jobs and too many agencies and regulators and nanny-ish manifestations of the state.

"That all needs to be cut back from an efficiency point of view. That is not the same thing as the debt.

"Of course you could cut back on spending and then use that money to reduce taxation.

"I think that there is debt problem in the sense that if we do nothing in the next few years, the debt ratio will rise very sharply.

"I think there will be some people on the markets who will be worried about default and when that happens then the rates at which the government can borrow will go up and the whole thing starts to snowball and get out of control.

"Then you end up with a banana republic sort of situation where default actually becomes inevitable because no one will lend you the money because of fear of default. It is worth avoiding that!

"I think we do need to take some action to stave it off by cutting the debt down a bit.

"However, I think it would be extremely dangerous, above and beyond that particular point, to go a long way very quickly and I think, in essence, we should relax about the debt and allow income and growth to do the job for us."

Click here to order a copy of The Trouble With Markets.