David Cameron is to call for moral capitalism: He needs to tackle moral hazard first

Philip Booth
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IT IS widely expected that the Prime Minister is going to start calling for a more moral form of capitalism. I have a simple test of whether a politician is trying to debate, or avoid, tough policy questions – I ask myself whether anybody would disagree with the opposite of what the politician is calling for.

During the 1997 election campaign, for example, the Labour Party called for an “integrated transport system”. Clearly nobody wanted the opposite – a dis-integrated transport system. What the Labour Party actually wanted was a state-planned transport system because they did not believe that the market would bring about a more integrated system. But it was not convenient for Labour to talk about specifics.

So, who is for a more immoral form of capitalism? Since no party would make that its campaign slogan, the harder question is what detailed policies does David Cameron want to put behind his empty slogan? Does he believe that morality within the market system can be improved by state regulation? Does he simply want people to look at their own consciences and freely choose a better way of life? Or does he, like some other politicians who call for a more moral capitalism, want a market system that punishes people who are reckless with and lose large amounts of other people’s money? These are the substantive policy issues on which the Prime Minister needs to reveal his position.

This newspaper recently criticised a recent report by the Vatican’s Justice and Peace Commission – published under its own auspices, it should be noted, not by the Pope himself – that called for global regulation of the financial system and a global bank bailout fund. Those criticisms were well targeted. However, if we go back 20 years, we will find some wise statements in a document called Centesimus annus published by John Paul II. The late pope noted that the social order will be all the more stable if the pursuit of personal interest is aligned to the interests of society as a whole so self interest and the interests of society are brought into “fruitful harmony”. Clearly this is not an original insight, but it was, in fact, an insight rooted in a recognition of the potential problem of moral failure.

Those who believe in free markets and a more moral capitalism need to consider this issue. To put it in more prosaic terms, have people been allowed to get away with reckless and imprudent behaviour because they are able to impose the costs on others? The answer to this question is, emphatically, “yes”. We have had the bailout of some banks in the UK. In the US, risk in the financial system has been underwritten in a big way for more than a generation. This has encouraged imprudent behaviour both by customers taking out credit and by bank managers, and there have been weak incentives for the providers of capital to rein in that behaviour.

Before financial systems were regulated, before deposits were insured and – in the US – mortgages guaranteed, prudent behaviour blossomed. People were disciplined by the market. Banks would often have unlimited liability or have double liability for shareholders. Alternatively, banks and insurance companies might be owned by their customers. On the stock exchange, a jobber’s word was his bond. Companies used all sorts of mechanisms to signal to the market that they would behave prudently and honestly. It was not just the standards of the time demanding it – the demands of the market helped to form the standards of the time.

This is not to say that, if you have completely free markets, morality will look after itself. But, if you ensure that those who behave recklessly, immorally and imprudently gain the most, you are asking for trouble – and you will attract exactly the wrong type of people into the markets. This is true in the welfare state for bankers just as it is true in the traditional welfare state where government imposes huge costs on work, saving and family formation.

Politicians who set up economic systems where the cost of immoral behaviour is pushed onto others, and then respond by calling for “more morality”, are trying to get water to flow uphill. Let Cameron make his speech, but then it would be nice to return to the traditional division of labour in this field. Let the Archbishop of Canterbury and the Vatican’s Justice and Peace Commission comment about the need for morality in finance. And perhaps the Prime Minister can start discussing the day-to-day policy issues that he seems to have left to the churches. Does the Prime Minister believe we should have an economic system that rewards imprudence and recklessness? If not, what policy reforms does he want to see and how is he going to bring those reforms about?

Philip Booth is Professor of Insurance and Risk Management at Cass Business School and the editorial director of the Institute of Economic Affairs.