BREXIT – Productivity and Patience....
Recent data from the ONS shows that since the financial crisis five sectors of the economy account for two thirds of the much-discussed decline in productivity growth. Strikingly these sectors only add up to some 11% of the economy.
The guiltiest sectors are electricity and gas (not much incentive to improve given the industry structures), telecoms (seems very odd!), banking (lives spent form filling and dealing with prosecutions) and more directly for our readers the management consultancy sector and the legal and financial services sector.
These last two sectors have grown but their productivity growth per soul has not matched most of the economy - even the NHS has done better!
So should we worry about this feeble rate of improvement in our industry’s performance? We should – the country is dropping down the league tables.
It is worth pointing out that output per head is a crude measure of productivity. Worthless work such as producing statistics and audit reports that are never read still generates revenue for the financial sector, but may actually harm the total economy by diverting resources to pointless activity and away from productive activity.
Mrs May’s Government is keen to find things to do that can readily get through Parliament despite their lack of a clear majority. Attacking the UK’s lousy productivity growth (growth in productivity half the G7 average since 2008) is clearly an attractive target (especially now the politicians are being banned from spending their days on improving their love lives).
Education may be part of the issue – as more people have gone to university, productivity has struggled. That may be too hot a potato for politicians! Are three years getting a poor-quality degree less productive than their peers who work for those years? (I find it easier to raise this point having recently sold a group of student pubs.)
Anyway, one politically appealing and apparently plausible theory is that we don’t have enough patient risk capital in the UK. Ideas and entrepreneurs simply do not get backing easily enough. Well - perhaps.
It is normal market dynamics that if there was a shortage of such patient capital, returns would be high for patient investors. However, UK venture capital returns are generally low (often negative), and have been so for decades. The assumption therefore must be that the market is adequately, or even over, funded. Oh dear – pouring even more money in could be a bad idea!
The term “patient capital” sounds very attractive. However, patience is not always a virtue. Patient capital may well be indolent capital. Investors need mechanisms to deal with companies which are failing, for whatever reason, to stop the waste of capital and human resources. Impatience does have an important role.
A very limited number of businesses need growth or development capital that is content to receive no income return or capital exit for a period of over 7 years. The UK venture capital and private investor markets operating through a variety of modes already provide substantial capital with a typical target investment period of up to 7 years.
It is worth noting that listed equity provides long-term capital whilst providing liquidity for investors. There are numerous examples of non-dividend paying listed companies that have thrived. Google is a very visible example. Apple has only recently paid a dividend. Patient capital is not just a private market activity. AIM and the LSE both provide excellent patient capital.
The UK has the world’s best-developed array of incentives to support equity investment in EIS, SEIS, VCTs, ECFs, and attractive tax breaks such as R & D credits. The floodgates are open – the problem is the lack of attractive opportunities.
Government interventions at national, regional and European levels, made by themselves investing into these hopefully growing businesses, have well under-performed the private sector in terms of return; even though they may have generated temporary employment in economically deprived regions and bought a few votes.
HM government talks much about the funding of the EIF (European Investment Bank) into UK venture funds, which will obviously be vulnerable as a result of Brexit. But, the remarkable fact is that the EIF does not publish its venture capital returns. Even moderate cynicism suggests the likely level of investment return these Eurocrats generate. I am not a moderate cynic.
The coming proposal from HMG seems to be to allow the British Business Bank to invest lots more money into UK venture capital deals, either directly or through funds. Basic market theory would suggest that this will lower investment returns across the venture capital market, unless there is a sudden and highly improbable growth in the quantity of attractive investments. Inevitably this loss of return will lead to a reduction in private funding commensurate with the volume of public money deployed. This is “crowding-out” and replaces return-desiring individuals with government-backed, civil service-manned organisations likely to have more mixed objectives thrust upon them.
Too easy a supply of venture capital encourages the funding of weak management teams pursuing overoptimistic goals. These doomed activities will consume good people and resources as long as they last, and this waste could actually be caused and prolonged by so-called ‘patient’, but misdirected, capital. Such activity would likely lead to a decline in productivity – which is definitely not HMG’s objective.
Growth in overall venture funding would come most easily from funding weak propositions.
The real problem is generating enough good new businesses - and that is not easy. Education, taxation, culture, regulatory hurdles, basic research and the other needed ingredients are too hard for politicians to fix.
A very attractive scenario for management consultants' reported productivity would be the continuing arrival of large additional volumes of regulation-driven work of high complexity that generates a large volume of high hourly rates - even if it pulls resources from more productive activity in other sectors. General Data Protection, MIFID and the like put consultants' kids through school.
Given the growth in such regulation and worthless pagination in recent years, our real contribution to the economy’s productivity must actually have been dire.
So, from a selfish viewpoint weak productivity growth probably is not a real worry for the profession – even if it is for the country. Regulatory increase and mortality have similar probabilities. And the omens are good – Brexit comes!
Coming shortly is the Great Repeal Bill to implement Brexit. Despite its title, it is in fact a repeal of one Act – The European Communities Act 1972 – and the massively larger adoption of hundreds of pieces of European law. Much of this European law will require changes to make sense (though in some cases it never did). Most of the European law is built around European institutions, which clearly do not fit easily post-Brexit, and the volume of such complications is so huge that no-one believes it possible to fix things properly in the next two years; so we are to have the use of “Henry VIII” powers – which are not reflective of Henry’s amorous tendencies (Westminster is little changed!) but celebrate his dictatorial habits - giving Ministers the right to change the statutes without really bothering MPs.
Now in the area of my specialist subject, overweening regulation, there were grounds for hope way back in 2006 when the Legislative and Regulatory Reform Act was passed, which provided that a Minister (“Henry”) can make any provision which he considers would eliminate burdensome regulation without reference to a parliamentary vote. A wonderful idea, but it got nobbled by MPs and the Civil Service – the process now requires a “Legislative Reform Order”, which frequently takes a year and a half to process and is such a bind that only some 31 Orders have been processed in 11 years, mostly dealing with trivial stuff such as the regulation of charitable lotteries.
It is probably a fair estimate that regulations introduced in those 11 years numbered in the tens of thousands. Canute would sadly be a better analogy than Henry.
So, it is extremely likely that the Great Repeal Bill will produce a shambles of ill-fitting European rules, which seem to be doomed to the same sluggish process and will generate years of mess. Given the scope for transitional regimes and infeasible rules there will be much need for professional services as that shambles is painfully sorted. Doubles all round…….
And yet Brexit could be the opportunity for actually thinning the regulatory forests, dumping daft support for ropey businesses and thus improving productivity and generating great conditions for new businesses. But this will not transpire. Blast.
Jon Moulton, Honorary Freeman
Founder, Better Capital LLP
Experienced and proven turnaround investment professionals
10, Buckingham Street, London
+44 (0)20 7440 0840
http://www.bettercapital.co.uk/team.cfm