In a recent and much anticipated speech, Ed Miliband called for more competition in the banking sector.  Among other positive results he argues that greater competition among banks will benefit small and medium sized businesses.

After decades of banking becoming more and more concentrated, I am determined that Labour will turn that tide.

I want to send a message to our small and medium-sized businesses: under the next Labour government, instead of you serving the banks, the banks will serve you.

 

[The Guardian 17 January 2014]

Progressives in Britain and the United States have placed and continue to place great importance on increased competition among banks to curb the power of the financial sector and shift lending back to productive enterprise rather than speculation.  The problem is a concentrated and moribund financial sector and Labour’s solution is greater competition.

Does the UK banking sector need more competition?

Discussion of a policy should not be obscured by the label one attaches to it.  With this warning in mind, I distinguish between liberal reform of capitalist economies and social democratic reform.  The first I define as specifying reforms that treat capitalism as an essentially stable and sustainable social structure afflicted by serious flaws, frequently termed “market failures”.  Almost all of these market failures allegedly result from insufficient competition. 

I use the term “liberal” to identify this policy approach because the implicit or explicit presumption is that if competition can be restored or maintained across markets, a relatively stable and benign capitalism results.  In the liberal framework competition does not lead to concentration as rival companies eliminating each other.  On the contrary, competition creates an equilibrium in which a market has many sellers and buyers that function as a check on the power any market specific participant.

In the case of the financial sector, the liberal approach to reform attributes the failures of banks to concentration of ownership which undermines competition.  The argument goes that were the financial sector less concentrated, competition would prevent or substantially reduce behaviour that results in unproductive lending and failures to serve the interests of households and non-financial businesses.  More competition would even reduce the danger of financial collapse as in 2007-2009 if fostered through appropriate polices (such as a strict division between so-called retail banking and investment banking as in the famous Glass-Steagall Act of 1933 in the United States).

Simply stated, the liberal reform approach asserts that competition is an effective regulator of markets, and the failures of capitalism result from it weakness or absence.  This analysis implies that the reform agenda should focus on restoration and intensification of competition.  In some cases the reforms must include strict measures such as that proposed by Ed Miliband for the capping of market shares.

In contrast, social democratic reform derives from the conviction that competition is not the solution to the abuses in the capitalist system, it is the cause of them.*  The process of competition involves ruthless economic warfare, a survival of the strong and powerful.  Fraud and other forms of criminality represent the logical extension of competitive pressures.  This approach to competition has its origins in Marx and subsequently adopted by writers as diverse as the anti-imperialist John A. Hobson and the fervent defender of capitalism Joseph Schumpeter.

Experience over the last twenty years strongly supports the view of competition as destructive for financial markets.  The destructiveness manifests itself in quite obvious ways.  First, it drives banks and other financial institutions to reckless behaviour.  Unlike in manufacturing, the scope for reducing unit costs in finance is very limited.  As the collapse of the financial sector in Iceland demonstrated, the way a bank pays a substantially higher return to depositors is by engaging in recklessly unsound investments that cannot be sustained. 

Second, banks have only one “product”, credit.  Credit can be presented under different names (i.e., “packaged”).  Selling the so-called financial products as if they were different involves varying degrees of deception of the buyer.  The experience of households with many of the “innovative” mortgage forms demonstrates how deception easily becomes outright fraud.

Third, with only one thing to sell either banks can compete by using reckless investments to cut prices, misrepresent their product (money), or seek new markets in which to sell it.  The infamous sub-prime mortgages are an example of the last, and the direct result of competitive pressures.  Competition not its absence accounts for the Global Financial Crisis of 2008.

The way out of this financial quandary

As I argue in my new book (The Economics of the 1%), competition in many if not most markets is destabilizing and contrary to the public interest.  In no market is that more true than in financial markets.  Among many others Ha-Joon Chang and Michael Burke have pointed out that in place of the dubious competitive mechanism the UK government should use its control of the Royal Bank of Scotland and partial control of Lloyds  to alter lending practices by banks. 

That proposal is a step towards the obvious social democratic reform of the financial sector.  All financial activities except the relatively minor should be moved into either the public sector or the non-profit sector.  In the later arrangement a government would treat the financial sector as it would a public utility, placing a ceiling on the rate of return.  The governing bodies of these institutions (“board of directors”) would include representatives of government, business, labour and consumer groups.

To put it in the proverbial nutshell, take competition out of banking by taking banking out of profit making.  A reform whose main element is intensification of competition, as proposed the Labour leader, would not eliminate the danger of future financial crises.  At the very least it must be accompanied by a contemporary equivalent the measures found in the Glass-Steagall Act or the strict regulation practiced by the Bank of England until the 1980s.

*The clearest statement of this position by a non-Marxist is the famous article by K. W. Rothschild, “Price Theory and Oligopoly,” Economic Journal 57, 227 (1947).  At the end of the article he concludes that capitalist competition lead to fascism.