The visible hand of the Treasury

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The effort to define the ‘third way’ for the centre left after socialism continues with Gordon Brown’s extended essay on economic philosophy to the Social Market Foundation. His analysis has many attractions – and many unresolved problems.

The search for the Third Way is on again. Gordon Brown, the chancellor, set out his economic philosophy in a thoughtful speech to the Social Market Foundation on Monday. Next week, Tony Blair launches a bid for intellectual leadership of the international centre-left under the slogan “progressive governance”.

The issue is how to define the relationship between state and market. Mr Brown follows the social democratic tradition of insisting that elected government, not the market, is the primary source of legitimate authority in society. Government must define objectives and should be ready to use market mechanisms to achieve these objectives cost effectively. This still gives government a big role. He also asserts that when objectives are too complex to be described clearly, as in health services, the state should not only finance the service but provide it.

This analysis has many attractions. It also has big flaws. If state provision is needed whenever objectives cannot be defined clearly, the role of state provision will be considerable. The list of functions that Mr Brown argues is too extensive for a regulator of a private healthcare system to perform is more or less the list of functions the Financial Services Authority and utility regulators perform today. And almost all these functions are currently the responsibility of the many regulators of food retailing. But nationalisation of banks, telephones and supermarkets cannot be where the argument is intended to lead.

Nor are the problems of defining and decentralising objectives solved if the activities concerned are publicly provided. Indeed, it is there we encounter them most acutely. How is central authority to be locally exercised? When Aneurin Bevan declared that the sound of a dropped bedpan in Tredegar Hospital would reverberate around the Palace of Westminster, he described a system that could not possibly work. If parliament was responsible for the dropped bedpan, it was in reality the responsibility of no one at all.

This problem is not resolved by forms of words that declare the need to reconcile national standards with local autonomy. These are incompatible. If you demand uniform standards – in health, in universities, in supermarkets – the result is low standards.

The fundamental strength of the market economy is the pluralist process of diversity and experiment, which generates improvement and innovation through rivalry and imitation. The strengths of that process are relevant to the public sector as well as the private. There is a conflict here between traditional social democracy – in which legitimacy is conferred from the top down through the blessing of elected politicians and their officials – and a market-based economy in which legitimacy in economic matters is earned from the bottom up through success in meeting consumers’ needs. There is no fudging this distinction: it is the difference between social democracy and a market society.

The market economy cannot be separated from the social, political and cultural environment in which it is embedded. The idea that individuals are overwhelmingly self-interested, but that their self-interest can be reconciled with the public good though the ingenious design of institutions, is a damaging misinterpretation of Adam Smith’s invisible hand. It leads to the creation of ever more complex contracts, rule structures, targets and incentive schemes, which fail to achieve their objectives. This is the lesson from trying to set accounting standards for Enron, run British public services and operate central planning systems in the Soviet Union.

The pursuit of social objectives by economic means can only be effectively decentralised if the associated values are internalised by the individuals and institutions involved; if corporate managers present a true and fair view of their affairs because they are proud of the genuine strengths of their business; if health workers deliver good but cost-effective healthcare because these outcomes reflect their professional objectives; if supermarkets sell good food at fair prices because that is what good supermarkets do. This is what a society that has reconciled fairness and enterprise looks like. And the objectives of that society are achieved not because people and organisations have been appropriately incentivised, but because fairness and enterprise are their objectives too. The desire of most people to do a good job is the most powerful asset a complex modern economy has, and one on which such an economy will be wise to rely.

Auditors, target setters and regulators can help at the margin, but like all policemen they can only enforce rules most people would voluntarily accept. The role of political leadership in a market economy should be to lead values rather than to set rules.

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