Let’s hear it for the disruptors

Date: 10 Mar 2020

Bumblebee Design

If government wants to act in a way that is truly “pro business”, it might start by helping challenger firms disrupt the status quo in financial services

The post-1979 orthodoxy holds that governments are there to facilitate the markets, to nudge at the edges and then to stand well back. Being “pro business” is code for minimal intervention and leaving business alone. Governments of every colour have tended to be anti state aid, pro limited regulation, pro reduced tax burdens, pro being “pro business”.

Looking at the success of recent governments, this limited government route seems wise. The public has so far not wanted its politicians to run the commanding heights of the British economy – fearing perhaps the chaos that has befallen our polity spreading to our economy.

However, just at this point of maximum disaffection with our politicians and our politics, there’s an argument to be made for a more proactive role for governments in the business of business. Arguably, what lies behind the dissatisfaction with politicians is the failure of governments to adapt to the fact that the post-1979 orthodoxy is no longer satisfying the electorate. The promised trickle-down effects of an unconstrained free market have simply not materialised sufficiently.

The unacceptable fact that working families are afflicted by poverty (70 per cent of children in poverty live in a family with at least one working parent) points to this failure. Businesses left to do their own thing brought us, along with incredible tech and inexpensive consumer goods, horse meat in lasagne, exploitative and low-quality work for some and, of course, the packaging and repackaging of financial securities that ultimately metastasised into the global financial crisis.

The government response to these issues has been, reluctantly, to regulate – but to do so with as much care and attention so as to remain in the “pro business” camp. Regulators make huge efforts to evaluate and assess the regulations they impose – something I know well from my time at HM Treasury and the FSA. But the regulatory response seems to miss a key point, which is that some of these failures had their roots in the very business models of the industries concerned. In the case of financial services, for example, the industry depends upon pushing products to consumers with little understanding of what they are buying and who tend to buy based on consumer loyalty (or inertia). They are unable to be the rational “economic man” envisaged by Adam Smith. And the business model is designed to exploit this: products are rarely designed with consumer needs in mind: they are designed around what can be sold.

Governments can overlay regulation on to these sectors, but when the issue is embedded within the business model, suboptimal consumer outcomes are inevitable. This is where challenger businesses have an important role: by bringing new ways of doing business and disrupting the status quo, they can help to achieve better outcomes for consumers.

But here we face a challenge: regulation, which is intended to constrain poor business behaviour, can actually serve to entrench it. Despite the vast tracts of regulation in financial services, the prevailing business model (basically packaging product and cross-subsidising from one product line to another) remains more or less unaltered. Why? Because the regulatory environment is so demanding that the biggest financial organisations have effectively become regulatory process machines – organisations with huge resources that manage and navigate the regulatory landscape with the provision of financial services a sideline to the regulatory machine.

Consequently, regulation becomes a barrier to entry for any new business wanting to challenge the prevailing business model.  For challenger organisations without the heft derived from years of profit, the regulatory burden is a huge barrier to entry; big banks are effectively buttressed by the regulatory regime. And as experts in regulation, big banks have a seat at the table with government that the innovative and entrepreneurial organisations can only dream of. On top of this, lobby groups represent the banks, who pay for their existence. Rather than just being subject to regulation, the big banks actually contribute to its maintenance and so bolster their own positions in the market.

One question doing the rounds in the world of financial regulation is whether the FCA should require financial-services businesses to centre consumers in their business model. The FCA currently requires firms to “treat customers fairly”, but that is a pretty lowly goal. Should the authorities be braver and require that firms put serving clients at the heart of the business model? This would be an intervention in business that governments have felt unable to make for decades. But if it helped challenger organisations gain the traction necessary to shift the balance of the industry, it could be deemed a pro- markets measure. Being “pro business” could start to mean something more than accepting the status quo.