David Green: Wealth extraction, not wealth creation. The Morrisons takeoever – and why government should be prepared to intervene.

11 Jul

David Green is Director of Civitas.

The Government is in a philosophical quandary. Its commitment to levelling up implies economic interventions in favour of left-behind regions. As a result, it has been attacked for abandoning the ideal of low taxes and small government. Simultaneously, it is pursuing some policies that imply continued commitment to the principle of non-interference in economic policy – not least in its approach to takeovers of British companies by private equity, brought to a head recently by offers to buy Morrisons.

The paradox was particularly striking when Kwasi Kwarteng announced new subsidy rules under the Subsidy Control Bill. He felt bound to say that the Government was not returning to the industrial strategy of the 1970s. There would be no ‘picking winners’ or bailing out of unsustainable companies. Producers will be backed only if they have good prospects of success and especially if they are supportive of decarbonisation. An innocent observer might conclude that a policy of avoiding lame ducks and backing promising ‘green’ technologies was picking winners.

The Government appears to have no clear criterion to help it distinguish between policies compatible with personal freedom and those that undermine it. Fortunately, one of the greatest defenders of liberty in the last 100 years grappled with this very problem.

Hayek argued that the main criterion was the rule of law, by which he meant that the Government should act through general laws that applied equally to all, including itself, and specifically that it should not grant preferential treatment to specific people. To do so would undermine the process of competitive discovery by which we reveal better ways of meeting human requirements.

What would this criterion imply for decarbonisation policy? It suggests not pre-judging which producers or technologies will be preferred. In vehicles, for example, there may be a role for hydrogen, hybrids, diesel, petrol, or all-electric. We should allow the competitive system to reveal the best approaches through trial and error.

But what should the Government do about private equity taking over British companies. Must it be accepted as an inevitable consequence of a free market and its ruling doctrine of non-interference?

Again, Hayek thought it through. It was the character of government activity that was important, he said, not the volume. Many measures were compatible with freedom. Moreover, he thought that a government that was ‘comparatively inactive but does the wrong things’ could do much more to ‘cripple the forces of  a market economy’ than one that is active, but confines itself to measures that assist ‘the spontaneous forces of the economy’.

How should this reasoning be applied today? The Morrisons takeover has come under strong fire from others in the financial sector. Legal and General, the City’s biggest fund manager, cautioned against loading Morrisons with debt and selling off its property assets on the cheap. Andrew Koch, a senior fund manager, feared that this strategy would lead to reduced tax paid to the Exchequer (because debt interest is deducted from profits).

Concerns in the City have been multiplied by the experience of Cobham, the defence group, which was sold to American private equity owners about two years ago. At the time, many warned that the new owners would break up the company, but the Johnson Government authorised the deal after getting some promises. Today, more than half of the business by value has been sold. James Anderson of Baillie Gifford, one of the world’s most successful investors, has recently described the underlying problem as a ‘deep sickness’ in UK capital markets.

The claims of these critics is consistent with the thinking of Adam Smith who warned against misplaced trust in manufacturers, speculators and merchants. They were ‘an order of men, whose interest is never exactly the same with that of the publick, who have generally an interest to deceive and even to oppress the publick, and who accordingly have, upon many occasions, both deceived and oppressed it’.

The Government should not fall into the trap of thinking that it should never intervene in corporate takeovers. There is a public interest in stopping the Morrisons takeover. The company’s model is to own the vast majority of its shops and run some its own manufacturers and farms. It is profitable. Private equity has been granted preferential advantages. Owners are allowed to pay tax as if they make capital gains and not profits subject to higher corporation tax. And owners are able to take advantage of the preferential treatment given to company debt compared with equity. A government that used its powers to encourage Hayek’s ‘spontaneous forces’ would equalise the treatment of debt and equity to preserve responsible private ownership.

If the Morrisons bid is allowed to proceed the owners will probably sell off the shops to another company they control and lease them back, giving them a capital gain and an income stream at the expense of Morrisons. This is wealth extraction not wealth creation. If the Government allows its squeamishness towards intervention to paralyse it into inaction, it will drop helplessly into the trap described by Hayek: that of crippling the spontaneous forces of a market economy by inaction.