Why ‘too big to fail’ is too much for us to take

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Neither a democratic society nor a market economy can accept the notion that a private business is “too big to fail”.

Liberal democracies of the modern world based on lightly regulated capitalism acknowledge two mechanisms of accountability – the marketplace and the ballot box. In the marketplace, organisations that do not meet, or respond to, the needs of society are ground between the twin pressures of their customers and their investors. At the ballot box, politicians that do not meet, or respond to, the needs of society suffer popular rejection.

Commercial success and democratic election are the only sources of legitimate authority in a society that no longer relies on spiritual leadership nor respects hereditary titles. An organisation exempt from either of these disciplines represents an unaccountable concentration of power. As we have today at Citigroup, Barclays and Deutsche Bank.

If “too big to fail” is incompatible with democracy, it also destroys the dynamism that is the central achievement of the market economy. In principle, there is no reason why disruptive innovations and radically new business models should not come from large, established, dominant companies. In practice, the bureaucratic culture of these organisations is such that this rarely happens. Revolutions in business generally come from new entrants. That is why so many of today’s market leaders – Microsoft and Google, Vodafone and Easyjet – are companies that did not exist a generation ago. These companies could not have succeeded if governments had been committed to the continued leadership of IBM and AOL, AT&T and British Airways.

Any form of selective government support distorts competition. To win such subsidy today, the companies concerned must, like General Motors and Citigroup, be both large and unsuccessful. It is difficult to imagine a policy more damaging to innovation and progress.

The assertion that in future we will supervise the activities of large banks so that their businesses do not fail represents a refusal to address the issue. Even if that assertion were credible – and it is not – the outcome would not deal with either the political problem or the economic problem. Such regulation fails to call managers effectively to account, while supervision that ruled out even the possibility of organisational failure would kill all enterprise.

There should be a clear distinction in public policy between the requirement for essential activities to survive and the continued existence of particular companies engaged in their provision. There are many services we cannot do without – the electricity grid and the water supply, the transport system and the telecommunications network. These activities are every bit as necessary to our personal and business lives as the banking sector and at least as interconnected. Even a brief hiatus in their supply is intolerable.

But the need to keep the water flowing does not establish a need to keep the water company in business. We do not mind if one chain of high street shops closes its doors, because there are many other places to buy our clothes and groceries. Other industries are different. We cannot contemplate keeping aircraft circling over London while the liquidator of Heathrow Airport Ltd finds the way to his office.

In all industries where there is or might be a dominant position in the supply of essential public services, there needs to be a special resolution regime. The key requirement is that assets that are needed for the continued provision of these services can be quickly separated from the organisations engaged in their supply. The businesses involved must be required to operate in such a way that such a separation is possible. In some relevant industries such a scheme exists; in others it does not. In all cases, review and contingency planning is required.

“Too big to fail” – whether the claimant is a bank or an auto company – is not a status we can live with. It is both better politics and better economics to deal with the problem by facilitating failure than by subsidising it.

Write to johnkay@johnkay.com
More columns at www.ft.com/johnkay

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