Plenary

Will HuttonChair, Big Innovation Centre,The Work Foundation

12/06/12

Remaking the Social Contract in the wake of the financial crisis

Will HuttonLondon child poverty conferenceDecember 10th

12/06/12

Good capitalism The future is by definition unknowable. No innovator or entrepreneur can be

sure that a good idea will become a commercial reality – or that wider framework in which business is being done is stable. This is “Knightian risk” – risk that cannot be reduced to mathematical probabilities

Consequently there is necessarily unpredictable change in business models – risk but also opportunity

To lift innovation and investment to optimal levels requires mechanisms for companies to lay off and socialise risk – and address co-ordination failures which are embedded in the market economy

Hence the importance of the ecosystem that underpins capitalism – co-created between public and private, a means of underwriting risk but which needs an attendant value system: equity

Risk must be socialised for ordinary citiizens – the social contract

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The rise of bad capitalism….

Size of UK banking sector

0

100

200

300

400

500

600

1880 1904 1928 1952 1976 2000

Banking sector assets (per cent of GDP)

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Long-run equity capital ratios

0

5

10

15

20

25

30

1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Per cent

United Kingdom

United States

Source: US – Berger, A., Herring, R. and Szegö, G. (1995). UK – Sheppard, D.K. (1971), British Bankers’ Association, published accounts and Bank calculations.

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15

20

25

30

35

40

00 01 02 03 04 05 06 07

Total trading assets as a proportion of total assets

Total loans to customers as a proportion of total assets

Per cent

Growth in trading book assets

JPMHSBCBofA

Citi

Credit Suisse

DeutscheUBS

BNP

SocGenBarclays

RBS

0

10

20

30

40

50

60

70

80

0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8Trading assets/total assets

Fina

ncia

l lev

erag

e

Line of best fit

Global banks’ trading portfolios and financial leverage

Trading books and leverage balloon

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All to create this model… Major UK banks’ aggregate balance sheet as at

2010

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Return on equity in finance rose…

-10

-5

0

5

10

15

20

25

30

35

1921 1929 1937 1945 1953 1961 1969 1977 1985 1993 2001

μ = 7.0σ = 2.0

μ = 21.0σ = 9.0

Per cent

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And remuneration in financial

services boomed…

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A brave new world: The profile of recession and recovery

Source: NIESR http://www.niesr.ac.uk/

12/06/12

Sterling’s Actual Exchange rate ( v euro) compared to

equilibrium

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1.1

1.2

1.3

1.4

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1.7

1990

1991

1992

1993

1994

1995

1996

1997

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2001

2002

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2007

2008

2009

2010

2011

Actual

Equilibrium

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A brave new world: A strategic trade gapComponents of the Current Account (% GDP) base

projection

Source:Centre for Business Research, University of Cambridge

12/06/12© The Work Foundation.

The West’s Dilemma - Bank assets as share of GDP

12/06/12

A brave new world: A long deleveraging process

Source: Haver Analytics; Bank for International Settlements; national central banks; McKinsey Global Institute

12/06/12

Good capitalism as the way forward Unproductive entrepreneurship v productive entrepreneurshipIncumbent v insurgents“Ownership tourism” v committed ownersDarwinian v CollaborativeFinance sole priority v business purpose and balanced score-cardTransactional workplace relations v hi trust workplacesRent-seeking managements v proportionally rewarded managersSocial contract as safety net v social contract as social insuranceClosed access v open accessOpaque v transparencyState capture/minimal state v private and public as co-dependent domainsPolitical capture v democratic processKey value system – fairness, due desert and proportionality

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The times they are a’changingBiggest Bank of England balance sheet ever – including war-time

Intellectual climate changing - Governor of Bank of England: lets get flexible about inflation targets and defer lowering public debt/GDP

Professor Michael Woodford at Jackson Hole. Lets drop inflation targets and adopt targets for Money GDP

The IMF World Economic Outlook. A 1 per cent cut in budget deficit can lead to a 1.7 per cent loss of output. Keynes was right – too much austerity too soon is self- defeating.

Antony Jenkins, Elizabeth Murdoch, Jack Welch, Richard Lambert, Alan Greenspan.

Desperation of Coalition government – funding for lending, Business bank, Catapaults, infrastructure guarantees. Like the 1930s – reality is breaking in.

Concern about social mobility

Decline of Tea Party Republicanism and Thatcherite Conservatism

12/06/12

Knowledge based industries defined by the OECD

Note: manufacturing classified by R&D intensity; services classified by ICT use and employment of graduates. Recreational and cultural industries

recognised as knowledge based by EU but not OECD, and includes libraries and museums.

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Knowledge economy and the 1980s recession and recovery

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990

ind

ex 1

980

=10

0

KE market based KE public based Manufacturing Other Services

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Knowledge economy and the 1990s recession and recovery

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000

ind

ex 1

990=

100

KE market based KE public based Manufacturing Other Services

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Knowledge based sectors leading the entrepreneurial revival

Note: all figures employees, excluding health employment. Knowledge service industries are OECD definition and include business, high tech, and financial services. Other sectors include transport, retailing, hospitality and

other services delivered by non-public organisations. SMEs defined as all with less than 250 employees.

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A short history of general purpose technologies (GPTs)…

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Revolutions of ‘general purpose

technologies’Different types of society and different historical circumstances have been transformed by groups of technologies. Archaeologists have recognised the crucial importance of ‘key factors’ in economic development in their classification of the ‘stone age’, ‘bronze age’ and ‘Iron age’

1784-1845: Early mechanisation and water power – carried by textiles and cotton industries

1845-1900: Steam power and steel – carried by railway expansion and heavy engineering

1900-1950: Electrical engineering and chemistry – carried by rise of electric / chemical industries

1950-1990: Petrochemicals and oil – carried by automotive and the rise of aviation

1990-2020: The digital economy – carried by new media, knowledge intensive and manu. services

2020-2040: Health economics, life sciences, low-carbon economy

The EconomistThe Economist's special survey "Innovation in Industry“ (20 February 1999) 's special survey "Innovation in Industry“ (20 February 1999)

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Twenty-first century prospects ? Grand ChallengesThe mobile phone

NanotechnologiesEnergy from fusionAdvanced materialsCarbon sequestrationSpaceManage the nitrogen cycleWaterHealth informatics Durable customised infrastructureCustomised medicineThe brainCyberspace securityEnhance virtual realityPersonalised learning

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Innovation as the product of a system

Source: NESTA

12/06/12

The Ecosystem Approach

Division of Labour in reality is necessarily structured through organisations and institutions

All confront risk which needs to be at the very least to be mitigated – and at system level risk has to be socialised

There is thus co-dependence and co-creation of business models both within the private sector and between public and private sectors.

Price mechanism cannot perform the co-ordination of relationships, information and idea flows – blockages, breakdowns and coordination failure thus the norm not a default possibility.

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The Ecosystem Approach ( cont )

Public sector is socialiser of risk and designer/custodian of ecosystem within private sector – and the public sector component

The system and actors have to be “open” to maximise interative flows of ideas/relationships/information – hence open innovation and absorptive capacity of firms crucial

Strategic questions for firms: What business am I in? What is the supportive ecosystem? How to promote open innovation? How to build my absorptive capacity?

Strategic question for governments: How to create framework that allows government to assess and evaluate private sector risk? Is the national and sectoral ecosystem fit for purpose? How can government be an open innovation hub itself?

What is social eco-system?

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Universities as interactive

partnersIntermediates

Innovative Sectors and Markets

Financial services

Manu-services

FMCG

Digital and creative

University Consortium (8 Russell Group

members)

The Enterprising StateBIC as a Microcosm of the UK

Innovation Ecosystem

Professional services

Energy Pharma

Private trusts:•Lord Sainsbury

•Jon Moulton

12/06/12

New Flexibilities

5/6 transformational GPTs likely during 50 year working life of a 2012 graduate

Open innovation business models new template – joint ventures, openness,

porousness ( Unilever and “ open innovation orchestrators”)

Average life expectancy of firms around 10 years

All skills and professions likely to become obsolescent

Need to commit to constant reinvention

Firms displacing responsibility for health, pensions and risk on to individuals

Good capitalism, commitment to innovation, new social contract and vibrant

civil society will underpin 21st century growth

12/06/12

What to do – macro economic policy

Mitigation of unknowable risks and consequential vicious/virtuous circles in credit and labour markets heart of Keynesian economics

Integration of fiscal, monetary and financial policyAbandon public debt/GDP ratio target and replace with debt service ratioRewrite Bank of England mandate and replace inflation target with money GDP

targetRe-orient liquidity and capital rules to support contra-cyclical lendingCreate scope for discretionary fiscal policy within ten year deficit reduction planReinstate capital spending cuts, in particular on infrastructure, housing and

innovationUse public guarantees and capital to de-risk new bank lending

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What to do – ownership, investment and innovation ecosystem

Risk mitigation to bring about more optimal levels of innovation and investment

Credit flows - indemnify new SME lending, Infrastructure bank

Innovation – Catapault network plus Technology Strategy Board. Grants and Public R and D spend count!

Ownership engagement and stewardship - tackle high discount rates, myopia and disengagement

Ownership revolution: re-conceive the idea of the company. Business purpose/fiduciary duties/voting strength rises the longer shares held

Support with new 3is and level playing field between debt and equity ( Mirrlees report )

Develop institutional network for British Mittelstand

Proportionate rewards

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Potential sectors

“ Manuservices” in aerospace, pharmaceuticals, defence, high tech

engineering( cars, chemicals)

Low carbon economy – energy production, energy efficiency, green

manufacturing plus associated services

Life sciences

Creative and cultural industries – design, electronic/digital media and

publishing, games

High tech and business services – computer, business to business services

Caring and servicing the newly young old

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What to do – a 21st century social contract

Socialising risk – but through intermediate institutionsNew trade unions – as employment shock absorbers and enterprise partnersSocial insurance to re-legitimise social security. Payments more directly linked

to benefits Flexi-security – a new workplace bargain. Acceptance of less job security in

exchange for more training plus lifelong learning, higher transitional but unconditional unemployment benefit and state assumes employer of last resort responsibilities ( eg job guarantee)

Housing, housing, housing – new build, mixed housing and revitalisation of housing associations

Education – British variant of Berufschule/apprenticeship? Lower tuition fees?

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Internationally …

Support euro survival – banking union, financial transactions tax etc

Peg pound to euroGlobal abandonment of inflation targetsGlobal implementation of Vickers Keep trade open – protect four pillars of EU including free

movement of peoplesDon’t be frightened of the BRICsSocial contracts are not burdens but enablersOur open society is in peril. It must be argued for and protected!

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Appendices and spare slides

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Potential sectors

“ Manuservices” in aerospace, pharmaceuticals, defence, high tech

engineering( cars, chemicals)

Low carbon economy – energy production, energy efficiency, green

manufacturing plus associated services

Life sciences

Creative and cultural industries – design, electronic/digital media and

publishing, games

High tech and business services – computer, business to business services

Caring and servicing the newly young old

12/06/12

New Flexibilities

5/6 transformational GPTs likely during 50 year working life of a 2012 graduate

Open innovation business models new template – joint ventures, openness,

porousness ( Unilever and “ open innovation orchestrators”)

Average life expectancy of firms around 10 years

All skills and professions likely to become obsolescent

Need to commit to constant reinvention

Firms displacing responsibility for health, pensions and risk on to individuals

Good capitalism, commitment to innovation, new social contract and vibrant

civil society will underpin 21st century growth

12/06/12

Universities as interactive

partnersIntermediates

Innovative Sectors and Markets

Financial services

Manu-services

FMCG

Digital and creative

University Consortium (8 Russell Group

members)

The Enterprising StateBIC as a Microcosm of the UK

Innovation Ecosystem

Professional services

Energy Pharma

Private trusts:•Lord Sainsbury

•Jon Moulton

12/06/12

Scaling up the ecosystem approach:

Common methodologies, theories, and diagnostic tools.

- Integrate open innovation approaches and distributed risk

management. Research themes: • Innovative markets, places and networks

• Innovation friendly financial system

• University-business linkages

• Skills for innovation

• Enterprising state and public action

Competence blocs: • Big data and digital

economy

• Bio-Med, life science and health care

• Low carbon, green tech and sustainability

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Partner investment for working together: An open innovation hub par excellence

Not just money…Partners open their doors to share

people and talentdataideas

Research, practice, trial testing, pilot companies, business and policy forums, and more….

Knowledge transfer between partners

Share good practice Solve problems which create systemic barriers to growth: Collective action is needed

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Where have the jobs been coming from over the last 30 years?

Manufacturing – minus 3.8 million

Health and Social care – 1.9 million

Professional, Scientific and Technical – 1.5 million

Administration and Business Services – 1.3 million

Education – 1.1 million

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And don’t forget geography

20%

40%

60%

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100%

120%

140%

160%

10% 15% 20% 25% 30% 35% 40%

Proportion of employment in Private Sector Knowledge Intensive Industries (2008)

Tota

l G

VA

gro

wth

19

95

-20

08

London

Milton Keynes

Edinburgh

Aldershot

Swindon

Derby

CambridgeReading

Stoke-on-TrentBlackpool

Barnsley

Birkenhead

Mansfield

R2 = 0.402