With a triple dip recession looming in the UK, it is increasingly clear that there is a need for fundamental reform of the UK economy. But there is little consensus about how to make this happen. The form of capitalism adopted by much of the West is predominantly based on the achievement of short term growth, with the banking crisis and the UK’s depressed economic performance arguably the result of short-term profit seeking with little regard for the longer term consequences. In the banking sector, retail banks have resorted to unsustainable tactics to make money from their customers, while the extreme financial incentives to increase profit in investment banking have led to dishonest dealings and collapsed markets. Likewise, on the high street, short term market incentives prompt grocers to squeeze their suppliers on cost while driving their customers to over-consume through carefully devised offers and by prompting impulse buying.
How can an economic recovery take place in the context of such unsustainable market forces? The policy response has not proved very helpful. When these sustainability problems arise, the usual government response is to reach for new policy levers, regulation or sanctions. Sometimes industry captains get together to try to find an answer. In conference after conference, people discuss the change that needs to be seen, usually to little effect.
One of the problems is that incumbent players in an industry cannot alter their ‘basis for competition’ and no amount of top down pressure can change this. Professor Clayton Christensen of Harvard Business School explains in his research that innovation within an industry normally takes place to achieve incremental change rather than transformation. So transforming a market is extremely difficult. As a result, unsustainable factors which are inherent to industry models actually grow with the market themselves to become larger and larger challenges to society as a whole.
This is not just a private sector problem. In the UK, demand for healthcare has grown by four per cent every year since the inception of the NHS. Between 1997 and 2007, the NHS budget grew from £44bn to £96bn. This is 225 per cent more growth than the FTSE 100 index and 170 per cent more than GDP growth over the same period. The reason is that it is in hospitals’ interest to supply more services, even though they are a publically funded good. Yet this level of inflation in healthcare costs is definitely not sustainable, and represents a global challenge in the coming years. The incentives are backwards.
However, an anomaly to this is the technology sector. Unlike many other sectors, this industry consistently transforms itself, altering not only its own business models but also transforming how society functions. Why is this? Let’s consider some of the factors:
- The sector takes its inspiration from visionaries who have developed globally transformative solutions, starting from their garage. As Steve Jobs put it, it is the ones who are crazy enough to think they can change the world who usually do.
- Technology communities are well connected, allowing knowledge and communications to travel quickly, and enabling ideas to develop into solutions.
- The tech industry has enjoyed a disproportionate share of the global venture capital spend.
- Platforms such as Windows, Apple, and Google Android are making it easier for many people to develop applications for a mass market.
- Governments and organisations have set up technology hubs for entrepreneurs to test and grow their solutions.
For these reasons and many others, it has been possible for new people to enter the market and transform it from the bottom up. Better solutions and new business models have been able to displace those that don’t work as well. Yet if any link in this chain were removed, barriers would prevent this process. For instance, if VC finance were scarce in technology, then it would be harder for solutions to scale to the next level of development and incumbent players would maintain more control.
What has happened naturally in the tech markets is that the “right thing has been the easiest thing”. This has created a truly transformative, adaptive market. There are fewer barriers preventing someone from setting up an innovative global tech business than an innovative healthcare solution or a bank. Yet the sector has not collaborated at corporate levels, they have not looked to Davos for solutions and it has not been organised top down.
How can we apply this learning to other sectors? There are already some examples where markets have been rebalanced without the use of regulation. The Fairtrade movement has inspired innovation and sustainability in coffee, cocoa and many other supply markets where natural short term market forces were leading to unsustainability. Unsustainable supply is bad for growers, manufacturers, retailers and consumers; so the Fairtrade system has effectively a more balanced and prosperous outcome for all.
The same approach could be used in large corporations to solve endemic problems which conventional strategy fails to address. I have been working with The Fairbanking Foundation, an organisation that works with banks to create and certify new financial products that improve the financial wellbeing of their consumers. Some products make it easier for customers to make and reach savings goals; others help customers to better manage income and expenditure. Both improve market sustainability. And this type of innovation requires no regulation. It just uses the market.
Likewise, in healthcare, we are looking at the barriers that prevent ‘the right thing’ from happening. On this basis we are designing and implementing solutions to overcome these blockers. First, one of the most serious problems in healthcare is that health organisations are not assessed on the basis of the value they deliver to patients – that is, on the basis of positive patient outcomes for every pound spent. So we are developing a value based measure to make this easier. Second, healthcare organisations are unable to transform their service models to satisfy today’s needs. So we’re setting up public sector vehicles to test and scale new service models with the potential to better serve the needs of a target group. These come from healthcare practitioners, social carers or members of the community.
If market forces are causing a sustainability failure, then we must find solutions which alter the market dynamics in order to drive sustainability. The logic applies equally to private and state controlled markets, or to problems internal to corporations. All that is required is thinking differently about the problem. Instead of creating more regulation, what is needed is a strategy for taking away barriers for the market to correct itself. In other words, we need to find ways to make the right thing the easiest thing.
Putting aside the euro-zone crisis, if there was one thing that came to dominate the financial news sheets this summer it was the near endless stream of stories about how the great and the good came to fiddle the taxman.
We heard of how the world’s super-rich had siphoned off as much as £13 trillion from their home countries into tax-free offshore accounts, how over 2,000 public sector officials came to enjoy preferential treatment at the expense of the taxpayer, and how everyone from comedians to Olympians to the prime minister himself became embroiled in tax loophole scandals. The issue even took centre stage in the US presidential election debates – it may still prove to be Mitt Romney’s Achilles’ heel.
Yet amidst all the furore, what riled people the most was the comment made earlier this year by David Gauke, exchequer secretary, who said that cash-in-hand work was “morally wrong.” The intriguing part of this story is that most of the anger was not directed at the people doing work off the books. Rather it was at those who deem such activity to be surreptitious and undesirable. A rough and ready YouGov poll undertaken at the time found that 75 per cent of Brits did not think it was ‘wrong’ to pay tradespeople in this way.
This begs the question, why do people appear so comfortable with cash-in-hand work? One explanation is because of the norms set by the wealthy elite. If the likes of oligarchs avoid paying taxes worth literally millions every year, why should the plumber or the taxi driver be any different?
Another reason is that people don’t feel as though hard working individuals are getting enough out of the state relative to what they are putting in. There are no doubt many families up and down the country who are asking themselves why they have to struggle to pay the price of higher taxes and cuts in public spending when they played little ostensible role in bringing about the financial crisis.
Whatever the cause, we appear to be at saturation point when it comes to demonising workers and entrepreneurs at the bottom of the ladder. That people may be forced into the informal economy through no fault of their own is something that support charities such as Community Links have been arguing for years. What has not been articulated so strongly up until now, however, is that the people who are working under the radar may in fact not just represent the downbeat and destitute but rather budding entrepreneurs with latent entrepreneurial assets.
Whether it’s plumbers, software developers, tutors or restaurateurs, there is evidence to suggest that tens of thousands of small business owners across the breadth of the UK currently engage in undeclared work as they seek to get their operations off the ground. Of the 1 in 5 small business owners we surveyed who said they had traded informally at one point in the past, 40 per cent said it was because it gave them the necessary breathing space before they had the capacity to register their business (see our new Untapped Enterprise report for more detail).
Of course, there are many entrepreneurs who trade in the informal sphere out of pure self-interest. Their goal is pure and simple: to avoid paying taxes that they could otherwise afford to cope with. But for all the stories we hear of deception and greed, there exist many other cases where entrepreneurs are excluded from the formal economy through little fault of their own. Taxes, red tape, a lack of financial credit and other barriers serve to make life untenable above the surface.
For these entrepreneurs, particularly small business owners, the informal economy is exactly the kind of protective environment they need to test their ideas and make their businesses more resilient and eventually profitable. It gives them the adequate breathing space before they can finally go on to make the transition to the legitimate economy. As such, the informal economy is an incubator, not just a refuge. To put it in Mitt Romney’s terms, it is a space for ‘makers’, not just ‘takers’.
If we accept this to be true, it is unwise to continue trying to address the prevalence of cash-in-hand work through measures such as penalties and sanctions that only treat it as though it were predominantly for the greedy and self-interested. Instead, we should be developing new support mechanisms that treat hidden entrepreneurs as aspirational, and which guide them along their slow and steady journey towards creating their own fully-fledged businesses.
Much more than this, however, is that everybody, whether policymakers or those in the business community, should be asking themselves one simple question: can we learn to live with the informal economy?