How to dramatically raise productivity. By Professor Richard Werner, from an interview with the UK’s Peter McCormack (below). Werner is a financial sector expert and experienced global macro fund manager, and a Professor of Banking, Finance and Economics at a number of universities in Europe.
Basically the post-war Japanese success was due to a fairly straightforward implementation of what is possible. The Japanese had researched quite well what can we achieve, what can be done? And they thought, oh, we can have high growth, 15% growth for decades. It’s actually possible. Let’s do it. That was announced, for example, by a new prime minister at the time, Ikeda, in 1960, who announced, well, we’re going to double national income in the next 10 years.
A storm of opposition — that’s nonsense, impossible, cannot be done. All the economists outraged: what, how dare you, this cannot be done, impossible. Well, they did it in four and a half years, way ahead of schedule. Of course it can be done. And so they kept doing it. And then it turned out that basically Japan was considered too successful by very powerful players …
Well, it delivered 15% growth for decades. It made — you double national income every four and a half years at 15% growth, and it can be done. They’ve proven it can be done.
And then Korea, Taiwan, Singapore copied it. And then in 1978, China copied it. Deng Xiaoping came to power, and the first thing he did is, let’s go to Japan. He went there with 300 of his top people, and he told the Japanese, “Okay guys, we’ve done a lot of ideology, the deductive approach, the Ricardo approach, which is logical arguments, the Mao Red Book. We’re all tired of that. We’re throwing out ideology. We just want to do pragmatic stuff that works. I’ve come here as a student. Teach me — how can I have double-digit growth?” And they told him, and that’s what China did.
Of course, the key was the monetary system. They asked him, so how many banks do you have? Oh, one bank, central planning. Well, the central planners love it — power maximization, control, but it doesn’t really work well. It works for the controllers, but everyone else is unhappy, more or less. …
Werner and his team studied banks in the West:
What we found analyzing those 5,000 banks of different sizes is it’s a very simple principle, which, you know, it’s not surprising, makes common sense. But again, the finance literature had sort of disputed it. Namely, it’s a rule in banking that we confirmed: big banks want to do big deals with big customers. They need to.
Who lends to small firms? It’s small banks. And that’s it. But that changes everything, because when you then consolidate the banking system, like in the UK, nobody lends to small firms. …
Big banks cannot be bothered doing small loans, because all loans take roughly the same amount of due diligence and paperwork — but the profit is proportional to the size of the loan. Big loans are vastly more profitable than small loans. So small business is starved of capital, and is consequently less productive.
A concentrated banking system, with just a few big banks, inevitably causes productivity to drop because the small business sector is overcapitalized.
Let me remind you of how a typical small business operates. Someone has a business idea. To get the business started, they need some capital (money), so they borrow some. If the business works, they pay it back and perhaps expand, etc. Similarly, an existing business may need capital in order to by the newest equipment, or to expand and reap economies of scale. The productivity gains provided by the new business idea or the new equipment depend on the availability of capital. And big banks just aren’t that interested in small loans.
The vast majority of people work for small firms. Small and medium-sized companies employ two-thirds, usually, of employment. The UK — yeah, 65%, roughly. In Germany and Japan, it used to be actually higher, between 70% and 80%. Anyway, this is the majority works for small firms. And now how can their productivity be higher?
Well, I’ll tell you why German small-firm productivity in the past … [had high] productivity … Whenever new technology came up, small firms would realize — I mean, they go to the fairs in their industry, the Messe and so on — and they realize, okay, these are new trends. And of course, oh, there’s a new technology that affects our industry, our sector, our market niche. Well, we’ve got to get it. It means we’ve got to spend some money, we’ve got to master that. We’re going to buy that technology and apply it. Where do we get the money from? Well, we go to our local bank, and that’s the system in Germany.
There’s — the number’s also been declining, but there’s still around 1,200 small local banks, cooperative banks mostly, some savings banks. And you go to the local bank and you explain — they know you already, because they only lend locally, they will not lend outside their local area, so they know all the firms there. Oh yeah, so you guys — okay, there’s this new technology, you guys want to get that? Okay, let’s look at the plans here. And within maybe two days, they would have the money and they can buy the technology, implement it.
In the UK, forget it. There’s just nothing. Yeah, they find out, okay, there’s this new technology, we got to get it. Oh, it’s too expensive, we can’t do it. Okay, let’s find a workaround, or other ways of — but they can’t really get the funding, that’s the problem. And so productivity stays low. And why is that? Because the banks are large, and large banks only do large customers, large business. They don’t want to deal with small firms. And that’s all it is.
Now, the consolidation of the UK banking system took place before the First World War. And the problem therefore has been known — I mean, every few years we have these studies, not just on productivity, there’s also studies on the banking sector, the problems with the UK banking sector. And they always come to the same conclusion — wow, it’s a concentrated banking sector. And there’s this great report, the Colwyn Report, which says that, yeah, the problem is a concentrated banking system. The Big Five dominate banking, they don’t lend to small firms and they give only short-term loans, one-year, two-year loans. And so that’s the problem. …
And that report, the Colwyn Report, I think a parliamentary committee, was published in 1918. So more than a century ago, the problem had been identified. But what had been done about it? Nothing,…
If you want a healthy, wealthy economy doing well, people doing well, you need many small banks.
Might upset the wrong people:
But in this country [the UK], there are strong interests in the City of London against this. I mean, if you want to set up a new bank for the super rich and you make your business case that, well, the super rich need a special bank, oh, you get the banking license in record time. But try to set up a local community bank — that’s definitely not going to be easy, to put it mildly. …
I can easily demonstrate that we can have in the UK 10% growth. I mean, give me the job at the Bank of England — the Bank of England could engineer 10%, 12% growth for two decades. But to do that, you need to implement policies that some very influential people don’t like. …
The most important thing is to establish many small banks, local banks, because it immediately takes some of their centralized power, the central planning power, and decentralizes it and spreads out the power, the decision-making power.
That’s what Deng Xiaoping was told by the Japanese when he asked them, tell me the secret of high growth. And they said, what, you only got one bank for a billion people?
How about you create 5,000 banks, and each bank has 30 branches, and each branch has 35 loan officers? Then you will have more than 5 million loan officers that each year will receive hundreds of millions of loan applications from small — because these are small banks, they need to lend to, and they will lend to small firms — from small firms. …
So you’ve moved from a centralized system — essentially the Soviet central planning system that the UK is very close to really, with five banks and the Bank of England, that’s pretty centralized — and China with one bank. So then they switched from the Soviet system to the highly successful decentralized system, which is what all the high-growth economies have done. When Britain was successful, it had thousands of banks.
We’re talking now, of course, about the 19th century, when growth was double digits. And there were literally thousands of banks. …
How to get high growth again:
Economic growth is simply a direct proportional function of bank credit creation for productive business investment. In other words, bank loans, the quantity of bank loans to productive businesses. And when you lend to small firms, that’s mostly productive, and that’s a simple way of doing it.
Therefore, if you set up 5,000 small local banks, as Deng Xiaoping did, then you will get a lot of investment in productive things, and you will get implementation of technology on a large scale, but decentralized. You get high growth — 15% growth for decades, four decades, as it happened — lifting more people out of poverty than anywhere else before. That can be done in any country. Other countries have demonstrated it. And so, you know, Britain can do this. We can have this high economic growth.
What limits? Ask Elon.
What about limits to growth? Well, there aren’t any limits, because growth is driven by productivity. Productivity is driven by technology. Technology is invented by humans. And the ultimate limit is human ingenuity. And nobody’s found a limit to that one.
To set up a bank you need a banking license from the government. And those are very difficult to obtain nowadays.
There has big bank consolidation over the last three decades throughout the western world. In that same period, the rate of productivity increase dropped and dropped. The two facts are connected.
Australia now has only five or six big banks, and that’s it. Back when productivity growth was higher, we had many banks and building societies. A small local bank or loan desk knows the local people and who is a good risk — but big banks generally do not.
hat-tip Peter S.