Bank share prices and the "national interest"
Yesterday, after Ed Miliband’s speech suggesting that a Labour government would refer the big UK banks to the Competition and Market Authority, who would be asked to set a limit on bank market share, there was some rather sloppy reporting of the impact on bank share prices. Many papers reported that “a billion pounds was wiped off the value of taxpayer-owned banks”, as if this were somehow automatically a bad thing (although the FT gave a more realistic account). In particular, David Gauke, the Exchequer Secretary to the Treasury, was quoted in several newspapers:
I don't know how helpful that is in terms of the national interest because that's UK taxpayers who have lost out
Meanwhile, ToryTreasury tweeted:
Ed Miliband's policy wiped £1bn off RBS & Lloyds shares this morning -a loss for taxpayers.
Let’s consider a possible A-level exam question (although I wouldn’t be surprised if economics teachers protest that this is too easy):
Suppose that that a highly concentrated industry is acting as an oligopoly. The competition authority orders the largest companies in the industry to be broken up. How would you expect the share prices of those companies to react and why?
The answer, obviously, is that share prices would be expected to fall. Large companies in oligopolistic industries earn supernormal profits. The expected future value of these profits is capitalised in share prices. Government actions to promote competition will reduce expected future profits and hence share prices. They will also reduce prices to consumers. The net impact will be an overall increase in welfare. This is really about as simple as it gets in microeconomics.
In other words, a negative share price reaction to Mr Miliband’s speech is consistent with both the rationale and objective of the policy. It doesn’t necessarily mean that markets believe the policy will increase competition – there are other reasons it could reduce share prices (transfers of wealth to competitors or consumers, or reduced efficiency). But it is certainly consistent with that view. By contrast, what would be really damning of the policy would have been no market reaction at all: that would have implied that financial markets, rightly or wrongly, either believed that the policy would be ineffective (indeed this is the FT’s interpretation), or that Mr Miliband would never be in a position to implement it.
What then are we to make of the comments coming from the Treasury? The above reasoning shows that they are simply wrong. If Mr Miliband’s policy does increase competition, then the result will be increased efficiency and overall welfare: losses to taxpayers (and other bank shareholders) will be more than outweighed by gains to consumers. This is almost certainly in the national interest.
Indeed, the comments are worse than that: they imply that he thinks any policy towards the state-owned banks will be against the national interest if it has a negative positive impact on their share price, and vice versa. It is difficult to think of a more wrong-headed approach. The government could for example bar new entrants to the sector. This would raise the share price of the state-owned banks, and hence benefit “UK taxpayers”. It would also reduce competition and hurt consumers, and would certainly be against the national interest.
I sincerely hope Mr Gauke, and ToryTreasury, were just making what they thought was an easy, if completely erroneous, political point, without bothering to think about the economics at all. If they actually believe what they said, they certainly shouldn’t be allowed anywhere near the economic policy-making process.
[Note: This blog is not about the merits of Mr Miliband’s proposals; it is about the interpretation of financial market reactions to them. I am certainly not arguing that they are the optimal way to address competition issues in the UK banking system. For what it’s worth, I think this FT editorial gets it about right. ]