Values, the Economy, and the Financial System

By Greg Fisher

Recently I have spent a lot of time thinking about the relationship between human values and economics & finance.  Specifically, this has been in two related areas: the types of corporate legal forms that exist (see Paul’s blog on this); and the “Social Investment market”.  In this blog I would like to begin to flesh out a way of thinking about these issues: at the core is an emphasis on human values in an economic and financial system that has a number of collective action challenges.  In particular, I believe that most people in the UK value living in a healthy society and they also value a “sense of community” but our economic system currently does an imperfect job of mirroring these values, and this needs to change.

This blog is timely: today marked the launch of Big Society Capital, which will have an important role in ways that I think are essential to a healthy society, and which I discuss in this blog.

In terms of corporate forms, I think a key challenge is to allow the creation of legal vehicles that enable (and remove the restrictions on) those people who want to pursue pro-social (and possibly less profitable) activities.  An excellent example of what I mean here is the “Community Interest Company” (CIC), which was a legal vehicle made possible through legislation changes in 2005.  In a nutshell, these organisations are social enterprises whose aims are pro-community.  CICs are constrained in particular ways e.g. there is an “asset lock”, which prevents them being sold to and absorbed by private corporations; and they are regulated by the CIC Regulator, which is the gatekeeper to the CIC label.  An important implication of these constraints is that other people (including potential customers and investors) can identify these organisations as being social enterprises: the “CIC” label can be viewed as an expression of the values and aims of those running the organisation.  It is a ready-made brand that has particular meaning.

There is a question here about whether different organisational legal forms are necessary.  I shall leave this to a future blog but in short, yes I think they are because they confer meaning and aims to stakeholders (actual and potential) in a credible way.  Consider this question: why don’t charities just set up as private companies and simply tell the word that they’re in fact doing charitable work?

Another fundamental question is whether we have the legislative environment that enables new legal forms of organisation, like the CIC, to emerge; and for legal forms that might be damaging to society in some way, to die.  I’m not sure we do.  Having spoken to one of the two originators of the CIC idea, he said a great deal of luck was involved in allowing the idea to manifest itself in to legislation.  We need a better legislative environment to enable such new organisational forms to emerge, which allow people to express their values in what they do.  Paul Ormerod and I are currently contemplating this in conjunction with Civitas.  For those familiar with Hayek, I am talking about what (I think) he meant by the emergence of institutions within the economy.

The second area I have been concerned with recently is the Social Investment market.  We can think of this market as supplying capital to those organisations pursuing dual bottom line activities.

For those unfamiliar with “social investments”, you can think of the return on such investments as having two components, or bottom lines.  One is the conventional financial bottom line and the other is the additional impact of the investment on society.  For example, suppose someone were to invest £1,000 in a social enterprise that delivered care services to the elderly in their area.  They might receive a lower return than on a single bottom line investment but if they valued care for elderly people, they would also receive a heart-warming feeling that would constitute a second bottom line (I will skip over the question of the measurability of social return – including whether it is necessary – in this blog).  Hence these investments are often referred to as dual bottom line.

Now, conventional economics would indicate that a free market system should lead to investments that mimic people’s preferences, so if people valued pro-social things, that’s what they’d get.  I’m very sympathetic to this although I prefer to frame the issue through the notion of values and not preferences because I feel the latter term is loaded with a number of inaccurate abstractions.  Human values are related to preferences but they are a better description of reality, in my opinion, and this term helps us to bridge the relevant literature in the field of psychology, and economics.

However – and this is a substantive point – conventional free market economics does not recognise collective action problems, and if we frame the problem in a conventional way, it will prevent the development of a market in the first place.  Related to this, there is now a deep literature on institutions in economics (e.g. New Institutional Economics), which means that many in the economics profession understand this point (but it is less understood by free market ideologues).  What I mean is that collective action is often required to agree a number of details concerning the architecture of a market before it can flourish.  For example, how do we measure social return?  What should the accounting standards for such things look like?  Do we need to agree new types of instruments or institutions?  How should this market be regulated?  Are there any legal barriers to this market?  These are institutional requirements that cannot be met by individuals acting in isolation and at the margin (which describes the world of conventional free market economics).

There are other, subtler forms of collective action required if the Social Investment market is to mature from its current nascent state.  For example, a report written last year by ClearlySo for the City of London Corporation, noted that one of the things discouraging institutional investors from being involved in this market is the lack of liquidity (i.e. market depth).  Of course, this is a Catch 22 problem (a lack of participation discouraging participation) that is not really about institutions.  So there are institutional and non-institutional collective action challenges.  If the market were to be catalysed by the likes of the City of London Corporation and Big Society Capital, these two could facilitate both the institutional framework and also things like benchmark securities, which would help to encourage liquidity.

"Build it and they will come" from the film "A Field of Dreams"

Once these forms of collective action are enabled and executed, the market should then look after itself and we would expect market forces to work, albeit within the context of a designed institutional framework (institutions should always remain under review of course).  Without these institutional changes, traditional (single bottom line) finance will be locked-in and the financial sector will perpetuate the problem I outlined at the beginning of this blog: our economic system will continue to do an imperfect job of mirroring our values.  Build it and they will come.

The good news is that both the City of London Corporation and Big Society capital are putting resources behind the type of collective action I mentioned above (I have enjoyed discussing it with people from both organisations).  They should both be applauded for this and, having only recently embarked on a journey, their challenge now is to frame a broad and cohesive vision of the destination, and a route to get there.  This would require going beyond conventional free market economics, and enabling the right sort of collective action to ensure the market achieves its full potential of better mirroring our values.  Another way of putting this is that the financial intermediation process would be “democratised”.

To conclude, one of my ambitions in Synthesis is to encourage the economy to better reflect society’s values.  One part of this is about developing a legislative system that enables new legal entities to emerge, which better reflect our values.  Another part is to encourage the development of a Social Investment market within the existing financial system.  I should emphasise very clearly that this is not inconsistent with a broadly economic liberal approach.  In fact, it is better to think of my framework as Hayekian (albeit informed by the new science of complex systems) because it includes a mixture of both requisite institutional formation and individuals responding to incentives.

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One Response to “Values, the Economy, and the Financial System”

  1. Kenan Simpson says:

    Very nice post Greg. With respect to your comment on values vs. preferences, do you mean to say that preferences are dependent on the institutional structure, whereas values are more fundamental? That is, should we design our institutions so that the emerging preferences are aligned with our values?

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