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Why "skin in the game" could be the key to reforming markets

Those with the power to make decisions on your behalf should share in the risks, not just enjoy the rewards.

Those with the power to make decisions on your behalf should share in the risks, not just enjoy the rewards.
Canary Wharf skyscrapers on the Isle of Dogs. Photograph: Getty Images.

"We are all in this together" has become the political catchphrase of this parliament. The phrase has come back to haunt a government that has introduced tax breaks for millionaires in an era of austerity, but Labour’s critique runs wider than this. Our argument at the next election will be about the way our economy works so that we tackle the causes of the cost-of-living crisis, not just the government’s priorities on tax and spend.

The campaign for a living wage embodies this idea. The question is not just whether tax credits can be protected, but whether companies will pay people a wage they can get by on. The debate on energy prices is another example. The job is not just to fund winter fuel payments but to reform the energy market so that customers are not taken for a ride. Occupational pensions typify the challenge: the difference between a 1 per cent and a 1.5 per cent charge from a provider can be tens of thousands of pounds more in a pension pot at the end of a working lifetime. Sharing in prosperity is about how our economy works, not just what the government spends.

In this context, a new paper by Duncan O'Leary published this week by the think-tank Demos is a welcome contribution to the debate. The paper explores a new idea for reforming markets: "skin in the game". The phrase comes from Warren Buffet, who demands that people investing his money have some of their own money at risk. They must have some skin in the game. The principle is that people who have the power to make decisions on your behalf should share in the risks, not just enjoy the rewards. Only then can they be truly accountable.

In the US, the government is already experimenting with the skin in the game idea. Banks can no longer package up and sell on all the debt from the mortgages they offer. They must retain some skin in the game: 5 per cent of every mortgage must stay on their balance sheets. The idea is that lenders start to consider not just whether they can sell a loan on to others in the market, but whether the loan itself is a good one. The hope is that more skin in the game will encourage more responsible lending.

O'Leary explores what this idea might mean in different policy areas. Is it right, for example, that half of FTSE 100 chief executives are not invested in the pension schemes that more than 90 per cent of their new staff are auto-enrolled into? Would companies pay more attention to pension charges if they were coming out of the CEOs pocket too? Is it sustainable that ratings agencies are paid by the organisations whose financial products they are rating? Should at least some of the fees be held back and paid according to how accurate the ratings prove? Perhaps some skin in the game would lead to greater accuracy.

The idea has the most obvious applications in finance. Is it fair that all financial services companies should pay the same industry levy to fund debt advice, regardless of their lending practices? Shouldn’t the lenders who drive people to debt advice, through hiking up rates when people miss payments, contribute more? Some skin in the game might encourage lenders to adopt a less adversarial approach with their customers.

But O'Leary also examines what it might mean in other areas too. Could companies be given more of a stake in whether the staff they make redundant find work when they leave? Could the skin in the game idea improve back-to-work support for those who find themselves off work through illness or accident? In Holland, for example, companies must pay up to an extra year’s sick pay if they do not take reasonable steps to reintegrate staff who suffer illness or disability. Here we have around 300,000 people flowing from work onto state benefits each year because of health-related issues, adding to the welfare bill.

The value of the skin in the game idea is twofold. First, it avoids the kind of top down micro-management that belongs to the politics of the last century, not this one. The task is to ensure that we really are "all in this together", but through reforming the incentives within markets, not tying business up in complex rules and regulation. The skin in the game idea has a simplicity to it that is attractive. Second, the principle seeks to prevent problems occurring and to align power and accountability where they have become detached from one another. Both are organising principles of Labour’s policy review that I lead, whether in the public or private sectors.

For Britain to become the global standard for an inclusive economy we must create a system that is fair from the start. The policy review will need to look at the skin in the game principle in more detail. But at first sight it looks like a key ingredient in the "recipe for responsible capitalism".