As next year’s general election approaches, politicians on both sides are likely to curse the financial sector for absorbing precious funds that could otherwise have gone towards healthcare, education and other social services. The complaint is not strictly fair, since the headline rescue packages – £250bn of loan guarantees, £50bn of capital injections and £200bn of special liquidity assistance – greatly exceed the amounts of public money the misadventurous banks will actually absorb in the longer term. Most will return to the Treasury once the banks revive, and private owners can shoulder their risks again.
Even so, the consequent short-term rise in public borrowing – to a projected (and likely exceeded) £175bn in the UK this financial year, from £30bn in 2008/9 – puts a strict cap on what can be afforded for the NHS, schools, universities, and the rising numbers in the real economy who lost their jobs when banks lost their capacity to lend.
For years, Britain’s financial firms – especially those clustered in the City of London – justified their stratospheric pay and comparable political influence through their disproportionate contribution to the economy. According to Reforming Financial Markets, the Treasury’s response to recent troubles published in July, financial services generate 8% of our national output, employ more than a million people, and finance our otherwise unsustainable appetite for imported food and manufactures, contributing £38bn to the balance of payments even in the crisis year of 2008.
The financial sector – with important centres in Leeds, Edinburgh and the south-west as well as London – is also credited with paying over £250bn in tax and National Insurance since 2000. The tax on financial incomes was, as The Love of Money Programme 2 showed, a significant contributor to the revenue boom that allowed the new Labour government to spend more on hospitals and schools after 1997.
But now that it’s absorbing rather than enlarging the nation’s wealth, people are bound to ask if finance can still justify its unusual size and influence. Even the chairman of the Financial Services Authority, Lord Turner, has been forced to raise the issue. Turner stunned the City on the 27th August by wondering out loud if our bankers, brokers, insurers and investment managers have moved from dynamism into sclerosis. He actually dared suggest that the industry the FSA regulates has grown too large – and that it promotes too many financial transactions, making the case for a Tobin Tax to slow the flows and stop investors chopping and churning so frequently.
Is Turner right? The argument that Britain’s finance has grown too big for its bonuses goes much wider than its recent implosion and the budgetary black hole. Even in the good times, critics argued that the City starved UK industry of capital through its century-old preference for investing abroad – and starved it of skilled labour by sidetracking top minds from real into financial engineering. Policies designed to make the UK attractive to foreign money were accused of holding back domestic enterprise – by keeping interest rates and the exchange rates too high, demanding short-term profit, and regulating so lightly that excessive risk-taking and fraud were bound to arise.
The big City ‘s usual defence is that its growth reflects success, caused by Britain having a comparative advantage in financial services. We therefore don’t just produce them for ourselves, but sell them to the rest of the world – capturing a useful chunk of other nations’ savings, which we can usefully invest in our own industries, infrastructures and public services. But there’s a darker side to this expansion, which Turner was already raising in speeches earlier this year. Being a financial hub makes the UK unusually exposed to risk, and contagious loss of confidence, when the wheels fall off the banking wagon. And some (if not most) of the sector’s recent profit may have come from adding to financial costs – by extracting a ‘rent’ from the real economy – rather than reducing those costs, and assisting industry, as an efficient financial sector is meant to do.
Finance is 8% of Britain’s GDP and is still a lot smaller than manufacturing’s 14%. The finance share has dropped from a peak of almost 11% in 1986, not least because that year’s Big Bang substantially cheapened many of the services it sells to other sectors. That deregulation was followed by an investment boom which helped some of those sectors (especially IT and other non-financial business services) grow substantially larger.
True, our major banks (and, in America, the biggest insurance company as well) have been given substantially larger assistance than the car, steel, coal or textile industries could have dreamed of during their consequently more protracted and painful structural upheavals. And whereas these industries had to shrink to survive, finance has been supported so it doesn’t have to downsize. That’s because bank collapses can send much bigger shock waves through the economy than any factory or mine closures.
On the other hand, UK agriculture – contributing less than 1% of GDP and half a million jobs – receives an ongoing subsidy of over £3bn per year. Farmers say a continued flow of home-grown food, and a working countryside, are essential. Bankers maintain (with economists’ support) a continued flow of credit is equally vital; and that we wouldn’t get on affordable terms without the investment instruments and risk transfers that financial markets provide.
Of course, most household saving and small business investment is done through commercial ‘High Street’ banks, which for most of history were separated from the City-based investment banks, and could be so again. But Turner’s FSA has, instead, sanctioned a deeper integration between commercial and investment banking, passing over the chance to re-impose a separation. The investment side, leeching capital a year ago, is now propping up continued losses on the commercial side. So it looks as if your High Street (or internet) bank will remain securely fastened to a very large, and still poorly understood, financial reprocessing unit in the backstreets of east London - whether the regulators believe it’s an essential extra limb or just a peacock’s tail.