In this second and final article in this series, our North American correspondent Cosimo Montagu examines why and how concessions to financial sector are the most likely outcome for our economy post Brexit.
Most importantly, this piece explores why even though this approach may shield some of the negative consequences of Brexit, the growth offered will be artificial in the long term, and politically extremely damaging for the British people.
At the first meeting of the Economy and Industrial Strategy Committee earlier this afternoon, the Prime Minister emphasised that the objective of the Government’s new industrial strategy should be to deliver an economy that works for all….. The discussion also underlined that Britain is open for business, we continue to seek investment from around the world
No10 Spokesperson – 1st meeting of the Cabinet Committee on Economy and Industrial Strategy
In the first article of this series, we looked at how Rahm’s Rule (“You never want a serious crisis to go to waste”) demonstrates both an opportunity and a threat for the post Brexit economy.
By prioritising regional growth, an industrial strategy (flying in the face on Thatcher’s Economics), and an economy that “works for all” – Theresa May’s Government have made some positive early statements about rebalancing the economy and seizing Brexit as an opportunity for the UK economy.
However, the quote above shows the underlying threat also promised by Rahm’s Rule.
Given a now near guaranteed contraction of the UK economy following Brexit (the Bank of England cut its 2017 growth forecast from 2.3% to 0.8% this week), the threat looms that the Government will set aside its new priorities, and instead will fall back on the financial sector to protect the UK economy. As Rahm’s rule also suggests – this approach will only see a further transfer of wealth to the financial sector, and artificial growth that will bring only long term political damage.
The dominance of the Financial Sector
Firstly – let address why it is likely the UK Government will depend on the Financial Sector to save us from Brexit? Since the 1980s, the UK has undergone a process increasingly described as “Financialisation” – a marked growth in the size of the financial sector relative to other areas of the economy, with London at the heart of the UK’s change. Financial services now alone contribute around 10% of UK GDP (comparative to 5-6% in 1998) while only making up 3.4% of employment. Importantly, financial services are responsible for 29% of net exports – the next biggest is the US at around 15%. Particularly given the growing problems of manufacturing in a global economy (competition, automation, and now trade following Brexit), financial services are regarded as the UK’s leading product and hope for growth. Situated primarily in London (circa 45% of UK total), it is also worth noting that the wealth generated by financial services is also easily visible by the political classes.
But more significantly, through its growth in size and status, financialisation has meant that financial institutions have installed themselves as the gatekeepers of almost all economic activity in the UK. Much as Uber has installed itself as the must have infrastructure for taxi services (raking in a nice 20% for a platform built on GoogleMaps), financial firms have such control over the infrastructure of the economy (as the ones who write and administer the loans to businesses, individuals and the Government) that we almost have no other route we can take when trying to stimulate the economy.
Evidence of this is already visible following Brexit, in the Bank of England’s £170bn stimulus package that came last week alongside the historic drop to 0.25% interest rates. Forget understanding the complexities of Quantitative Easing, Term Funding and Corporate Buy Backs – you don’t need to. All these measures ultimately have the same objective, pump cheap money through the infrastructure of the financial sector, or buy up their debts, so more money is lent back to us and the Government. For their part in this, the financial sector get to charge a higher interest rate – generating wealth and protecting them from the decrease in interest rates. If we do not take this approach, lending will dry up as Banks decide that a 0.25% + fees return is not enough to warrant the risks of lending.
This reliance on the infrastructure of the financial sector is actually doubly evidence, as it was the exact strategy used to handle the 2008 crisis. Through Funding for Lending (£58bn as of March 2016), Help to Buy (£10.9bn as of Dec 2015) and again – Quantitative Easing (£375bn in the 1st wave alone), the Government relied on pumping money into the financial sector, so they could lend us money, to generate spending and asset inflation.
Monetary stimulus is however not the only way we rely on the financial sector to promote growth. Calls are now increasingly being made for “structural” changes to the UK economy to stimulate foreign investment – a cut in Corporation Tax, and Workers’ Rights legislation. Friendly corporate taxes, and lower requirements for worker rights will encourage foreign firms to invest in UK companies.
Again, the reason this approach is likely is because it has precedent for policy makers. Since 2009, Corporation Tax has dropped from 28% to 18% under the Conservative government, described by George Osborne (in 2015) as a move to “show the world the UK is open for business”. Sound familiar? Before being removed from office, Osborne had promised a further drop to 15%. The European average is nearer 20.5% Almost all economic forecasts for 2017 have already factored a cut in corporation tax into their predictions.
Why a continued reliance on finance will fail
So what is the problem on this reliance on finance? To an extent, it seemed to work post 2008 right? GDP bounced back from -2% in 2009 to between 0.5% – 1% between 2013 and 2015. Before Brexit, we were predicted to start heading up to +2% in 2017. Brexit has been the big bad beast that spoilt the “long term economic plan”. With some clever monetary stimulus or structural reform maintaining or increasing investment when outside the EU, the financial sector will save us again.
No. Despite apparent GDP rises and the image of growth, evidence is starting to show that the returns that the financial sector give to the economy are artificial – and of benefit to few outside of this sector.
In a speech delivered just one week after Brexit, Andy Haldane (Chief Economist at the Bank of England) delivered a little known speech called “Whose Recovery”, examining the who has benefited from the economic “Recovery” the UK has experienced since 2008. This is one of the most important economic studies of recent times, completely overshadowed by the implosion of the UK political establishment.
What Haldane’s speech shows is that when you actually step back and examine GDP and growth on a regional basis, the results are startling. Outside of London and the financial sector, real wages (the amount your money buys you after inflation) have fallen more since 2008 than anytime since “at least the middle of the 19th century“. Again, only in London and the South-East is GDP above where it was in 2008. For the rest of the UK:
GDP per head still lies below its pre-crisis peak, in some cases strikingly so. For example, in Northern Ireland GDP per head remains 11% below its peak, in Yorkshire and Humberside 6% below and here in Wales 2% below.
In summary, outside of London, the UK has not had an economic recovery. The financial sector’s dominance of the economic infrastructure has ensured Government attempts to stimulate the economy have been captured primarily by this sector, maintaining the profit margins of firms – and inflating the prices of assets they own (i.e. the London Housing market). The final proof of this – in London, median net wealth has risen by 50% since 2008. The rest of the UK is only 10-20%. In the Midlands, it has actually fallen by nearly 10%. This is not a recovery for all.
Due to the dominance of the financial sector, London lives in an economic bubble; it sees returns that do not exist in the wider economy. This reality is why we cannot allow the current status quo to continue for the UK economy after Brexit.
Reading between the lines of “Whose Recovery”, it is not difficult to understand some of the frustration and anger felt across the UK that led to the Brexit vote. If the UK continues its reliance on the financial sector for growth as we did after 2008, we will only see more anger build within the system as artificial GDP growth is not translated into growth across the UK. Immigrants and the EU have already been scapegoated, the next hammer blow can only fall on our own political and social system.
As Rahm’s Rule states – “a crisis provides an excellent opportunity to do things we could not before.” Let us ensure we use this opportunity to rebalance our economy, and transfer wealth to the wider economy and away from the infrastructure of the financial sector.
We shouldn’t need another crisis to realize that change is needed.