Bashing bankers has now become so commonplace as to be cliché. As governments bailed out struggling banks around the world in the wake of the financial crisis a decade ago, the watching public struggled to understand how it could be right that the financial sector benefitted from a government-funded safety net when its risky (and profitable) activities backfired.
The crisis spurred a broader rebellion against capitalism itself, and in the UK, prompted concern that our economy is afflicted by ‘financialisation’ – the process of the financial sector becoming increasingly influential, politically and economically.
Critics of finance should, of course, recognise its benefits. The financial sector provides myriad services without which a modern economy couldn’t function. It allows us to borrow and spread the cost of big purchases, such as housing; provides a return on our savings (in normal times, at least); and channels investment into businesses. And innovations in finance have the power to help us achieve societal goals, and to change the way big business operates for the better.
But despite these positives, the widely held view that something has gone wrong is well-founded. There are two key issues: finance as a source of systemic risk; and finance as a source of negative effects on the ‘real’ economy (the non-financial part) – both resulting from the sector’s increasing size and significance.
Since the financial crisis, much has been done to tackle the systemic risk: regulators in the UK and internationally have worked to reduce the risk that the sector poses to the economy as a whole. Banks are now required to hold more collateral, and in the UK, so-called ‘casino’ banking – the most speculative, short-term trading activity – is kept separate from the retail banking services used by households and businesses. The government has also introduced bank-specific taxes “to ensure that banks and building societies make a fair contribution, reflecting the risks they pose to the financial system and the wider UK economy”.
But policy has been much less responsive when it comes to addressing the second category: the ongoing negative effects that finance has on the economy, outside of times of crisis. The sector’s size, and the demand it creates for sterling, contributed to a 10-year period between the mid-1990s and the financial crisis during which the pound was very strong. This made life more difficult for exporters and increased UK manufacturers’ reliance on imported inputs, which in turn has limited the boost to exports from the pound’s recent falls in value.
Ten years on from the crash, the most important banking reform has still not been enacted
The financial sector’s tendency to cluster in one region, or ‘agglomerate’, also means that financial activity and the wealth it generates has become increasingly concentrated in London. Banks extract a substantial fee for ‘intermediation’ (the services it provides to borrowers and savers) which doesn’t look to have fallen even as productivity has improved, suggesting inadequate competition in the sector. And it doesn’t channel sufficient funds into business investment, instead preferring the relative safety (or at least as it appears) of real estate – boosting house prices for ordinary buyers.
The implications of this are profound. Start-ups and innovative businesses perceived as risky investment prospects don’t get the finance they need to grow, while runaway house prices in London and the South East mean a large proportion of the population is now likely to be locked out of home ownership. In fact, the UK has persistently poor investment rates relative to otherwise comparable countries such as Germany, Japan and the US, which is likely to have contributed to our disappointing productivity performance. And of course London has decoupled from the rest of the UK economy, with many regions outside the Capital struggling to find new economic identities as manufacturing has declined.
The proliferation of insecure work, and stagnating wages, is a symptom of these issues: across the country, manufacturing jobs have either been replaced with low-skill, low-pay service sector work, or not replaced at all, creating long-term economic inactivity and dependency on the state. And most unfairly, it means that how well you do in life is increasingly a function of where you are born.
The good news, however, is that it is possible to turn this around – to make our financial sector a driver of success across the whole economy.
To boost long-term investment, we need to ensure the right incentives are in place. First, the high-frequency trading of company shares, which now makes up the majority of equity trading and adds negligible value to the economy, could be made less profitable by taxing it. Second, more ‘intermediary’ institutions, such as asset managers, that trade in shares could be required to act in the interests of the people who ultimately own them. Currently these intermediaries are often rewarded on the basis of the volume of trading activity they undertake, rather than the underlying performance of the companies in which they are investing – regulation could rectify this.
Government can facilitate alternative sources of business investment, for instance by setting up specialist public banks to invest in key sectors and regions. Government can also look to shift the financial sector away from socially useless and destabilising activities – such as speculative, over-investment in property – through macroprudential tools. For example, a house price inflation target for the Bank of England would end expectations of perennial strong price growth, dampening the speculative activity that makes these expectations self-fulfilling.
Corporate buyback culture is financial engineering not value creation
Alongside these targeted measures, industrial strategy – interventions by the government to change what the UK produces and how – is essential to rebalancing the economy and ensuring that non-financial sectors can thrive. The goal should be to support and diversify the UK’s export sectors and strengthen domestic supply chains. Over the long term, only a profound restructuring of our economy along these lines will enable us to overcome the problems associated with our financial sector.
The challenges financialisation poses to the economy, and to our future prosperity, are serious but not insurmountable. Finance can, and should, be recast as servant, not master, of a thriving economy.