Planning for a rainy day: why Britain needs a financial stability fund

We've got to try and prevent the next crisis – but also plan for what happens if we don't, writes Victoria Barr

Even with robust reform of financial sector regulation, it would be a mistake to think that a financial crisis could never happen again. With the benefit of hindsight, we can now observe a long trend in political economy in which the lessons of the 1930s were forgotten over time: depression-era restrictions separating investment from retail banking were eroded in the US, while in the UK, a "light-touch" approach to financial sector regulation was pursued by both Labour and Conservative governments.

Over time, new cohorts of personnel will staff central banks. They will have learned about the recent crisis from textbooks rather than personal experience, and will be influenced by new intellectual agendas. Within the financial sector, a new generation of bankers will emerge, confident about the merits of their financial innovation and impatient with the fussiness of their compliance departments. Finally, future politicians, mindful of the importance of the City to British economic performance, may be swayed by persuasive arguments to relax capital adequacy requirements; to allow economies of scale to be exploited from the greater fusion of retail and investment banking; or to celebrate a merger which turns a national champion into an international behemoth, ignoring that the bank may have become too big for one sovereign to bail out alone. These processes are not inevitable, but they are not impossible to imagine over, say, the next seventy years.

The concern that the financial crisis may reoccur lies behind many of the current regulatory reforms. However, the risk of reoccurrence also has implications for the management of the public finances. If financial fragility builds up, unnoticed or ignored, during stable economic periods, then it is possible that economic and fiscal forecasts could be out by a wide margin. The Treasury’s public finance forecasts and decision-making on levels of taxation and spending before 2008 were based on the expectation that the UK economy would continue to grow at around 2.5 per cent per year. This expectation was very much in line with the consensus view among independent forecasters at the time. However, the latest estimate of what the UK’s average annual growth rate will end up being between 2007/08 and 2016/17 is less than half that, at 1.2 per cent.

The UK was hit particularly hard by the financial crisis, partly because it has a large financial services industry relative to the size of the economy. The City is a source of great economic strength for Britain, a sector in which we excel internationally and which, in good times, provides a healthy stream of revenue for the Exchequer. However, as recent events have clearly demonstrated, it also brings with it fragility and risk. In this regard, it shares some of the characteristics of the so-called "natural resource curse", where the discovery of natural resources, like oil, brings great wealth to a country, but also fiscal volatility and other undesirable side effects.

Many countries have attempted to avoid the natural resource curse through the introduction of revenue stabilisation funds, which aim to smooth income over time and insulate the rest of the economy from the impact of natural resources exploitation. In fact, countries have also introduced similar "accounts", sometimes called sovereign wealth funds, to achieve a range of other objectives: to meet certain fiscal targets; to save to meet long-term obligations; and to anticipate the costs of future financial crises.

Such an approach has attractive properties for the UK. The government should establish a Financial Services Revenue Stabilisation Account, or "rainy day fund", which could only be accessed in the event of a serious financial crisis. In addition to supporting measures to maintain stability in the banking sector, the funds in the account could also be used to counteract the negative impact of a financial crisis on the wider economy (such as measures to boost aggregate demand (e.g. tax cuts) or to avoid cuts to public services).

The planned size of the fund should be subject to further analysis. As the fund is only intended for use in serious financial crises, it should be possible to allow the fund to build up over time. The monies in the fund should be invested conservatively in counter-cyclical and liquid assets, able to withstand the asset price volatility which accompanies financial crises and which can be accessed quickly without the liquidation of the fund itself causing market turmoil.

The fund is intended to improve the management of tax revenues in a country with a large financial sector. However, for simplicity, payments into the account need not be explicitly hypothecated from particular revenues from the financial services sector, although this would be the spirit of the fund. We do not recommend an additional levy to pay for contributions to the fund.

The disadvantage of a Stabilisation Account is the opportunity cost of locking tax revenues away. The funds invested in the account could otherwise be used for different purposes, such as investment, reducing taxes or paying down the national debt. These are not trivial concerns.  However, the contingency function of the fund, and the capability to respond to a serious crisis that it would give a future government, are sufficiently important to warrant foregoing other expenditure in the short term. 

At the current time, we remain in the middle of an economic crisis, and the government’s priority must be to jump start the economy out of the current slump. Payments into the Stabilisation Account should therefore not commence until the economy is growing strongly again.

In addition to regulatory reform to reduce the likelihood of a financial crisis occurring again, Labour should acknowledge that crises are difficult to predict and economic forecasting prone to error. A ‘rainy day fund’ would ensure that any future government is better placed to take action during a crisis and signal the Labour party’s commitment to securing Britain’s long-term economic stability.

A Rainy Day Fund: Why Britain needs a financial sector revenue stabilisation fund is published today by the Fabian Society – click here to read the full publication.

Photograph: Getty Images

Victoria Barr is an economist at FTI Consulting. She has previously worked at Frontier Economics, the World Bank and as the Economy and Welfare Policy Of?cer at the Labour party during the 2010 general election.

Photo: Getty
Show Hide image

Tory right-wingers are furious about Big Ben – but it’s their time that’s running out

They could take both Corbyn and the present moment seriously. Instead, they are arguing about a clock.

Jeremy Corbyn, it is often said, wants to take Britain back to the 1970s.

The insult is halfway to an insight. It’s true that the Labour leader and his inner circle regard British economic policy since the late 1970s as an extended disaster that led to the election of Donald Trump and the vote to leave the European Union: a “failed experiment”, as Andrew Fisher, Corbyn’s influential policy chief, puts it in his 2014 book of the same name.

The Labour leader views the 1970s not as a blighted decade waiting for a saviour, but as a time when trade unions still had teeth, privatisation was not treated as a panacea and inequality was lower.

Theresa May doesn’t see the past four decades in quite the same light, but she does believe that the Brexit vote was, in part, the destabilising consequence of an economic settlement that has left too many people in Britain without a stake in society. This means, for now at least, an ideology that was until recently a consensus has no defenders at the top of either party.

May’s successor might conceivably be an unrepentant cheerleader for free markets and the Anglo-Saxon model of capitalism, but as things stand, whoever replaces May faces an uphill battle to be anything other than a brief pause before Corbyn takes over. Because of the sputtering British economy and the prospect of a severe downturn after Brexit – coupled with the Labour leader’s rising personal ratings – it is the opposition that has momentum on its side, in both senses of the word.

All of which might, you would expect, trigger panic among members of the Conservative right. Neoliberalism is their experiment, after all, the great legacy of their beloved Margaret Thatcher. Yet while there are a few ministers and backbenchers, particularly from the 2010 intake, who grasp the scale of the threat that Corbynism poses to their favoured form of capitalism, they are outnumbered by the unaware.

For the most part, the average Tory believes, in essence, that the 2017 election was a blip and that the same approach with a more persuasive centre-forward will restore the Conservative majority and put Corbyn back in his box next time round. There are some MPs who are angry that Nick Timothy, May’s former aide, has waltzed straight from the 2017 disaster to a column in the Daily Telegraph. That the column is titled “Ideas to Win” only adds to the rage. But most generally agree with his diagnosis that the party will do better at the next election than at the last, almost by default.

And it’s not that the Conservative right isn’t panicked by anything, as a result of some state of advanced Zen calm: many are exercised by the silence of Big Ben during its scheduled four years of repairs.

Yet you don’t even have to go as far back as 1970 for a period of silence from Elizabeth Tower. The bongs stopped ringing for planned maintenance in 2007 and for two years from 1983 to 1985, and the Great Clock stopped unexpectedly in 1976. What distinguishes this period of renovation from its predecessors is not its length but the hysteria it has generated, among both the right-wing press and the Conservative right. The Brexit Secretary, David Davis, described letting the bells go quiet as “mad”, while James Gray, a Conservative backbencher, went further, dubbing the repairs “bonkers”.

The reason why the bongs must be stilled is that they risk deafening and endangering the workers repairing the bell. Working around them would further extend the maintenance period, potentially silencing the clock for ever. The real divide isn’t between people who are happy for the bell to fall silent and those who want to keep it ringing, but between politicians who want to repair and preserve the bell and those who risk its future by squabbling over a four-year silence. There may well be “mad” behaviour on display, but it certainly isn’t coming from the repairmen.

The row is a microcosm of the wider battle over parliament’s renovation. The estate badly needs urgent repairs to make it fire-safe and vermin-free – in the past year, the authorities have had to spend in excess of £100,000 on pest control, with bed bugs the latest pest to make a home at Westminster. If it isn’t made safe, it could burn down.

The cheapest and most secure option for MPs is to decamp down the road to the Queen Elizabeth II Conference Centre, just a few minutes’ walk from parliament. But the current delay, facilitated by Theresa May, increases the cost of repairs. The Prime Minister has also weighed in on the row over Big Ben, telling reporters that it “cannot be right” for the bell to go quiet. Westminster’s traditionalists, largely drawn from the Conservative right, talk up the importance of preserving the institution but their foot-dragging endangers the institution they want to protect. As for May, her interventions in both cases speak to one of her biggest flaws: while she is not an idiot, she is altogether too willing to say idiotic things in order to pander to her party’s rightmost flank. That same deference to the Tory right caused her to shred or water down her attempts to rejig the British economic model, ceding that ground to Corbyn.

A Labour victory at the next election isn’t written in stone. The winds blowing in the opposition’s favour are all very much in the control of the government. The Conservatives could embark on a programme of extensive housebuilding, or step in to get wages growing again or to turn around Britain’s low productivity. Philip Hammond could use his next Budget to ease the cuts to public spending. They could, in short, either declare that the experiment hasn’t failed and vigorously defend it, or write off their old project and create another one. They could take both Corbyn and the present moment seriously. Instead, they are arguing about a clock, oblivious to the reality that their time is running out. 

Stephen Bush is special correspondent at the New Statesman. His daily briefing, Morning Call, provides a quick and essential guide to domestic and global politics.

This article first appeared in the 24 August 2017 issue of the New Statesman, Sunni vs Shia