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.

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Banishing safe seats, and other proposals to bridge the democratic divide

How to improve key areas of democracy.

Labour’s election train is finally pulling into the station, with its new leader announced in just over a fortnight. However, a summer absorbed in the party’s internal democracy has obscured a deeper truth confronting the country: the general election confirmed that unequal political participation rates in the UK – by age, class, ethnicity and region– have become increasingly hardwired into how our democracy operates.

IPPR’s new report underscores the scale of the democratic divide.  For example, less than half of 18-24 year olds voted, compared to nearly four-fifths of the over-65s, while three-quarters of "AB" individuals cast a ballot, against just over half of "DE" registered voters. Critically, this marks a sharp rise in turnout inequality over time. In 1987, for example, turnout rates by class were almost identical but have steadily diverged since.

Similarly, age-based differences have got significantly worse over time. In 1964 turnout for 18-24 year olds was 76.4 per cent, almost matching the 76.7 per cent turnout rate of those aged 65 or over. By 2005 only 38.2 per cent of 18-24 year olds voted against 74.3 per cent of 65+ year olds, with only a very slight improvement this year.

Underlying growing disparities of electoral voice are striking divergences in perceptions of the fairness and effectiveness of our democracy. For example, IPPR/YouGov polling suggests a striking 63 per cent of "DE" individuals think that our democratic system serves their interests badly, while "AB" voters are evenly split.

Given these signs of democratic distress, there remains a strong case for establishing a wide-ranging constitutional convention to reset how our democracy operates. Yet Westminster shows no appetite for such constitutional reformation, and there would only be so much a civil society-led convention could achieve in terms of practical change.

In our report we therefore propose a series of achievable reforms that could update the civic, institutional and technological architecture of our democracy in the here and now, with the explicit goal of ensuring that all voices are better heard in the political process.

On electoral reform, while we reiterate our support for proportional representation for national elections, we know this simply isn’t going to happen this Parliament. We had a referendum on change in 2011 and it was heavily lost. The energies of electoral reformers should therefore focus on extending PR in local government, where it is more obviously in the self-interest of the major parties, as a means of extending their geographical reach.

In addition, the reduction in the number of MPs provides an opportunity to chip away at the number of safe seats. More than half of seats are "safe", a number that has grown over time, even allowing for the electoral earthquake in Scotland. Safe seats typically have lower levels of participation, lower turnout rates, and less electorally powerful voters. While safe seats will always be with us in a first-past-the-post system, too many can be damaging to democracy.

Given this, we have recommended that the various Boundary Commissions of the UK be given a new duty to consider the electoral competitiveness of seats – ie. to tilt against the creation of safe seats – when boundaries are redrawn. The priority would be to meet their current duties of ensuring the geographic coherence of a seat and roughly equal electorates.

However, where these duties can be met we suggest that the Commissions should consider revising boundaries to reduce the number of safe seats, as a step to increasing participation and the voting power of the average elector. Of course, this will clearly not "abolish" all safe seats – nor should it  but it could help re-empower millions of voters currently with little meaningful say over the outcome of elections and force political parties to up their game in safe seats.

At the same time, the transition to the individual electoral registration process risks excluding millions from the franchise, people who are disproportionately younger, poorer or from an ethnic minority. For example, there are clear inequalities by age and ethnicity in terms of who is registered to vote: in the 2010 general election, for which figures are most accurate, 90 per cent of people aged 55-64 were registered, compared to 55 per cent of those aged 18-24, while nearly 20 per cent of BME individuals were not registered to vote, compared to only 7 per cent of the "white British" population.

There are simple steps the government could take to ensure all who are eligible are able to vote: extending the registration deadline to December 2016, and making support available to local authorities to assist registration efforts, weighted towards authorities with higher levels of under-registration, could help reduce inequalities.  In the longer term, electoral registration officers should be given new duties, and the Electoral Commission more powers, to drive up registration rates, with a particular focus on presently under-registered demographics. 

Finally, we recommend introducing a Democracy Commission. At present, the Electoral Commission effectively regulates elections and party funding. Democracy, however, is far richer and broader than electoral processes. It is about formal representation, but also about participation and deliberation, in what Marc Stears has called "everyday democracy".

A statutorily independent Democracy Commission could give institutional ballast to the latter and help reinvigorate democratic life by providing research, resources and capacity-building to facilitate local, civil society-led initiatives that aim to increase broad-based levels of powerful democratic participation or deliberation in collective decision-making processes.

For example, a Democracy Commission could work with the GLA to introduce participatory budgeting in London, assist the Greater Manchester Combined Authority in instituting a public deliberative body with real teeth over how to integrate health and social care in the area, help the Scottish government conduct citizens’ juries on the future constitutional shape of the country, or support civil-society experiments to bring people closer to collective political decision-making processes in their locality.

We are living in a paradoxical political era, where growing political inequality is accompanied by ongoing social and technological change that has the capacity to collapse unnecessary political and economic hierarchies and build a more inclusive, participatory and responsive democracy. However, there is no guarantee that the age of the network will necessarily lead to democratic revival. The institutions and technologies of our political system, products of the 19th century, are struggling in the fluidity and fracture of the 21st century, inhibiting democratic renewal.

With our economy post-industrial, our ways of communicating increasingly digital and more networked, our identities and relationships ever more variegated and complex, it is therefore critical public policy seeks to update the democratic infrastructure of the UK, and, in so doing, help reverse entrenched political inequality.

Such an agenda is vital. If we simply accept the current institutional arrangements of our political system as the limits of our ambition, we must also content ourselves to live in a divided – and therefore inherently partial – democracy. Yet our democracy is not immutable but malleable, and capable of being reformed for the better; reform today can make democratic life more equal. After all, the story of British democracy’s evolution is one of yesterday’s impossible becoming today’s ordinary.

Mathew Lawrence is a research fellow at IPPR and the co-author of "The Democracy Commission: Reforming democracy to combat political inequality". He tweets at @dantonshead.