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

Could Labour implement universal basic income?

The battle over this radical policy is moving gradually into the mainstream.

Shadow chancellor John McDonnell has called universal basic income (UBI) “an idea whose time may well have come”. It means a fixed regular payment to each citizen, irrespective of income or behaviour. It is seen by both socialists and Silicon Valley as a panacea for the post-industrial world, addressing unrestrained inequality, economic insecurity, and automation-generated unemployment in the modern economy.

Guy Standing, a professor at Soas and founding member of Basic Income Earth Network (BIEN), says a “perfect storm of factors have suddenly pushed us into being a mainstream policy question” in recent years. “A lot of people who were sitting on their hands, as it were, have started to come out in favour ... I'm inundated with requests to speak and involvement in conferences, and it's indicative of the sudden realisation that if the growing inequality and growing economic insecurities persist, then the drift to fascist populism will continue. 

“Of course, in the background, a lot of these techies including prominent names in Silicon Valley have come out in favour because they see robots displacing us all. I don't buy that argument, but it's added to a growing chorus of people saying that we should take it more seriously.”

Standing's recent book charts the long history of thinking about UBI (through ancient Greece, Thomas More, and Martin Luther King). But the idea's rise to prominence is the result of a interlinked developments in the economy and the nature of work. As Labour MP Jonathan Reynolds argues, changes such as the rise of self-employment and the gig economy challenge the appropriateness of the traditional welfare state. It's “based around the principle of compulsion, and broadly believing there's two binary states – people in work, and people out of work. We know it's becoming a much more complicated picture than that... The state can't keep up with the complexity of people's lives.”

For Standing, the prospects of UBI being implemented successfully depend largely on how it is framed. He is wary of libertarians who see it as an opportunity to dismantle the welfare state, and believes it needs to be placed within the context of chronic economic insecurity for a growing number within the post-industrial economy.

“The argument that I think is going to prove really important for the left is linked to the growth of the 'precariat',” he says, meaning those living without predictability or security. “People in the precariat are experiencing chronic insecurity that will not be overcome by any existing policy.” 

Even so, support from business could be key. Peter Swenson's work on the history of the welfare state finds that reforms and expansions of social policy have only succeeded when key sections of the capitalist class are in support. He, and other academics, resist the idea that the welfare state is simply the focal point for the battle between left and right over Robin-Hood style redistribution. If UBI is to make its way into policy, support from business may be more important than the strengthening of the left.

Reynolds claims UBI may solve not just policy problems, but political ones.  "You have to say that Labour's situation, in terms of how we've struggled on all of these issues (the party's polling is significantly behind on running the welfare state) over the last few years, means that we should definitely be open to new thinking in this area.” Both he and Standing  are part of the working group that was brought together by McDonnell in February to produce a publication on the issue before the next general election, which would then be discussed across the country. Understandably, the group didn't quite meet its deadline. But Standing says “the general thrust of the plans hasn't changed”.

Standing is hopeful that important sections of the Labour Party are either in support, or can be won over. Clearly, the leadership is generally supportive of the idea – both McDonnell and Corbyn have expressed as much in public statements. Standing says many MPs are “rethinking their position ... many of them have not taken up a position because they thought that this was not an issue to be considered. I think we're seeing a real opening for a much more constructive discussion.”

Reynolds says that “there's people on the right and the left of the party who are in favour, there's people on the right and the left who are against”.
 
Nevertheless, discussion is winning over important Labour constituencies. It's not just radical activist groups, but also trade unions, who are coming round to the idea. According to Standing: “Unite now supports it, as well as a lot of unions in Europe. It used to be the case that the unions were among the most fierce critics of a basic income, on the spurious grounds (in my view) that if people had a basic income they wouldn't push for higher wages and employers wouldn't give higher wages.

“We found in our pilots and in our psychological research that people who have basic security have a stronger bargaining position and are therefore more likely to stand up for their rights, and can lead to improvement in wages and working conditions. So I think that all of those objections are gradually being exposed by theoretical arguments against them, or empirical evidence, from pilots.”

Reynolds agrees that “there's a lot of support coming from the wider labour movement”, but warns that people must not be too optimistic about anything happening quickly. “Clearly it's going to need a radical change to how the tax and benefits system would work, and you'd obviously be completely recasting how personal allowances work, and all of that,” he says. “I think this is sort of the cutting edge of thinking about the future and what our economy will look like in 50-100 years' time, that is the frame that we're looking at.” 

Rudy Schulkind is a Danson scholar who recently graduated in philosophy and politics from St Anne's College Oxford.