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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As long as Jeremy Corbyn's Labour opponents are divided, he will rule

The leader's foes have yet to agree on when and how a challenge should take place.

Labour MPs began plotting to remove Jeremy Corbyn as leader before he even held the position. They have not stopped since. From the outset, most regarded him as electorally and morally defective. Nothing has caused them to relinquish this view.

A week before the first major elections of this parliament, Labour found itself conducting a debate normally confined to far-right internet forums: was Hitler a Zionist? For some MPs, the distress lay in how unsurprised they were by all this. Since Corbyn’s election last September, the party has become a mainstream venue for hitherto fringe discussions.

Many MPs believe that Labour will be incapable of rebuilding its standing among the Jewish community as long as Corbyn remains leader. In the 1930s, Jewish support for the party was as high as 80 per cent. “They handed you your . . . membership just after your circumcision,” quipped the father in the 1976 television play Bar Mitzvah Boy. By the time of the last general election, a poll found that support had fallen to a mere 22 per cent. It now stands at just 8.5 per cent.

Corbyn’s critics cite his typical rejection of anti-Semitism and "all forms of racism" (as if unable to condemn the former in isolation), his defence of a tweet sent by his brother, Piers (“Zionists can’t cope with anyone supporting rights for Palestine”), and his description of Hamas and Hezbollah as “friends”. The Lab­our leader dismissed the latter remark as a diplomatic nicety but such courtesy was not displayed when he addressed Labour Friends of Israel and failed to mention the country’s name. When challenged on his record of combating anti-Semitism, Corbyn frequently invokes his parents’ presence at the Battle of Cable Street, a reference that does not provide the reassurance intended. The Jewish community does not doubt that Labour has stood with it in the past. It questions whether it is prepared to stand with it in the present.

MPs say that Labour’s inept response to anti-Semitism has strengthened the moral case for challenging Corbyn. One shadow cabinet minister spoke of how the fear of “enormous reputational damage” had pushed him to the brink of resignation. As the New Statesman went to press, Corbyn’s first electoral test was looming. Every forecast showed the party on course to become the first opposition to lose council seats in a non-general-election year since 1985. Yet Corbyn appeared to insist on 3 May that this would not happen, gifting his opponents a benchmark by which to judge him.

Sadiq Khan was projected to become the party’s first successful London mayoral candidate since 2004. But having distanced himself from Corbyn throughout the race, he intends to deny him any credit if he wins. Regardless of the results on 5 May, there will be no challenge to the Labour leader before the EU referendum on 23 June. Many of the party’s most Corbyn-phobic MPs are also among its most Europhile. No cause, they stress, should distract from the defence of the UK’s 43-year EU membership.

Whether Corbyn should be challenged in the four weeks between the referendum and the summer recess is a matter of dispute among even his most committed opponents. Some contend that MPs have nothing to lose from trying and should be prepared to “grind him down” through multiple attempts, if necessary. Others fear that he would be empowered by winning a larger mandate than he did last September and argue that he must be given “longer to fail”. Still more hope that Corbyn will instigate a midterm handover to the shadow chancellor, John McDonnell, his closest ally, whom they regard as a beatable opponent.

Those who are familiar with members’ thinking describe many as “anxious” and in need of “reassurance” but determined that Corbyn receives adequate time to “set out his stall”. One shadow cabinet minister spoke of being “caught between Scylla and Charybdis” – that is, “a Labour Party membership which is ardently Corbynista and a British electorate which is ardently anti-Corbynista”. In their most pessimistic moments, some MPs gloomily wonder which group will deselect them first. The possibility that a new Conservative leader could trigger an early general election is cited by some as cause for haste and by others as the only means by which Corbynism can be definitively discredited.

The enduring debate over whether the Labour leader would automatically make the ballot if challenged (the party’s rules are ambiguous) is dismissed by most as irrelevant. Shadow cabinet members believe that Corbyn would achieve the requisite nominations. Momentum, the Labour leader’s praetorian guard, has privately instructed its members to be prepared to lobby MPs for this purpose.

There is no agreement on who should face Corbyn if his removal is attempted. The veteran MP Margaret Hodge has been touted as a “stalking horse” to lead the charge before making way for a figure such as the former paratrooper Dan Jarvis or the shadow business secretary, Angela Eagle. But in the view of a large number of shadow cabinet members, no challenge will materialise. They cite the high bar for putative leaders – the endorsement of 20 per cent of Labour MPs and MEPs – and the likelihood of failure. Many have long regarded mass front-bench resignations and trade union support as ­essential preconditions for a successful challenge, conditions they believe will not be met less than a year after Corbyn’s victory.

When Tony Blair resigned as Labour leader in 2007, he had already agreed not to fight the next general election and faced a pre-eminent rival in Gordon Brown. Neither situation exists today. The last Labour leader to be constitutionally deposed was J R Clynes in 1922 – when MPs, not members, were sovereign. Politics past and present militate against Corbyn’s opponents. There is but one man who can remove the leader: himself.

George Eaton is political editor of the New Statesman.

This article first appeared in the 06 April 2016 issue of the New Statesman, The longest hatred