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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Northern Ireland's election: Will Arlene Foster pay the price for a domestic scandal?

The wind is in Sinn Féin's sails. But both parties have to work together after the poll. 

Will voters use the forthcoming elections to the Northern Ireland assembly to punish ministerial incompetence?

After all, these elections are all about the Democratic Unionists’ Arlene Foster and her disastrous mishandling of the Renewable Heat Incentive scheme, the energy subsidy she previously introduced as enterprise minister without putting cost controls in place, thus racking-up a £500m liability for the Northern Ireland Executive.

Her refusal to stand aside as First Minister and allow an independent investigation triggered a sequence of events that collapsed the power-sharing executive that runs Northern Ireland, necessitating this poll.

The electorate offers its verdict on Thursday.

So far, there has been a predictable rhythm to the campaign. Cautious and insular, the parties have all been here before and know how to harvest their vote. Elections in Northern Ireland are effectively a race to see who can shore up their core the most, (made harder by the overall reduction in seats from 108 to 90 across 18 multi-member constituencies).

Foster knows she is fighting for her political life. Her woeful handling of the RHI scandal, exposed her severe limitations as a politician. Brittle and stubborn, she further damaged her reputation at the DUP’s manifesto launch by refusing to take any questions from journalists on the basis she had "man flu".

Her pitch was a sectarian "Project Fear" warning that Sinn Fein might overtake the DUP as the largest party and push for an early referendum on Irish unity. Sinn Féin president Gerry Adams joked after the launch on Twitter: "Just for the record, I didn't give Arlene the flu." 

Foster’s campaign might be ugly, but in Northern Ireland’s hyper-tribal polity, it could prove effective. If the DUP suffers a reversal, however, her colleagues may yet think twice about re-nominating her for First Minister/deputy First Minister.

Meanwhile, as Sinn Féin’s new "leader in the North" Michelle O’Neill finds herself in exactly the same situation as Foster was 12 months ago at the last assembly elections - taking over from a male predecessor who had been a mainstay of the political process for years.

O’Neill is so far proving formidable. She benefits from the fact the wind is blowing in Sinn Féin’s sails. After all, the reasons for this election - the DUP’s incompetence - will play well among republicans and nationalists. 

Sinn Féin’s pitch is therefore about ensuring "equality, respect and integrity", with O’Neill claiming this is "the most important election since the Good Friday Agreement". The Shinners are pushing for the strongest possible mandate in what O’Neill describes as the "short, sharp negotiation" that will take place after the elections. She says she doesn’t want a new agreement, "just the implementation of previous ones".

In terms of the other parties, Mike Nesbitt, a former television journalist turned leader of the Ulster Unionists, deserves credit for trying to appeal beyond the tribe. He has offered his second preference vote to the nationalist Social Democratic and Labour party. Tactically, he has to try something to dislodge the UUP from the political sediment.

Both the UUP and SDLP are essentially fighting for relevance in these elections. They constantly claim the electorate has had enough of the SF-DUP duopoly and wants change, it’s just that the voters never vote for it. 

Following Thursday’s results comes the hard bargaining, if the parties are to get power-sharing up and running again and avoid a period of direct rule from the Northern Ireland Office. Both Foster and O’Neill need to be seen to strike a hard bargain. Foster will be desperate to claim she is still in control of events. O’Neill, the newcomer, will want to show she is no pushover.

If she is smart, Foster will  push for an early restoration of the executive and try to put this mess behind her. If, on the other hand, there is a lengthy delay, the election could become a running sore. After all, as the DUP may yet have to be reminded, power-sharing lies at the heart of the Good Friday Agreement

Kevin Meagher is associate editor of Labour Uncut and a former special adviser at the Northern Ireland office.