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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How can London’s mothers escape the poverty trap?

Despite its booming jobs market, London’s poverty rate is high. What can be done about it?

Why are mothers in London less likely to work than their counterparts across the country, and how can we ensure that having more parents in jobs brings the capital’s high child poverty rates down?

The answers to these two questions, examined in a new CPAG report on parental employment in the capital, may become increasingly nationally significant as policymakers look to ensure jobs growth doesn’t stall and that a job becomes a more much reliable route out of poverty than it is currently – 64 per cent of poor children live in working families.

The choice any parent makes when balancing work and family life is deeply personal.  It’s a choice driven by a wide range of factors but principally by what parents, with their unique viewpoint, regard as best for their families. The man in Whitehall doesn’t know best.

But the personal is also political. Every one of these personal choices is shaped, limited or encouraged by an external context.   Are there suitable jobs out there? Is there childcare available that is affordable and will work for their child(ren)? And what will be the financial gains from working?

In London, 40 per cent of mothers in couples are not working. In the rest of the country, the figure is much lower – 27 per cent. While employment rates amongst lone parents in London have significantly increased in recent years, the proportion of mothers in couples out of work remains stuck at about 12 percentage points higher than the rest of the UK.

The benefits system has played a part in increasing London’s lone parent employment rate. More and more lone parents are expected to seek work. In 2008, there was no obligation on single parents to start looking for work until their youngest child turned 16. Now they need to start looking when their youngest is five (the Welfare Reform and Work Bill would reduce this down to three). But the more stringent “conditionality” regime, while significant, doesn’t wholly explain the higher employment rate. For example, we know more lone parents with much younger children have also moved into jobs.  It also raises the question of what sacrifices families have had to make to meet the new conditionality.  

Mothers in couples in London, who are not mandated to work, have not entered work to the same level as lone parents. So, what is it about the context in London that makes it less likely for mothers in couples to work? Here are four reasons highlighted in our report for policymakers to consider:

1. The higher cost of working in London is likely to play a significant role in this. London parents are much less likely to be able to call on informal (cheaper or free) childcare from family and friends than other parts in the country: only one in nine children in London receives informal childcare compared to an average of one in three for England. And London childcare costs for under 5s dwarf those in the rest of the country, so for many parents support available through tax credits is inadequate.

2. Add to this high housing and transport costs, and parents are left facing a toxic combination of high costs that can mean they see less financial rewards from their work than parents in other parts of the country.

3. Effective employment support can enable parents to enter work, particularly those who might have taken a break from employment while raising children. But whilst workless lone parents and workless couples are be able to access statutory employment support, if you have a working partner, but don’t work yourself, or if you are working on a low wage and want to progress, there is no statutory support available.

4. The nature of the jobs market in London may also be locking mums out. The number of part time jobs in the capital is increasing, but these jobs don’t attract the same London premium as full time work.  That may be partly why London mums who work are more likely to work full time than working mums in other parts of the country. But this leaves London families facing even higher childcare costs.

Parental employment is a thorny issue. Parenting is a 24-hour job in itself which must be balanced with any additional employment and parents’ individual choices should be at the forefront of this debate. Policy must focus on creating the context that enables parents to make positive choices about employment. That means being able to access the right support to help with looking for work, creating a jobs market that works for families, and childcare options that support child development and enable parents to see financial gains from working.

When it comes to helping parents move into jobs they can raise a family on, getting it right for London, may also go a long way to getting it right for the rest of the country.