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

Mass surveillance doesn’t work – it’s time to go back to the drawing board

Lacking an answer to the problem of radicalisation, the government has confused tactics with strategy.

This week saw the release of not one but two parliamentary reports on the government’s proposed new spying law, the first from the Intelligence and Security Committee and the second from the Joint Committee on the Draft Investigatory Powers Bill.

Both reports suggested the government hasn’t fully made the case for some elements of mass surveillance put forward in the Bill. But neither went so far as to ask the most important question in this debate – does mass surveillance actually work?

The proposed law, known as the Investigatory Powers Bill, looks set to enshrine almost all the government’s mass surveillance powers and capabilities in a single law for the first time. It has been touted by the Prime Minister as a vital weapon in the UK’s fight against Islamic State.

Most of the noise about mass surveillance since the Snowden revelations has predictably come from civil liberties groups. But the privacy and safeguards debate skips over the highly dubious assumption underpinning the Investigatory Powers Bill – that mass surveillance will stop terrorists.

In fact, mass surveillance is not only ineffective but downright counter-productive.

A 2009 report by the US government found that only 1.2 per cent of tips provided to the FBI by mass surveillance techniques made a significant contribution to counter-terrorism efforts. Another recent study by the New America Foundation found that National Security Agency mass data collection played a role in, at most, 1.8 per cent of terrorism cases examined. By contrast, traditional investigative methods initiated 60 per cent of investigations. Suddenly mass surveillance doesn’t seem so vital.

This is because the technology is far from perfect. As computer scientist Ray Corrigan has written, “Even if your magic terrorist-catching machine has a false positive rate of 1 in 1,000—and no security technology comes anywhere near this—every time you asked it for suspects in the UK it would flag 60,000 innocent people.”

Perversely, this lack of precision means mass surveillance can actually frustrate counter-terrorism efforts. Michael Adebolajo, who brutally murdered Fusilier Lee Rigby in 2013, was so well known to the security services prior to the attack they had even tried to recruit him as an informant. Yet insufficient monitoring later on let him slip through the net. The same thing happened with the Hebdo killers. Mass surveillance means intelligence analysts are forced to spend their time fruitlessly sifting through endless reams of data rather than carrying out the targeted monitoring and detection that’s really needed.

Counter-radicalisation experts have meanwhile argued that mass surveillance may alienate Muslim communities, making them distrustful of the police and possibly even contributing to radicalisation. In 2014, Jonathan Russell from the counter-extremism group Quilliam wrote that the “introduction of a sweeping [mass surveillance] law…will be exploited by extremists to show that the government wants to spy on its own citizens [and] that all Muslims are suspected of being terrorists.” This will set alarm bells ringing for those who know the fight against terrorism will ultimately be won only by preventing radicalisation in the first place.

And therein lies the real problem with this Bill. It’s tactics, not strategy. If we stop for a second and think about what the problem is – namely that thousands of young Britons are at risk of radicalisation – we’d never prescribe mass surveillance as the answer. It would be nonsensical to propose something that risks making alienation worse.

The trouble is we don’t have a convincing answer to the actual problem. The government’s counter-radicalisation strategy is mired in controversy. So instead a different question is being posed. Not how do we stop people from signing up to join Islamic State, but how do we gather as much communications data as possible? GCHQ have an answer for that. It’s a classic case of confusing a tactic – and a highly unreliable one at that – with a strategy actually designed to tackle the root of the problem.

Never mind our privacy for a moment. For the sake of our security, it’s time to go back to the drawing board and think of something better.

 

Andrew Noakes is Senior Advocacy Officer at the Remote Control Project. He writes about covert and unconventional methods of warfare, counter-terrorism, and human rights.