Around the world, a rising backlash against globalisation appears to threaten the “liberal world order”. The vote to leave the European Union was one manifestation of this trend. Many economic and political commentators have decried this as a retreat from the values of cosmopolitanism and internationalism. But what if, rather than a nativist backlash, resistance to globalisation was a rational response to economic trends that have severely impacted many parts of the UK economy?
In the immediate post-war period, the globalisation of trade flows, combined with limits on the movement of financial capital, was accompanied by rising living standards in the UK and around the world. But this all changed in the 1980s when restrictions on the movement of financial capital – money, shares, debt and other financial assets – were dismantled.
Gross cross-border capital flows rose from about 5 per cent of world GDP in the mid-1990s to about 20 per cent in 2007, or about three times faster than world trade flows. Financial globalisation, as this new phase was called, meant that huge sums of money could now be moved vast distances in milliseconds. This has increased the risk of financial crises, without the promised effects on growth.
The UK’s finance sector has clearly benefited from financial globalisation. The rest of the UK economy, on the other hand, has not. Today I’ve launched a report which shows the links between financial globalisation, rising levels of debt, and the UK’s declining international competitiveness.
Between 1970 and 2007, financial output grew from 5 per cent to 15 per cent of total economic output. The “rentier share” – the amount of national income accruing to those who earn money from unproductive, or rent-seeking, investments – increased from 4 per cent to 14 per cent of total output between 1970 and 2000. Financial profits increased by a similar magnitude over this time period. These two trends are linked: much of the modern activity of finance represents unproductive speculation and trading, rather than investment in productive economic activity.
In fact, most financial profits over the last 40 years have been derived either from lending ever greater amounts of money to consumers to purchase housing, or from the creation and sale of related debt-backed securities (and derivatives on those securities, and insurance on losses on those derivatives and securities, and so on). House price inflation, driven by rising debt levels, convinced consumers that they were becoming better off, encouraging them to borrow even more.
Thanks to the removal of restrictions on capital mobility, rising asset prices in the UK attracted surplus capital from the rest of the world, which helped to inflate the largest speculative housing bubble in history. These capital inflows compensated for our persistent, and widening current account deficit, keeping the value of our currency high even as our international competitiveness declined. This process has damaged the UK’s exporters and has decimated regions of the UK which had previously been centres of global manufacturing.
It is not a coincidence that these are the places that were most likely to vote Leave: the anger found in the UK’s regions about the economic impact of globalisation is, on this reading, entirely rational. Rather than chastising citizens outside of London for “voting against their interests”, the UK’s political class would do well to critically assess the impact that the removal of restrictions on capital mobility and the deregulation of our finance sector has had on the British economy.
To build a sustainable, prosperous, and more equal economy outside of the EU, the UK must end its dependence on debt-fuelled consumption, driven by the assumption of continuous increases in house prices, and financed by financial flows from the rest of the world. In today’s report, I argue that the Bank of England should have a house price inflation target, implemented by limiting the amount of credit that banks are able to issue for house purchases.
Further measures will be needed to rebalance the economy away from “socially useless” speculation and towards productive investment. I argue that we should implement a financial transactions tax on currency transactions to curb speculative inflows into the UK finance sector. Banks and shadow banks should also be taxed much more, and more effectively, with the proceeds directed into an industrial strategy designed to promote the UK’s exporters. Over the longer term, we must come up with more sustainable ways to increase growth and pay for pensions, rather than relying on financial speculation.This will require a much more active role for the state in industrial strategy and long-term investment.
We should accept that financial globalisation has created many more losers than winners, and that many people are right to be angry about the economic changes of the last 40 years. Accepting and addressing these issues is the only way to build a post-Brexit economy that benefits, to coin a phrase, the many, not the few.