It’s not just the economy that has been skewed out of shape by our financial services sector – society has been too
Even after more than five years of traumatic financial and economic crisis, Britain’s banks are often still presented as a source of national strength that must be shored up by taxpayers and protected by politicians.
But the claim that our outsized banking system is a prized national asset just doesn’t stand up to scrutiny. True, the taxes paid by the financial sector in the boom years will probably just about cover the price tag for the bailout – but they don’t come close to meeting the other costs of the financial crisis, including the deepest recession in living memory.
More fundamentally, though, the wider economy is extremely poorly served by the financial sector. Since the “big bang” deregulation in 1986, banks have dramatically outperformed those in every other sector. At the very least that must be cause to wonder whether they have been making excess profits, at the expense of the rest of the economy.
Britain’s longstanding problems of a chronically low investment-to-GDP ratio, and a well-documented “funding gap” for mid-sized firms certainly suggest the financial sector has done a poor job of channelling savers’ funds to where they can be used most productively – the most fundamental role of banks.
By sucking international money into the UK, the City’s prowess may also have contributed to the strength of sterling, which is now widely seen as a major contributor to the decline of the manufacturing sector, and the rapid widening of the UK’s trade deficits in the late-1990s.
Viewed in this way, the success of financial services may have acted as a form of “Dutch disease” – usually used to explain how a plentiful supply of natural resources can distort economies by causing an overvalued currency. In other words, far from being a boon, the City’s dominance may have been a curse.
And it’s not just the economy that has been skewed out of shape by the sheer scale of our financial services sector: society has been too. Inequality in the UK is at a historic high, as top earners have raced away from the rest of the workforce. More than half – 60% – of the increase in the share of income gobbled up by the top tenth of earners between 1998 and 2008 went to finance workers.
So while investment bankers indulge in luxury London homes, exotic holidays and fast cars, the argument that a strong finance sector benefits the workforce as a whole relies on the idea of “trickle down” – the notion that as financiers spend their enormous bonuses, the money will circulate around the rest of the economy. However, the income of the super-rich often leaks overseas, as they invest in the international capital markets, buy property abroad, or salt their money in tax havens.
Meanwhile, in the decade before the crash, low-income families, whose stagnant wages were being eaten away by inflation, borrowed from the banks to maintain their standard of living, and were left vulnerable when house prices turned down and lending dried up. It was an unsustainable business model, over-dependent on credit, and under-serving large parts of the UK. For the banks, of course, it was hugely profitable.
Neither has financial services been a great engine of job creation: just 36,000 new posts were created in finance and closely associated sectors between 1991 and 2007.
And we shouldn’t forget that the extreme emphasis the UK places on its financial services industry is an international anomaly: before the crisis, the size of the banks’ balance sheets relative to GDP was larger than in any other major economy. It’s hardly surprising, then, that during the financial crisis the UK had to pledge more support to its financial services industry, as a percentage of GDP, than most other countries (see figure below). More than five years on, lending to ordinary businesses is still falling.
A crisis of the kind that the UK has endured brings a once-in-a-lifetime opportunity to implement genuine, deep-seated reform of the financial sector, which would force banks to support the rest of the economy, instead of distorting Britain’s business model towards unsustainable, unbalanced, unfair growth. A good start would be to consider all options for RBS, including breaking it up into a network of small, regional banks. Given its extensive branch network and large market share, the public’s 82% stake represents a unique opportunity to set the UK’s banking sector on a better path.
• This mythbuster is part of a series co-ordinated by the New Economics Foundation and the Tax Justice Network.