Just how far the British economy has been pulled out of shape by the last 30 years of rampant financialisation is only now becoming clear. But while rebalancing the economy is vital, let no one think that achieving it will be easy.
The extent of the challenge was one of the themes emerging from the TUC’s important ‘After Austerity’ conference on 26 June. Rebalancing is not just (or maybe even at all) a question of putting in place an industrial policy. So baleful and far-reaching have been the effects of the City on the rest of the economy that there are now massive regional, age, human capital and public-private imbalances as well as those we are familiar with in wealth and finance.
The starting point is that the overdevelopment of finance and the underdevelopment, or rather de-development, of industry are two sides of the same coin. Manufacturing is weak because finance is powerful. At the conference, Cambridge economist Ha-Joon Chang pointed out that the UK, the sixth largest economy in the world, ranked 20th in manufacturing output per head, behind Luxemburg and Iceland. Meanwhile, finance is five times larger than three decades ago. ‘Is it even three times better?’ asks US economist Dean Baker. ‘I don’t think so.’
Can manufacturing be revived? Recent history suggests we shouldn’t bank on it. Sterling has lost 30 per cent of its value in the last three years, points out Chang. But that has not triggered the expected export boom, leaving the UK with a whopping £100bn trade deficit – and also acutely vulnerable to international market sentiment in the medium term.
One reason is that during the years of City triumphalism, many complete supply chains have disappeared, so that while for instance Nissan's Sunderland plant is touted as a manufacturing success, 80 per cent of the components used in its cars are imported. The UK’s largest manufacturing industry is now food processing.
‘Has manufacturing lost critical mass?’ muses Chang. ‘It will take a very big push to get it back’. For sure, it won’t happen when finance attracts the most ambitious with higher salaries and even with the current devaluation keeps sterling higher than it would otherwise be; creams off resources that it previously channelled to industry through bonuses and profits when there were any and subsidies when there weren't; when it destabilises the real economy through excessive leverage and the derivatives that escape the regulators' (and its own) power to control.
But there’s still more to it than that. As Mariana Mazzucato told the conference, finance has consistently rewarded activities focused on value extraction rather than value creation, destroying value and misdirecting investment in the process. For instance, instead of favouring ‘good’ risk embodied in high R&D spending (most innovations fail) it instead rewards share buybacks and dividend distribution, which are inversely related to R&D and human capital formation, and speculation. Perversely, it is the most innovative UK companies that have been penalised by punitive lending rates since the financial crisis. Reforming finance so that it rewards Schumpeterian ‘creative destruction’ rather than ‘destructive creation’ is an essential part of the rebalancing process.
This leads on to another important skew that needs to be righted: gross undervaluing, and rewarding, of the innovation role played by the public sector. It’s true that the state isn’t particularly good at ‘picking winners’ – but as Mazzucato points out, it’s no worse than the private sector, where the part played by venture capital is vastly exaggerated. Up till recently the US government contributed 60 per cent of the country’s R&D effort, especially the fundamental research that private finance won’t touch. The internet, most of the technologies that Apple has combined so artfully in the iPhone, Google’s algorithms and revolutionary new drug classes all come out of publicly funded research. Cutting back on this effort is a fundamental error. What does need rectifying, however, is the balance between companies, many of which compound the injury by paying minimal rates of tax, and the public sector. Once again, profits are privatised while the costs accrue to the state.
One pernicious effect of the financialisation process has been to detach senior corporate managers from their own firms and align them with the City institutions: in effect they are now part of finance rather than the real world. This has set their pay free to soar (as in finance) and encouraged them to bear down down on suppliers and their own workers, whose pay has barely moved in real terms (and whose pensions are now being sacrificed too). This has caused what Lord Skidelsky terms a ‘crisis of inequality’ and consequently – quite apart from moral considerations – ‘severe underconsumption in relation to the size of the economy’. In turn, since investment is far more sensitive to demand than to interest rates, companies have gone on an investment strike, instead piling up cash reserves of £700bn. So a higher minimum wage and a strengthening of workers’ bargaining rights are economically indispensable for any meaningful rebalancing too.
Almost everyone outside the City agrees that these kinds of reform, while difficult, are urgently necessary. But at this point we run up against the most glaring imbalance of all: power. Right on cue, a recent study by Democratic Audit warns that democracy in the UK is in ‘long-term terminal decline’ as the power of corporations keeps growing, politicians become less representative of their constituencies, and disillusioned citizens stop voting or even discussing current affairs. Put another way, as the BBC's Robert Peston did on air last October, what are the chances of rebalancing taking place if it means weakening a sector that supplies not just 10 per cent of tax revenues and 3 per cent of GDP, but also - as was revealed the same day - 51 per cent of Tory party funds? Not much, you might think. And yet… In the space of a year, the phone-hacking scandal has destroyed the thrall in which Rupert Murdoch held politicians of all parties, and the Libor affair may just mark a similar moment for the banks. With the press and the banks both involtarily busy cutting themselves down to size, there may never be a better opportunity to kick-start the process.