Our economic system still fails to allocate enough funds to strategic investments such as infrastructure, industry and education. Alexander Tziamalis tells how our times call for important economic and policy decisions.
On the 15th of September 2008, Lehman Brothers, an investment bank with assets of $640 billion and debts of $620 billion, went bankrupt (Lioudis, 2017). The demise of this old and iconic business with assets worth more than the gross domestic product of a medium-sized economy amplified the panic that had already started to engulf most financial markets. By October 2008, over $10 trillion of market capitalisation had been eroded from global equity markets and systemic banks such as AIG, Merrill Lynch, HBOS, Alliance &Leicester, Royal Bank of Scotland, Bradford & Bingley and Hypo were expected to follow the fate of Lehman Brothers. The recession had started.
“A repeated lesson from history is that angry citizens will vote for short-sighted, nationalistic solutions.”
So, where does this leave us? In many countries affected by the 2008 crisis, the situation economically is fragile with public debts higher than ever before, various productivity challenges and monetary policies spent, after a decade of artificially bolstering aggregate demand. Worse, the financial crisis of 2008 has contributed to the rise of populist parties in many western countries.
A repeated lesson from history is that angry citizens will vote for short-sighted, nationalistic solutions. The crisis’ political legacy was Donald Trump’s trade wars, the vote for Brexit in the UK, Italy’s populist coalition and aggressively nationalistic governments in Hungary, Poland and nearly France. There’s even a neonazi party in the Greek parliament – a country that lost nearly a third of its gross domestic product. These are just some of the maturing political grapes of wrath stemming from the latest financial crisis.
Citizens are right to be angry. The financial crisis has made inequality even more extreme – the richest 1% of humanity owns more than 50% of the wealth (The Guardian, 2018). Financial institutions were bailed out but struggling families weren’t. Most of the bankers who caused this crisis kept their bonuses (Brookings, 2016) but workers lost their jobs – youth unemployment is over 40% in Greece and 35% in Spain (Statista, 2018). Most of all, citizens sense that very little has changed structurally in our economies. The celebrated BASEL III framework that was supposed to moderate the banking sector is merely a set of weak measures to limit risk-taking by banks (Bloomberg, 2017). It is also likely that it will soften further, as the global economy returns to growth. Other important factors that contributed to the 2008 financial crisis remain the same.
“Most of all, citizens sense that very little has changed structurally in our economies.”
The extensive deregulation of the financial sector which brought too many, and aggressive, players in the lending business is still our landscape. In fact, we now witness the proliferation of online trading platforms which actively encourage betting. As the governor of the Bank of England admitted, many banks are still “too big to fail” (Skynews, 2017) – a morally hazardous sanctuary reserved for financial sector companies alone. Also, the record low interest rates that contributed so much to the subprime mortgage explosion have by now lowered even more, ultra-low deposit mortgages have returned (BBC, 2018), debts grow fast (FTAdviser, 2018) and a new generation of home owners will probably struggle to service their loans when interest rates rise, again.
These political developments and the economic nationalism they bring are, at best, headwinds in economic development. At worse, they could push economies back into recession; global trade would be reduced as import inflation rises. South European countries would struggle to refinance their debts, and growth in Asia could slow, possibly exposing a lot of private sector debt as unsustainable.
It is possible that many politicians and policy makers would like to see the power of the financial sector reduced. But the truth is that we cannot replace the financial sector; we simply don’t have an equally effective alternative at the moment. Particularly in the UK, the City functions as a magnet for international capital, benefitting the economy in many ways. Any economic slowdown would be felt most acutely by the weakest members of our society. Yet we can and should moderate the financial system, with a view to reduce volatility and gear it towards long-term investment and growth goals.
To start with the stability of the financial system, the mandate to separate retail from the investment arms of large banks is just not effective enough. Bank departments will simply continue to communicate and plan their risk strategy as one unit, making the separation ineffective in practice. “[Ring-fences] tend to be permeable and if you really want to separate operations very clearly and decisively, you put them in different organisations,” were the words of former US central banker, Paul Volcker, before a UK Parliamentary Committee in 2012 (UK Parliament, 2013). His opinion was shared by former governor of the Bank of England, Sir Mervyn King, who told the same committee: “I always thought total separation was the way to go”. If the UK is to continue leading the global financial sector, a bolder move should be considered.
“Many politicians and policy makers would like to see the power of the financial sector reduced. But the truth is we simply don’t have an equally effective alternative at the moment.”
Looking ahead, we need to tune our financial sector to work better for industry, employment, infrastructure and education. One interesting idea that could contribute to this would be revisiting Keynes’ concept of a transaction levy (Keynes, 1936) – later popularised as “Tobin Tax”, from James Tobin’s idea of a currency transaction tax. Variations of this idea have gained traction across the political spectrum in recent years. A levy on big banks to fund future bail-outs was pursued by the Obama administration in 2015 (Guardian, 2015) but stalled at the Republican-controlled Congress. Merkel’s Germany, France and other European countries are currently pushing, in earnest, for a tax on financial transactions within the EU (Politico, 2018). China has already drafted but not yet enforced the legislation required (Bloomberg, 2016).
From this article I argue for a version of transaction tax that would reduce short-term speculation while promoting long-term growth. I suggest a “Fund for Growth” which would capture a small percentage of a transaction’s value and invest in long-term projects that the financial sector normally struggles to fund. But with a critical alteration: For short-term transactions the fund would be no more than a tax, in accordance with the tax Keynes envisioned. For longer-term investors though, the fund could reimburse the tax or even offer a dividend from any profits made. As a form of tax, this could generate revenue and promote stability in the system by making speculation a little more expensive. In addition however, this mechanism could alter the choice architecture of investors and promote longer-term investment as tax-efficient.
“Looking ahead, we need to tune our financial sector to work better for industry, employment, infrastructure and education.”
Such a fund would receive widespread public and business support and would strengthen the UK infrastructure, education sector and industry. There are certainly concerns about the practicality of a transaction tax in complex financial systems but the main obstacle here is the perception that such a tax would reduce the competitiveness of the UK financial sector, especially in the times of Brexit and weak government. Yet, if the EU proceeds with its plans to impose a similar tax, there is little fear of losing business to the Continent. In fact, drafting a transactions tax would give the UK an important bargaining chip in the future trade relationship with the bloc.
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