UK’s Debt-Fueled Recovery Could Prove Fragile

Challenging the dangerous imbalances in the UK economy, where the banking sector contributes 450% of nominal GDP, is imperative. But weeks ahead of a general election, no one wants to redefine the rules of the game.

Challenging the dangerous imbalances in the UK economy, where the banking sector contributes 450% of nominal GDP, is imperative. But weeks ahead of a general election, no one wants to redefine the rules of the game.

The UK has the most unbalanced economy of any OECD country. The country’s imposing banking sector contributes 450% of nominal GDP, creating structural weaknesses and economic inequalities. But there is little political will to challenge the hegemony of the banks. Just a few weeks ahead of the UK’s general election on May 7, no mainstream party has come up with a vision for an alternative, more stable economy.

“So-called left and right are in lock step in the UK and there’s very little difference between the policies of the Conservatives, the Labour opposition party, or the Liberal Democrats,” said Johnna Montgomerie, a Canadian-born lecturer in economics at Goldsmiths University, London. “They argue about ‘this much austerity’ or ‘that much austerity’, but they forget the fact that austerity politics is not working. They talk about a labour debt problem, but they don’t want to talk about the City’s debt problem. I hate to be cynical, but none of them offer a real alternative.”

The UK’s banking sector amounted to just 100% of GDP in 1975, but that was before the Conservative Party began the deregulation of the banks in 1979. The process of deregulation continued for many years and transformed the size of British banks.

Now almost a fifth of global banking activity is booked in the UK. Foreign banks are a particularly large part of the UK’s banking, accounting for 30% of assets. The Bank of England says there are 150 deposit-taking foreign branches and 98 deposit-taking foreign subsidiaries from 56 different countries.

The US, despite having a large banking sector, has a far more diversified economy and a vastly smaller banking sector relative to total GDP. In Europe, the French banking sector also dominates the national economy with 390% GDP, but most rich nations have a less imposing ratio. In Japan, for instance, it is 200% of GDP.

But the UK’s banking sector hasn’t even finished inflating. In an article asking “Why is the banking system so big and is that a problem?” the Bank of England predicts that it could double in size over the next 35 years. “The size of the UK banking system could reach 950% of GDP by 2050, far outstripping the projected increase in other G20 banking systems,” the report said.

James Meadway, the senior economist at London’s New Economics Foundation, said: “The UK’s economy is dangerously unbalanced. Although the City of London is at the heart of the global financial system, it’s a different question as to whether it’s good for the rest of the British economy. The reason the crash was so severe in the UK is we have such a large financial system so there was a major impact on the rest of the economy and it created a deep recession.

“But the financial sector doesn’t bring in that many taxes for the general economy. The people who really benefit are the people who run it. That’s where the huge pay cheques and the bonuses go. It doesn’t serve businesses in the rest of the economy particularly well to have a City of London that looks like this. It actually has a huge distorting effect.”

Although the Conservative-Liberal Democrat Coalition Government can point to economic growth of 2.6% in 2014, up from 1.7% in 2013, the foundation of that growth is fragile.

Meadway says the figures are fuelled by consumer spending rather than growth in the real economy. “The figures are not spectacular, but they have allowed the Government to say it’s back on track. In a way they’re right. The problem is it’s exactly the same track we were on between 2001 and the crash of 2008. We have a consumer debt problem based on rising house prices.”

The UK’s housing market has been soaring again for the past few years. Because the value of property has a strong effect on consumer spending through rising wealth and confidence, much Government activity since the crash has been focused on re-inflating prices. They have done this by subsidising mortgage credit through schemes such as Help to Buy. Meanwhile, the Government has done far too little to address the UK’s chronic housing shortage. A low rate of investment in house building has added to the increase in prices.

Clearly, a certain section of society benefits from the housing price bonanza. Baby Boomers in their fifties have made hundreds of thousands of pounds from their houses and are fuelling the UK economy by spending money on weekend breaks and boutique hotels. But there is a downside to using house price rises to propel economic growth.

The next generation has to pay colossal amounts to get on the housing ladder, especially in London, where the average home now costs £518,000 (US$763,000).  Business Secretary Vince Cable says 40% of homebuyers in London are taking out mortgages worth at least four times their income to get on the housing ladder.

Meanwhile, UK household borrowing is on the rise. Unsecured lending – such as credit card debt and payday loans – is increasing at a rate of close to £1 billion a month.  

Connected to the dominance of the financial sector is the increasing inequality in UK society. FTSE 100 chief executives now typically earn 120 times as much as their average employee, up from 47 times as much in 2000, according to Incomes Data Services, a research company. Back in the 1970s, the UK was the most equal country in Europe; now it is the most unequal.

But the Conservative Party’s policies have served only to exacerbate the divide. Recently, Chancellor George Osborne raised the salary at which people pay the higher 40% rate of income tax to £50,000, guaranteeing a tax cut for high earners. The new policy continued Osborne’s policy of cutting taxes for the wealthy. Back in 2012, he cut the 50% rate of income tax for those earning over £150,000.

The opposite scenario is apparent at the other end of the spectrum. The Government’s austerity politics have had a chronic effect on living standards. Severe cuts in social services and plummeting real wages have led to widespread hardship.

Food banks have been opening at the rate of two a week, according to the Trussel Trust, which runs most of them. The Trust said the number of people given three days of emergency food rose from almost 350,000 in 2012-13 to more than 900,000 the following year. More than a third of the recipients are children.

James Meadway sees the food banks as evidence of a breakdown in the economic system of one of the world’s richest nations.

“The proceeds of growth have gone to the people at the top so the ‘trickle-down theory’ is not working. Four out of five jobs have been created in the private sector and are low paid and increasingly insecure. Real wages have fallen at the fastest rate since the 1870s and we’ve seen the biggest sustained decline in living standards since Queen Victoria was on the throne,” Meadway said.

Johnna Montgomerie says the UK economic recovery is far more perilous than it is in the US. Although she points out many parallels between the two economies, including deindustrialisation, rising corporate power, deregulation and finance-led growth, there are also substantial differences in favour of the US.

“The US economy is quite diversified and much more balanced regionally, whereas the UK is unbalanced between the prosperous South and poorer North and private debt to GDP ratio is twice as high in the UK as in the US,” she said. “Another major factor is the greater dominance of the banking sector in the UK. The US has a better financial eco-system with regional banks and credit unions to fund SMEs. In the UK, it’s very centralised and dominated by a handful of big banks.”

Montgomerie says that without a loan stream from federally backed or state-backed banks, the loan book for the UK’s SEMs has been decimated. “The UK doesn’t have as many thriving SMEs as the US. Even though credit is plentiful and the money supply is growing hugely it doesn’t filter down as its not being used for productive purposes,” she said.

The UK, she said, needs to radically restructure its banking system and a good European model exists in Germany, where a system of local banks has revolutionised private enterprise. The German Sparkassen hold about a third of bank assets and about 40% of all customer deposits. They make it much easier for SMEs to get credit, providing about 40% of business loans. 

Sparkassen usually operate within the boundaries of a local council and can’t lend outside that area. During the recession in Germany they increased loans to business while the large commercial banks cut them. The UK has one similar bank, the Airdrie Savings Bank, which has eight branches and 60,000 customers in the Lanarkshire and Glasgow areas of Scotland. Around 80% of its loans go to local businesses and 35% are for five years or more. Good local knowledge kept losses down after the crisis so that only 1.7% of total lending was written off in 2010.  

But Montgomerie sees little political will to change the UK’s banking model, which is based around five “Too Big to Fail” banks. Still guaranteed to be bailed out by the taxpayer – as they were after the 2008 crisis – the banks’ power has remained untouched.

“One thing I would do is to tax all pounds and dollars equally. I’m less concerned about higher income tax on the rich as I am about taxing capital gains. Financial transactions should be considered commercial transactions. I pay VAT so why shouldn’t someone who sells a derivative, or an asset-backed security, not pay tax on it? Yet, George Osborne threatened to take the UK out of the EU if it imposed a 0.1% tax on currency transactions. There’s no logical reason why not and it comes down to political ideology in the end.”