Thursday, 14 March 2013

Where should we plant the Money Tree?

Ed Miliband has announced that a future labour government would create a network of regional banks, similar to the long-established Sparkassen of Germany, to boost loans to SMEs. This would be a "local deposits for local business loans" model, with the banks prohibited from lending outside their region or speculating with deposits via international markets (probably). This is a cute manoeuvre that serves to push the Party's regionalist credentials while implicitly criticising the under-performing Funding for Lending Scheme and the failure of quantitative easing (QE) to get investment away from property and FTSE shares and into startups and growth-constrained manufacturers. The problem is that this may be little more than a cute manoeuvre. There are solid arguments in favour of a more balanced banking system, but the very problems this is expected to address, the regional imbalances of the economy, are simultaneously impediments to its success.

It's worth remembering that the UK once had a thriving regional banking system, around 150 years ago, providing funding for industry and commerce. The gradual consolidation of these banks into large national chains saw funds increasingly diverted via the City, where they could access a mix of high-yield investments abroad and low-risk gilts. This process continued through the twentieth century, culminating in the merging of retail and investment banks after deregulation in the 1980s. This process, coinciding with the dismantling of much of the industrial base, exacerbated the pull of capital from the regions to the City. Parallel to this, the growth of the housing market (which shifted investment away from industry to property), and the uneven growth in property values (which favoured London and the South East), further sucked capital out of the regions and led to the corruption of purpose of regional lenders like Northern Rock.

In this context, newly-minted regional banks will be trying to arrest the tide of history. Indeed, one obvious criticism is that this is shutting the stable door long after the horse has bolted and enjoyed many years of retirement at stud. Sparkassen are essentially savings banks, so their loan book is largely dependent on their ability to raise funds locally. Unsurprisingly, there are many more of them in what used to be West Germany. This isn't a factor of the different political systems prior to unification, but of the availability of savings today. A UK equivalent would face the structural problem that it is more difficult to raise capital in the North East than in the South East.

Even when capital can be raised, the attractiveness of property as an asset class means that a lot of the available investment will be diverted to bricks and mortar, which means that building societies (which are marginal in Germany) will be strong competitors for savings with the regional banks in the UK. Of course, building new houses in Cumbernauld is not as attractive an investment as building them in Crawley, so despite the best intentions of government, capital is likely to leech out of the regions indirectly. For example, loans to building firms based in the North that then bid for contracts in the South. No doubt some bright spark will realise the benefits of relocating his property development business headquarters from Leyton to Lichfield, while continuing to focus on riverside flats in Lambeth.

In theory, regional banks committed to investing in local business could have a dramatic effect if they were to act as a conduit for massive capital injections. The sketchy Labour plan talks about these banks operating in tandem with a national investment bank, much as the Sparkassen coordinate with the KfW national development bank in Germany, so this is a real possibility, but the key question is: just how much money will they be able to channel this way? In some respects, this is a recasting of New Labour's strategy of pumping money into the regions via public expenditure - i.e. public sector jobs and big infrastructure projects. The difference is that the money will be distributed via the private sector. According to Miliband: "I am determined that One Nation Labour becomes the party of the small business and the entrepreneur". If New Labour was an out-and-out neoliberal cheerleader, supporting big capital while using tax receipts to recycle to the regions, then One Nation Labour is being positioned as (among other things) the champion of small capital. It shows how corrupting "triangulation" is when you end up sounding like a latter-day Pierre Poujade.

David Cameron recently claimed that there is no Magic Money Tree, but as many have pointed out, that is precisely what QE is. The money created to fund the gilt purchase has no material origin - i.e. it doesn't represent actual value in the form of labour or a natural resource - so this is as close to ex nihilo (out of nothing) as sophistry allows. As we all now know, this "new money" has largely gone into property, shares and other assets beloved of the already wealthy. It hasn't turned into loans to SMEs, and certainly hasn't been biased more towards the regions than London. While the regions have picked up a disproportionate share of the austerity tab, in terms of public expenditure cuts and depressed standards of living, QE has served to insulate London and the South East to a degree, though obviously more in Kensington than Kennington.

When the economic history of this era comes to be written, QE will probably be seen as a massive failure of nerve more than a failure of imagination. The desire to prop up an unbalanced economy and prevent catastrophic collapse led to the very causes of that imbalance being further subsidised: property and financial services. This wasn't inevitable. The £375bn of gilts purchased since 2009 could have been used as collateral to fund a national investment bank, with explicit rules set in respect of the level of funding to go to the regions (and even to specific sectors). This would have been the opportune time to set up regional banks, both to act as conduits for that primary investment and to recycle the increase in savings that would have occurred as those investments boosted local employment. For the record, Labour were in government in 2009.

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