From De-Industrialization to De-Financialization?

England’s Troubled Search for a Sustainable Economic Model 

When I spent a very intellectually exciting Sabbatical at Cambridge University in 1978/79 – with many encounters with Joan Robinson, John Eatwell, Geoff Harcourt, and others – a debate was raging in the UK about “de-industrialization”, i.e. the demise of the British manufacturing sector. The De-Industrialization Debate

This was the time when North Sea Oil had become on-stream, when Ms. Thatcher brought down the labor unions, when strikes and gasoline shortages required me to scour the Cambridge surroundings with an empty canister to hunt for gasoline to make sure I could bring my wife and newly born son back in my 2 CV car from Heathrow to Cambridge. At that time a serious debate had started – at least in academe – about how to use the new oil riches, whether to invest in fighting the impending “Dutch disease” aspect of oil in a new phase of industrialization, or whether to go towards high-value financial services as the future competitive advantage of the UK.

In order to put this debate into context, one needs to remember that in the decades before the UK had been the mainstay of the European machinery, motorcycle and car industries, building on its earlier successes in engineering industries which had developed from its rich resource base in coal and steel. By 1979 the motorcycle industry had moved to Japan, and the only cars still produced in the UK were General Motors and Japanese assembly affiliates – apart from the few hand-made luxury cars (which soon after were also taken over by foreign companies). For an Austrian economist the most shocking experience was a trip to the mid-England town Corby which had had a coal mine and a number of industrial activities, but had been partially abandoned with the closing of the coalmine. To see the boarded-up, partly broken into, partly burned terrace houses, the defunct city center, the few forlorn unemployed in the weed-infested streets left a deep impression on me. Such images of decline and despair were unseen in Continental Europe.

The Exorbitant Rise of the Financial Sector

The past 30 years have seen the phenomenal rise of the financial sector and of other high-value services in the British economy. In the late 1970’s bank assets were about 100% of British GDP. Today they amount to 500% of GDP (third highest in Europe behind only Iceland and Switzerland). Half of GDP growth in this period is due to finance, construction and property, more than 2/3 of profits during this time accrued to the financial sector. At the same time, the share of manufacturing in British GDP has fallen from 20% to 12% of GDP (for comparison: Germany and Austria: around 30% each).

This leads to a debate – fuelled ferociously by the present crisis – that the financial sector is too big for the UK economy and needs to be shrunk. A recent report by the National Audit Office shows that so far taxpayers have put up 850 bill £, about 50% of GDP, to bail out the financial sector, in the form of equity, quasi-equity, guarantees and quantitative easing. The debate is not only about individual institutes being “too big to fail”, but now turns to the size – and concomitant risks – of the sector in the whole economy. And this is not only a debate about abstract numbers: the fact that only one year after nearly bringing down the world economy, banks are making huge profits again (using the cheap money they have received from the state and national bank, i.e. the taxpayers, on trading, not lending, and the outrage that renewed bonus payments in the amount of billions of Pounds, is seen by the suffering public that “no lessons have been learned”, that “business as before” is conducted once again, increasing fears that a next larger crisis is just around the corner.

Lessons Learned?

The debate is also fuelled by the nomination of Michel Barnier as EU Commissioner for Internal Market and Financial Services, who is seen by UK financial interests as a threat to the unbridled dominance and supremacy of London as a global financial center. The hysterical outcries by British bankers against EU-wide stricter financial market regulation are signs of the mood.

The exorbitant growth of the financial sector has also drawn much talent away from the “real economy” into the financial sector. We Continental Europeans always marvelled at the fact that Brits with degrees in literature, in theology, in mathematics and physics would find (very) gainful employment in the financial sector. Today, observers see this as the financial sector crowding out the real sector in the search for talent. Extremely high salaries in the financial sector cannot be matched by the real sector. In addition, the inflow of foreign wealth into the country has driven up the exchange rate of the British Pound, making exports less competitive. In this sense, the financial sector is seen as predatory on the British economy, while performing – in the words of Financial Supervisory Authority chair Lord Turner – no value-added services.

Today the British economy is in a mess: North Sea Oil is running out, the manufacturing sector has been reduced to minimal size where supply chains rely on imports, because many semi-finished products are no longer produced in Britain; the financial sector is no longer sustainable in its size and needs to be reduced, but no master plan for substitute value-added is available; the public budget deficit reaches double-digit amounts and the danger of future hyper-inflation or even a public sector default is not negligible. A general election is looming, and so far neither party has come up with a viable plan for the future. Both parties have strong ties to the financial industry, Labour because they promoted its recent rise to dominance, the Tories because many in the highest ranks of the financial sector are their supporters, not only at the polls, but also financially. Thus, they tinker at the fringes, admonishing bankers not to pay excessive bonuses, fighting against centralised European regulation – with the aim to maintain London’s claim to financial fame. The major, election-campaign related discussion is about when to start withdrawing the financial stimulus and how to do it, but the “sectoral” problem of a too large financial sector is not being addressed. Economic theory does not provide guidance about optimal sizes of individual sectors in economic activity, but recent experience with Iceland and Ireland has shown that risks to the national economy from very large financial sectors are high.

A Possible Way Forward

A rebalancing of the economy is necessary: the state of the physical and especially immaterial (schools, health system) infrastructure is lamentable; regional disparities are large; social cohesion is threatened – as the outcry against excessive (1 million and more pounds) bonuses not just for CEO’s, but for many traders and investment bankers shows, while unemployment is rising, small and medium-sized enterprises complain about a credit crunch and anti-EU sentiment is being fuelled by the major parties and a number of fringe populists.

Before the crisis, in  Austria and Germany the machinery and electronics giant Siemens had been called a financial market actor with an engineering sector as appendix. In England, recently the Tory politician John Redwood called Britain a “large bank with a medium-sized government attached to it”. Siemens is in a painful process to restructure its engineering sector to maintain its global competitiveness and financial viability. A similar task is needed for England. While Siemens’ management is feeling the economic pressure to undertake this task jointly with its labour force, the countervailing pressures against downsizing exerted by the powerful financial sector actors in London have so far prevented the government from even beginning to embark on this vitally important task.

One solution seems obvious: there is tremendous scope for “greening the economy” in the UK. The transport sector, the industrial/services  sector, commercial and private housing – all these areas are in dire need of being made more environment-friendly. Investment into the technology of renewable energy sources, building codes for low-energy intensity buildings, promoting private housing insulation, re-investing into public transport improvements could show a way forward. In addition, the ageing of the population will require more resources and facilities for long-term care. The education sector requires rejuvenation, in order to activate the talents and creativity of all the population. There are many obvious needs in the UK. They might sound less “sexy” to economic policy makers than promoting ever-new and more complex financial engineering products, but they have the potential of serving the needs of the large majority of the population without engendering high systemic risks.