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Posted 19/05/2014

After the financial collapse of 2008 the Queen asked: “Why did nobody notice the awful financial crisis earlier?” If I can be so bold as to put words into the mouth of the monarch, she could today ask, “Why did nobody tell us that the financial crisis would last so long and at the same time that jobs would be so scarce and that pay would go down?”

Trying to understand the economy is like volunteering for a whole upper jaw of root canal treatment. It need not be like that. What is happening is a story that can be told easily enough in outline and we can see the impact coming over generations.

Prior to the financial collapse of 2008 British public sector debt was the equivalent of 66% of GDP. However, with the bail out of the Royal Bank of Scotland and Lloyds, amongst others, the debt doubled to 147% of GDP.

Average household debt, in the main mortgages, in the UK stands at £56,000, having also doubled in the eight years from 2000 to 2008. This represents (estimates vary) between 140-200% of GDP.

McKinsey Global Institute estimated that in 2008 the UK’s overall debt to GDP ratio was 469%.

At a time like this when there is a net shortage of demand, a major drop in employment, consumption and investment, it makes sense for the government to behave in a counter intuitive way and boost demand. It does this through infrastructure investment and injecting income into the economy to boost demand. To do this the Government takes on extra borrowing. There are limits.

This is a classically Keynesian position and one that has helped different states and economies come out of what would otherwise have been enormously long slumps in demand. As GDP grows the state benefits from a higher tax take and from meeting lower unemployment costs.

The austerity – “You can’t spend what you’ve not got” decisions and debate shows how much the British, European and American political community is nervous and hamstrung.

Away from state finances a health check on the British banks was given in 2012 and not that much has changed. In delivering The Financial Stability report of the Bank of England the then Governor Sir Mervyn King said; “This problem can be handled, we should not be frightened of it… then we can take pride, in the fact that the UK will have a banking system that is at the start line ready to support our economic recovery, with balance sheets in which people can have confidence, because the numbers mean what they say.”

So what is the problem that needs to be tackled before we can start to have economic recovery? The Bank of England identified three groups of issues that are understated and masked in the big banks.

Firstly, credit losses are understated: that is loans made to companies, property developers and to mortgages. Banks are not reflecting the rate of recovery that they are in practice likely to achieve.

Secondly, banks are understating what they will have to pay out in fines and repayments for misconduct in miss selling, payment protection, money laundering and rate fixing.

Thirdly, banks need to comply with regulation; they need a minimum capital position to enable them to operate. Given the international risks faced (exposure to countries defaulting) the banks do not hold sufficient capital.

In summary, the banks have over egged the value of their balance sheets and underestimated the risks that they face, in the order of £60 billion: made up of £15billion as leniency extended to customers, £10 billion extra for misconduct and £35 billion for risk of international default.

One recommendation is made, in the report; that the banks go through the detail of their balance sheets, to strengthen the capital buffers and sustain the availability of credit, banks, “either raise capital or take steps to restructure their business and balance sheets that do not hinder lending to the real economy.” It does beg the question of who would put more capital into the banks?

For zombie businesses and households struggling to pay mortgages the increase in interest rates destined to come in the next few years is a huge threat.

Very big bangs strike terror into the heart. The financial collapse of 2008 was a very big bang. It is having a devastating impact. As a result we have been distracted from the simultaneous transformative effects of off-shoring and new technology.

In the 25 years previous to the financial collapse of 2008, the world labour market doubled in size. China, India, Brazil and Russia joined the international trading system, bringing their economic advantage of cheap labour. This coincided with another new variable, the continued growth of computing and communication technology.

As consumers we no longer go to Jessop’s (RIP) to buy a camera, we use our phone, made in China, with a built in camera, or if we are really keen, we go online to make our purchase.

Countries emerging into the world market want to attract mobile investments, finance is mobile and corporations want to maintain quality, win market share and cut costs.

Companies decide that cleaning or logistics or IT or Personnel is not a ‘core business’. It gets outsourced to a specialist supplier.  Another step kicks in: off-shoring.  A business or service provider decides that an entire line of work can be relocated to a low cost centre. Much manufacturing has moved off shore and now services are on the move.

India has over 100 million English speakers and a growing, educated and ambitious middle class. Major multinationals like KPMG, Wipro and Tata take companies through the stages of setting up their own offshore base or buying into a shared service centre.

So on top of the loss of manufacturing jobs, it is estimated that, in recent years, over 2 million jobs in the USA and Europe have been off shored with the majority of the service jobs going to India.

Comparative advantage and trade work to the net benefit of the economy and the country. This theory works as long as the government supports the unemployed or the people on low incomes caught in the transition. In fact, what happens is that inequality intensifies.

As subjects of the good Queen we have a mix of generations getting shaken about and re-ordered by two big invisible hands. One hand is made up of a seriously unstable banking system and the other of low-skilled and increasingly high-skilled jobs being off-shored. Both hands are at work now and look to be the dominant hands for decades ahead. 

You would think that we would talk about this a bit more. Remind me to have a word with the Queen’s speechwriter.

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