Whose Brexit is it anyway?

Although last year’s Brexit referendum was initially proposed by the Conservatives, it was conducted across party political lines as MPs were allowed to vote with their conscience. And as we all know, the question on the ballot paper simply asked whether the UK should remain part of the EU or leave the EU. No thought was given to the form which Brexit should take. For a long time, Theresa May simply relied on the slogan “Brexit means Brexit” without giving any further indication of what that meant. By the time of her Lancaster House speech on 17 January, we finally got more insight when we were told that the government’s negotiating position would be based on the principle that “No deal is better than a bad deal for Britain.”

Most economists are horrified by that stance. It is simply not credible to assume that the rest of the EU is going to back down in the face of UK intransigence. What is more, this statement has made its way into the Conservative election manifesto. So either the Conservatives are committed to driving the UK economy over the edge of the cliff in the event they do not get the deal they want, or they will be forced to break the pledge upon which basis they were elected (assuming they win next week’s election).

But rather than treat the Brexit negotiations as a single party issue, there is a strong case for cross-party representation in the UK negotiating team. Indeed, if we accept the claims of those who believe Brexit is the biggest single issue facing the UK since World War II (maybe a slight exaggeration but you get the point), surely it deserves a similarly united national response. It would certainly help to assuage the 48.1% who voted against Brexit that their concerns will be listened to.

Whilst Labour believes the UK should continue down the path which their political opponents have already carved out, it does at least believe that “leaving the EU with ‘no deal’ is the worst possible deal”. It also makes the sensible suggestion that the UK should seek to remain part of organisations such as Horizon 2020, Euratom, the European Medicines Agency and Erasmus, and advocates protecting the rights of foreign nationals already in the UK. The Liberal Democrats are even more direct and parts of their manifesto sound like they wish to overturn the result. But at least the “aim for membership of the single market and customs union” sounds like a rational economic plan. The Scottish Nationalists have not yet released their manifesto, but you can be pretty sure that their aim will be to ensure that Scotland remains part of the EU.

On the basis of these varying degrees of support for the EU, my suggestion would be for the UK government to assemble a cross-party negotiating team, perhaps weighted by parliamentary representation. Based on the latest analysis by www.electoralcalculus.co.uk, this would imply giving the Conservatives a 60% weighting; Labour 32%; the SNP 8% and the Lib Dems 0%.  I do not expect this to happen, of course. As Philip Stephens noted in the FT four weeks ago, “Theresa May is dangerously disdainful of dissent” pointing out that “Mrs May assumes a monopoly of wisdom on setting Britain’s terms for EU exit. The record suggests she can claim anything but.” Ben Chu in today’s Independent suggests that the whole Conservative manifesto strategy is designed to bolster the prime minister’s position rather than looking after the UK’s best economic interest. In effect, we face a principal-agent problem whereby the agent (in this case the prime minister) has an incentive to work in her own interests rather than the principals who commissioned her (the electorate).

One solution to the principal-agent problem is to provide a high level of transparency – the prime minister’s insistence that she does not intend to reveal details of the discussions on a rolling basis surely adds fuel to Chu’s suspicion. Fortunately, we can rely on the rest of the EU to deliver that transparency. Giving the principal a stake in the outcome is also another useful solution. The issue (as noted above) is whether May’s objective is to secure her own or the national interest. A final check is thus to impose greater accountability. Packing off Conservative party representatives to Brussels for two years who then come back with a deal which is set to be rubber stamped by parliament is simply not enough. I thus maintain that at the very least other political parties should be represented during the negotiations, who are not bound by some form of parliamentary omerta. Some issues are too important to be left to politicians. This is one of them.

Being Wayne Rooney

Wayne Rooney is one of the most famous footballers in the world. He is the record goal scorer for his club, Manchester United, and for the English national team, and has won everything worth winning at club level (including 5 league titles, an FA Cup and the Champions League). However, over the last 12 months, questions have increasingly been raised about his continued ability to cut it at the highest level which has raised speculation that he will leave Man United at the end of the season. Not that football journalists know anything – The Guardian reported earlier this month that he would leave the club at the end of the season  having suggested just three months ago that he has no intention of leaving. Meanwhile the fans, not exactly models of consistency themselves, are generally in agreement that it is time to go.

But whilst the fans treat usually football decisions in the context of the on-field activities, there are in reality a lot of other economic factors to consider. Look at it from Rooney’s point of view. He is 31 years old and reported to be paid around £300k per week on a contract  believed to run until June 2019. Even if we assume this figure is around £260k, as reported in a number of media outlets, this means he can expect a gross income in the region of £27 million even if he never kicks a ball again. From the club’s perspective, it would appear to make sense to offload their highest earner if he is no longer able to perform at the level demanded of him. Indeed, as of mid-2016, the club was paying out £203 million per annum on wages – implying that Rooney accounted for just less than 7% of the total.

But Man United also earned £268 million in commercial revenue – primarily sponsorship and retail activities (here for more detail on the club’s accounts. It is slow to load, but worth it for an in-depth look at the accounts of a major football club). We should be in no doubt that Rooney has helped sell a lot of replica shirts. But now that he is no longer in the England squad, his commercial value will undoubtedly have slumped. Footballing considerations aside, the club appears to have little to gain financially by keeping him on. Of course, no other club in Europe is going to pay Rooney £13.5 million per year so unless he decides to join the exodus to China, where silly money is apparently on offer, what to do? The rational response would be to hang around for the next couple of years and bank the cash. Fans forums would, of course, be inundated with comments suggesting that he is only in it for the money and that such actions will tarnish his legacy. But frankly, you can trash my legacy for £27 million any day.

Rooney’s logical response to this criticism should be to ask the fans what they would do in the same situation? If your employer told you not to come in to work for the next two years whilst still paying your salary, most people would say it is illogical to refuse. After all, you could travel; learn a foreign language; do further study or take up a new hobby. Failure to understand the rationality of this position is a form of cognitive bias, defined as “a systematic pattern of deviation from norm or rationality in judgment, whereby inferences about other people and situations may be drawn in an illogical fashion.” It is not just football fans who suffer such biases, of course. Financial markets are riddled with them, which goes towards explaining why many investors make decisions which they can justify at the time but with hindsight appear ridiculous.

As it happens, the rumour mill is in full swing suggesting that various clubs are currently bidding for Rooney’s services. He may indeed be tempted to go elsewhere: It is not as if he is short of money so he can presumably afford to take a pay cut. The motivations for him wanting to do so are fully in line with evidence from psychology which suggests that factors other than money can motivate sportspeople. Like actors, sportsmen (and women) are motivated by adulation. So long as he continues to be reasonably well paid, Rooney might be tempted to trade off some of his extraordinarily high current salary for a lower one and a continued presence in the public eye.

Still, it’s a nice problem to have. As for me, if I were faced with Rooney’s decision I’d take the money on offer from Man United. In fact, I would take a small fraction of his salary in order not to play football. Now you might say that I am not as good a footballer as Wayne Rooney so am in no way as deserving. But that is only true on the field of play. When both of us are doing nothing, I’m just as good as he is.

Age concern

Without wishing to trivialise in any way the horrific bombing in Manchester, the suspension of the UK election campaign came at a fortuitous time for the prime minister who was undoubtedly on the ropes on Monday regarding her U-turn on plans to fund care for the elderly. Dealing with old age care is an issue of major economic importance, and I did note last weekend that “tackling the problems of an ageing society will require us to think differently on tax and social insurance issues.” But it is worthwhile digging into some of the economic implications of an issue which not only affects the UK but is a problem for all ageing societies.

To remind you of the story so far, the Conservative manifesto last week suggested that those requiring long-term old age care would be required to run down their assets to “a single capital floor, set at £100,000, more than four times the current means test threshold.” The implication is that households will have to pay a lot less than they do today. Whilst that is true of the current system, it omits the fact that under legislation already on the books “from April 2020, there will be a cap limiting the amount people will have to pay for their care and support”. Moreover, the threshold beyond which people receive no financial support is due to rise from £23,250 to £118,500 (these reforms were originally scheduled for 2016 but local authorities balked at the additional costs this would impose, hence the delay until 2020).

In other words, a significantly more favourable plan is already scheduled to come into play in 2020 than that proposed by the Conservatives. As it currently stands, someone who has lifetime care costs of £150,000 could lose up to 90% of their accumulated wealth. Raising the support threshold and imposing a cap significantly reduces this proportion. By contrast, the Conservatives’ plan placed no such upper limit so that all but the final £100,000 of an individual’s assets could be used to fund their care needs. I am indebted to the FT’s economics correspondent, Chris Giles, for working out the tax rates on assets in different care systems (see chart). What is evident is the magnitude of the costs under the current system (the green area) versus the proposals set out by the Dilnot Commission in 2010 (black line). Last week’s Conservative plans (red line) help those at the lower end of the asset scale but they are far less favourable compared to what was proposed in 2010.

The idea of scrapping the cap caused an outcry for both good and bad reasons. The bad reason is the notion that today’s generation of pensioners be protected so that they can hand over their stock of assets to future generations. Whilst this may reflect an instinctive desire to help one’s offspring, there is no reason why today’s tax revenues should be used to ring-fence bequests to future generations. A better objection is that the absence of a cap promotes unfairness due to the fact that for any given wealth cohort some will be afflicted by illnesses which require extensive old age care whilst others will not. For example, an unfortunate pensioner who suffers from dementia may require many years of care whereas someone with the same assets who dies suddenly at the same age will not face the same care burden. There is no sense of social insurance: people are very much on their own.

Whether the reaction of the public and politicians was motivated more by the latter than the former matters less than the fact that the Conservatives responded to the groundswell of opposition by announcing they would indeed place an “absolute limit” on care costs (without saying what the limit would be). What is absolutely not true is the prime minister’s assertion that “nothing has changed from the principles on social care policy that we set out on our manifesto.” In fact, everything has changed. The principle of a cap means that we have some notion of risk pooling rather than one which forces individuals to bear full personal liability.

A more pertinent question is how this should be funded, which is the bit no-one talks about. The Dilnot Commission pointed out that there are three ways to fund old age care provision. The obvious way is to do what we do now – raise the additional revenue from general taxation, which will mean higher taxes. A second option would be to change the balance of spending away from other items and towards care provision. However, a third option would be to introduce a specific tax increase which should be paid “at least in part by those who are benefitting directly from the reforms. In particular, it would seem sensible for at least a part of the burden to fall on those over state pension age.” Dilnot further suggested that “it would be sensible to do so through an existing tax, rather than creating a new tax” which would most obviously suggest targeting inheritance tax.

I am not even averse to the idea of levying a specific tax in order to build up a social insurance fund, although governments are generally very bad at ring-fencing revenues for specific tasks. Whatever the ultimate outcome, the UK government clearly has to think more carefully about generational outcomes than it has up to now. The current pay-as-you-go option is not fit for purpose. But nor is a system which mitigates against a market for social insurance. There is plenty to ponder but it certainly will not be resolved before the election, and it is increasingly a problem which all industrialised countries have to face up to. Ageing societies don't come cheap.

A partial change of tack from the Conservatives

Having previously looked at the Labour Party manifesto (here), in the interests of balance it is only fair that I take a look at the economic consequences of the Conservatives’ election promises – particularly since they are nailed on favourites to win the election, so what they have to say is probably more relevant. However, since they did not offer any attempt to cost their proposals – unlike Labour or the Lib Dems – it is harder to offer a precise assessment.

What is striking is that last week’s document highlighted “Five giant challenges” in a similar vein to the famous 1979 manifesto which highlighted “Our five tasks.” But there the similarities end. Indeed, the overall tone was widely interpreted as a step back from the Thatcherite policies which have dominated the Conservatives’ agenda for almost 40 years. This view is based on an apparently innocuous couple of sentences tucked away on page 9 which suggested “We do not believe in untrammelled free markets. We reject the cult of selfish individualism.” That is most certainly not the Conservative philosophy which has been presented to me throughout most of my adult life.

So why the change of direction? Perhaps it is because, as John Kay pointed out in an FT column recently (here) , “a great intellectual failure of the past two decades is the inability to offer a more nuanced account of the market economy than that contained in the mantra of ‘greed is good.’” I could not agree more. One of the motivating factors behind this blog in the first place was to point out that systematic indifference to the fate of swathes of the British economy, which had been left to contend with the forces of free market economics, would ultimately weaken, rather than strengthen, it (see my first post from June 2016). Market self-regulation clearly produces outcomes which are damaging both to the company and the consumer (think of the scandals in banking in recent years) and as Kay points out, “the legitimacy of modern business organisation has been further undermined by continuing revelations of corporate wrongdoing … and by the disclosure of the aggressive tax avoidance.”

Does this mean that a Conservative government under Theresa May will take a step to the left (or more accurately, the centre) of the political spectrum on economic matters? Admittedly, one of its consumer protection policies was a rehash of an old Labour policy promising to introduce tariff caps on domestic energy bills. This ironically, was a policy described by David Cameron as “Marxist”. But it is not the whole story.

From a macro perspective, the Conservatives now only “aim for a balanced budget by the middle of the next decade.” At the time of the 2015 election, the budget forecast showed that the UK was on track for a budget surplus by 2018-19. One of the problems which the government has faced since 2010 is that income tax receipts have continued to fall below expectations (chart), which has blown a £30-40bn hole in the budget with the result that filling the fiscal gap has taken far longer than anticipated. At least the Conservatives have dropped the pledge not to raise income taxes or National Insurance Contributions, which caused such a controversy in March. 

All this matters because the government will increasingly have to face up to the problem of rising healthcare costs resulting from an ageing society as baby boomers retire in droves. One of the ways which the Conservatives have tackled this is to propose a reduction in the cap on welfare spending for the elderly, which means that those receiving social care must fund the entire cost until they reach their last £100,000 of assets. This is hugely unpopular amongst traditional Conservative supporters and it also flies in the face of the Dilnot Commission recommendation that a limit be placed on lifetime social care contributions (a review body set up by the coalition government in 2010). Nobody likes the idea of running down their childrens’ inheritance to pay for care costs, hence its unpopularity, but it is a recognition that tackling the problems of an ageing society will require us to think differently on tax and social insurance issues in future.

I have managed to get this far without talking about Brexit, primarily because there is nothing new to say. The Conservatives continue to believe “Britain needs a strong and stable government to get the best Brexit deal … delivered by a smooth, orderly Brexit.” But it also remains committed to reducing annual net migration to ”the tens of thousands, rather than the hundreds of thousands we have seen over the last two decades.” Having failed for the last seven years to deliver this pledge I remain unconvinced that it is achievable any time soon (never mind the fact that the figures are almost certainly wrong, as the UK’s sample based system has huge margins of error). Moreover, it continues to target a net figure whilst only focusing on migration inflows. Even more strange is that whilst the manifesto states a desire to ensure that the flow of skilled migrants continues, in the next paragraph it announces a plan to ”double the Immigration Skills Charge levied on companies employing migrant workers.”

This highlights the lack of joined-up thinking on immigration and highlights why businesses are increasingly expressing disquiet about the costs of immigration curbs.  Moreover, in its Fiscal Sustainability Report, released in January, the OBR assumed long-term net immigration of 185,000 per year. Its low immigration scenario, which assumed a net figure of 105,000 per year, reckons that in 30 years’ time the UK’s net debt to GDP ratio will be 11% higher than in the already unfavourable baseline, rising to 20% and 30% higher on a 40 and 50 year view respectively. Obviously, we should take long-term forecasts with a huge pinch of salt but they should remind us that immigration curbs come at a substantial economic cost.

Quite clearly, Theresa May is banking on the idea that she can win a large enough majority to silence the hardliners within her party who believe in the primacy of free markets and Brexit-at-any-price. She will have to, because there is enough material there to enrage the old-school Thatcherites who have a habit of making life hard for vulnerable prime ministers. As an economic plan, aside from the immigration pledge (and maybe the energy caps), it has its good points. But by pushing out yet again the point at which the UK balances its fiscal budget, I do question whether the last seven years of austerity have been worth the cost.

On Trump, risk and uncertainty

As if Donald Trump’s tribulations were not bad enough, we learned today that Brazilian President Temer has been caught on tape endorsing bribery payments. The net result was that Brazilian financial markets took a hammering with the equity market opening 10 per cent down, which triggered an automatic halt in trading, whilst the currency wiped all its year-to-date gains. This comes a day after US – and by definition global – markets suffered heavily in the wake of mounting disquiet regarding the conduct of President Trump.

Without making any comment on the rights and wrongs of their respective actions, what is most fascinating was the market response which has been extremely negative. We should not overlook the fact that the VIX index – a measure of option volatility on the S&P500 – was at 24 year lows at the start of last week. This index is often referred to in the financial press as the “fear index” because the extent to which volatility changes is associated with changes in market sentiment. As it happens, this is a little misleading because the VIX is a measure of market perceived volatility in either direction. But a surge from a low below 10 last week to above 15 today is a measure of a market which is nervous.

What has struck many investors as odd over recent months has been the extent to which markets have been able to shrug off the uncertainties in the wake of Donald Trump’s election, driving US equity indices to record highs and volatility to multi-year lows. The surge in prices has clearly been driven by expectations of the Trump reflation trade. But as I noted at the start of the year, “I suspect markets will not get the benefit of the hoped-for fiscal stimulus” and I still stand by that view, primarily because the president’s difficulties will make it much harder for him to drive through his economic agenda. Predicting that markets will correct is a mug’s game but in the absence of a tailwind from expectations of stronger growth, it might be harder for equities to make big gains from here, particularly when valuations are already high and the Fed is raising rates.

Last week’s interview by The Economist of the President, which resulted in a scathing assessment of Trumponomics, did not fill me with much hope that a growth plan is forthcoming. The Q&A transcript struck me as a rambling and superficial overview of his plan. However, none of this should have come as any surprise. So it always felt strange to me that markets could be so sanguine and, despite the fact we are living in some of the most extraordinary economic times in recent history, that equity volatility could decline so far.

This supports the view which I have held for many months that whilst markets can price risk they cannot price uncertainty, and as a result have simply given up trying to do so. This difference between risk and uncertainty is a long-held tenet in economic and financial circles and stems from Frank Knight’s 1921 book “Risk, Uncertainty, and Profit” which made a clear distinction between known unknowns and unknown unknowns (long before Donald Rumsfeld picked up on the concept). It does go a long way towards explaining why markets can suddenly switch from a stable state to an unstable one. In the wake of both the Brexit referendum result and Trump’s election, markets realised very quickly that sharp sell-offs were unnecessary and that there was potential for a rally. Investors knew full well that it could all go wrong but probably rationalised the view that there was no point in waiting for the other shoe to drop. Far better to ride the cycle on the way up and deal with the consequences of the sell-off as and when it happened.

But just as many of us failed to pick up the tail risks last year, so investors have to beware the possibility that these risks begin to manifest, perhaps in the form of no Trump reflation trade. If we can’t price uncertainty, then maybe investors will be forced to pay more for risk protection. That alone might take the edge off the recent US rally. Of course, it may not, but if and when the correction finally does occur, it could be all the more painful.

Labour's fiscal policy: Marks for effort

The UK election campaign, which is being met with indifference at home never mind abroad, took a radical turn today with the publication of the Labour Party’s manifesto. Much of what was leaked last Thursday was included in today’s plan, with one or two additions, and it is very much a series of tax and spend proposals which offers a radical alternative to the economic status quo of market over state. It is, I suspect, the economic plan of a party which does not expect to win an election: Many of the proposals would simply not be acceptable to higher earners or corporates, which will bear the brunt of additional tax rises. At a time when companies have to think about where they want to be located post-Brexit, it is a plan which will encourage footloose capital to move elsewhere. Nonetheless, it does raise very big questions about the nature of the state and the role of fiscal policy, which have been neglected for too long.

The philosophy which the UK electorate has bought into since Thatcher’s time is that a relatively small state is a good thing and that markets provide freedom of choice. But this is not always true. For one thing, private companies are not always as efficient as their proponents claim because they waste resources in the competitive process which could otherwise be used more effectively for service provision – a bit like moving parts which generate heat rather than mechanical energy. Whilst on the whole, they do deliver lower cost services there are real questions as to whether private entities are run for the benefit of shareholders or their customers.

In a competitive market the two sets of interests are aligned, but certain industries are best viewed as natural monopolies. Gas, electricity and water supply all fall into this category and so unpopular is the notion that private sector energy companies are ripping off the consumer, that the Conservatives have stolen one of Labour’s old ideas by planning to impose price caps (what price free markets?). Nor are huge infrastructure projects  necessarily suited to a private sector which does always not have the scale to manage them properly. For example, the UK has outsourced the construction of the Hinkley Point nuclear power station to EDF – a French state-owned company – and a state-backed Chinese entity. The first decade after the privatisation of the UK rail network was characterised by a shambolic series of events which means that today, the Labour Party’s policy of re-nationalising the rail network is actually very popular (it plans to do this as local franchises expire which means that the cost to the Exchequer is limited).

Of course, not all privatised utilities are bad. No-one would seriously advocate renationalising the telecoms network. But it is right to have a debate about which industries require more state involvement, and we should not dismiss the issue as being one for the socialists. Incidentally, the privatisation programme sparked by the Thatcher government in the 1980s was designed to create a nation of small shareholders, in which households held a stake in the nationalised utilities. But that idea faded quickly as shares were snapped up by institutions which in turn sold out to foreign utilities. Whatever the rights and wrongs of today’s energy and water markets in the UK, what we have now is not what was envisaged in the 1980s.

Looking more closely at Labour’s plans, there was more detail on the tax and spending pledges which will result in a tax rise of £48.6bn by the end of the next parliament, or just over 2% of GDP. According to the sober analysis of the Financial Times, this would put taxes relative to GDP at their highest since 1949. But even then, the state will still be significantly smaller than in many other European countries. As I noted last week, a large chunk of the additional taxes will fall on corporates, which are expected to contribute almost £20bn of the £48.6bn increase, and another £6.4bn from higher income taxpayers in what the Daily Mail helpfully described as Corbyn’s class war. What was truly radical was the idea that a Labour government would “consider new options such as a land value tax” which ironically was supported by the likes of Adam Smith, a hero of many on the Conservative right.

It is questionable whether these figures would ever be realised, however. Raising taxes changes the behaviour of those on whom the tax is levied so if tax elasticities are high, revenues may well be far lower than anticipated. Nonetheless, Labour did a good job of allaying fears of an unfunded rise in current spending, even if many people will be less than happy about the prospect of higher taxes. A potential Labour government will, of course, have to borrow to fund its capital spending plans. That is normal. At issue is how much it would need to borrow and what would the market charge. I suspect we will never get the chance to find out.

Even if one does not like the ideas presented today, they represent a rather more grown-up approach to the question of fiscal policy than we have become used to in recent decades. If we want a better healthcare system, we are going to have to pay for it. More policemen? Fine, but the money has to come from somewhere. There is, however, a whiff of the 1970s about the plan. It fails to account for the fact that more money does not necessarily mean better services. It also treats the UK as a small closed economy whereas in reality a globalised environment will pose limits on the government’s ability to operate the fiscal levers. A former Labour prime minister, Jim Callaghan, recognised as such in 1976 when he said “We used to think that you could spend your way out of a recession, and increase employment by cutting taxes and boosting Government spending. I tell you in all candour that that option no longer exists.” Still, I will give Labour marks for trying, and we should not be too surprised if some its ideas ultimately end up being adopted by the Conservatives. It would not be the first time.

The case for a National Investment Bank

One of the policy proposals put forward in the leaked Labour Party manifesto last week was the establishment of a National Investment Bank (NIB) to facilitate £250bn of spending on infrastructure over the next ten years. There was no detail in the document about how this might be set up, but there is some merit to the idea if done properly and in this post I offer a look at how it might work.

It is important to be clear at the outset what it should not be. It should not be a conduit for monetary creation by the Bank of England – the so-called People’s QE plan proposed by Jeremy Corbyn when he took over as Labour leader in 2015. PQE essentially requires the central bank to buy the bonds necessary to capitalise such an institution. But this policy is fraught with danger primarily because it erodes the boundaries between government and central bank to an unacceptable degree. In the form envisaged, it allows government to force the central bank to create money to finance whatever projects it deems fit. Moreover, a policy which requires monetary creation on such a scale would also have potential inflationary consequences and no central banker worth their salt is ever likely to endorse such a plan.

That said, there is no reason why a NIB should not work. The UK has tried it before and it was remarkably successful though perhaps not in the way initially envisaged. The Industrial and Commercial Finance Corporation (ICFC) was set up in 1945 by the Bank of England with funding from major commercial lenders to provide capital to small and medium-sized companies. In order to free itself from the constraints of relying on the clearing banks for funds, the ICFC began to tap the market to raise capital. This had an adverse side effect in as much as it raised pressure to generate greater returns on equity, which in turn led to a shift away from longer term, less attractive returns which its core mission delivered, to shorter term higher return projects, which caused problems during times of economic downturn. But by the 1980s it had shifted focus to become a leading provider of finance for management buyouts and had expanded internationally. It became a public limited company in 1987, when the banks sold their stakes, and it was fully privatised in 1994.

Currently, the UK is the only G7 economy not to have an institution which provides finance to the SME sector. In Germany, the Kreditanstalt für Wiederaufbau (KfW) has supported industry since 1948 and in the US, the Small Business Administration (SBA) has operated since 1953. Admittedly, the UK government did dip its toes into the water recently when it established the Green Investment Bank (GIB) in 2012. But despite apparently being successful, it was sold to Macquarie Bank last month for a price (£2.3bn) less than the initial £3.8bn of capital injected by the government.

In an excellent paper commissioned for the Labour Party in 2011, the lawyer Nick Tott outlined the case for a NIB.  But just to show that the case was not party political, former MPC member Adam Posen made a similarly excellent case in a 2011 speech which suggested that not only was there a case for a NIB, but that there was a need for an “entity to bundle and securitize loans made to SMEs … to create a more liquid and deep market for illiquid securities.” The biggest question remains how to capitalise such an institution. The government could commit up to £5bn as initial seed capital – after all it put almost £4bn into the GIB – and it could issue another (say) £5bn of bonds backed by Treasury guarantee. In future years it could divert part of the income generated by National Savings and Investments (NS&I) which raised £11.3bn for the Exchequer in 2015-16 and has assets of £120bn.

Admittedly, this is pretty small scale stuff and would be in no way able to fund the £25bn per annum of infrastructure which the Labour Party is calling for. This is probably a good argument in favour of limiting the remit of such an institution to SME lending rather than big public infrastructure projects. That, after all, is what such institutions do in other countries. Moreover, as Tott points out, it “would need a wide measure of independence from government.” It cannot simply be an arm of government to finance all sorts of pet projects, otherwise those who brand it a return to 1970s-style profligacy will likely be proved right.

A NIB would have to be run along commercial lines. As Posen pointed out, “The existing banks will scream about the unfair cost of capital advantage such an institution would have, but ... since the major banks in the UK have benefitted from a too-big-to-fail situation, any disadvantage they have in funding conditions is offset by the funding advantage they have over smaller or newer financial institutions, which they have gladly accepted. [Admittedly] public sector banks do tend to underperform private banks in credit allocation, and do tend to erode private banks’ profits. Yet most if not all countries have ongoing public lenders of various types (even the US has the SBA), and their existence on a limited scale, while perhaps wasteful at the margin, does not lead to the destruction of the private-sector banking systems in those countries … Let us remember that the UK and other western private-sector banks did that themselves during a period of financial liberalization and privatization unprecedented in postwar economic history.”

There are good reasons why the UK needs to do something to raise investment. For one thing, it is about to lose its EU funding which will put a hole in the transfers to many of the English regions (places like Hartlepool, which were very much pro-Brexit, have received considerable funding in recent years). A more generic macroeconomic problem is that the rate of business investment growth has been below the rate of depreciation since the great recession. This is not an issue which gets much airplay in the big picture story, and I am not sure of the extent to which it represents a change in business behaviour or whether it is a measurement problem. But it means in effect that the UK capital stock is declining, which may be one explanation behind the slowdown in potential growth in recent years. The UK needs to raise its investment levels. Whether a NIB is the right way to go about it remains to be seen. But it is an idea which should not be dismissed out of hand.