A progressive approach to globalised finance needs to create a financial sector that funds investment in the real economy
“I sympathise, therefore, with those who would minimise, rather than with those who would maximise, economic entanglement among nations. Ideas, knowledge, science, hospitality, travel – these are the things which should of their nature be international. But …above all, let finance be primarily national.” John Maynard Keynes, National Self-Sufficiency, 1933
“We need a financial system that serves society.” Christine Lagarde, managing director, International Monetary Fund, 2016
There are many aspects of globalisation that are very positive. As Keynes pointed out, the international circulation of ideas, scientific knowledge and people helps growth and is a positive force for peace amongst nations.
There is, however, one aspect of globalisation that has been clearly damaging in net terms, as its costs largely outweigh its benefits. This is globalised private finance, particularly if liberalised and poorly regulated.
After the 2007/8 global financial crisis, the limitations of a purely private and globalised financial sector to fund the real economy became more evident. The private financial system is not performing well enough to support the real economy. It is pro-cyclical – over-lending in boom times, and rationing credit during and after crises, limiting working capital and, especially, long-term finance crucial for investment. In general, it has not funded sufficient long-term investment in innovation that businesses need to grow and create jobs; key sectors like infrastructure, renewable energy and energy efficiency, essential for structural transformation to a greener and more inclusive economy, have not received enough funding. Small and medium enterprises, key for employment, get insufficient and costly credit.
Furthermore, the private financial sector, particularly if not properly regulated, has been a major factor in causing frequent and very costly crises, most recently in several Eurozone countries, but previously in the United States and the United Kingdom, and in many emerging economies.
Stiglitz argues that market failures in liberalised financial markets are likely to be endemic as those markets are particularly information-intensive, making information imperfections and asymmetries more important and disruptive than in other economic sectors. Therefore in important parts of financial markets, market failures are greater than government failures, as Stiglitz insightfully argues. In such cases government interventions are more desirable than in other sectors. This provides a very robust case for a “visible hand of government,” through effective public development banks to fund private investment and through an expansion of productive forward-looking public investment as well as through strong regulation of private financial markets.
A progressive response to financial liberalisation must therefore include helping to create a financial sector that funds investment in the real economy, creating jobs and increasing productivity. To be effective, it needs to be complemented by sufficient public investment that will crowd in more private investment, especially when private investment is discouraged by uncertainty and lack of aggregate demand.
In recent years, the valuable role that national, regional and multilateral development banks can play has received much wider recognition. So, increasingly, has the greater need for instruments to implement more long-term national or regional development.
It is also interesting that the role of development banks has been highlighted in developed countries. Thus the European Investment Bank has been and is playing a prominent role in the provision of long-term lending for investment in infrastructure, innovation and green energy, as well as SMEs, especially during and after the Eurozone debt crisis as private lending fell.
At a national European level, Germany’s public development bank, KfW, the second largest commercial German bank, has played a very positive role in increasing lending counter-cyclically (for example to SMEs) during the crisis, as well as funding on a significant scale key sectors, such as renewables. In fact, KfW played a very major role in funding the initial private investment in German solar and wind energy, broadly seen as very successful in achieving sustainable growth in Germany.
It is very positive that the Labour party is proposing the creation of a business investment bank (BIB) as this would help in a major way to finance much-needed UK private investment, which is currently very low and is essential for increasing UK productivity, as well as sustainable growth. An important feature of successful development banks is that their scale is large, as a proportion of the total economy, so their positive impact on funding investment in key sectors is significant.
It may be useful to compare the scale of a potential BIB with the German KfW, to give a first idea of desirable scale (Other analysis is clearly required, such as need and likely market gaps for the UK case). The total loan exposure of the KfW is around €500bn, approximately £430bn. If we assume a similar scale for the UK, in proportion to its population, total exposure of the BIB would reach £ 340 billion after several years. The equity required in paid in-capital for a British business investment bank, to lend on that scale, assuming a leverage of 1:9 to achieve the best possible rating of AAA, can be estimated at around £40bn. This could be done by contributing £10 billion a year, for four years. The impact on the UK economy, in terms of investment, jobs, growth and productivity could be very large, given the significant leverage the BIB would have.
Professor Griffith-Jones will be speaking at a session entitled Too far, too fast? Has the pace of globalisation left too many people behind? at the Fabian New Year conference on 14 January.
Image: Lawrence OP