Tuesday, 27 September 2011

A stimulating proposition

Old fashioned economic stimulus has a new name for the twenty-first century. Concepts such as Keynesianism, state intervention and pump priming have been replaced by quantitative easing. According to Bob McTeer, quantitative easing is “different from traditional monetary policy only in its magnitude and pre-announcement of amount and timing.”

And if we accept quantitative easing is not so very far removed from traditional monetary policy, it merely becomes the latest in a long line of government economic intervention. Nick Clegg told the Liberal Democrat conference last week that Britain should invest its way out of the downturn. Across the Atlantic, and there are growing demands for the Obama administration to use the government’s economic heft to create jobs. This is fuelling the loud and increasingly antagonistic political debate over how successful fiscal stimulus policies are, and both proponents and opponents are looking to the past to reinforce their position.

Since the Second World War, the US Congress has passed economic stimulus bills during five of the past seven recessions — in 1964, 1971, 1975, 1981 and 2001. Jason Furman of the Brookings Institution's Hamilton Project has noted that measures taken in the 1960s and 1970s were relatively ineffective. This changed with prompt intervention in 1981, and by 2001 tax cuts came as the US slid in to recession, rather than following the start of economic recovery.

The Great Depression and New Deal

The golden age of government intervention came amidst the economic chaos and social despair of the Great Depression. In the period starting with the crash of the US stock market on Black Tuesday (29 October 1929) and the inauguration of President Roosevelt (4 March 1933) the US economy crumpled  and confidence evaporated.

Industrial production almost halved, unemployment sextupled and foreign trade collapsed by 70% as America stumbled through the darkest days of the depression. Prices slumped by a third as the US entered a devastating deflationary spiral, compounding the economic and fiscal pressures. All this combined to give Roosevelt the worst Presidential inheritance since Lincoln’s receipt of a fracturing union in 1860.

Roosevelt’s policy response was immediate, energetic and arguably successful. In his election campaign he had promised a new deal for the American people, and this was delivered in the first hundred days of his frenetic administration.  The closure and reform of the entire banking system was followed by federal work programmes (FERA, WPA, CCC and the NRA) and programmes to revitalise the agricultural sector and the poorest rural areas (such as the iconic Tennessee Valley Authority). So many acronyms and initialisms emanated from FDR’s White House that they became known as the ‘Alphabet Agencies’.

So does the New Deal offer lessons to inform today’s debate on stimulus? Unfortunately, it can be used as fuel for both sides of the debate. Proponents argue that the New Deal pushed the US economy into recovery. Keynesian economists suggest it helped, but did not go far enough (FDR was still keen to balance the books and was forced into reverses from 1937 by a resurgent Republican Party).  

Opponents suggest the New Deal prolonged the Depression with Cole and Ohanian stating that “New Deal policies are an important contributing factor to the persistence of the Great Depression”. They have quantified their theory, and extrapolated that New Deal policies prolonged the Depression by seven years. Their findings are echoed by Gallaway and Vedder, who argue that without the New Deal, the unemployment rate would have been 6.7% instead of 17.2%. But this interpretation is not without critics, including DeLong, who states that this work produces "flawed conclusions" based on "flawed foundations", and the entire foundation "is made out of mud".

Lincoln’s New Deal

The unprecedented economic hardship of the Great Depression resulted in unprecedented levels of government intervention. But Roosevelt’s New Deal was not the USA’s first government stimulus package. Abraham Lincoln fostered an economic development programme that featured some of the most audacious displays of governmental involvement.

His administration oversaw the birth of the First Transcontinental Railroad, linking America from coast to coast and stimulating the development of vast expanses of her lonely interior. Under the Pacific Railroad Act 1862 the Central Pacific and Union Pacific Railroads received generous federal subsidies of both cash and land, encouraging them to forge ahead with ambitious line building plans. Lincoln was, according to Stephen Ambrose, "the best and most powerful friend the transcontinental railroads ever had."

Grants of land were also the staple of his expansion of higher education through the foundation of Land Grant Colleges. This programme led to the establishment of colleges throughout the US, including prestigious establishments such as the University of California, MIT, the University of Vermont, Texas A&M and Cornell University.

Other Lincoln policies included Federal agricultural improvement programmes, protectionist tariffs which forged the development of the US steel industry and national control over the banking industry to free capital for investment. Some claim this set the scene for the rise of US economic dominance. Others suggest it precipitated the Panic of 1873.

The birth of dirigisme and Colbert

Crossing back to the Old World, and it is obvious that state intervention in the economy is as old as economic life. Whether it is the ancient Egyptian state grain stores or fixed price bread and wheat distribution under the Roman Republic, states have always meddled in the economy. One of the most concerted attempts to go a step further and direct economic development was found in France under King Louis XIV.

Jean-Baptiste Colbert was the Minister of Finance of France from 1665 to 1683 where hard work and thrift made him a respected advisor. He intervened in industrial policy, establishing the Manufacture royale de glaces de miroirs (the Royal Glass Works) to replace dependence on imported Venetian glass. The company continues to this day as one of France’s leading conglomerates under the name Saint-Gobain S.A.

Colbert established the French merchant marine, protected the fledgling Compagnie française des Indes orientales (French East India Company), reformed medieval guilds and restrictive economic practises and oversaw construction of the Canal du Midi. He eventually balanced France’s chaotic budgets, and returned the monarchy to surplus. All of this would be undone in Louis XIV’s numerous wars of expansion, wrecking Colbert’s carefully nurtured prudence.

Out of all of this the only clear lesson in the history of economic stimulus is that there is no clear right or wrong. Policy makers are damned if they do and certainly damned if they don’t.

Friday, 23 September 2011

Prophecies of doom – the warning echoes of Thomas Malthus

Two minutes after midnight on 12 October 1999 a baby boy was born in Sarajevo, Bosnia. He was 3.55kg (8lbs), healthy and welcomed in to the world by the Secretary General of the United Nations, Kofi Annan. The baby, Adnan Mević, was given such high profile attention after being selected by the United Nations Population Fund as the symbolic six billionth person concurrently alive on Earth.

Just twelve years later and the Day of Six Billion will be superseded on 31 October as the world welcomes its seven billionth inhabitant. Both of these days are highly symbolic projections – no demographer can be certain of the world’s population let alone able to balance births and deaths to reach an accurate conclusion on the six or seven billionth person. But they do prompt debate on the world’s population, rekindle discussion on the earth’s ‘carrying capacity’ and see demographers and politicians ask how many people can the earth support?

World population in 1800 – 1 billion

One name above all others is associated with the arguments – the Reverend Thomas Malthus. In 1798 he published “An Essay on the Principle of Population”, which argued that population would expand in times of plenty until checked by a shortage of primary resources. If the population continued to grow in excess of the earth’s ability to provide for them, it would be checked by “premature death” that “in some shape or other visit the human race”. His prediction was that mankind, through warfare are “active and able ministers of depopulations”:

“But should they fail in this war of extermination, sickly seasons, epidemics, pestilence, and plague advance in terrific array, and sweep off their thousands and tens of thousands. Should success be still incomplete, gigantic inevitable famine stalks in the rear, and with one mighty blow levels the population with the food of the world.”

Malthus’s work is considered the most influential founding text on population. It was not, however, the first book to consider overpopulation. Jonathan Swift’s devastating satire in “A Modest Proposal” (a preferred shortening of the unwieldy long title of “A Modest Proposal for Preventing the Children of Poor People in Ireland From Being a Burden on Their Parents or Country, and for Making Them Beneficial to the Publick”) mockingly suggested a radical use for ‘surplus’ Irish children.

The tract retains its ability to shock, puncturing even the cynicism of the twenty-first century reader. Swift argues that 100,000 surplus children of the Irish poor could be sold for good price to grace the tables of the better off:

“a young healthy child well nursed, is, at a year old, a most delicious nourishing and wholesome food, whether stewed, roasted, baked, or boiled; and I make no doubt that it will equally serve in a fricasie, or a ragoust.”

Swift’s Ireland would suffer the terrible consequences of overpopulation and crop failure in the Great Famine. But Malthus’s concerns were largely confounded in nineteenth century Britain by improvements in agriculture and vast imports of wheat from the American and Canadian plains and Russian steppes.

World population in 1900 – 1.65 billion

Malthus’s work continued to be widely read, and influenced Charles Darwin’s “On The Origin of Species” and his theory that the struggle to survive was a consequence of overpopulation and the spur to natural selection and evolution.  Both works would heavily influence the development of eugenic theory, with Henry Fairfield Osborn advocating “humane birth selection through humane birth control” in order to avoid a Malthusian catastrophy by eliminating the “unfit”. The predictions of human catastrophe were largely rejected by the end of the nineteenth and early twentieth centuries, and those advocating population controls were largely concerned with conservation issues.

Malthusian ideas were largely dormant until 1948, when two works would spark a debate that would become one of the twentieth century’s biggest issues. Fairfield Osborn’s ‘Our Plundered Planet’ and William Vogt’s ‘Road to Survival’ were both best-sellers and triggered the debate that would develop into the ‘population bomb’. Vogt argued for population control whilst Osborn criticized man’s poor stewardship of the earth and depletion of natural resources.  

World population in 1950 – 2.5 billion

The concept of a population explosion was explored throughout the 50s and 60s. On 11 January 1960, Time magazine featured a front cover on the population explosion. Rachel Carson’s ‘Silent Spring’ in 1962 would be followed by the widely read and hugely influential ‘The Population Bomb’ by Paul Ehrlich in 1968.

Population control was now more than an intellectual discourse, it was a struggle for mankind’s survival. The vast and increasing populations of India and China were cited as major contributors to population growth, and it was these countries that embarked on high profile population control campaigns. China’s ‘one-child policy’ was introduced in 1978 and the authorities claim that it has since prevented 400 million births.

India’s national policy was more permissive, focusing on education, contraception and legalization of abortion. As a result, China’s fertility rate is currently 1.8 (and below the replacement rate of 2.1), whilst India’s is 2.7. India is predicted to overtake China as the most populous nation in 2026. Concerns about overpopulated extended to humanitarian relief, for example with Lyndon Johnson’s shipments of wheat to famine-struck India in 1966. The grain was exported on the strict condition that the country accelerated its family planning campaign.

World population in 2050? 12 billion, 9.75 billion, 5 billion?  

But catastrophe was averted and famine avoided by the Green Revolution, which caused a dramatic increase in the production of cereal crops. More recently, the debate on population has been linked with concerns over global warming, resource depletion and peak oil. The concept of the Earth’s ‘carrying capacity’ has been discussed, reigniting the debate on the planet’s ability to cope with an increasing population. 

Wednesday, 14 September 2011

The long life of a temporary tax

One of the biggest political battles within the Coalition is on the fate of the 50p tax rate. Those on the right question its effectiveness, with the Institute for Fiscal Studies suggesting it costs more in lost taxes than it yields in additional revenue. Others have suggested it is an essential plank in restoring fiscal stability, and a manifestation of Cameron’s statement that ‘we are all in this together’.

There had been plenty of taxes before income tax – estate duties, ship money, window tax, wool tax, brick tax, wallpaper tax and the gloriously named hair powder taxes. Duties have been levied on beards, newspapers, paper, tea, ribbons, perfumes and horses. Income tax itself is barely 200 years old, and was first announced in 1798 and introduced in 1799. It was part of series of desperate measures taken by the UK Parliament to finance ruinously expensive wars against Napoleonic France.

The time was ripe for fiscal intervention – Britain’s cash starved navy had been brought to the brink of mutiny in 1797, and the UK’s national debt was increasing in the face of a better organised and militarily successful France. Holding office as both the Prime Minister and Chancellor of the Exchequer, William Pitt the Younger convinced himself of the need for a dramatic new tax.

The tax was introduced at the rate of 10% on all incomes above £60 per annum to be paid in six equal instalments. Most importantly, it was a temporary tax – only to be levied for the duration of the wars against Napoleon. It was expected to yield £10m, and, whilst actual receipts of £6m were disappointing, it did establish Income Tax as a useful source of increasing the coffers.

In 1802 Pitt resigned as Prime Minister and was replaced by Henry Addington. A short-lived peace treaty with Napoleon allowed Addington to repeal income tax. However, renewed fighting led to Addington’s Income Tax Act 1803 which set the pattern for income tax today.

A year after Waterloo, income tax was repealed ‘with a thundering peal of applause’ and, such was the public animosity against the tax, Parliament decided that all documents connected with it should be collected, cut into pieces and pulped. It appeared that no record of the hated tax would remain. Fortunately for supporters of the tax and historians, a complete copy of the papers had been sent to the King's Remembrancer.

The tax would lay in abeyance for 26 years, until brought back as a surprise feature to Sir Robert Peel’s 1842 budget. As a Conservative, Peel opposed income taxes in principal, but was faced with deepening deficits and little alternative. Only those with incomes above £150 per annum were affected

Special income tax regimes were introduced to pay for both the First and Second World Wars. At the start of the First World War the standard rate of income tax was 6%, which produced an income to the Exchequer of £44 million with a further £3 million in super-tax. By 1918, the standard rate had risen to 30%, realising £257 million with £36 million more in super-tax. This did little to dampen the spectacular growth of the national debt. In 1914 this stood at £706m and by 1920 it had risen to an unsustainable £7,875m.

Lessons were learnt when Britain geared up for another world-wide conflict. On the eve of the outbreak of the Second World War, the standard rate of income tax was 29% with surtax at 41% for incomes over £50,000. Ten million people were liable for tax, and the total sum raised was £400 million. Successive increases in income tax rates and the steady lowering of allowances ensured that by 1945 these figures were a 50% rate of income tax, surtax at 48% for incomes over £20,000, fourteen million taxpayers and nearly £1,400 million raised.

Discussions on the impact of the 50p tax rate have to be put into perspective when set against the special rates introduced in 1947-8 and 1967-8:

·                    For 1947-48 a special contribution was payable when a person’s total income exceeded £2,000. For investment income over £5,000 it was 50%. So with income tax at 45% and surtax at 52.5%, the effective rate was 147.5%.
·                    In 1967-68, the special charge was imposed. For investment income over £8,000, the rate was 45% which - with income tax at 41.25% and surtax at 50% - meant a total rate of 136.25%.
Even without the surtaxes, the highest rates of income tax were enough to make the pips squeak. In 1973, the top rate of income tax was 75%, a rate that was increased to 83% in 1974. This eventually reduced over the course of the Thatcher government – falling to 60% in 1979 and then 40% in 1988

Saturday, 10 September 2011

Phoenix parties - the strange death and resurrection of centre-right parties

Murdo Fraser MSP has made an attention grabbing pledge in his bid for the leadership of the Scottish Conservatives. If he wins the election in October, he will wind up the party and start again. He argues that the Conservatives are a toxic brand north of the border, and that Scotland needs and deserves a new centre-right political alternative free from the emotive baggage of the 80s and 90s.

It is hard to argue against the charge that the Scottish Conservatives have seen better days. In 1955 they reached a high water mark, taking 50.1% of the vote and exactly half (36 out of 72) of country’s MPs. Their share of the vote receded decade by decade, falling below 40% in the 60s, 30% in the 70s and 25% in the 80s.

The coup de grâce came in Labour’s landslide victory in 1997, when the Conservative Party’s share of the vote slumped to 17.5% and it was left without a single MP in the entire country. The party declined still further in the three subsequent elections, but did recover a single MP (for the rural border constituencies of Galloway and Upper Nithsdale (in 2001) and Dumfriesshire, Clydesdale & Tweeddale (in 2005 and 2010).

The demise of the Scottish Conservatives is not without parallel, even in the confines of the United Kingdom. The once mighty Ulster Unionist Party has no Westminster representation, with its support largely hovered by the Democratic Unionist Party. The UUP has taken the opposite step to that proposed by Murdo Fraser, by fighting elections on a joint Conservative Unionist platform.

In Wales, the Conservatives were similarly wiped out in the 1997 election, but have since recovered their fortunes to take 27.1% of the vote and 9 of the country’s 40 MPs. Given the party has never been as strong in Wales as in Scotland, this represents one of their best electoral performances (only in 1979 and 1983 did the party do any better, taking 11 and 14 MPs respectively).

There are lessons for the Scottish Conservatives from around the world. The most striking example of a party that died and then returned from the grave is that of the Progressive Conservative Party. The Progressives had been the traditional right wing alternative in Canada’s two party system (alternating in government with the Liberals). They dominated the late 50s and early 60s, and emerged from a long, Liberal-dominated wilderness to rule Canada from 1984 to 1993.

In 1984 the Progressives took 50% of the vote and a remarkable 211 seats out of 282 in the Canadian Parliament. They retained control in 1988 with 43% of the vote and 169 MPs out of 295. A perfect storm of incumbent unpopularity, recession and the emergence of new political parties saw the Progressives absolutely wiped out in 1993 - they won just 16% of the vote and retained only 2 MPs.

Nature abhors a vacuum, and seems to abhor the absence of a credible right wing alternative. After years of Liberal dominance, on 16 October 2003 the Canadian Reform Conservative Alliance and the Progressive Conservative Party of Canada announced plans to merge. The new Conservative Party of Canada was an instant success and, in the Federal Election of 2006, it took 36.27% of the vote and 124 out of 308 MPs. Stephen Harper, the leader of the Conservatives, became Canada’s 22nd Prime Minister, leading a minority Conservative administration.

 The party consolidated its position in the 2011 Federal Elections, increasing its share of the vote to 39.62% and taking 167 out of 308 MPs and earning a slim majority in the Commons. This time, it was the turn of two Canadian stalwarts to face electoral collapse. The Liberal Party’s share of the vote slumped to 18.91% (from 40.9% in 2000 and a sharp decline on their 30.1% share in 2006), and they retained only 34 MPs. The Bloq Quebecois fell from returning 47 MPs in 2006 to retaining just 4 as the New Democratic Party swept their Quebec heartlands.

Closer to home, Ireland’s Fianna Fáil dramatically lost their status as Ireland’s traditional party of government in 2011’s election. In 2007 they formed the government with 41.6% of the vote and 77 out of 166 TDs in the Dáil Éireann. By 2011 they had slumped to 17.4% of the vote and returned only 20 TDs. Fine Gael’s performance in 2011 marked a clear reversal of fortunes that, whilst not as complete as Canada’s Conservatives, was still a notable achievement. In 2002 they had been routed by a Fianna Fáil–Progressive Democrats alliance riding high on the Celtic Tiger’s booming economy, returning only 31 TDs with 22.5% of the vote. In 2011 they received 36.1% of the vote and returned 76 TDs.

It is too soon to tell if Canada’s Liberal Party and Bloq Quebecois or Ireland’s Fianna Fáil will recover their fortunes. But the success of Canadian Conservatives and Ireland’s Fine Gael demonstrates a stunning revival of fortunes is possible. Whether this can be emulated by either the Scottish Conservatives or a successor centre-right party remains to be seen.

Murdo Fraser and his supporters may also take comfort in the collaborative example of Germany’s centre-right. The Christian Democratic Union (CDU) operates in 15 of the 16 Länder (or states), leaving their sister party, the Christian Social Union (CSU) to operate in Bavaria (a state that includes roughly 15% of Germany’s population, compared to Scotland’s 8.5%). In Parliament and in Government, the CDU/CSU operate as a single Bundestagsfraktion, and have done for decades.

Wednesday, 7 September 2011

The urge to amalgamate

Amidst a Scottish legislative programme consisting of 15 Bills, a single policy caught the media’s attention. Alex Salmond announced plans for the creation of a single Scottish police force and fire and emergency service. This would amalgamate today’s eight police forces and eight fire services into one national body for each.

The push for amalgamation is not peculiar to the SNP, to Scotland or to the current climate of budget constraints. The prospect of reducing the number of Scottish forces was raised earlier in the year, and again in 2010.

South of the border, moves to rationalise police forces in England and Wales were announced by Charles Clarke on 6 February 2006, only to meet with stiff local and organisational opposition. The plans were eventually shelved in August 2006, but only after £11.5m was spent by police forces on planning.

Policing is an especially emotive issue, and one in which local loyalties and democratic accountability trumps the logic of cost savings, scale and operational efficiency. The SNP move will be seen as a step forward in forging a separate Scottish identity – the emergency forces united under the saltire. Such a move in England would create howls of protest and fear of a centralised police state.

The British system bucks the European trend of having national police organisations. France has la police nationale, Germany, the Bundeskriminalamt and Italy, the Carabinieri. Closer to home, Ireland’s national police service, An Garda Síochána, is the same from Malin to Mizen. Even the USA, fiercely defensive of states’ rights and home of the municipal police force, has the FBI. Why does the UK have such an expensive array of police forces? And what is the historical context for amalgamation?

Although night watches and guardians of the peace were in existence long before the 19th century, modern policing in the UK began with London’s Metropolitan Police. In 1829, Robert Peel introduced the Metropolitan Police Act and London’s police force (along with the affectionate nickname of ‘Bobbies’) was born.

The Municipal Corporations Act 1835 along with the Rural Constabulary Act 1839 and the County Police Act 1840 allowed boroughs and counties to create their own police forces. With the County and Borough Police Act 1856 this was made mandatory (and was mirrored in Scotland by the General Police Act (Scotland) 1857).  By 1860, there were around 200 separate police forces, and by 1900 this had grown to 243 forces.

The pressure for consolidation and amalgamation has existed almost since the inception of modern policing. It was the logical solution to stretched police resources and duplication of effort, especially when the smallest historic boroughs and counties had their own separate forces.

Provisions in the County Police Act 1840 permitted voluntary amalgamations. It facilitated the demise of South Molton Borough Police (merged into Devon Constabulary in 1877), Launceston Borough Police (amalgamated in 1883 with Cornwall Constabulary) and Chipping Norton Borough Police (into Oxfordshire Constabulary). Given these boroughs had populations of roughly 16,800, 3,600 and 18,000 respectively at the time of amalgamation, it is hard to see how they could justify separate forces (although the existence of an independent Chipping Norton police could have added spice to the media storm around the Chipping Norton set).
Another wave of consolidations came under the auspices of the Local Government Act 1888 which forced amalgamation for towns with populations of less than 10,000. Deal, Bideford, Falmoth and Tenterden, along with 12 other forces, merged into their respective county constabularies at this time.

A further batch of small forces would be rationalised under the Defence (Amalgamation of Police Forces) Regulations 1942. This act focused on Kent for obvious civil defence purposes, and saw Dover, Folkestone, Maidstone, Margate, Rochester, Tunbridge Wells and Ramsgate lose their independent police forces.

The first wholesale, centralised and planned consolidation came with the Police Act 1946. This reduced the number of constabularies to 131 and saw the demise of the splendidly named Liberty of Peterborough Constabulary and the pleasantly obscure Chepping Wycombe Borough Police.

Serious rationalisation would come under the Police Act 1964, which dramatically reduced the number of forces to 49. This saw the first major protests against forced amalgamations, led by the still infant Luton Borough Police. Luton’s separate police force had only come into existence on 1 April 1964, and it was almost immediately threatened with forced amalgamation into Bedfordshire Constabulary. The campaign eventually led to Luton serving a High Court writ on Henry Brooke, the Home Secretary.

All vestiges of smaller, historic county forces would be swept away alongside local government reform in the Local Government Act 1972, with Bristol, Birmingham, Leeds, Hull and Bradford losing their independent police forces. A similar rationalisation saw Scottish constabularies reduce from 20 city and county based forces to the eight that are currently facing merger.

Although these reforms left police forces in the same shape as we see today, calls for rationalisation did not disappear. In 1981 the Chief Constable of Greater Manchester, James Anderton, called for 10 regional police forces across England and Wales.

The rationalisation of territorial police forces has been accompanied by the demise of a vast array of special forces, covering the railways, canals, docks, rivers, airports, parks, markets, cathedrals and even Eton College. Some have survived, including constabularies for the City of London’s Markets, Cambridge University (Oxford’s force, populary known the Bulldogs, was disbanded in 2003), Salisbury Cathedral and York Minster.

The only anomaly in the history of multiple police forces has been the position of Northern Ireland. The Royal Ulster Constabulary remained as the single police force for the north of Ireland following partition in 1922. It was the remnant of the Royal Irish Constabulary that had previously policed the whole island (with the exception of Dublin’s city constabulary). On 4 November 2001 the RUC became the Police Service of Northern Ireland as part of the Good Friday Agreement. With the RUC’s demise one of the bitterest grievances of northern Irish Catholics was tackled.  

Policing in the UK has moved a long way from nearly 250 separate territorial forces and a medley of special forces for everything from cathedrals to markets, ports to power stations. There are now just 39 territorial forces in England, 4 in Wales, 8 in Scotland and one in Northern Ireland and four principal ‘special police forces’ (the British Transport Police, Ministry of Defence Police, Civil Nuclear Constabulary and the Scottish Crime and Drug Enforcement Agency).

Does the seemingly relentless move to consolidation, amalgamation and merger signal the death of local policing? How does it fit in with the Coalition government’s localism agenda? And, in an age of austerity and severe budget cuts, can we afford to ignore the cost savings, efficiency gains and eradication of duplication that larger forces may bring?  

Tuesday, 6 September 2011

Breaking up is so very hard to do

On 12 September 2011 the final report of the Independent Commission on Banking under Sir John Vickers will be issued. It is likely to recommend the ring fencing of the UK’s retail banks, and thus the separation of the riskier investment banking operations. Whether this will be accepted by the government has been cast into doubt amidst strong lobbying that it will impact on economic recovery and Britain’s future growth prospects.

Although the current economic crisis looks set to rival the Great Depression in length, it has not yet had quite the same cataclysmic social and political impacts. It is therefore unsurprising that the political response to the credit crunch and systemic failure of the banking system has not yet yielded reform on a scale comparable with those promulgated in the US in the 1930s.

The Banking Act of 1933 is more commonly known as the Glass–Steagall Act, named for the Democractic Senator from Virginia, Carter Glass, and the Democratic Congressman from Alabama, Henry B. Steagall. It was a revolutionary piece of legislation for revolutionary times.

It was enacted as part of Roosevelt’s New Deal legislation, and against the backdrop of the failure of more than 5,000 banks in the Great Depression. Most totemic of all was the failure of the Bank of United States on 11 December 1930, which saw one of America’s largest commercial banks collapse.

Confidence in America’s fiscal system was already at rock bottom when the new FDR administration attempted comprehensive surgery to revive the banks. On Monday 6 March 1933, President Roosevelt issued a proclamation ordering the suspension of all banking transactions, effective immediately. The nationwide bank holiday was to extend to Thursday 9 March, during which time emergency legislation was considered in Congress.

The emergency banking legislation was followed by the Glass-Steagall Act in June 1933. The Act forced the separation of commercial and investment banks. Commercial banks could not embark on risky trading activities (such as underwriting the sales of stocks and bonds), and investment banks could not take deposits.

Glass-Steagall was repealed in November 1999, and was followed by a wave of mergers that created the banking behemoths – the banks that were “too big to fail”.

The UK is not the only country that is considering greater regulation of its banking industry. The US has implemented the Dodd–Frank Wall Street Reform and Consumer Protection Act. The EU has agreed a new financial supervision framework, including the European Systemic Risk Board. And Basel III promises to strengthen regulation, supervision and risk management of the banking system.

But there is, as yet, no new Glass-Steagal and no new Bretton Woods, which is a shame. As economist Paul Romer noted: “a crisis is a terrible thing to waste”.

Monday, 5 September 2011

Gilty secret

An interesting graph on the front page of the Financial Times shows the turbulent history of Britain's 20th century finances through the yields of UK Gilts. The graph serves to illustrate the relatively benign treatment of the UK's current sovereign debt. Whilst Britain is hardly in the most robust fiscal condition it is being compared to the Eurozone and the USA. A decisive government decision to tackle deficits and debts contrasts with jitters over Eurozone stability and US political wrangling, and sees the UK joining Switzerland as a relative safe haven.

In mid-August, UK ten year bonds were trading at a yield 2.24%, marking the lowest yields on UK sovereign debt since the 1890s. This contrasts with their peak in the mid 1970s and early 1980s, when they pushed above 14%. They shot up to these heady heights amidst the IMF bailout of the UK and the abolition of exchange controls, and were triggered by the collapse of the Bretton Woods system of fixed convertability when the US ended dollar convertability of gold on 15 August 1971.

Yields then generally declined from double figures down to last month's long-term lows, with a temporary spike above 12% in the early 1990s recession. The comparatively benign outlook from the 1890s ended in 1900, when yields would drift up towards 6%, spiking after the conclusion of the First World War. The fiscal trauma of that conflict did not have as devestating a consequence on UK yields as later recessions, and the Second World War was even kinder, with yields drifting back towards 2%.

Whilst the graph vividly demonstrates that UK borrowing was, historically, much more expensive (sometimes eye-wateringly so). Given the size of the UK debt and the punitive measures being taken to tame and reduce it, it has to be hoped that they continue to reflect the late 19th rather than the late 20th century.