An abundance of caution for a ‘stagnation nation’? Financial services policy development in post-growth Britain

Abstract

This commentary discusses the relationship between the UK Labour Party and the financial services sector in the context of an approach to economic policy and growth. It highlights the historical scepticism of the Labour Party towards financial services, rooted in ideology and practical experience alongside a recognition of the need to engage with the sector to promote economic growth and investment. The Labour Party’s evolving stance towards financial services is outlined, which has oscillated between support in the 1990s and early 2000s, to a more critical view in the 2010s, with a more recent return to advocacy. The commentary draws attention to a tension in the party’s encouragement of an industry that can provide economic growth at home, while at the same time being wary of developing policies designed to provide necessary growth in other areas, such as in green technologies, but that might incur the disapproval of global financial investors. Labour’s dilemmas are illustrative of the contemporary problems of policy formation in a relatively small but open economy, where options to promote growth and green investment are constrained in the face of the disciplinary power of global financial capital.

Introduction

By the mid-2020s, the UK economy had become an exemplar of a certain kind of economic decline. According to the head of one of the UK’s leading independent think tanks, the Resolution Foundation, the weakness of the economy was such that it had plumbed unprecedented depths:

Nobody who’s alive and working in the British economy today has ever seen anything like this. This is definitely not what normal looks like. This is what failure looks like (Torsten Bell, quoted in BBC Panorama, 2023)

Bell was referring specifically to long-term wage stagnation; in the period following the 2008 global financial crisis (GFC) the UK economy embarked on a slower and shallower growth trajectory than most of its peer competitor economies. Already struggling under the weight of decades of under investment, the post-GFC response of successive UK governments was to impose austerity resulting in large, cumulative cuts in public spending (Gray and Barford, 2018) which, after a referendum on membership of the European Union, made it more difficult to access the UK’s largest market for its goods and services. These difficulties were exacerbated by the implications of a post-pandemic shift in global macroeconomic conditions that brought higher inflation, more fragile international supply chains and a sharp increase in global geopolitical tensions.

The parlous state of the UK economy was laid bare by Bell’s own Resolution Foundation in a comprehensive and wide ranging inquiry which described the UK as a ‘stagnation nation’, and detailed the poor international performance of the UK against its peers on a range of economic metrics, such as low productivity, the aforementioned stagnant income growth, as well as very high levels of social and geographical inequality (Resolution Foundation and Centre for Economic Performance LSE, 2023). The report noted that formulating an economic strategy that would change the recent course of UK economic development was nontrivial, given that it would not only have to address the manifest failures but also do so amidst the added complexity of addressing the looming climate crisis and the need to accelerate the shift to a low carbon economy.

The Resolution Foundation inquiry was widely seen as a policy intervention ahead of the next UK general election – the report’s sub-title being ‘A New Economic Strategy for Britain’ – and at least attempted to lighten the gloom by identifying areas of competitive strength in the UK economy that could be targeted and supported to generate the growth, wages and – critically – the returns necessary to repair crumbling infrastructure and build the new forms needed for an environment of climate instability. The report points to the strengths of the UK’s services economy as a beacon of hope, currently ranking second among global exporters. In doing so, the report’s authors were keen to draw attention to the diversity of UK’s service industries strengths, focusing in particular on the ‘other business services category’ – professional business services such as law, accountancy and management consultancy, etc. – arguing that the UK services economy ‘is far from a finance dominated, one-trick pony’, noting that that financial services fell from 12% of total exports in 2009 to just 9% by 2022 (Resolution Foundation and Centre for Economic Performance LSE, 2023: 119–120). The financial services industry is also relatively small, with only about a one million employees, and a declining proportion of the total workforce, down from 4% in 1992 to 3% in 2022.

Yet, while the UK’s traded services economy is indeed broad, and the relative importance of financial services in decline, it is notable that the Resolution Foundation’s own analysis reveals that the most globally competitive UK-based services in are financial in orientation, with both ‘insurance and pensions services’ and ‘financial services’ having the highest levels of international comparative advantage. ¹ The financial services sector earned a trade surplus of £45b in 2021 (Hutton, 2022), despite the hurdles presented by Brexit. Moreover, as economic geography and regional studies research has revealed over a long period of time, financial services and business services are highly complementary and intimately related through complex financial and business services networks that are produced through co-location in financial centres (Haberly and Wojcik, 2022; Iliopoulos and Wójcik, 2022). Financial services may be contributing a smaller share of exports than previously, but remains a highly competitive industry producing core revenues that supports the wider networks and ecologies of business services.

Therefore, any attempt to place the UK economy on a new trajectory will necessarily have to engage the financial services sector, not only as one of the economy’s few leading edge, competitive sectors, but also an industry that will be vital in helping to focus and direct investment in critically important areas. At the time of writing – late Spring 2024 – all the indications are that it will be the UK Labour Party, traditionally a party of the centre left, that will form the next government, given the very low standing in opinion polls of the ruling Conservative Party and a succession of heavy losses in local elections, which are normally indicative of future voter intentions.

The Labour Party does not have a consistent track record of engagement with the financial services sector, which it has approached at turns with either extreme caution or passive acceptance. Given the importance of this sector to any future economic strategy, how the Labour Party plans to approach the financial services sector may be a guide to how it seeks to avoid mistakes of the past and endeavour to plot a course that addresses the problems of low growth, low wages and chronic inequality in the UK economy in an era of looming environmental crisis. Moreover, Labour policy will provide an example of the options open to a relatively small but open economy seeking to promote growth and green investment in the face of the constraints imposed by global financial capital. The remainder of this commentary is organised as follows. Firstly, ‘Labour and finance’ explores the chequered history of the relationship between the Labour Party and the UK financial services sector, and of its oscillation between rejection and acceptance, while part ‘Continuity or change?’ explores the consequences of the Labour’s identification of security and stability as a key tenet of its future economic strategy. The final part of the paper, ‘Back to the future?’, provides some conclusions, and suggests that an abundance of caution in policy development means the Labour Party’s approach is likely to be more of the same rather than a brave new world.

Labour and finance

For much of its existence the UK Labour Party has tended to instinctively adopt a broadly sceptical view of financial services. This is partly rooted in ideology, influenced by thinkers as diverse as Keynes and Marx who, despite their other differences, shared a wariness of money and finance, and both were critical of the ways in which the financial system had an overly powerful – and at times destructive – influence on the rest of the economy. Labour’s wariness is also rooted in practical experience: both Harold Wilson and James Callaghan faced serious foreign exchange and bond market crises during their time in 10 Downing Street (Bennett, 2017).

Long periods in opposition, however, can encourage political parties to critically reflect on long-held views, chip the edges off animosities, and encourage new accommodations and working relationships in order to forge a route to power. By the early 1990s, after four successive general election defeats, Labour actively began seeking out business and financial interests, to convince them that they wanted to work cooperatively and productively when in government (Ramsay, 2012). Such assurances were made in what became known as the Prawn Cocktail Offensive, in which party leader John Smith and his colleagues held private lunches and meetings with key executives in the City of London. The success of this campaign, and the regulatory affordances included in its programme for government, meant that following its election in 1997 the New Labour government faced not, as many feared, a run on the pound, but rather a sterling crisis in reverse (Leyshon, 1998), where the value of the pound increased, attributed to Labour promising to stick to the previous government’s spending plans, adhering to a new system of fiscal rules, its wariness of joining a single currency and immediately enacting a radical restructuring of the institutional governance of monetary policy and financial regulation, including central bank independence.

For a while, this new settlement seemed to work, helped by broadly benign macroeconomic conditions and a gradual downward shift in interest rates. As rates fell, asset prices increased and the London financial district grew, competing effectively with New York, and the two jostled for the status of the world’s preeminent financial centre. The Labour government congratulated itself on having enrolled an internationally successful financial district into an ad hoc growth and regional development model where tax revenues from profits could be recycled into public sector spending, which was disproportionately more important outside London’s financial heartland (Lee et al., 2009).

The global financial crisis of 2008 brought this era to an abrupt end, and required the government to necessarily authorise highly expensive bank bailouts. As the previous Conservative government discovered after its mishandling of the UK’s entry into the European Exchange Rate Mechanism in 1992, the British electorate is unforgiving of governments that oversee financial crises. Within 2 years of the global financial crisis, despite Labour Prime Minister Gordon Brown and Chancellor of the Exchequer Alistair Darling being credited with shaping the financial stabilisation programme that ‘saved’ the financial system at the start of the crisis (Krugman, 2008), Labour lost a general election which consigned them to another long period in opposition.

After a defeat that was attributed in part to the financial crisis, the sceptical view of financial services reemerged as Labour in opposition shifted to the left. By 2017 its manifesto for the general election depicted financial services sector more as a problem to be solved than as a political partner. Finance was depicted as a drag on the rest of the economy, holding back ‘small business and local economies’. The manifesto proposed a National Investment Bank, funded by bonds backed by government guarantee, to intermediate private capital that could support a new ‘network of regional development banks that, unlike giant City of London firms, will be dedicated to supporting inclusive growth in their communities’ (Labour Party, 2017). A new Stamp Duty Tax was promised to cover a wider range of financial assets to ensure that ‘the public gets a fairer share of financial system profits’.

While the Labour Party fared better in the 2017 election than predicted, it managed only to reduce the government’s majority. In its manifesto for the 2019 election, Labour maintained its commitment to a National Investment Bank, and added a criticism of ‘financial speculators’ in the foreword of Labour leader Jeremy Corbyn (Labour Party, 2019) but, conducted under the shadow of Brexit, meant that any other policy concern was drowned out. Labour went on to record one of its heaviest general election defeats and was facing up to at least 14 years in opposition, perhaps even longer, given the scale of the defeat and the swing in the vote required for it to gain a working majority of MPs in parliament.

But 5 years later, following a pandemic, several changes of Conservative prime minister, and an ill-judged Autumn Statement in 2022 that triggered a financial crisis in which, as Wren-Lewis (2022) describes, financial markets ‘inflicted pain on a government that thought unfunded tax cuts made sense when public services are in dire trouble’, political sentiment changed to the extent that at the time of writing opinion polls suggest that Labour is likely to be elected to power with a majority at the 2024 election. If so, how is it likely to approach the financial services sector?

One indication that this approach might be more 1997 than 2017 emerged in reports of ‘Prawn Cocktail Offensive 2.0’ (Partridge, 2022), as new leader Kier Starmer, the Shadow Chancellor of the Exchequer Rachel Reeves, and Shadow Business Secretary Jonathan Reynolds replicated the manoeuvres of Labour in the early 1990s by meeting and greeting senior financiers and business leaders. Reeves, a former Bank of England economist, even visited the annual Davos meeting in 2024 to make it clear that a key aim of a future Labour government would be to make the UK a stable environment for business (Fleming, 2024).

While at the time of writing the Labour Party have not yet drawn up a manifesto, they have issued several position papers, including Financing Growth: Labour’s Plan for Financial Services (Labour Party, 2024), which includes policy proposals formulated with the help of an Advisory Panel made up of individuals holding senior positions in UK banks, insurance firms, building societies and regulatory institutions. Gone are the radical objectives of the manifestos of the 2010s, and in their place four guiding principles – ‘Promote our financial services sector as one of our competitive advantages’; ‘Balance consumer protection, competitiveness, and financial stability’; ‘Support the independence of the UK’s financial institutions’, and; ‘Maintain our commitment to fiscal responsibility’ – replacing a critique of financial services with a promise of support, an acknowledgement of the sector’s growth potential and a willingness to help it compete in the global marketplace.

A combination of advocacy with a commitment to stability and responsibility is resonant with Rachels Reeves’ attempt to provide reassurances to the business and community through her promotion of ‘securonomics’ (Reeves, 2023a), a neologism she aligns with concepts such as Dani Rodrik’s ‘productivist paradigm’ and Janet Yellen’s ‘modern supply side economics’ (Reeves, 2024), which in her words prioritises

economic strength and resilience in the face of our uncertain world. Addressing the challenges of the future, and finding the opportunities within them. It also focuses on securing the finances of working people. Good jobs, decent pay, strong public services and an end to relentless increases in the cost of living. (Reeves, 2023b)

Launched in a speech at the Peterson Institute in Washington DC in 2023, the concept draws strongly on the turn to industrial strategy in the US, which through the CHIPS Act and the Inflation Reduction Act, signalled a turn away from open border globalisation to a more purposive direction of investment to improve domestic economic development and security, given growing fears about the fragility of supply chains in the face of geopolitical tensions, and concerns about the growing power of China.

Continuity or change?

Labour’s ambitions for securonomics are necessarily more modest than in the US, lacking the power and resources to make the economic weather and dictate the terms of trade (see Farrell and Newman, 2023), and is better seen as a response to the pleas of business and finance for a commitment to greater economic stability to enable better planning and consistency of strategy. And in its approach to financial services, as set out in Financing Growth, Labour certainly offers more continuity than change from the policies of the current Conservative government, in at least four respects.

First, Labour has shown strong support for the requirement in the 2023 Financial Services and Markets Bill that gives the Prudential Regulation Authority, the arm of the Bank of England that now regulates and supervises financial services firms, a new secondary objective to facilitate the international competitiveness and economic growth of the UK. This is despite concerns within some think tanks and among academics that this sets regulation on a dangerous path (e.g. Finance Innovation Lab, 2023), and undermines the overriding prudential objective of financial regulation, even perhaps sowing the seeds of a future financial crisis. At a conference held in the Bank of England (2023), a concern among many of the participants was that while encouraging competition was all very well in theory, in practice, the development of metrics that can accurately measure progress towards such an objective is far more difficult, notwithstanding Labour’s intention to establish a new Regulatory Innovation Office tasked with developing such data.

Second, Labour also wants to push further with Open Banking, where APIs are used to share customer data with third party providers to encourage the transferability of accounts and to better tailor financial products to individuals. This is motivated in part by a desire to have a more competitive and contestable financial services sector, to deliver better consumer outcomes and encourage new forms of competition that might reduce levels of market concentration and centralisation, reducing the risk of once more being faced with ‘too big to fail’ banks in a future crisis.

Third, Labour intends to give full support for Ron Kalifa’s report on UK fintech (Kalifa, 2021), commissioned by Rishi Sunak when Chancellor of the Exchequer. Given that Kalifa is a member of Labour’s financial advisory panel, this continuity is perhaps unsurprising. The Kalifa report was seen to be a post-Brexit strategy for the revival of financial services, which was so poorly served in the EU-UK Trade and Co-operation Agreement. As Hall (2021) has noted, in ‘a document stretching to over 1200 pages, only four and a half focus on financial services’. There has been a shift from regulation based on ‘passporting’, where compliance at home was sufficient to allow access to all other domestic markets in the EU, to a post-Brexit system based on equivalence, where permissions for each EU country market has to be sought to demonstrate that UK regulation is at least as robust as that of the market a UK firm seeks to enter. This, as Hall points out, is inefficient and expensive, because ‘seeking permissions on a state by state basis will add complexity and hence costs for financial services firms’. The Kalifa report made several suggestions that would help bolster the fintech industry in the UK, with a focus on skills, investment, regulation and the promotion of a number of provincial fintech centres, which aligned with the then government’s focus on levelling up regional economies. This latter aspect, as well as the report’s recommendation that the UK government move towards a central bank digital currency and making the UK a centre for tokenised government borrowing, have been enthusiastically adopted by Labour. However, progress reports on the implementation of the Kalifa recommendations have been lukewarm at best (Flinders, 2023), not least because fintech firms are not immune from the problems of Brexit faced by other financial services firms. But for startup and scale up fintech firms, the problems are in many ways worse, because the additional costs of market expansion in Europe have made obtaining investment capital for UK firms more difficult, exacerbated by a macroeconomic environment of higher interest rates which make all venture capital investments trickier propositions.

Fourth, and finally, Labour wants to use UK financial services to accelerate the transition to Net Zero and the lowering of carbon emissions, and to help transform the London financial district into a global centre for green investment, initially promising to commit £28 billion per annum to be invested in various green technologies and infrastructure. This represents a continuity of policy that until recently, from the last Labour Government, through the Coalition, and to the various Conservative governments since 2015, were aligned in pushing forward both Net Zero and London’s role as a ‘zero-aligned’ financial centre.

For all the continuity, there are some promised divergences from current government policy on financial services, of which two are particularly significant. First, a revival of interest in financial inclusion. Labour has made a pledge to develop a national financial inclusion strategy, which was a strong policy theme of the Labour government from 1997, which responded to the rapid withdrawal of bank and building society branches across UK that occurred in the 1990s. In the intervening period, these closure processes have continued apace (Clark et al., 2023). While partly mitigated by the acceleration of contactless transactions during the Covid-19 pandemic, accessing physical cash and obtaining face to face financial advice remains a problem for many. Labour proposes to create large numbers of shared banking hubs, where services and costs are shared by financial institutions would otherwise have abandoned a community, an idea that first circulated in financial inclusion policy circles in the 1990s. This period also saw the UK policy community explore institutional innovations and developments in the global south which sought to overcome a chronic lack of money and investment in communities. Labour’s proposal to establish a digital sandbox designed to test fintech business models that might tackle problems of financial exclusion, modelled on those in Ghana and India, for example, is an echo of such earlier policy explorations.

Second, as part of an ambition to introduce greater financial resilience, Labour proposes regulatory reform in key areas. Some measures are relatively straightforward, such as introducing new regulations to the buy now pay later (BNPL) market, which provides interest free loans, available mainly through fintech companies, which has grown rapidly largely without regulatory oversight, with fears that a new debt crisis is being fostered. Regulation of this market will be relatively easy to achieve given that the largest BNPL firms, such as Klarna for example, actually advocate greater regulation, not least because there are currently few barriers to entry to what is a highly competitive market. Some measures are more difficult and complex, such as the ambition to bring greater stability and resilience to the UK’s mortgage market, which is notoriously exposed to interest rate volatility, by introducing a market for mortgage products that are both longer-term and with more stable rates of interest than currently.

Back to the future?

While at the time of writing it is likely that Labour will win the next election, it is of course not guaranteed, and it remains to be seen how many of the proposals in the Financing Growth document make it to the manifesto. But all the indications are that the tendency towards continuity rather than change is revealing of a timidity in public policy formulation that either does not comprehend the scale of the crisis facing the UK or, more likely, given another run of four successive general election defeats, Labour is proposing only tinkering with policy measures through a fear of an electorate that has kept the party in opposition for a decade and a half. The emphasis placed on fiscal prudence and stability – and the fear of being depicted as fiscally irresponsible in attacks by political opponents (Stacey and Harvey, 2024) – meant that just days after releasing Financing Growth, Labour lowered the amount to be invested annually in its green prosperity plan from £28bn to £15bn, blaming the reduction on the worsening of economic prospects since the commitment was announced in 2021. By 2023 UK government debt exceeded 100% of annual national income, a level last reached in the 1960s, the result of a series of extraordinary commitments in government spending, ranging from the hangover from the global financial crisis, the Covid-19 pandemic and more recent interventions such as energy support schemes in the wake of the Russian invasion of Ukraine.

Awareness of the long-term decline of the UK goes at least part of the way to explain the intention behind the 2022 Autumn Statement, in which newly appointed Prime Minister Liz Truss and her Chancellor of the Exchequer Kwasi Kwarteng sought to stimulate growth in a dramatic ‘with one bound they were free’ manoeuvre, proposing extensive deregulation and £45bn of unfunded tax cuts that would feed through to spending in the rest of the economy. However, rather than propel the economy forward, these proposals generated withering assessments by analysts in financial services firms (Partington, 2022), as well as by other economic commentators, who argued that such developments would do little if anything to improve productivity and growth, but rather accelerate consumption for its own sake and exacerbate the long term problems of the UK economy. As a result, investors took fright, the value of the pound plummeted in foreign exchange markets and crashed the price of secondary government debt in the bond market, both limiting the UK’s ability to borrow and increasing the cost of doing so through a risk premium being added to UK debt as a result of the instability (Ashworth, 2022). Neither Truss nor Kwarteng lasted much longer and, if nothing else, the event was a reminder of the power of financial markets and the UK’s vulnerability to moving too far away from the overriding imperatives of financial capital.

Labour too are keen to explore growth opportunities. Green investment is certainly one prospect, being an area that might have wide ranging impacts across the rest of the economy if successful because innovations can be brought forward to hasten the transition to Net Zero and also gain traction in international markets. It is the desire for growth that also explains Labour’s reembrace of financial services as a favoured industry. There is a pragmatism in seeking growth where it can be found. Even so, there are some concerns about a rekindling of the affair between Labour and the financial sector. Shaxson (2024), for example, argues that, as previously, it is more likely than not to end in tears, ensuring a further distortion of the economy towards the interests of the financial community and the holders of financial assets, reinforcing what he has previously described as Britain’s distinctive ‘finance curse’ (Shaxson, 2019), where narrow financial concerns crowd out other interests, and in doing so takes away at least as much as it gives. This, he argues, needs to be broken by a far more robust approach to ensure finance is better directed to the long term productive investments necessary for long-term economic growth. Such an approach was exactly what Labour proposed in 2017 and 2019, of course, but on each occasion, they failed to gain sufficient support to get elected. And here lies the dilemma. The Labour Party recognises the requirement to secure growth, which needs investment, and for growth to be of a kind that addresses the advancing climate crisis, and that will generate the surpluses needed to upgrade infrastructure. However, as it approached an election campaign, the Labour Party felt obliged to cut an ambitious programme for green investment precisely because of concerns that its spending plans would break the convention on fiscal rules that debt as a proportion of GDP should fall over a 5 year period of government. As the 2022 fiscal statement crisis illustrated, a failure to explain how a government plans to pay for things – be it tax cuts or green investment – means that financial markets are likely to react by selling the currency making government borrowing more expensive.

The role that financial markets have played in in the history of the Labour Party while in power means that having a macroeconomic policy that is ‘transparent, credible and sustainable . . . is something that Labour Chancellors and shadow Chancellors normally understand’ (Wren-Lewis, 2022). Hence, a near-future Labour government is likely to be favourably disposed to the growth-generating possibilities of UK and UK-based financial services, while also cautious and wary of the damage that the financial system can do to the overall economy and to the government’s prospects in power.

While this caution is understandable, for all the reasons given above, it also signals the contemporary dilemma of economic public policy in the UK, and especially one that has a well-established competitive advantage in financial services. Reeves’ Mais Lecture makes it clear that she understands the scale of the problem a new government will inherit, and targets security and stability as a platform for attracting and promoting investment. And while the state will seek to take an active role, it’s ability to do so will be constrained by its fiscal rules. Such rules now exist in most OECD countries, they set limits on what a government can tax and spend, and are designed to prevent politicians mortgaging long-term futures for short-term political gain so protecting future generations from unsustainable debt. Such rules have been operational in the UK since 1997, introduced by the last Labour government as part of their attempt to convince international investors that they intended to be fiscally responsible. As the UK government discovered in September 2022, financial markets and investors are quickly able to sanction fiscal policies designed more in optimism than by careful calculation. However, any incoming government with a plan to bring about conjunctural change should recognise that such rules are not immutable – indeed, the UK has had nine sets of fiscal rules since their introduction (Pope and Hourston, 2022) – and recognise that they need to be designed to better fit the context, which in the case of the problems facing the UK would certainly mean extending their time horizons. As Prieg (2024) observes, the current 5 year limit set for the operation fiscal rules means that ‘it is assumed that tax and spending decisions have no impact on the economy after five years, which means we underestimate the [long-term] benefits of investing in climate policies, education and skills’. The scale of the crisis, and the urgent need for long-term investment in the UK means that much longer investment horizons are needed. Yet despite this, Reeves has not only committed an incoming Labour government to 5 year fiscal rules and a target where levels of debt as a percentage of GDP are required to fall between Years 4 and 5, she also promised to introduce new rules that would prevent her or future Chancellors of the Exchequer from changing the fiscal rules save for ‘an escape clause that would only suspend the rules if the OBR declared the UK was in an economic crisis’ (Reeves, 2024). Given that many observers argue that that is where the UK already is, clauses such as this suggest there is a fear that things might have to get worse before they get better. Tying one’s hands like this is revealing of the fear of upsetting financial markets and the consequences that follow that has long preoccupied Labour Prime Ministers and Chancellors of the Exchequer: one might want to – indeed, need to – move the UK in a radically different direction, ideally at pace, but doing this in a small open economy is to do so under the glare of the disciplining power of financial capital. To attract this kind of capital, one also has to dance to its tune.