Mr Osborne's Tangential Relaionship With Truth

After quoting from Mr Osborne's budget speech in my last two posts I am left a little queasy. As usual his words don't connect to reality in a direct way. Look at his claim that:

In places like Edinburgh and London, we have a world beating asset management industry.

Well, if you read to the end of my post you will have noticed that Britain's fund industry is only world beating in a world where Dublin and Luxembourg don't exist.

Take this example from my last post:

Many observers of the British tax system complain that it has long biased debt financing over equity investment.

The point he is referring to is that dividends are paid out of profits after tax while interest is paid from pretax profit. So it is cheaper for companies to raise funds from bonds than shares. We are talking about 20% corporation tax, not 0.5% stamp duty.

So how much difference does stamp duty make to the cost of capital? while corporation tax is paid every year, stamp duty is only charged if shares are sold and it is not charged when a company first issues its shares. So basically, not much. It is a tax on speculation rather than companies seeking finance. The effect of the cut will be an incentive to speculation.

It is tempting to propose Mr Osborne for the Pontius Pilate "What Is Truth" award. But at least Pilate was interested in truth.

Stamping Out Duty

While we are on the subject of stamp duty, this is a tax where I would favour extending the base. Stamp duty is charged on the sale of shares at 0.5%, however it is not levied on the sale of corporate bonds or other forms of securities. This seems unfair. As the chancellor said in his budget speech:

Many observers of the British tax system complain that it has long biased debt financing over equity investment.

So today I am extending stamp duty to apply to debt financing through bonds on an equal basis to shares. No he didn't say that. He said this:

So today I am abolishing altogether stamp duty on shares traded on growth markets such as AIM.

So while the rest of the world thinks that taxing financial transactions will help to stabilise their economies, Britain has a different approach.

In parts of Europe they’re introducing a financial transaction tax. Here in Britain we’re getting rid of one.

Labour should promise to extend stamp duty to sales of all traded securities equally, including shares, bonds, derivatives, mortgage backed securities, collateralised debt obligations ...

Island Nation Financial Centres

The Cyprus tragedy should also inspire us to think about its business model for banking. The island is a recent arrival to the world of offshore banking. Just like Ireland and Iceland the rapid growth of its banking sector spurred on by light regulation and low taxation left the islands vulnerable to the fragility of finance.

One concern should be the competition between jurisdictions to attract financial business. Competition for example over tax.

Which brings me to Mr Osborne's recent budget. Banks are not the only firms in the finance sector.

Financial services are about much more than banking. In places like Edinburgh and London, we have a world beating asset management industry. But they are losing business to other places in Europe.

We act now with a package of measures to reverse this decline – and we will abolish the schedule 19 tax which is only payable by UK domiciled funds.

Schedule 19 didn't make the headlines. It is the 0.5% stamp duty paid by asset management firms when investors sell out of the funds.

According to the FT:

Scrapping the so-called ‘schedule 19’ tax will bring the UK in line with Dublin, which also charges no tax, and make it more competitive than Luxembourg, which charges a small fee. Dublin and Luxembourg are the UK fund management industry’s main offshore rivals.

There are around £700bn-worth of UK domiciled funds, compared with about €2tn registered in Luxembourg and €1tn registered in Dublin.

I had thought that the government's policy was to re-balance the economy away from finance and towards other sectors, such as manufacturing. Now it seems tax cuts and regulatory reform are being used to boost the finance sector.

"An Approach We Should Take"

To answer my own question, I don't think that Britain will go the way of Cyprus. My argument is that Cyprus and its tragedy is a better pointer to the real problem than Greece and its troubles. While I wonder how much Russian money there is spinning through British banks, the real worry is the instability of the finance sector.

Not so long ago some commentators were proclaiming the end of the eurozone crisis. I was sceptical; the crisis was in remission, not cured. My opinion was based, not so much on the capacity of eurozone leaders for policy errors, but my awareness that the fundamental problems in the banking and finance sector have not been resolved.

There had been a plan for a European fund to recapitalise failing banks. When the time came for the fund to act in Cyprus, it didn't happen.  So when Mr Dijsselbloem, the Dutch chair of the Eurogroup committee said that the Cyprus solution "is an approach that we should take," he was right.

The shareholders and bondholders of failing banks should be the ones to take the loss, not the taxpayer. This is the approach that should have been taken when Ireland's banks got into trouble. Instead the ECB forced the Irish government to underwrite the banks turning the banking crisis into a public debt crisis.

The fear back then was that losses in Irish banks would undermine banks in other places whose failure in turn would lead to more failures with a cascade of banks collapsing like a line of dominoes. It could happen like that. The problems in Cyprus's banks were triggered by the losses on Greek bonds included in Greece's bail out package.

That is where my question could becomes serious. How are the dominoes set up and where does Britain's banking sector stand in the line up?


Mr Dijsselbloem implies that each country will be responsible for its own banks if they fail. While he has been forced to "clarify" his comments, we should still ask how big is the banking sector compared to a country's national income? I have found some ECB figures for the aggregated assets of banks and compared them to Eurostat figures for GDP.



Source: ECB, Eurostat

As you can see, Luxembourg and Malta are ahead of us in the queue.

Could We Be the Next Cyprus?

Back in 2010 the drive for austerity was driven by a fear that we could all go the way of Greece. The country's high level of government debt led to a crisis in which government could not raise funds from the market and was forced to accept an EU-IMF bailout with harsh terms and savage cuts.

Of course we in Britain, and most of Europe, were in a very different position from Greece. A financial crisis has caused the economic crisis and countries were badly affected even if they had low public debt before 2008. (Ireland and Spain had lower debt than Britain which was less indebted than Germany or France.)

Despite the fact that the problem lay in the banks, the narrative turned to public debt with Greece as the exemplar. The banks are still the problem and fixing the finance sector should be the priority.

Cyprus presents us with a new model. A small country whose banking sector towers over its economy. The aggregate balance sheet of the Cyprus banks is some 800% of the country's GDP. When the banks hit trouble can a small country cope?

Instead of worrying whether Britain could go the way of Greece, is this an opportunity to ask could we go the way of Cyprus? The aggregate balance sheet of banks in Britain is over 500% of GDP.

During the crisis the last government took action to stabilise the finance sector, recapitalising some major banks forcing others to recapitalise themselves and providing guarantees to keep them solvent. Since then the pace of reform has slowed. Each proposal has been compromised from the outset by fear of the power of the financial sector. Each proposal has been watered down further by financial sector lobbying.

Yet still the banks have failed to recognise the bad loans on their books, to raise their capital to a safe level, or to separate the activities which government should underwrite from those which should be at the risk of investors. Could Cyprus be the wake up call?

A Simple Keynesian Narrative

The coalition government has been remarkably successful in establishing its narrative that identifies the economic crisis with public debt. The falsehoods behind this narrative are well documented, but the success of this story will be halted not by argument but only when the electorate has grown tired of austerity which fails to lead to economic revival.

Recently, the prime minister has found a different narrative.We are in a race with other countries; emerging economies are catching up; we risk being left behind. Britain must be more competitive. This narrative is no more honest than the last. The global economy is not a zero sum game. One country's win is not another country's loss and new arrivals in the club of rich nations do not make the old members poorer.

I keep asking where is Labour's narrative?

The Tory narrative works because it deals with familiar ideas. Personal debt and household debt may be completely different from national debt but the Tory tale has a feel of familiarity. "Maxing out the national credit card" is an absurd notion, but it connects to how people feel when personal debt is out of control. Equally the global race sounds plausible not just to sports fans but to people whose only connection to racing is school sports day.

As a simple Keynesian I would like to see narrative which emphasises investment to boost effective demand and increase growth. The problem is that these terms lack the immediacy of the Tory metaphors. I want to propose one small step towards a more homely narrative.

Instead of talking about growth we should talk about income. The parallels between national income and household income may not be exact but it does open a way of connecting to people's experience. For example, if you are in debt one way out is to increase your income. Paying down the national debt will be easier if we increase national income.

Britain's economic problem is not debt, but the failure to increase national income. The government cannot increase national income itself, but it should remove the obstacles to increasing income. That is where the narrative turns to investment.  The language of investment should also connect to people's direct experience. We invest now to increase income in the future. We should avoid talk of "stimulus" and of tax cuts or deficit financing.

Investment is not just public, although that is needed. Equally important is removing the constraints on private investment, through reform of the finance sector including flagship projects like regional enterprise banks.

This is a small contribution towards constructing a coherent narrative to counter the Tory dominance of the political story.