Here's a short piece on the financial meltdown in the UK, for Il Mulino:
From Blair to Brown, From Boom to Bust: Britain’s Economic Crisis and its Political Consequences
One of the first signs of something dangerous brewing in the world financial system came in the United Kingdom, in the late summer of 2007. A small regional bank, Northern Rock, requested liquidity support from the Bank of England, a clear sign of financial difficulty. The immediate response was panic: the bank’s shares collapsed and depositors rushed to withdraw their savings, leading to scenes reminiscent of Mary Poppins as desperate account-holders queued in the street outside Northern Rock branches. This was the first run on a bank in the UK since the 19th century, and a huge embarrassment for a country whose economy has revolved around the financial sector in recent decades. By the second quarter of 2008 Britain had entered what is proving to be the longest recession since the 1930s.
The run on Northern Rock and its subsequent rescue by the government is a defining moment in the recent economic and political history of the UK. Although the financial crisis is obviously not a solely British problem – the Northern Rock bank run began on 15th September 2007, but on the same date a year later Lehman Brothers’ bankruptcy provoked a world financial meltdown – it has had particularly powerful consequences, both economic and political, in the UK. It has made the defeat of the Labour government in next year’s general election almost inevitable, but it has also called into question a model of economic growth centred on finance which dates back to the 1980s and the glory days of Margaret Thatcher. For these reasons, the economic crisis of the late 2000s is a likely turning point in British politics.
The Financialization of the British Economy from Thatcher to Blair
Although it is a Labour government that has the bad luck to preside over the current crisis, its origins can be relatively uncontroversially traced back to the dominant Conservative figure of recent British history, Margaret Thatcher. Thatcher promoted the ‘financialization’ of the British economy in two ways. First, and perhaps unintentionally, by following a tough anti-inflationary policy in the early 1980s which decimated British manufacturing industry, leaving the financial sector as the central motor of the economy. Second, a series of regulatory and fiscal measures taken in the 1980s liberalized the financial sector, removing a range of restrictions on financial activity and promoting a modernization and rapid expansion of the financial sector.
The so-called ‘Big Bang’ of 1986 – which removed some key regulations and established electronic trading in the London stock exchange – brought a surge in capital flows to the City of London, and a boom in lending to British consumers. Also in 1986, the Thatcher government passed the Building Societies Act deregulating the usually small mutual financial institutions which financed most housing purchases in the UK. The majority of building societies, including Northern Rock, converted to banks owned by share-holders as a direct result of this legislation, and adopted more expansionary lending practices. This led to a rapid increase in property prices, following by an equally rapid collapse of the property market in the early 1990s.
The changes to the financial sector, along with most other reforms promoted by the Thatcher governments, were strongly opposed by the Labour party at the time, but by the mid-1990s Labour had begun to adopt a much less confrontational strategy under Tony Blair. Blair’s centrist orientation had two clear consequences for Labour’s attitude to finance. First, Labour became very anxious to court middle-class voters who, notwithstanding the collapse of property prices, were supportive of many aspects of the Thatcherite economic programme. Second, Labour was desperate to win over the City of London, launching what became known as a ‘prawn cocktail’ offensive, aimed at reassuring powerful figures in the banking world that Labour would not only protect and nurture the financial sector, but promote its expansion as a motor of economic growth. One of Blair’s key allies, the current Business Secretary Peter Mandelson, famously stated that ‘we are intensely relaxed about people getting filthy rich, as long as they pay their taxes’. Such thinking was informed by the ‘third way’ advocated by Blairite sociologist Anthony Giddens, who argued that progressive politics needed to move ‘beyond left and right’.
In practice, this meant that once in power Labour (or ‘new Labour’ as Blair insisted on rebranding the party) would maintain the deregulatory approach to the financial sector pioneered by the Conservatives. The housing market reached its bottom in 1995-6, and had entered another rapidly expansionary phase once Labour were elected in 1997. This time, the rise in the housing market was bolstered by trends in the world economy, and in particular the spectacular housing boom in the United States and the associated innovations in the financial sector. Securitization of residential housing mortgages – in which banks lent money for housing purchases but then sold on the debt to investors – was also adopted by British banks, and the City of London became a major centre for hedge funds dealing in a range of sophisticated and risky financial products.
New Labour’s Boom Politics
This closeness to the City is one of the reasons the New Labour governments of Blair and Brown have been criticized from the left as neoliberal or ‘post-Thatcherite’. Indeed, the rhetoric of New Labour, which celebrates business and entrepreneurship almost as enthusiastically as predecessor Conservative governments, has appealed particularly to the middle classes, whilst neglecting the kinds of messages appreciated by the traditional Labour constituencies of manual workers and public sector employees. However this rhetoric is perhaps misleading as an indicator of party policy. In many respects, Labour has followed a classical social democratic strategy, increasing the fiscal burden on higher income groups and raising public spending sharply, particularly in the areas of health and education.
The curious outcome of Labour’s fiscal policy has been that Blair and Brown can claim to be the only centre-left politicians in recent European history to significantly expand the role of the state in the economy. Even before the financial crisis, public spending had increased substantially, from £315.9 billion in 1996-7, the last year of Conservative government, to £550 billion in 2006-7, a real terms increase of 37% (data from the Institute for Fiscal Studies). Of course, such numbers need to be interpreted carefully, and it is worth recalling that almost all of this increase was accounted for by growth in GDP, so that the share of government spending in total output only increased by 1% to 40.9%, still a relatively low figure by European standards. But looking inside the statistics we can see that Labour made important structural changes to government spending during its first decade in office, changes which are now proving to have major consequences.
First, the strong economic and employment growth of the late 1990s and early 2000s allowed Labour to shift government spending away from unemployment support and deficit financing, which both declined in real terms, and towards the provision of public services. In particular, health spending more than doubled from £44 billion in 1996-7 to £112 billion last year, a real increase of just over 100%, whilst education spending grew by 62% in real terms (from £37.8 to £81.7 billion). Much of this spending involved recruitment of large numbers of new public sector employees, and is therefore difficult to reverse quickly. This dramatic public sector growth was financed in part by the growth of government deficits after 2002, in part by economic growth delivering higher government revenues, and only in part by higher taxes. Higher government spending had the effect of stimulating economic activity, particularly by expanding public sector employment, which lowered the overall unemployment rate (a very large proportion of net employment growth in the 2000s was accounted for by government hiring).
This public sector expansion complemented another important source of economic growth in the New Labour decade: credit-driven consumption. In the 1990s, the City of London enjoyed spectacular growth in its revenues, with the financial sector growing to the extent that total financial assets in the UK amounted to 440% of GDP in 2006 (from 100% in 1980). Part of this growth was accounted for by a consistent rise in household borrowing in the UK. UK consumers borrowed to buy houses, cars, holidays and even everyday purchases. The influx of credit into the housing market led to a rapid rise in house prices, to which consumers responded by increasing their borrowing, including extracting equity from their homes to finance other spending. This borrowing fuelled economic growth, which enhanced consumer confidence and encouraged further increases in indebtedness. In 2006, UK household debt exceeded £1 trillion, comfortably higher than annual GDP.
The growth of credit and the significant unfunded increases in government spending contributed to Britain’s comparatively strong economic performance between the mid-1990s and the mid-2000s. Economic growth averaged 3% between 1997-2007, the longest period of consistent growth the UK had enjoyed for decades, and significantly higher than the Eurozone average. Labour Prime Ministers Blair and Brown, not surprisingly, took the credit for this economic record. As a result, the Labour government was particularly vulnerable when the financial meltdown of 2008 plunged the world into recession.
From Boom to Bust: Britain’s Economic Collapse
The collapse of Northern Rock in 2007 was an early sign that Britain’s long period of economic growth was drawing to a close. It also came at an awkward moment for Gordon Brown, who had only just taken over from Tony Blair as Prime Minister after ten years as Chancellor of the Exchequer (Treasury Minister). The Brown-Blair partnership had proved enormously successful, but strains in the relationship, and Blair’s declining popularity after the invasion of Iraq in 2003, led to Brown placing pressure on Blair to resign and hand over the keys to Number 10 Downing Street. Brown took over as Labour leader and Prime Minister in June 2007, and initially enjoyed huge popularity, which translated into a jump in Labour support in opinion polls. This led to speculation that Brown would dissolve parliament and hold a general election in order to legitimize his premiership, but despite evidence of preparations for such a decision, Brown quickly announced that there would be no immediate election. Soon afterwards, his popularity began to decline and opinion polls have consistently given the Conservatives a substantial lead ever since late 2007.
Given Brown’s failure to revive Labour’s popularity, the emerging difficulties in the financial markets were a serious political threat. As Chancellor, Brown had been in charge of economic policy under Tony Blair, and was to an important degree the architect of the arrangements for economic management which began to collapse in 2007. In particular, at the beginning of his tenure as Chancellor Brown had made major changes to the monetary policy framework and the regulation of the financial sector, the key policy areas related to the economic crisis. One of the new Labour government’s first moves in 1997 had been to give operational independence to the Bank of England, the UK’s central bank. Brown established an independent Monetary Policy Committee, which would be responsible for adjusting interest rates to achieve an inflation target defined by the government (currently 2%). A second important step was the creation in autumn 1997 of the Financial Services Authority (FSA), which took over important regulatory responsibilities from the Bank of England and became the principal regulator of the financial sector.
The current crisis revealed the weaknesses of these institutions and exposed Gordon Brown to extensive criticism. First of all, monetary policy suddenly came under intense scrutiny during the financial meltdown of 2008. The Bank of England had proved successful in maintaining the standard measure of inflation (the Retail Price Index or RPI) close to the government’s target of 2%, and had kept interest rates relatively low at the same time. Naturally enough, this was lauded as a success for some time, especially since both employment and growth were maintained at historically high levels until 2007. But the popping of the housing bubbles in the United States and the UK, and their subsequent disastrous impact on the financial system, revealed a fundamental flaw in Gordon Brown’s monetary architecture. Asset prices – and particularly real estate prices – were not included in RPI, and by the mid-2000s had reached dangerously high levels in the UK, as low interest rates encouraged highly leveraged speculative investment in the property market. The claim that the UK had achieved a ‘Goldilocks economy’ – in which the Bank of England was able to maintain levels of demand that were ‘just right’ – was exposed as a delusion. Instead, economic growth had been fuelled by asset price inflation with which the Bank of England had not concerned itself, and the collapse of asset prices in 2008 effectively bankrupted many of Britain’s most important financial institutions.
Northern Rock was an early victim of this swift change in the real estate market. Although sub-prime lending – predatory mortgages sold to low-income housebuyers in a rising property market – was not as significant a problem in the UK as in the United States, the Northern Rock collapse laid bare the recklessness of many of Britain’s banks. Northern Rock had enthusiastically adopted two innovative features of the mortgage lending of the early 21st century. First, it had financed its activities by borrowing money in the wholesale markets, rather than simply relying on savings deposits. The collapse of the bank in September 2007 resulted from Rock’s increasing difficulties in raising the funds it needed to operate when these markets became more reluctant to lend. Second, Northern Rock had offered mortgages to customers with little or no savings, even making loans of up to 125% of the value of the house being purchased. In a rising market, this was a low-risk activity, since the collateral would quickly grow in value. By 2007 the housing market was starting to fall, leaving Northern Rock with many non-paying mortgages on its books which were not covered by collateral. After the bank’s collapse, a great deal of criticism focused on the role of the Financial Services Authority, which as the regulator was charged with ensuring that banks like Northern Rock did not take dangerous risks in their lending practices. The FSA failed to identify the problems at Northern Rock before the bank’s collapse, and indeed failed to intervene in any of the other cases of financial institutions which in the course of 2007-8 ended up being rescued by the government.
In short, the financial meltdown of the late 2000s undermined all of the policy successes claimed by Gordon Brown and New Labour over their decade in power. The independence of the Bank of England had not prevented an asset price bubble which destabilized the whole economy, and the regulatory framework designed by Brown had apparently not noticed that banks had built balance sheets which left them dangerously exposed to any turbulence in the financial markets. Finally, the Labour governments had built up public spending to levels which quickly became unsustainable when the credit-fuelled growth of consumption ceased, leaving the UK with the biggest fiscal deficit in Western Europe in 2009 (around 12% of GDP). How will this affect the general elections to be held in spring 2010?
Brown’s Decline and the Revival of the Conservatives
Although the financial crisis has made a Labour defeat next year almost certain, Labour was probably heading towards defeat anyway. In 2005, Tony Blair’s third election as leader, Labour won the election by a slender margin: its comfortable majority in the House of Commons was an artefact of the electoral system, as Labour in fact won only 35% of the vote, just 3% more than the Conservatives. Labour’s dominance of the political scene from the mid-1990s was due in large part to the collapse of support for the Conservatives and their inability to find an effective leader. In late 2005 the Conservatives elected a new leader, David Cameron. Unlike his immediate predecessors, Cameron was young (under 40), political moderate, and an excellent performer on television. Cameron immediately set about updating Conservative policy and revolutionizing the party’s image.
Cameron’s principal aim was to modernize the Conservative image and change the party’s reputation for representing old-fashioned attitudes on social an cultural issues, and hard-line views on ethnic minorities. This centrist strategy was not met with particular enthusiasm within the party, but the Conservatives were also weary of opposition and Cameron’s effective performance as leader gave him a good deal of room for manoeuvre in changing the party’s message. Much of the change appeared relatively superficial and focused on presentation: Cameron promoted a younger generation of Tories to senior positions, and made an effort to give a higher profile to women and ethnic minorities within the party (although the inner circle of the party leadership remains the exclusive preserve of white men, many of whom have attended the same prestigious private schools).
Labour’s decline and the economic crisis have presented Cameron’s Conservatives with an opportunity to return to power after an unusually long absence of 13 years (the party’s longest period in opposition in its modern history). After the narrow 2005 electoral victory, Labour’s support in opinion polls steadily declined, and apart from brief recoveries in the summer of 2007 (when Gordon Brown took over) and the autumn of 2008 (in the immediate wake of the financial crisis), the Conservatives have enjoyed a consistent lead in the opinion polls. The European elections of 2009 were a total disaster for Gordon Brown, with the Labour party finishing third on only 15% of the vote, behind the fringe Euroskeptic party UKIP (United Kingdom Independence Party). Alongside heavy defeat in local elections and parliamentary by-elections, Brown came under intense pressure to resign, but managed to remain in place, largely because of the party’s fear that a further change of leader within a single legislature would prove unpopular. As the 2010 election approaches, Labour appears destined for a heavy defeat.
What does the likely Conservative victory imply for the political situation in the UK? Cameron’s modernizing strategy and clear appeal to the centre suggests that a change of government will not have radical implications for policy-making. However, closer attention to the party’s politial message suggests that a Conservative government is likely to make significant changes. First and most obviously, Cameron has decided not to make any major breaks with the Euroskeptic positions which are dominant in the Conservative party today. Most tellingly, he has taken the risky decision of pulling the Conservative party out of the EPP-ED group in the European Parliament, and instead allying with assorted Euroskeptic forces in the European Conservatives and Reformists group. This is likely to lead to the unusual situation that a Conservative Prime Minister in the UK will have difficulty adopting an effective working relationship in the European institutions with the centre-right leaders of the other largest European Union states (Merkel, Sarkozy and Berlusconi), all of whom remain within the EPP.
Other signs of likely discontinuity can be identified in the Conservatives’ reaction to the financial crisis. Initially the crisis placed Cameron on the defensive, as Gordon Brown’s high profile in the international response to the crisis briefly revived his popularity and left the Conservatives in the awkward position of having to offer their support to the sitting government. However once the immediate panic of autumn 2008 passed, the Conservatives quickly moved into active opposition, criticizing the fiscal consequences of Labour’s expansionary approach to the crisis. In the Conservative party conference of September 2009, Cameron delivered a tough speech indicating a shift towards a more aggressive position against the growth of the public sector under Labour. Whilst the Conservatives supported Brown’s reduction of VAT sales tax in late 2008 and the decision to bail out financial institutions with government money, it has recently shifted to criticism of the government for allowing the budget deficit to rise to its current high level (the direct consequence, of course, of these very decisions the Conservatives initially supported). Cameron pinned the blame for the crisis on the growth of government under Labour: ‘And here is the big argument in British politics today, put plainly and simply. Labour say that to solve the country's problems, we need more government. Don't they see? It is more government that got us into this mess. Why is our economy broken? Not just because Labour wrongly thought they'd abolished boom and bust. But because government got too big, spent too much and doubled the national debt.’
This more aggressive strategy has also involved supporting the Bank of England governor Mervyn King in his increasingly critical comments on government policy, and arguing for the abolition of the Financial Services Authority and the incorporation of its supervisory functions into the Bank of England. This suggests a change of approach in Conservative policy, away from the more conciliatory, centrist message of Cameron’s early period as leader, and towards a tougher, more traditionally conservative line on economic policy. Before the crisis, the Conservatives limited their criticisms of increased government spending, recognizing the popularity of Labour’s heavy investment of public money in public services such as health and education. In recent months, Cameron has argued strongly that deficit reduction must be a priority, with the clear implication that a future Conservative government will carry out substantial cuts to public spending.
This offers the Labour government an opportunity to transform the next general election into a choice between a centre-left party supportive of the public sector, and a centre-right alternative which will set out to reduce public spending substantially in order to bring down public borrowing to the internationally low levels of the pre-2008 period. The likely outcome of Conservative policies will be a decline in the availability of public healthcare and education services, and an increase in poverty amongst low-income groups. The result of the election will depend on Labour’s ability to mobilize the support of the likely losers from such a political change. Given the political exhaustion of the Labour party after 13 years in government, and the unpopularity of its leader, any other outcome but a Conservative victory appears unlikely.