WEEKLY COMMENT 10-08-2017
By Barry Edwards
The Institute for Public Policy Research (IPPR) Commission on Economic Justice has recently published a discussion paper entitled ‘Financing Investment, Reforming finance markets for the long-term’. The IPPR is a landmark initiative to rethink economic policy for post-Brexit Britain. Launched in November 2016, the Commission brings together leading figures from across society – from business and trade unions, civil society organisations and academia – to examine the challenges facing the UK economy and make practical recommendations for reform. If you click on the link below you can read the paper, it is 35 pages of script and it is well worth reading;
The IPPR states that “The reform of financial markets is vital if the UK is to be upgraded to a high-investment, high-productivity and high-wage economy”. The paper makes three main propositions that it discusses at length which are;
- The profitability of the UK’s finance sector rests in part on a failure to pass on the benefits of its rising productivity to the rest of the domestic economy. Despite huge advances in information technologies and analytical capacity, the unit cost of intermediation to the non-financial economy is higher now than it was in the 1950s
- Raising SME investment requires shifting the focus of bank lending to small, high-growth firms, and the development of new specialist banks. UK banks are overly focused on real estate, leaving a gap in the supply of finance needed to improve productivity and growth in the economy
- Promoting longer-term corporate investment requires a stronger alignment of the incentives of companies with the savers who ultimately own their shares. By reforming executive pay, extending fiduciary duty to intermediary institutions such as fund managers and brokers, and ending exemptions for Stamp Duty Reserve Tax, the incentives for excessive short-termism in equity markets can be reduced.
The conclusions they come to are summarised below;
Reform of our financial system should be focused on improving the flow of capital to the businesses most in need of investment, and aligning the incentives between company directors and the long-term savers who, ultimately, own their shares.
Raising SME investment requires shifting the focus of bank lending to small, high-growth firms. Banks’ current reliance on traditional property collateral for business lending means that horizontal interventions alone, such as the Funding for Lending Scheme, will not ensure finance reaches the places it is most needed to upgrade the economy. Instead, we propose that:
- The Bank of England should consider the case for raising the relative cost of real estate lending
- The Government should look at helping the private sector develop ways of using intellectual property as collateral
- The Government capitalises new specialist banks that can develop the expertise necessary to finance currently under-capitalised projects, both in particular sectors and in particular regions of the country.
Aligning incentives in equity markets and promoting longer-term corporate investment requires changing incentive structures for the institutions and actors that intermediate share ownership. We propose that:
- the Government strengthens the legal fiduciary principle that applies to pension trustees and extends it to asset managers, brokers and other institutions that act as shareholding intermediaries
- a new Responsible Ownership Commission is established to help institutions interpret their fiduciary duty and ensure that there is sufficient disclosure of information to monitor and enforce behaviour
- the Government scraps the ‘market maker’ relief on stamp duty reserve tax to reduce short-term speculative trading
- the funds raised from this are used to introduce new reliefs in capital gains tax and corporation tax designed to incentivise longer-term ownership of shares.
As you can see the government has a big job to make all this happen which often means that it will take a long time to implement and may not finally be achieved as proposed. There is a long history of government measures to help SME’s and encouragement for long-term investment which have not addressed the underlying problems outlined in this discussion paper. Proposing the use of tax revenue for establishing specialised investment and lending institutions has never really been adopted by any government because politicians in this country are unwilling to involve government in competing with banks.
Although the ambitions of the IPPR are very genuine and relevant, they will struggle to persuade the government to interfere in a substantial way to provide the long-term capital that is desperately needed by business to counter the effects of Brexit. The UK has over the years fallen behind other major economies in the provision of long-term investment and, as this paper points out, this needs to be improved if the country is going to compete effectively in the future.
We have seen recently genuine concepts proposed by government, such as the industrial strategy green paper, which we discussed a fortnight ago but the core problem of accessing the finance to make it happen is not explained in any detail. In the main, it is usually left to the banks to organise the financing with some government guarantees which does not materialise fully and tends not to achieve the original intentions. A different approach has to be taken which draws on all these concepts but brings all the ideas together into a structured format.
If the UK is going to revitalise business and infrastructure investment this must be done. Next week this weekly comment will explain how this can be achieved and implemented without requiring tax revenue to be committed. All the components are already in place and the main job is to bring them all together to create an effective organisation that will fulfil this ambition.
That’s all for this week.