LONDON, Sept 13 (Askume Breakingviews) – A committee studying the financial health of British businesses has not given up its action. After a lengthy investigation, a government-appointed panel of economists and experts concluded that U.K. financial institutions offer less support to domestic businesses than their European and U.S. rivals. To revive a sluggish economy and a moribund stock market, the group recommended sweeping reforms to provide long-term capital to industry.
This account summarises the work of the many working groups and committees that have recommended reforms to the UK financial sector in recent years. However, this particular group reached its conclusions almost a century ago. The Finance and Industry Commission was set up in 1929, the year of the stock market crash, and was led by Scottish lawyer Hugh Macmillan. Its members included such luminaries as economist John Maynard Keynes and trade union leader Ernest Bevin. Its diagnosis of the gap between British finance and industry was so significant that financiers and policymakers were still debating the “Macmillan gap” decades later.
Now British politicians, investors and regulators are once again concerned about the lack of financial support for domestic companies. The number of companies listed on the London Stock Exchange has fallen significantly . UK-listed shares trade at a significant discount to US stocks. British entrepreneurs complain of a lack of financing for new start-ups. The country’s investment record is one of the worst among developed countries. Governments, faced with huge debts and spending cuts, are unable to help.
Ministers and regulators have responded very quickly with regulatory reforms. They changed pension rules, eased requirements for stock exchange listings and removed limits on investment research payments. Before leaving office, the previous Conservative government explicitly gave UK financial regulators responsibility for promoting international competitiveness and reintroduced requirements that the previous Conservative government scrapped in 2012. At a packed summit in the City of London last week, LSE chief executive Julia Hoggett described the latest changes as “the most ambitious capital markets reform agenda in the world right now”.
These periodic reforms are based on an attractive idea: that changes to financial regulations and taxation could help unleash a flood of new investment, stimulate British business and reignite economic growth. However, this analysis ignores the deep fault lines that separate the country’s financial sector from the rest of the economy.
Britain is highly dependent on finance. Financial services account for about 12% of economic output , compared with about 7% in the United States. Most of this activity comes from London. The city is the world’s second-largest asset management centre, a major foreign exchange trading venue, and the largest over-the-counter derivatives trading venue. British companies can and do use these services, but London’s success as a financial centre depends on attracting clients from around the world.
This unbalanced system has persisted for centuries. As historian David Kynaston points out in his history of the Bank of England, To the Last Sand , the City of London had long favoured merchants and traders over domestic industrialists. It was the financial centre of the British Empire and later became the main banking centre of the European Union. The wealth and taxes it generated inevitably distorted the domestic economy. Indeed, the promise of making money in the City of London has long attracted ambitious young Britons who might otherwise have pursued careers in other industries.
The dominance of finance also drives short-term decision-making. In 2011, the British government asked economist John Kay to study whether the British stock market was helping businesses and providing good returns for savers. He concluded that mistrust and the wrong incentives could lead companies to make poor decisions. The continued growth of passive index-tracking investment funds and the growth of private equity over the next decade have exacerbated the problem.
Recent and potential future reforms appear to be too timid to reverse these trends. Take, for example, the current debate over the absence of UK shares from UK pension fund portfolios. The UK retirement industry surprisingly invested only 4.4% of its assets in house shares last year, according to a study by the New Finance think tank . In other countries with large retirement industries, such as Australia and South Korea, the proportion is much higher.
But that doesn’t mean the change will make British investors more supportive of domestic companies. In the mid-1990s, when British equities accounted for more than half the value of pension fund assets, senior executives often complained that fund managers in London were obsessed with short-term performance, struggled to grasp new technology, and prioritised dividends rather than reinvestment for growth.
However, the push for reform shows no signs of slowing down. At last week’s summit, Nigel Wilson, the former boss of insurance company Legal & General, delivered a report titled ” Tomorrow’s Capital Markets ” . His proposals include giving retail investors more incentive to buy UK shares, reintroducing tax credits for pension funds investing in domestic shares and abolishing stamp duty on share transactions. Some delegates even suggested obliging employees to invest part of their pay into retirement.
These suggestions may be made with good intentions. But they hold a particular grudge for an industry that has long played a vital role in the British economy, and the results are clearly mixed.
The Macmillan Commission finally got its wish. In 1945, the Labour government and the Bank of England forced the Bank of England to set up the Industrial and Commercial Finance Corporation, which eventually became the Venture Capital Corporation 3i (III.L) . Its goal is to provide long-term financing to small and medium-sized enterprises. However, despite these efforts, the gap between UK finance and business remains as wide as ever.
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