James Foreman-Peck, Cardiff Business School, Director of the Welsh Institute for Research in Economics and Development
Amid the choking of the financial system on the ‘toxic’ assets it has created, no-one has pointed out the silver lining of this poisonous cloud. This is the income gap between Wales and England – particularly the south east, which will almost certainly narrow over the next few years. Welsh incomes per head will be less far behind. Much of the past economic divergence has stemmed from the precocious growth of financial services and incomes in the City. These will now enter a more sober phase of expansion, even after recovery from the latest crash. By contrast, with any luck the rest of the UK economy, including Wales, will plough on much as before.
Why then has there not been widespread rejoicing in Wales? Maybe we needed this natural experiment to show us that, actually we do not care very much about divergences in Gross Value Added per head – even though the Welsh Assembly Government once attached importance to these numbers. What matters more to people perhaps is their absolute and year-on-year living standards, which until the latest price squeeze, had on average been good.
Where the present financial crisis will be unwelcome in Wales is in falling house prices and the seizing up the housing market. House prices have risen in almost every year since the end of the Second World War. For sustained periods of decline we must look back to the 1930s. The forecast by the Nationwide Building Society’s Chief Executive that house prices are likely to fall by one quarter over the next two years therefore takes some digesting. Is he right?
Tighter housing finance must mean lower prices for a while – defaults on mortgage payments will increase, first time buyers will be scarce, ability to take on larger mortgages will be constrained – and, no less importantly, downwards revisions of house price expectations pull in the same direction. Surely some demand for housing has been fuelled by the belief that house prices will rise strongly. How much will the price adjustment hurt? Negative equity – a greater debt than resale value of the house – only matters if you are obliged to sell up. Those that must move or can no longer afford their payments will suffer. But in due course the upward climb of house prices will resume and equity will become positive again.
Another source of disquiet is that since the run on Northern Rock, and perhaps exacerbated by the collapse of Lehman Brothers, the shotgun marriage of Lloyds TSB and HBOS, and the sudden absorption of the Derbyshire and Cheshire Building Societies by the much larger Nationwide, quite a few people have been jumpy about the safety of their savings. However it is clear that neither the UK nor the US governments are going to allow a financial failure that disrupts ordinary customers.
Of course the Scots will bemoan the loss of their national bank to London, but probably without much sympathy from Wales. For the (admittedly much smaller) Bank of Wales was acquired by the Bank of Scotland and in due course disappeared some years ago. Although about the same size as the Derbyshire and Cheshire Building Societies, Wales’ Principality Building Society is weathering the storm well. The reason seems to be sound management, as reflected in the high and rising proportion of their loan business financed by members’ savings – in accordance with the original model of the Building Society Movement. In their latest report the Principality indicated that their ratio was 88 percent, while the Cheshire had thought they were doing well with little more than 60 percent. Reliance on financial markets in times of panic is to be avoided as much as possible. But accessing these markets was how, for instance, Northern Rock grew so rapidly. The 3-6-3 model of banking was apparently then popular (‘borrow at 3 percent, lend at 6 percent, on the golf course by 3pm’). Bankers should know about the creditworthiness of those to whom they grant loans and the reliability of their own sources of funds. Wales, or at least the Principality, has opted for slower but more secure growth.
One other possible cause for concern about the current financial crisis has not been much discussed. With one third of the work force in the public sector, we might expect the economy of Wales to be reasonably insulated against much of the demand shock. But the City reputedly provided one quarter of corporation tax and more generally the downturn is likely to hit government finances hard. This could put pressure on the public sector and thus on Welsh central government funding.
No doubt a sense of responsibility not to trigger panic – coupled with historical ignorance – has limited discussion of analogies with the world financial crises of 1929-1931. Were such an informed conversation to take place, it ought to be reassuring. Before 1929 the Welsh economy, and to a lesser extent the British economy, were over-dependent on export industries that were demonstrably uncompetitive, which is not now the case. Then financial crises struck both the US and European economies. Instead of bolstering confidence in their financial system, the monetary authorities in the US undermined it, continuing to publish a monthly index of numbers of bank failures that they permitted. In both the US and Europe cooperation was inadequate to prevent the breakdown of the international monetary system, the US quickly went its own way, followed by the larger European economies. Inevitably, export economies like Wales and the UK suffered badly with the disruption and collapse of world trade. In contrast we now see massive concerted efforts of major governments and central banks to return the world economy to normal, with so far apparently reasonable success.