The New Deal

Professor R. Ross Mackay argues that we should take a leaf out of Franklin D. Roosevelt’s book and prescribe a new advance for the 21st Century to overcome the credit crunch.

This is a fascinating but alarming time. We are witnessing the financial systems astonishing volatility and how it is underpinned by animal spirits. At present, the economy and the community have lost trust and confidence in finance. The key question is how we restore trust, without losing the energy and drive of capitalism?

One way in which financial institutions build income and add to share value is to accept excessive risk. That is what happened in Northern Rock and other finance companies in serious trouble. Loans were made to people who could not repay. Toxic debt followed from doubtful practices, including teaser rates: mortgages offered at artificially low interest, but climbing at a later date. Lending became reckless with securitisation – loans bundled together and sold to other institutions. This had the effect of making the initial lender indifferent as to loan repayment.

The incentive for financial institutions to take excessive risk was enhanced by a bonus culture that emphasised short-term returns and immediate growth – without recognising long-term risks. Markets, especially financial markets, often fail to work as advertised. Failure can be self-reinforcing, rather than self-correcting. Finance markets are different. Financial growth relies on innovations that are for a time lucrative, but are eventually disastrous. Financial instability is a direct consequence of a period of growth and stability. Over confidence encourages excessive optimism, financial experiment, financial innovation and excessive risk taking. Speculation – gambling on the turn of the market – does little harm when it merely operates on the surface of the economy: it is disastrous when it becomes the heartbeat.

At the heart of the credit crunch is loss of trust. The unwillingness of banks to lend to each other is a breakdown of trust. Neither the public nor the banks trust the available information on the risks that banks have taken. There is no reliable way to value their assets. The High Street has fallen out of love with the City. The loss of trust and respect links to a bonus culture and a payment and compensation system that has been over generous. That culture and reward system has been at the heart of excessive risk-taking.

We will come out of recession and we will recover from the disastrous mistakes that have been made. However, the cost to the real economy and to jobs and to community will be substantial. We cannot return to business as usual. The financial system cannot be allowed simply to privatise gains and socialise losses. There has to be recognition of a wider social and civic responsibility by those who control finance, money and power.

Refocusing the Economy

A famous economist of the last century – Joseph Schumpeter – described capital as a means of dictating a new direction to production. Economic development is a harsh process. It depends on innovation and involves creative destruction. Creative destruction implies that old industries wither on the vine: physical and human capital is not slightly reduced in value, it is destroyed. New trades have to be learned, new habits to be acquired. A new set of external and internal economies of scale has to be developed. Given severe decline, it takes time and capital to provide a new direction for industry. The next step forward is likely to be difficult, but the financial system is important in finding new direction. The longer the delay, the harder it will be to employ those who have become accustomed to and demoralised by unemployment.

Unfortunately, UK finance recognises no responsibility for a new sense of direction, for the economy and for the regions. The task of the City, it is argued, is to make money for its shareholders. The City refuses to recognise any wider role within the UK. Lending is astonishingly concentrated on the capital city – to a much greater degree than in the rest of Europe. Part of the problem in finding a new direction is the failure of the City to commit to British companies and to locations outside the capital. The financial system is both too wide and too narrow. It regards itself as international, but does not accept any responsibility for regional balance.

Regional Balance

Market Economies provide a tension between the dynamism generated by new investment and the lingering decay associated with dated investment. Economic growth is uneven, or so it has been in the UK over the last 35 years. New capital and new investment has concentrated on the capital and its commuting regions, the rest of the country has lost ground. The realisation of potential, the development of people, the recovery of local economies and local communities depends on a better-directed demand.

Demand and growth has concentrated on the most heavily populated parts of the most crowded country within Europe. They have added to congestion, to commuting, to housing problems, to inflation. They have created severe problems for those who work in the capital and its zone of influence.

New Labour has been negligent when it comes to the growing regional divide within the UK. It has protested that inequality within regions is at least as great as inequality between regions. It is a naïve claim. First, because the two forms of inequality cannot be compared and second, because inter and intra regional inequality grow together. They are both products of an increasingly unequal economy and society.

Regional imbalance has particular pertinence to Wales, one of the poorest regions within the UK. The problem is starting to be addressed by some public bodies. By 2016, 50 per cent of BBC production will be outside of London. This will include 17 per cent from Scotland, Wales and Northern Ireland. It is too little and too late, but it is an attempt to overcome the concentration of BBC creative resources in and around London. That concentration was unquestioned, indeed it was celebrated, until recently. However, it is now recognised as the BBC’s Achilles heel. Spreading employment is the key to winning a decent settlement in the next licence fee negotiations and, critically, its next charter.

A New Deal for the 21st Century

The deep depression of the 1930s must be avoided. This financial crisis must be met with programmes designed to maintain demand. Our greatest primary task is to put people to work and to encourage creative effort. The UK government has recognised the importance of a swift response – via lower interest rates and higher public expenditure. Social housing needs new investment: housing repossessions should be a last resort. But a New Deal for the 21st Century has to be broader and deeper than has yet been recognised.

Part of the 1930s New Deal for the United States involved projects to stimulate and reorganise the use of the United States natural resources. A new deal for the United Kingdom must link to climate change by building a low carbon economy of high-skill workers who build a new energy infrastructure. Wales has considerable potential for sustainable energy development: both wind and wave power. We could bolster Wales’s micro-generation capacity and link generators to the National Grid. Wales may even learn from Scotland. Maitland Mackie (the ice cream man) has a plan for wind turbines designed to generate income for local communities and for Scottish farmers. In Wales, as elsewhere, we need to restore the links with localities and people. Economic development is not just about money or goods and services. The other side of the development coin is the need to play closer attention to human development, if we want to balance the productivity needs of the economy with the social needs of its human resources and so ensure that people gain from the beneficial imp
acts of structural economic change.


Deregulation has contributed to competitive innovation in finance. Light touch, or soft touch regulation, was part of a strategy designed to add to the power of the City and to open new fields of opportunity for capital. A clear focus on the dilemmas of financial fragility and systemic and spreading risk must be part of a new regulatory framework. We are not the fully informed, ice-cold calculators that Economics 101 presumes. Given stability and growth, we are more optimistic than we should be. With loss of confidence, panic sets in. Money seeking to expand itself without committing to long-term investment in the real economy adds to risk and to instability.

And finally, the strength and energy of markets and the economy does not depend on everything being privatised and marketised. When you have organisations that have public obligations and a public role you have sources of employment that are sheltered from the abrupt reversals that can destroy productive capacity, jobs and community. The obvious and high relevant example is the Post Office. In recent years, every effort has been made to withdraw revenue sources. The shock to the economy provided by private finance may encourage us to recognise that the Post Office has an important community role. Building the Post Office business is a proper government objective: reducing its business is not.

Professor R. Ross Mackay

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