When The Herd Moves

A few more days like this, and Sir Paul Marshall will be funding Sovintern. If it is not Mary Harrington:

In This House, we love Horrible Histories. You might describe the TV series as “attention-deficit Blackadder”: high-speed history-themed comedy sketches, focusing less on narrative than violence and fart jokes. My daughter can sing the whole royal succession song from memory. But my personal favourite is “Born 2 Rule”, a boy-band-style ballad sung by the Hanoverian Georges I, II, III, and IV. It’s funny, if you like that sort of thing, and also conveys the prevailing modern British attitude to our monarchy: important, but also slightly ridiculous.

I doubt this week’s royal visit by Charles III to Washington will do anything to change that. The first visit to the United States by a reigning monarch since 2007, it is to mark this year’s 250th anniversary of American independence — their repudiation of our Crown. The actual Horrible Histories version of these events was in the style of football commentary, naturally featuring George III. I think overall it manages to ridicule everyone equally. But wondering how they’d portray the meeting between Trump and Charles III brought home to me how differently Brits and Americans still feel about many aspects of the transatlantic relationship.

For a central theme of British history, over the period most frequently covered by Horrible Histories, was the tendency of British people to leave Britain and set up home literally anywhere else around the world. The aggregate result was, for a long time, a global empire comprising both extended-family settler states and also colonial holdings. Meanwhile the particular, ambivalent “specialness” of Britain’s relationship with America stems both from this common genealogical story, and also from America’s later role in bringing that empire to an end.

In its aftermath, Britain’s self-image and economic survival has been shored up from three directions: closer economic ties with Europe, vague ties of (sometimes) goodwill with a post-imperial “Commonwealth”, and a close, if subordinate, military relationship with the USA. For a long time, this trifecta afforded British grandees more than enough opportunities to think and act internationally, as if Great Britain were still a global imperial power. But as the long 20th century comes to an end, it’s growing increasingly clear that the settlement won’t hold much longer.

In extended families, there are always topics you shouldn’t raise over Christmas dinner. In this case, the most sensitive is the British Empire, and America’s role in dismantling it. This story has been sanitised over the generations, but my step-grandfather, an RAF pilot and Colditz captive, felt it viscerally and hated Americans. I never really understood why. Hadn’t they fought alongside us in the war? Perhaps, I wondered, it was because American soldiers had liberated him from Colditz before he could put his escape plan into action, and so spoiled his fun?

It was only recently that I learned more about the punitive terms of US wartime loans to Britain, and the way US politicians demanded an end to Britain’s “imperial preference” trade protectionism as a condition of wartime assistance. From a US perspective, this was all robust realpolitik aimed at bolstering the US national interest. From a British one, it weakened Britain economically and helped foster the disintegration of the British Empire, which had been a US foreign policy aim from Woodrow Wilson onward. In this context, I’ve come to wonder if my step-grandfather, an upper-class Englishman, spoke that way about America because he understood that our cousins across the Atlantic had both aided Britain in the Second World War, and also played a key role in ending the empire he’d been raised to govern.

In turn, it was this same process of disintegration that later prompted the famous line uttered in 1962 by Dean Acheson, erstwhile US Secretary of State, about how Britain had “lost an empire and not yet found a role”. Acheson made the remark at a West Point Military Academy conference, in which he predicted that Britain would need to move toward Europe. This would be necessary, Acheson said, because seeking to expand our influence via the Commonwealth and “special relationship” with the USA wasn’t enough to make Britain a “power” in our own right. In particular, he thought, Britain had tried to carve out a role on the basis of “being the head of a commonwealth which has no political structure or unity or strength and enjoys a fragile and precarious economic relationship”. This role, he thought, was “about played out”, and what would most likely replace it would be closer union with Europe.

What Acheson left out of this is that British politicians came to believe we needed closer union with Europe because imperial preference had been forcibly ended, in favour of the GATT. The integration with Europe that Acheson predicted wasn’t realised until 1973, when Britain joined the Common Market. But by that point it was viewed as an alternative trading bloc to replace the erstwhile imperial one (a decision that would, in turn, have further negative consequences for British manufacturing).

Three years later, and one year after the referendum that confirmed Britain’s EEC membership, Elizabeth II visited the USA to mark the bicentennial of America’s independence from the British Empire. In her address, she cited the Commonwealth whose geopolitical force Acheson dismissed so brutally, as an example of the positive influence America had exerted on Britain. For, she said, America taught us the moral importance of freeing peoples to govern themselves. As she put it: “Without that great act in the cause of liberty performed in Independence Hall two hundred years ago, we could never have transformed an Empire into a Commonwealth!”

I wondered, on reading this, whether she intended the ironic subtext. We might also wonder if the point when the empire disintegrated is also the one where British monarchs became slightly ridiculous, as well as historically important. Either way, we very much do have the USA to thank for the Empire having become a Commonwealth. Indeed, when it was formed, the point of the Commonwealth was mostly to give the formerly imperial British monarch somewhere to visit, other than bits of the British Isles. As critics pointed out at the time, including Acheson, as a group it was never cohesive. These days, at least some of its members are so far from friendly they’ve taken to voting via the UN for Britain to send them money.

But is it time to revisit our wider alliances? In its current form, the Commonwealth has proved too internally contradictory to be supportive; but America’s rival internationalist body, the UN, itself now also feels a relic of the past. This year, Trump withdrew US funding and membership from multiple UN-affiliated organisations, and this is hardly the only recent indicator that the postwar age of internationalism is coming to an end. History is back, sometimes horribly so.

Meanwhile Britain is, to put it mildly, not well-placed for balance-of-power games. We import too much of our food and energy, and our military is down to three men and a popgun. Everyone in Europe hates us for Brexit, and everyone in Britain hates Trump for tariffs, Greenland, Iran, petrol prices, and killing the housing market, to name but a few. This is all further complicated by a Net Zero commitment that has left Britain deeply reliant on China, a fact we don’t really talk about: we just wave through the London super-embassy with the secret underground rooms a few feet from important data cables full of sensitive City messages.

But we’ve come back from worse. On the occasion of Elizabeth’s 1976 visit, to mark a major anniversary of this most testy and rivalrous of special relationships, we were as gravely in the doldrums as we are today. Then, as now, we had Belfast car bombs, failing utilities, and an overwhelming sense of government sclerosis. Our transatlantic cousins had would-be Presidential assassins too: security for the Queen was beefed up in the wake of two attempts to murder President Gerald Ford in 1975.

And yet eventually the sclerosis ended. A few years later, a radical government was elected and (even if improvements were unevenly distributed) the country changed. So for those on either side of the pond now tempted to paint Britain in shades of disaster: it wasn’t all over then, and I doubt it is now. Likewise, notwithstanding the “No Kings” boomers and their fears of Orange Caesar, I fully expect the American republic to survive its 250th anniversary as much a republic as ever.

But not everything is the same as it was in 1976. In Britain, we are militarily much weaker. Every indicator is that this will matter as time goes on. But there are deep historic reasons to feel nervous about closer military cooperation with Europe. There are also more recent, Iraq and Afghanistan-shaped ones for feeling nervous about leaning too far toward America. With this in mind, I wonder if we haven’t been too quick to forget about, or dismiss, the friendship of our other cousins: those who, like America, had their roots in Britain’s imperial expansion and have since become polities in their own right.

Britain will surely continue to need and feel a deep kinship with America, one that goes well beyond bare political calculation. But as postwar history attests, we also sometimes have divergent interests, not just in the distant past of 1776 but in the present era too. So in the short term we must hope that Charles III has the wit and grace to adapt to his new role as emollient regal vanguard for Britain’s new small-power politics, and that in this role he inclines more toward important than slightly ridiculous.

Meanwhile, though, Canada, Australia, and New Zealand all remain within the Commonwealth. These are also globe-spanning special relationships and deep ties that Britain might benefit from reinforcing. As history rumbles back into gear, sometimes horribly, we might all be relieved to ease the pressure on the American special relationship, by remembering there are other branches of the extended family too. Even if that that sometimes means getting into trouble with the cousins Down Under as well, for making songs about them escaping from prison disguised as kangaroos.

Then it is Dominik A. Leusder:

The grim forecasts just keep on coming. Only last week, EY Item Club warned that the economic hit of the Iran war on the British economy could be the worst since Covid — even as Deloitte predicted that 250,000 British workers will lose their jobs by the middle of 2027, bringing the unemployment rate up to 5.8%. Once again, the country is at risk of recession. In truth, of course, Britain’s economic troubles far predate the Iran war. Despite Keir Starmer and Kemi Badenoch’s claims to the contrary, something about the country’s political economy seems fundamentally broken. On key economic indicators, the United Kingdom has deeply underperformed relative to its peers: real wages saw zero growth in the 15 years following the 2008 Great Financial Crisis, while productivity has been sluggish for over a decade. Public services, from the NHS to local government, are visibly straining under a legacy of chronic underinvestment.

Andy Burnham, who might yet succeed Starmer, has issued his own diagnosis of Britain’s predicament: the “four horsemen” he proffers are deindustrialisation, privatisation, austerity and Brexit. The first two are simply shadows cast by the elephant trampling across the room; the latter are misguided reactions to the damage it left in its wake. The grey behemoth in question is finance.

Just how broken is Britain, then, and what role did finance play? The “too much finance” argument has fallen somewhat out of fashion since the crisis. But “financialisation” — that is, the extent of the growth of the financial sector and financial asset accumulation — remains the central cause of the country’s malaise. It broke the link between corporate profits and productive investment, inflated asset prices and living costs, and hollowed out manufacturing and investment into research and development (R&D), thus leaving the economy structurally vulnerable to the policy disasters that followed the crisis. Now that geopolitics and trade fragmentation have exposed the vulnerability of lacking a domestic manufacturing base, it is worth re-considering finance as the main culprit.

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The United Kingdom’s relative economic decline and its attendant political dysfunction can be understood as the outcome of several self-reinforcing trends — what economists might call a bad equilibrium — with finance at the centre. Where underperformance has been starkest is in the growth of productivity and wages. Data from the Office for National Statistics reveals that, between March 2008 and June 2023, the United Kingdom saw zero growth in real average weekly earnings. By contrast, cumulative real wage growth in France and Germany registered 10% or more during the same period. This astonishing gap is partly the result of a similar trend in productivity growth, which has been poor in both historical and comparative terms. Among the UK’s larger peers, only Italy, bedevilled by deep structural problems and policy failures of its own, performed worse on these measures.

The primary driver of long-term growth is investment, specifically investment into productive assets as well as research and development. This is known as fixed capital formation and includes investment by businesses, households and government. The country’s economic future, principally its growth trajectory and the sustainability of its national debt, depends on present levels of investment being sufficient to drive productivity growth over the long run. And investment decisions depend principally on the expectation of profits. This profit-investment nexus — complemented by public investment in key areas like education, research and infrastructure — forms the beating heart of a healthy market economy. But in Britain, more than almost anywhere else, it appears to have broken down.

Since early 1989, private investment has declined dramatically. As a share of gross domestic product, private fixed capital formation and net investment (which accounts for depreciation) are down by 30% and 76% respectively. These are extraordinary figures. The more narrow measure of business investment (which excludes investment by financial corporations, non-profits and investment into housing) is down 51% as a share of GDP from its peak in mid 2000.

Yet there was plenty to invest: the total surplus in the corporate sector (gross operating surplus, a broad measure of profits that includes the value added after compensating labour but before rent, taxes, dividends and depreciation) has increased fivefold since the mid-Eighties. Where did those surpluses go? The short answer is that finance absorbed them, channelling capital and resources away from productive investment and into financial asset accumulation, shareholder payouts and property speculation.

To understand how this process unfolded, it helps to trace two interconnected stories. The first concerns the deregulatory reforms of the Eighties that unleashed the financial sector. The second concerns the consequences of that expansion: how it distorted the relationship between profits and investment, contributed to the decline of British manufacturing, and left the economy vulnerable to the shocks that followed. Together, they provide a stylised account of how “too much finance” took its toll on the economy. 

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Starting in 1980, Margaret Thatcher and her cabinet enacted a series of deregulatory reforms, beginning with the removal of the credit-rationing “Corset” to allow banks to create credit freely. Other reforms such as the Housing Act 1980 (which included the infamous Right to Buy) and the Local Government, Planning and Land Act 1980 created a large surplus of public land that could be privatised and transformed into financial assets. If 1980 created the flow of money and assets, 1986 created the mechanism to intermediate it. The “Big Bang” in October of that year was the watershed moment: the reform of the London Stock Exchange resulted in the removal of fixed commissions, the introduction of electronic trading and the opening up to foreign banks. It also changed the nature of the domestic financial system in a way that would prove highly consequential.

By the late Eighties, London had already become the centre of the global “offshore” dollar market, acting as the neutral and lightly regulated clearing house for international capital. This sat at odds with its hamstrung banks and exchange: Japanese or American banks in London couldn’t trade equities with the same ease with which they could trade currencies. This was despite the fact that there was no formal separation of commercial banking and merchant banking as there was in the United States. Previously, British banks were prevented from acting in both capacities by tradition, the Bank of England’s “eyebrow” — and by the very rules that were amended in 1986. The liberalisation of the domestic market allowed banks to act in “single capacity” and enabled the City to accommodate and integrate the rapidly expanding presence of global finance. The decades after 1986 would see foreign owners continue to pour into UK financial assets: above all, housing.

The reforms were enacted to arrest the City’s declining competitiveness relative to Wall Street. But they were also, implicitly, a bet on a particular model of growth: one that prioritised financial services over the country’s traditional strengths in manufacturing, which was already under severe pressure from global competition and the recession of the early Eighties. The reforms’ architects, chief among them Nigel Lawson, chancellor between 1983 and 1989, expected that a larger and more dynamic financial sector would reinvigorate the British economy. Indeed, the reforms turned out to be highly consequential — just not in the way Lawson expected. “I didn’t give it a great deal of thought at that time,” he would later say about 1986 and its consequences.

Whatever was left of manufacturing at this point was walloped by the subsequent exchange rate consequences: the capital inflows into sterling assets strengthened the currency, making sterling-denominated goods exports uncompetitive. The other immediate consequence was a build of catastrophic financial risk, resulting in the aptly-named “Lawson Boom” later that same decade, and, ultimately, the 2008 crisis. More consequentially for the real economy, however, the reforms produced a set of incentives that made holding and trading financial assets consistently more profitable than investing in productive capacity. In a financialised economy, simply sitting on assets, such as property, equities or financial instruments, could generate higher returns than expanding production lines or product innovation. The result was a stagnation of the productive sector.

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In the years leading up to the 2008 crisis, the financialisation of the British economy had a direct and measurable impact on the relationship between corporate surpluses and investment. That is: when companies made a profit, much of that profit went straight into finance. The share of the private sector’s surplus that accrued to financial corporations grew from 7.7% in 1986 to 16.9% in 2007. This change in the sectoral composition of the economy reflected an enormous misdirection of resources and misallocation of capital. Since British equities were volatile during the period, property became the favoured asset class from the mid-Nineties onward. The financial sector itself facilitated this process. The composition of bank lending shifted dramatically: the mortgage share of total lending rose from around 30% to 65%. Instead of supporting productive investment, credit growth largely financed the acquisition of property assets.

How did this process unfold over time? In the early Nineties, the returns gap between financial assets and productive capital was reinforced by the poor economic conditions that followed the Lawson housing bubble and the European Exchange Rate Mechanism crisis. Household demand was crushed and unemployment climbed to over 10%. Real wage growth across the decade slowed to 1.6% annually, from 4.4% in the Eighties. With domestic demand and therefore profits weak, the incentive for productive investment was further diminished. At length, the recovery of both property prices and real wages after 1997 started to close this returns gap. Nonetheless, the profit-investment relationship did not reassert itself. The gap had been large enough for long enough to cause a structural break, permanently altering the incentive structure of the British economy. So, even when conditions improved, the structural malincentives created by financialisation remained. As a result, the economy-wide share of private net investment continued to fall.

It was not just financial asset substitution. Firms increasingly used profits for share buybacks, to pay out dividends and to hoard cash — extracting value from the productive economy rather than reinvesting in it. The extent of shareholder value extraction is remarkable: dividend payout ratios (the share of net income distributed to shareholders) rose from 30-40% in the Seventies to 60-70% by the 2000s. This was devastating for precisely the kinds of long-term spending on which future growth depends. R&D is the easiest budget item to cut when shareholders demand short-term returns, and Britain’s R&D intensity suffered accordingly. Masking the underlying weakness were “wealth effects” — rising property prices made households feel richer — and an expansion of household debt to sustain consumption. This mask of credit-fuelled growth slipped off in 2008. After the crisis, the financial sector’s size and returns on financial assets more or less flatlined. 

But the damage had been done — and the underlying problems persisted. Financialisation had shifted the composition of total surplus towards finance, a sector with inherently low capital investment needs compared to manufacturing. In relative terms, this reduced both the overall level of fixed capital formation and R&D spending, which is overwhelmingly concentrated in the manufacturing sector. The result is that Britain lags relative to peers like Germany, where manufacturing still comprises just under 20% of economic value creation. Every year of stagnant R&D spending makes this gap wider and harder to close; the cumulative damage to the country’s future potential to innovate is enormous. Britain’s financialised economy also misallocates human capital: financial workers capture 60% of top income decile gains while comprising just 5% of the workforce, drawing talented individuals away from engineering, research, medicine, education and public service.

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In this way, the economy’s resources — capital, labour and institutional attention — have been directed away from productive activity. This redirection explains the long-term structural trends in the British economy. But to account for the drastic worsening of the productivity and wage growth trends after the crisis, we have to look at policy. Burnham was correct to identify austerity and Brexit as two of the apocalyptic horsemen. But the reasons they belong on the list have to do with how they worsened the structural obstacles to investment created during the financialisation era. Whatever industrial growth might have been possible after the eclipse of finance’s dominance was wrecked on the shores of these grand and unforced policy errors.

The fiscal consolidation programme of the Cameron-Osborne era consisted almost entirely (80-85%) of spending cuts, and disproportionately hit public investment, infrastructure and R&D-enabling spending. In the first three years, capital spending was cut by nearly a third in real terms and public investment was pushed down to its lowest levels since the Sixties. By any measure, this was one of the most sustained, and in its cumulative effects severe, austerity programmes in modern history. What sets it apart is that it was voluntary: the UK had its own currency, its own central bank, ultra-low borrowing costs throughout and faced no market pressure whatsoever to consolidate at this pace. Yet it did so in a front-loaded fashion between 2010 and 2013, just when public spending was most needed and cheapest to finance.

This matters not just for demand. Public investment is not a substitute for private investment but complementary to it: spending on infrastructure, education and research all raise the expected returns to productive investment in the corporate sector. At the same time, average real wages experienced their longest sustained fall since at least the Victorian era. Why would firms expand if there is not much growth in demand from consumers? And why should they invest in labour-saving (that is, productivity enhancing) processes and technologies in the absence of sustained wage growth? The broken profit-investment nexus, already weakened by decades of financialisation, was now further undermined by deliberate policy choices.

The pressure on both real wages and investment started to ease in 2013 and 2014: austerity tapered off while a lower oil price and a stronger pound lifted some of the cost pressures. Brexit snuffed out this nascent recovery halfway through 2016. Since then, the net investment share of GDP reversed course and has not found its way back. It remains well below its 2007/08 levels. By some estimates, Brexit accounts for something like a third of the total growth shortfall that has accumulated since 2016, with the investment channel accounting for the largest single component. Real wages recovered only during the pandemic, when labour shortages and a churn in hiring restored the long-term trend.

The answer to “who broke Britain” must therefore include the governments between 2010 and 2016. Austerity seems to have been informed by the notion that the drag on competitiveness and productivity was the size of the welfare state, whereas Brexit assumed the panacea was remaking Britain’s trade and regulatory relationship with Europe. What these policies reflected was a failure to diagnose what was actually ailing the British economy and a thoughtless, almost frantic administration of the wrong treatments. This is strangely reminiscent of actions of Britain’s elite in the Eighties: overreacting to their own post-imperial decline by defenestrating industrial production, betting the house on finance — and losing. 

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The extent of the mess is such that Britain will likely not be restored to the ranks of the world’s great industrial countries. That privilege belongs now to the late industrialisers in East Asia, all of which kept finance in check. But a plan to fix Britain does not require reindustrialisation to that extent. Manufacturing’s share of economic output has declined across all advanced economies, who also underwent varying degrees of financialisation. What distinguishes them from the UK is the extent to which this process has taken hold and to which it has created a reliance on financial services. Apart from gradually cutting this sector to size, it is not clear how this process can be reversed without a large public concerted investment programme: in infrastructure, in education, in the energy transition — all designed to raise aggregate demand and the expected returns to private capital formation.

But given the British economy’s unusual tendency to generate inflation, as well as the sensitivity of sterling and government borrowing costs to fiscal signals, any sizable public investment programme would require a more accommodative central bank, one willing to support larger fiscal commitments rather than reflexively tightening against them. The Bank of England, however, seems more concerned with the interests of the financial sector, which favours stable prices and fiscal prudence. The policies of successive British governments too have reflected these priorities: the financial sector’s weight in the British economy is not just an economic but a political fact. It shapes the incentives of policymakers, the structure of the tax base, and the terms on which Britain engages with the rest of the world.

It won’t be easy to eradicate the pro-finance bias. But starting with the right diagnosis is crucial. The intensity of Britain’s economic malady relative to that of its peer countries is not about trade relationships or welfare spending or European regulations. It is a particularly unfortunate child of the neoliberal turn, whose main macroeconomic legacy has been the rise of finance and the steady erosion of productive investment despite burgeoning profits. It would be politically expedient to point out that countries who have been able to insulate themselves from the worst effects of this era, chief among them China, are in a position to determine their external affairs autonomously. In the “post-neoliberal” era, then, the first step to “fixing” Britain should involve accepting that the City of London’s status as a global financial centre, far from being the crown jewel of the British economy, has come at an enormous cost to the country’s productive capacity and, ultimately, to its sovereignty.