Bringing back the Wonderful Life: using local banks to boost job creation, productivity & competitiveness

  • Election 24

Professor Richard A. Werner, University of Winchester 

In this piece, Professor Richard A. Werner, University of Winchester, discusses how local banks can boost job creation, productivity & competitiveness.

Election issues addressed

  • Boost job creation, especially outside the largest cities
  • Expand access to finance, especially for small firms and local entrepreneurs
  • Fight inequality, including regional disparities, the North-South divide; income and wealth inequality; perceived unfair availability of opportunities
  • Boost UK productivity by overcoming the central hurdle, learning from Germany’s secret

Background

Professors of economics at Stanford University have admitted in a study published in a leading economics journal that modern macroeconomics has singularly failed: The four main questions in macroeconomics today are still the very same as about a century ago, namely what determines the ups and downs of economic growth in the short-term; how does monetary policy work; how does fiscal policy work; and what determines growth and development in the long-term, including why some countries develop faster than others. In fact, the core tenets of mainstream economics are theories that are simply not true, such as the claim that markets are in equilibrium or that lower interest rates result in higher growth and higher rates result in lower growth.

Likewise, mainstream development economics has failed, if the goal was to help countries develop. The deregulation and liberalisation policies advanced for more than 70 years by the IMF, the World Bank, governments and the various development organisations have not been able to ensure that a single country moved from developing country status to become a developed economy. The only five countries or regions that have succeeded in doing this in the past century – Japan, Korea, Taiwan, Singapore and China – have done so based on policies forbidden by this Washington Consensus development economics, as a World Bank study reluctantly admitted.

The core issue

What could be the reason why development economics and macroeconomics have singularly failed? Remember that UK governments, of whichever party orientation, have also generally followed this mainstream economics advice. So, there is a good chance that the same flaw in mainstream economics is responsible for the UK’s main economic problems.

Adopting the scientific research methodology, we find that ignorance of the role of banks has been a fundamental flaw in mainstream economics for the past century. Economists have wrongly thought that banks are merely financial intermediaries that only reallocate existing money. In actual fact, it has recently been empirically proven that the money supply is created by banks since each bank creates new money when it gives out a loan.

That’s why it is so important what type of banks and what banking system we have. In a country with very few but very large banks, like the UK, only mortgages and big business deals will get funded by the banks. Small firms don’t receive loans, because big banks want to do big deals. It is only small banks that will lend to small firms.

Since big deals are mostly about property lending, M&A lending or loans to private equity funds and hedge funds, most of the money created by UK banks is used to purchase assets. This drives asset price inflation, which is unsustainable and causes the recurring banking crises.

But in Japan, Korea, Taiwan, China, Germany, Switzerland, Austria and the USA there are many banks. That is why small firms obtain funding and a larger proportion of bank credit creation supports business investment in the real economy – which results in sustainable and high economic growth.

Consider China, which under Chairman Mao was organised like a Soviet centrally planned economy, and thus only had one bank – the central bank. When Deng Xiaoping came to power in 1978, he immediately visited Japan, in search of the secret of its high growth. He returned to China and knew what to do: He founded thousands of banks, small banks, local banks, savings banks, regional banks, village banks, provincial banks. He realised that a central bank creating and allocating all the money supply can never be as efficient as an army of millions of loan officers working at 5,000 money creating banks that lend to small firms via their 50 branches each, with several dozen loan officers each receiving hundreds of millions of loan applications from small firms. Six million loan officers checking business plans and kicking tyres would be better, Deng concluded, than six central planners playing God. When banks lend for productive investment, it results in growth, not inflation or asset bubbles and crises. And he was right: China delivered four decades of double-digit growth, lifting more people out of poverty than anywhere before in history.

The UK used to have many hundreds of banks, county and country banks, with many regional and local branch networks. There also used to be higher economic growth, thriving industry, many diverse job opportunities across the country, and wealth and income generation were not concentrated in the City of London. Germany has close to two thousand banks, the UK only has less than two hundred domestic banks. Not only have the UK banks been closing hundreds of branches, they have long disenfranchised the local bank managers, losing rich local knowledge as the appetite to lend to local small firms disappeared. The engaged and helpful local banker in the perennial movie “It’s a Wonderful Life” with James Stewart is as much a fiction in Britain today as its pre-Christmas fairy tale.

The more banks there are in an economy, and the closer bank branches are to companies, the better economic performance and job creation. German productivity has been higher than in the UK mainly because there are many small local banks in Germany able to quickly fund the upgrading to new technologies. This has created the largest number of Hidden Champions, small firms that are global market leaders – and helped millions in the middle class to prosper. Let’s solve many of the UK’s deep economic and social problems in one stroke by bringing back local banking. Even inflation will be lower if we have more local banks.

Policy ideas and recommendations

  • Establish thirty new local commercial banks across the country lending only to local small firms, with 50% of bank ownership with a local charity to prevent future takeovers.
  • Adopt a simplified regulatory regime for banks below £1.5bn balance sheet size (similar to the US, but even simpler; unlike so far in the UK and EU, where small banks have to meet the same stringent and expensive requirements as the Megabanks).
  • Simplify the regime for bank authorisation by switching to a process of registration, whereby a bank will automatically receive a license, as long as it meets a short list of key criteria that can be easily assessed objectively and that are manageable and realistic for small banks to meet. There was a time when one could get a banking license by registering a bank at the Post Office!

About the author

Professor Richard A. Werner is a university professor in banking and finance. Until 2018 he was Professor of International Banking at the University of Southampton (having joined in April 2004). From 1997 to 2004 he was assistant professor in economics and finance at Sophia University, Tokyo and he has also taught development finance and sustainability at Moscow State University, as well as a range of economics, banking and finance courses at a number of other universities. In 1995, he advanced the concept of ‘quantitative easing’ and The World Economic Forum, Davos, selected him as “Global Leader for Tomorrow” in 2003.

Image credit: Tech Daily, Unsplash