Friday, March 9, 2012

Look after demand, and funding for businesses looks after itself.

The British establishment continues to hyperventilate about the alleged shortage of bank lending to businesses. E.g. see here, here, here,or here.

Well here is some news for the establishment: the banking industry is heavily subsidised. Thus it needs to contract. So if we want to allocate resources optimally, we need to get used to a smaller bank industry. And that bit of news will have the establishment soiling their pants, given that they are so keen on banks funding small and medium sized businesses.

According to Andrew Haldane of the Bank of England, the too big to fail subsidy is significantly larger than bank profits. See 3rd paragraph under the heading “Implicit subsidies” here:

According to Mervyn King, the bank industry has expanded by a whapping factor of ten relative to GDP over the last fifty years. That is, total bank balance sheets have expanded from 50% of GDP fifty years ago to five times GDP nowadays.

But mysteriously, economic growth fifty years ago was perfectly respectable.

So contrary to the above claims by the establishment, optimum allocation of resources (i.e. maximising economic growth) will come from treating banks like any other business, and boosting demand by enough to bring us back to full employment.

Anyone with a grasp of economics knows what changes will ensue, but I’ll run through them for the benefit of those who are not sure. Also anyone with a grasp of the subject knows how to bring bank subsidies to an end, but I’ll explain how to do it below as well for those who don’t know. In short, those with a grasp of economics can stop reading now – except for a quick point about the title of this post: “Look after demand, and funding for businesses looks after itself”.

That phrase is of course a variation on Keynes’s dictum: “Look after unemployment, and the budget will look after itself”. And the latter two phrases also amount to much the same as Mosler’s law: “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.” (See near top of Warren Mosler’s site.)

The changes brought by a smaller bank industry.

Stopping bank subsidies will raise the cost of borrowing. That in turn means businesses will have to put more reliance on other forms of funding: equity, friends and family, retained profits. But the total capital available to businesses will nevertheless decline. That means business will have to go for less capital intensive forms of production. Plus some relatively capital intensive forms of economic activity will become uneconomic, while labour intensive activities will tend to expand.

The change WILL CAUSE a temporary rise in unemployment because a new set of skills will be required, and it takes time to learn new skills. But enduring a period during which unemployment is higher than it otherwise would have been is entirely justified if it leads to a better allocation of resources.

Ending or reducing bank subsidies.

Those who deposit money in banks can currently “have their cake and eat it”. That is, they reap the benefits of having their money used by their bank in a commercial manner, while being insulated (thanks to the taxpayer) from the risks normally associated with commercial activity. This is a farce, and it should be stopped. For more details, see here.

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