Should the UK Regulate its Banking Industry?

Skyline of Canary Wharf, London
Skyline of Canary Wharf, London

Since 2008, the greatest debate between Parliament and the City in the UK has focused around regulation. That is, in light of the devastating effects of global financial meltdown, should the state play a greater role in mediating and monitoring the activities of the economy’s biggest banks? There are obvious benefits and downsides to doing so. The whole debate has been a little cagey, due to the prolonged effects of the crash and the recession that has followed. It has, after all, been 6 years of sluggish recovery, including a double-dip recession, unseen in the UK since the 1950s. But now that statistics show that the UK economy is growing at a reasonable rate – the fastest in the G8 according to particular figures – an ideological question must be answered. After all, this is what the entire debate is all about – should the state intervene in the economy? This article attempts to answer the title question using politics as well as economics, in order to shed some light on the issues surrounding state economic intervention.

The Neoclassical Approach

The orthodox economists will argue that state intervention in the economy beyond a certain point is not conducive to economic growth. Therefore, in order to get the best out of the City of London, Parliament should, in general, leave the banks to their own devices and, should it be required to do so, manage the effects of an independent financial sector (which is pretty much what went on in the aftermath of the 2008 crisis). This theoretical viewpoint stems from the works of neoclassical patron-saint Adam Smith, with additional thoughts from William Jevons, who wrote on the macroeconomy as an amalgamation of microeconomic activity.

By this assertion, a government must do all it can to leave private, microeconomic activity to develop itself, and must reduce its own role to simply support and provide legal rights (including concepts such as the recognition of private property). This includes promoting free trade and setting the building blocks of capitalism in place. By doing so, the private sector will foster itself and build a strong and resilient economy, which the state can then draw from, in the form of light taxation, to provide ‘essential’ services such as policing, healthcare, and education. Any further intervention by the state, which to the neoclassical school is an entity focused towards consumption and not growth, would hamper the ability of the private sector to flourish. Therefore, Parliament should relinquish its hold on the UK banking industry – the government currently owns significant stakes in both the Royal Bank of Scotland (RBS) and Lloyds Banking Groups, both of which were bailed out during the aftermath of the 2008 crisis.

The Heterodox Critique

Other economists point to the government bailouts of RBS and Lloyds as exact examples of why the government should intervene further in the financial sector, and the wider economy more generally. Their critique is thus: why, if neoclassical microeconomics works so well, did the 2008 financial crisis happen at all? The state, they argue, should not be a safety net for the failure of orthodox economics, but an active part of the process of economic growth. Neoclassical economists refer to the dynamic of the state in such a process as ‘state-capitalism’, supposedly dumbfounded that the state can act in any other than a purely consumptive capacity.

Heterodox economists, such as John Weeks, critique neoclassical scholars on the basis that the latter ignore the structures and biases that influence the success (and failure) of the macroeconomy as an amalgamation of the microeconomy. It is impossible, Weeks argues, to isolate an economy from its context – e.g. the influence of external economies, the reliance of an economy on the global system etc. The state thus plays an important role in negating the impact of these external forces, and indeed the inequality that is perpetuated within an economy itself through the dynamic of capitalism. Thus, in relation to the UK financial services industry, heterodox economists argue that the government should be as involved as possible, in order to protect the wider economy from the effects of microeconomic mismanagement. They arrive at this premise from the opposite direction to neoclassical economists, believing that macroeconomic policy can and should influence microeconomic activity.

The Heterodox Development Model

East Asian examples are often quoted in favour of a heterodox approach to state economic policy. In the 1950s and 60s, the Japanese economy took off – with a kick start from the Americans and the Korean War – by controlled management from central government, who poured capital into manufacturing, to increase exports. Similar dynamics were apparent in South Korea and Taiwan in the 1970s and 80s, with service-orientated growth in Singapore and Hong Kong during the same period. In all of these economies, the state fostered a dynamic private sector, which in turn worked to bolster the government, producing fast growth on a reasonably stable trajectory.

There are of course warnings to be heeded when applying the same principle to the UK and its financial services industry. The nature of banking, and its international focus, means that overregulation and interference from the government could lead to an exodus of business, as already happens in sectors such as wealth management and insurance, where companies look to base their operations outside of the UK. There is also then the case that the heterodox model is not universally exportable, due, as in the heterodox critique in the first place, its reliance on the external global economy for an export market.


Politicians must therefore be careful. The general consensus since 2008 is that the government must be more involved in the financial services industry. The City has witness the transformation of its regulator, the Financial Conduct Authority, in a state attempt to broaden the impact of financial policing given the continued emergence of cases of insider trading and interest rate manipulation amongst the City’s biggest banks. All in all, however, the 2008 crisis proved that the neoclassical utopia of seamless microeconomic activity producing a healthy macroeconomy in fact requires a steadfast state to save the very basic features of its structure. This would suggest that the state in fact has a more than ready role to play in the activity of the private sector; in the UK, the financial service industry specifically.


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