Hamish McRae: Full recovery will not depend on the politicians, but on banks' customers

Economic view

It is an obvious paradox. Governments around the world want to get back for taxpayers the money they have spent on supporting the banks. But the more money they try to take back, the more they are likely to curb the ability of the banks to extend credit and hence support growth.

Things are not presented that way, of course. In Britain the supertax on bonuses was presented as a choice for banks: they could avoid the tax if they cut bonuses and instead used the funds to build up capital. But in practice, banks are prisoners of the market for talent and while they may be able to trim bonus payments – and more importantly, restructure how they are paid – the net effect of the UK tax measures will be to reduce capital, not increase it.

In the US, President Barack Obama has promised to make the banks pay back all the money that taxpayers have spent supporting the industry and has brought in this new tax on the liabilities of the 50 largest US banks. As in the UK, such additional taxation will doubtless be popular but the practical effect may largely be to restrict, at the margin, the amount banks have available to lend. A tax on a bank liability is a tax on a bank deposit. If deposits cost more then loans cost more. So either you charge more for the loan or you make smaller loans. The effect is marginal because the amount projected to be raised is less than $10bn, or around 5 per cent of the profits of the US banking industry.

We don't yet have a full sight of what other countries will do to bank taxation but it is quite clear that the industry will be more closely scrutinised and regulated. As a result, it will grow more slowly than would otherwise be the case. Or rather, banks in the developed world will grow more slowly; we should remember that the largest banks in the world are now in China. Whether people think it is good or bad for western banks to have to pay in this way for their past excesses is beside the point. It is going to happen. And that leads to a huge question: if banks are more closely constrained in what they can do, how will economic growth be financed?

Before going further, let's make one caveat. Part of the reason for the slow growth of credit at the moment, certainly in the UK but also in other developed economies, is not so much a lack of supply but a lack of demand. You can see that in the two graphs here. The first shows that has happened to private-sector investment. It has plunged, running down nearly 30 per cent year-on-year. As a proportion of GDP, investment is now close to 12 per cent, lower than at any time since the 1950s. Consumption has come down too, but by a minimal amount. The other shows what has happened to personal savings. They have soared – in the space of a year they have shot back to the level of 1997.

That is fact. What about motivation? For consumers it is easy. They are saving more because they choose to. They are certainly not doing so because they are being bribed by high interest rates on their bank deposits, so you might infer that they are saving despite adverse incentives to do so. What is happening, to a large extent, is that people are using any monthly surplus during this period of low mortgage payments either to pay back mortgages faster or to clear credit card debts.

But for companies, it is harder to know the motive. Some may be in the hands of their bankers and forced to chop back everything, but there must be many others that simply cannot see the case for investment to increase capacity when they have plant lying idle. In service industries, much of the investment is in IT. So do you buy new computers or install new software when the present kit works OK? Maybe better to wait a few months.

Goldman Sachs has commented on the ability of the banking system to finance growth in a recent paper. Shortage of credit won't stop any recovery, but it will restrict it. In total, there may be enough cash around but the individuals and companies that have the spare cash may not be the same ones that want to spend it.

In the medium term, a strong case can be made for medium and large companies to go to the markets for money, rather than relying too heavily on the banks. The Treasury, just last week, produced a discussion paper calling for a more diverse funding model. The problem is partly a size thing. Lord Myners, introducing the report, said: "Here in the UK, our large corporations have had a great deal of success in accessing finance directly from credit markets with a surge in corporate bond issuance. Smaller firms, however, have not been able to similarly replace bank lending by directly tapping financial markets or non-bank financing."

In some ways, this is less of a problem for the UK than it is for other countries. By tradition, British companies have relied less on bank loans and more on securities market finance for funding than their counterparts on the Continent and in Japan. It used to be fashionable to praise the German and Japanese system in particular for their close links between companies and banks, and to attack the British market-based system. It was claimed that the German and Japanese system enabled companies to take a longer-term view of their investments. That argument looks silly now, for we know what has happened in Japan over the past two decades, with banks unable to write off their loans to companies because it would have made them insolvent. Meanwhile in Germany, the authorities are seeking ways to improve access for medium-sized companies to market finance to try to make them less reliant on banks.

In the medium term, that is the direction the world will go, shifting power from banks to securities markets. But until then banking is key to the recovery. Focussing on the UK, Goldman Sachs argues that there are strong incentives for lending to resume. There is a big gap between deposit rates and lending rates, making loans very profitable. Default rates have probably peaked and the collateral values against which loans are made are rising. The issue is how quickly lenders and potential borrowers will respond.

My feeling is that will depend on the speed at which trust is rebuilt between banks and customers. Banks are being attacked by politicians, and some parts of the press. But what matters more is whether customers can recover. Think back a couple of years. How many firms or individuals then had loans thrown at them, only to discover that on re-negotiation this year, the tone of the banks was utterly different? There is nothing new here. The US poet Robert Frost remarked: "A bank is a place where they lend you an umbrella in fair weather and ask for it back when it begins to rain."

But if it is an old problem, for the next few years it will restrict our willingness to borrow and that, more than politicians, will hobble the recovery.

We can still beat China with hi-tech skills and craft production

Why is Bosch shutting its alternator plant in South Wales and moving production to Hungary? I suppose we know the answer, which is that wage costs there are 65 per cent the level of Wales and an alternator is a commodity item.

But why is Saab worth nothing? You could buy the plant, the brand, the design expertise, everything for a dollar and there are no takers. It is a question we had to confront when Rover collapsed but it somehow seems more stark. We could understand, given British Leyland's tortured history, that Rover was a dog. But Saab?

Behind these two stories is a far bigger one. We know China has become the world's largest car market but how many of us could name a Chinese car company? Chery, Haima, Great Wall Motors? This is an industry, central to our perception of what the developed world is supposed to be good at, where the balance of power has shifted. Does our experience, our body of skills count for nothing?

I find this deeply troubling. There must surely be some way to justify the premium we charge for our labour – and that goes for East as well as West Europe and North America. I can understand that it is tough to make alternators at a competitive price in South Wales, but if Sweden cannot make competitive cars, how secure is the – actually very efficient – car-assembly business we still have in Britain?

My instinct is that there are two branches of manufacturing that will thrive here, despite China. One will be top-end: high technology products where a close relationship between manufacturer and customer is helpful: specialised medical equipment, aircraft engines, pharmaceuticals and so on. I am encouraged by the signs that some production is being brought back to the UK from east Asia, largely because we are more flexible.

The other is manufacturing with a large element of craft or style: luxury products where human skill is the key to quality and people are happy to pay. So Bentley and Rolls-Royce will be all right – unlike Saab.