Spex 53

Issue 53 27 October 2014
SMU Political-Economic Exchange

AN SMU ECONOMICS INTELLIGENCE CLUB PUBLICATION

This Issue in Brief:
English Productivity: A Cause for Concern?

Although the improvements in Great Britains employment market
since the end of the 2008-2009 financial crisis have been significant,
Dinh Thai An posits that productivity levels in the current English
employment market are a cause for concern, especially in the long
run.

Shadow Banking: An Indian Perspective

In collaboration with

Siddhant Hiremath gives a brief overview of how the shadow
banking system operates in India; how does this phenomenon exist
in the Indian banking system and what are its implications for Indias
financial services sector?

The Scottish Referendum

The Scottish referendum for independence may have taken place
more than a month ago, but some uncertainties still linger on. Advait
Halve analyses the outcome of the poll, and discusses in brief what is
in store for post-referendum Scotland, bearing in mind the promises
that Westminister has made to the Scottish people.

Proudly supported by

English Productivity: A Cause for Concern?

By Dinh Thai An

Since the onset of the financial crisis, unemployment has become a common problem for many developed
countries. In the US, the jobless rate rose to an all-time high of 10% in 2010. The circumstances in many
southern European countries were even more miserable. In sharp contrast, the highest unemployment
rate in Britain since the crisis was only 8.5% in 2012, and this decreased further to 6.5% in April 2014.

Unlike the US, where many discouraged workers have left the workforce, the number of people at work in
the UK actually increased, making the improvement in Great Britains employment market admirable.

However, this achievement cannot be a cause for satisfaction. The optimistic employment figure came on
the back of weak productivity figures. As can be seen from the chart below, productivity in Britain
continued to fall since 2008, and was much lower than that of pre-crisis levels. Moreover, an average
worker in the UK was 16% less productive than that of those in other G7 countries. Compared with France,
US and Germany, the gap became more pronounced, reaching nearly 30%.

2

Thanks to the ruthless pursuit of growth by George Osborne and David Camerons forensic, relentless
focus on growth, the UKs economy has grown impressively at an annualized rate at 1.2%. Furthermore,
due to the Help-to-Buy program which made housing prices more affordable and provided easy access
to credit for most people, consumer spending, which accounted for nearly 70% of GDP, has hence risen
sharply since 2010. In theory, a surge in demand will lead to an increase in investments, as businesses must
expand their operations to serve more customers.

However, this has not happened. Although many consumers can borrow money and enjoy their shopping
sprees, businesses are still facing difficulties in acquiring credit. The amount of lending to businesses is still
modest when viewed in the context of the huge scale of the British financial industry. The Bank of England
reported that lending to businesses accounted for nearly 450 million in October 2013, only one-thirds of
the aggregate sum of personal loans and mortgages.
3

It is alarming that lending to businesses has started to contract, and this trend may continue for quite a
long time to come. As a result, this has wrecked business investment levels, which have declined 30%
since the financial crisis. The firms of today now spend less on machines, equipment and capital
investments than they did in 1998.

A lack of access to credit has helped to explain why firms do not want to invest in new equipment.
Moreover, compounding the problem further were the fragile recoveries in both the US and the EU,
which are Britains main export markets. This in turn makes firms more reluctant than before to make
any investment decisions, as new factories and equipment could take a long period of time to deliver
desired results. As a result, in a report by The Economist, Britain ranked 159 out of 170 countries in
terms of fixed investments as a percentage of GDP.

Higher Levels of Employment

While firms are reluctant to invest in new equipment, they are however willing to hire more workers, as
spurred on by lower levels of real wages. In the absence of new technology and investments, an
increase in employment levels could decrease productivity further, as more labour inputs are used to
produce nearly the same amount of outputs.
The inflation rate in Britain is a bit higher than those of other developed countries. While many

developed countries are haunted by deflation or low inflation, the CPI of Britain has increased over
1% annually. Contributing to high inflation is the fact that many Britons can now borrow money to
finance their spending easily. Assuming ceteris paribus, a large amount of demand-pull inflation could
be translated into lower wages.

4

In fact, according to the Office for
National Statistics (ONS), since
2010, the rise in wages often lagged
behind that of inflation. It was only
until February 2014 where payrolls
were able to match inflation rates.
Another report by the ONS also
pointed out that real incomes have
been falling for at least 50 years,
reducing labour costs markedly and
encouraging firms to hire more.

In addition, low wages could also lead to companies hoarding labour. With consumer spending still on
the rise, there is an impression amongst businesses that the economy will pick up soon, thereby
motivating them to retain workers instead of laying them off, so as to be in the best position possible
to ride the early waves of any potential recovery. Besides, with falling real wages, the opportunity costs
of firing staff is high, as firms would have to spend more on rehiring and retraining expenditures.
Consequences
While the current model, with low productivity levels and high employment numbers, has helped
Britain achieve growth and solved the jobless issue, it would not be sustainable in the long term.
After all, sustainable growth can only be achieved by advancements in productivity. Increased
productivity means that the economy can produce more products and services with a limited amount
of inputs, enabling it to create more wealth. Moreover, living standards can only be improved through
means of effective usage and distribution of all resources.

However, with a lack of investments, Britains productivity has fallen miserably, having negative
implications on the economy. According to the Bank of England, underinvestment in projects by businesses
has increased spare capacity levels.
5

Statistics show that capacity utilization in Britain has fallen from 75% in 2010 to 68% in 2014.
Furthermore, with regards to a report by the ONS, the output gap in Britain is about 14%. If this trend
were to continue, it is unlikely that Britains GDP would be able to overtake its pre-crisis levels.

Stagnant productivity can have harmful effects on wages. With low productivity, which translates into
lesser products and services being produced, it is very difficult for firms to improve their profits. As a result,
employers tend to squeeze the salaries paid to their workers. One way to do so is to use the zero contract,
a kind of labour agreement that offers a great deal of flexibility to employers, and little-to-no benefits and
security for employees. Besides, there is no obligation for the employers to provide work for their
employees, meaning that these contracts could be terminated at any time. Generally, workers under these
contracts are paid peanuts and work under poor conditions.

Normally, zero contract jobs are for teenagers and the elderly who would like to earn extra income.
However, according to the ONS, last year, the number of people working under zero contract schemes
has increased by nearly 3 times. Most notably is the number of youngsters and graduates who were trapped
in these kinds of contracts for a long period of time. Given such a scenario, it is unlikely that incomes will
increase, at least in the short term.

With that, as a result of falling wages, consumer spending will suffer. Moreover, if the housing bubble
becomes bigger, (and it is a very big if), monetary policy must be tightened, making it harder for people to

6

borrow and spend. Without real income increasing accordingly, the economy could possibly start to
contract.

Besides, low productivity can increase inflation as the same amount of money is used to purchase a
smaller amount of goods. If this had happened, the Bank of England would have been forced to increase
interest rates, depriving firms who are in need of money the necessary financial recourse that they would
need to invest. As a result, a vicious cycle will ensue, where low productivity rates lead to high inflation,
which subsequently lowers productivity.

Conclusion

Although the current model has helped Britain to experience growth and bring more jobs to its citizens, this
is not sustainable in the long run. The best solution would be to extend credits to businesses which are in
need of money and have sound investment plans. This is the only way to solve the productivity problems
facing the UK, and to increase the likelihood of creating more wealth for the nation.

7

References

Larry Eliot. UK productivity gap with developed nations now widest for 20 years

http://www.theguardian.com/business/2014/feb/20/britainSproductivitySgapSwidens

Staff and agencies: Real wages have been falling for longest period for at least 50 years, ONS says

http://www.theguardian.com/business/2014/jan/31/realSwagesSfallingSlongestSperiodSonsSrecord

BBC: ONS: After six years, wage rises match inflation

http://www.bbc.com/news/businessS27047966

BBC: Drop in real wages longest for 50 years, says ONS


BBC: What are zeroShours contracts?


TOM MCTAGUE, MAIL ONLINE DEPUTY POLITICAL EDITOR: Britain's zeroShours army: How 1.4 million jobs now come with
no promise of work
http://www.dailymail.co.uk/news/articleS2616682/ZeroShoursSarmyS1S4SmillionStrappedScontractsSnoSpromiseSwork.html

8

Shadow Banking: An Indian Perspective
by Siddhant Hiremath

What is Shadow Banking?

In a sentence, shadow banking or the shadow banking system refers to the non-banking financial
institutions which do not possess a banking license but still offer services similar to traditional commercial
banks. Examples of these are hedge funds, money market funds and structured investment vehicles.
Former Chairman of the Federal Reserve, Ben Bernanke defines shadow banking as comprising a diverse
set of institutions and markets that, collectively, carry out traditional banking functions, but do so outside,
or in ways only loosely linked to, the traditional system of regulated depository institutions. However,
many banking institutions also engage in shadow banking activities, either through off-balance sheet
activities or through sponsorship of shadow banking entities.

Shadow banking institutions are typically involved in credit and liquidity creation within the financial
sector. Instead of taking deposits, they rely on short term funding provided by asset backed commercial
paper or the repo market, and use these funds to buy assets with longer term maturities. But because
shadow institutions are not subject to traditional bank regulations, they are unable to depend on a lender
of the last resort such as a central bank, or other regulatory agencies.

It is for this reason that shadow banking was one of the primary factors leading up to the subprime
mortgage crisis in 2007, and the subsequent recession. When the accuracy of credit rating agencies was
called into question, investors lost confidence and decided to withdraw their funds, many of which were
invested in shadow institutions. In order to repay investors, shadow banks had to resort to selling their
assets at a loss, thus reducing the value of those assets and forcing other shadow banks to reduce their
book value of the assets to reflect the lower market price, creating further uncertainty.
Shadow Banking in India

Compared to the rest of the world, the shadow banking system in India is of a relatively smaller size.
Entities generally known as shadow banks elsewhere, in India are called non-banking finance companies
(NBFCs). The primary reason for this is that conservative banking practices in India have ensured that
NBFCs are under constant regulatory surveillance by the Reserve Bank of India.
9

NBFCs in India are financial intermediaries that play a supplementary role to banks, especially in the
matter of credit creation in rural areas. India has around 12,000 NBFCs that extend credit to companies
that invest in securities and are subject to RBI regulation.

Systemically important NBFCs in India possess assets exceeding USD 107.3 billion, or 10% of total bank
assets with financing companies. Today, NBFC is the fastest growing segment in the Indian financial
sector, with an annual growth rate higher than the banking sector. More significant, however, is the vast
informal shadow financing sector that exists alongside the banks and finance companies and serves
entrepreneurs, SMEs, small investors and the huge population of urban and rural poor with limited or no
access to banking services.

This informal shadow financing sector consists of a range of networks, some legal and some illegal, from
commodity trade financiers, gold saving and loan companies to chit funds, pawn brokers and money
lenders. Nearly 40% of rural lending comes from the informal sector. The best example of a link from the
formal sector to the informal sector are microfinance institutions (MFIs). MFIs are a particular type of
NBFC that lend to the poorer section of the population, but unlike microcredit organizations, MFIs are
interested in making a profit. In lieu of this, they often charge exorbitantly high rates of interest and levy
penalties, and individuals are left with no option but to borrow from the informal financial market to
repay these debts.

Risks of Shadow Banking

Despite NBFCs coming under the RBIs regulation, the Indian banking system continues to be vulnerable to
shadow banking practices. The business model used by NBFCs includes enhanced risk, weaker
underwriting standards and increased levels of complexity in their activities, thus inherently being a riskier
model. Some of these riskier features undertaken by NBFCs include credit creation, loan securitization and
loan provisions dependent on short-term funding.

Some of the major risks that Indian NBFCs are exposed to include:

Risks arising from arbitrage, regulatory gaps and contagion effect

10

Systemic risks resulting from a concentration of exposure to sensitive sectors

Interconnected risk, as NBFCs are highly dependent on bank loans and other bank funding

Liquidity risks arising from asset-liability mismatches, which can easily translate into solvency risks

During the 2008 global crisis, interlinkages for funding between mutual funds, NBFCs and commercial
banks caused a liquidity crunch. When institutional investors began pulling out their investments, the
liquidity issues were exacerbated. Moreover, banks became risk-averse and lending activities were
restricted.

Thus, despite the RBIs regulation of NBFCs, the effects of the 2008 crisis on the Indian market proved that
the financial system requires further strengthening. Regulatory frameworks, both in India as well as abroad,
must be flexible enough to allow for reviews and changes as and when required by the sector.

11

References

http://www.businessSstandard.com/article/opinion/whatSisSshadowSbankingS114083000778_1.html

http://www.equitymaster.com/detail.asp?date=07/12/2013&story=3&title=DoesSshadowSbankingSexistSinS
IndiaSSII

http://www.euromoney.com/Article/3252657/IndiaSslowdownSsparksSdebateSoverSthreatSfromSshadowS
financing.html?single=true

http://www.forbes.com/sites/robertlenzner/2014/06/30/theSunregulatedSshadowSbankingSsystemS
triggeredStheS2008SfinancialScrisis/

http://www.imf.org/external/pubs/ft/fandd/2013/06/basics.htm

http://www.federalreserve.gov/newsevents/speech/bernanke20120413a.htm

http://www.stlouisfed.org/publications/re/articles/?id=2165

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1323190

http://www.reuters.com/article/2012/02/07/usSshadowSbankingSidUSTRE81611820120207

12

The Scottish Referendum
by Advait Halve

Simply put, a referendum asks a person to vote yes or no to a proposal. On September 18, 2014 the people
of Scotland were asked whether they wanted to be an independent country. The answer? 55.3% of voters
said no.
Why?

Scotland has been an integral part of the United
Kingdom for over 300 years. It has often been
observed that large structural changes lead to major
economic changes. Take Greece, for example. Home
to a suffering economy, there was speculation that
Greece may exit the Eurozone and revert back to its
old currency. This, for obvious reasons, never
happened. Investor confidence in the Eurozone,
especially Greece, was at an all- time low. An
independent currency would be volatile and dissuade
investors, resulting in a massive decline in world trade.
Common knowledge, isnt it? Go back half a decade or so, and Alex Salmond, the leader of the Scottish

National Party (SNP), derided the British pound. Today, he is desperate to keep it.

Another major cause for concern is the Scottish banking system. Two of the countrys largest banks Royal
Bank of Scotland (RBS) and Lloyds had to be bailed out after nearly collapsing in the early-to-mid 2000s.
Salmond, in late 2013, announced that under future independence arrangements, the Bank of England
(BoE) would act as a lender of the last resort for any and all Scottish banks, safeguarding them from any
future crises or economic disasters. If such a deal was struck, what sense does it make for the BoE to
continue to fund Scottish bailouts if Scotland was to become independent? None at all!
And then we move to credibility. Consider the bond between Scotland and England to be a marriage of
sorts, where one partners reputation rubs off on the other. The United Kingdom was, and continues to
remain one of the worlds largest economies (the second largest in Europe).

13

The UK also benefits as it is a permanent member of the United Nations Security Council, plays a major role
at G20 conferences, holds a position of leadership in NATO and so on. Scotland gains from all of this, and
would lose out tremendously were they to separate from the UK. (It is interesting to note that both Gordon
Brown and David Cameron, former and current British Prime Ministers respectively, have Scottish roots!)

Furthermore, while the UK is a part of the European Union, it is no guarantee that an independent Scotland
would be as well. This would result in a massive loss in employment opportunities, as Scottish citizens
would no longer be able to live and work in other parts of Europe, especially the UK.

Whats Next?

There is no chance of the Scottish independence movement fading away soon. Despite failing at the vote,
45% of voters approximately 1.6 million people, wanted an independent nation, and those numbers do
not just go away. The outcome of the vote was a boon in the sense that it helped avoid all the chaos that
would have possibly occurred had the result been a yes. It is, however, evident that the vote was a positive
outcome for both the Scottish as well as the British economy.

The referendum, however, does signal a growing problem as far as regional co-operation is concerned, but
there is no immediate sense of emergency. The result of the vote caused sparks to fly in the business
community, all breathing a sigh of relief. The pound skyrocketed, and trade on the London Stock Exchange
surged.

Clashes between the SNP, David Cameron and the rest of Westminster will continue to exist and
develop. Camerons speech on the 19
th
of September included talks about offering Scottish members of
parliament greater fiscal powers in the region, but tensions still very much exist. Furthermore, Alex
Salmonds resignation is likely to hurt the SNP in the future.

As mentioned before, the outcome of the vote does not change the fact that a large number of Scottish
citizens favoured, and still favour independence. As such, the independence movement is unlikely to come
to an end. The SNP recently accused Westminister of not delivering on its promises, a serious consideration
for Cameron and his MPs as we head into the future.
14

The desire for self-government, whether in England or Scotland, looks unlikely to fade away. Back in 2010,
a report published by the Scottish government highlighted their desire for full fiscal autonomy, equalities
legislation, and formal participation rights in EU policy-making among other things all demands that still
need to be met. Membership in the SNP surged after the referendum, creating opportunities for mobilizing
support ahead of the upcoming Westminster election campaigns.

Lastly, the outcome of the referendum must not be mistaken to be a setback. Instead, it opens up the
possibility of other independence referendums in the not-so-near future. This will only be possible if pro-
independence leaders are inspired, and are able to inspire others that such a vote could be won.

15

References

Halligan, L. (2014, September 20). Scotland: What the future holds. The Telegraph. Retrieved from:

http://www.telegraph.co.uk/finance/11110955/ScotlandSWhatStheSfutureSholds.html

Nicholson, D. (2014, March 5). 5 Reasons Why Scottish Independence Would Be An Economic Disaster.
Forbes. Retrieved from:
http://www.forbes.com/sites/davidnicholson/2014/03/05/5SreasonsSwhySscottishSindependenceSwouldSbeS
anSeconomicSdisaster/

Crichton, T. (2014, October 14). David Cameron sparks furious row as he snubs Westminster debate on
delivering more powers for Scotland. Daily Record. Retrieved from:
http://www.dailyrecord.co.uk/news/politics/davidScameronSsparksSfuriousSrowS4433244

Dixon, K. (2014, October 15). Tomorrows Scotland. Counter Punch. Retrieved from:

http://www.counterpunch.org/2014/10/15/tomorrowsSscotland/

16
Issue 53 October 2014

SEIC Correspondents for Issue 53:

Wong Shi Jun Aaron (Vice President, SPEX)
Undergraduate
Lee Kong Chian School of Business
Singapore Management University
aaron.wong.2012@business.smu.edu.sg

Zhou Li (Creative Director)
Undergraduate
School of Economics
li.zhou.2012@economics.smu.edu.sg

Dinh Thai An (Writer)
Undergraduate
School of Economics
thaian.dinh.2013@economics.smu.edu.sg
Siddhant Hiremath (Writer)
Undergraduate
School of Economics
sshiremath.2012@economics.smu.edu.sg
Advait Halve (Writer)
Undergraduate
School of Economics
advaithalve.2014@economics.smu.edu.sg

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Issue 53 27 October 2014

SMU Political-Economic Exchange

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