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Britain needs a new 3i

The writer is a professor of management studies at Oxford university’s Saïd Business School

We need small businesses as never before. A post-Covid-19 economy will look different in ways that we cannot yet fathom. As jobs in some companies are permanently lost, the emergence of new ones depends on innovation and expansion in others, and this in turn depends upon whether small and medium-sized enterprises can obtain growth-oriented finance.

The UK most needs these successful SMEs in the less prosperous regions outside London: how else will levelling-up occur? Without it, be fearful of further political earthquakes.

Yet currently, SME balance sheets are being eroded by new liabilities: short-term, arms-length, London-directed, fixed repayment loans offered by banks and Whitehall.

Those most exposed to loss are in the places where help is most needed: indeed, this financing structure is why we have the levelling-up problem. Long-term finance that shares the risk and is locally informed because it is locally based is essential for regional prosperity.

The SME overdrafts now provided by the London clearing banks are only suited to short-term working capital, not to funding long-term growth. The UK had pro-growth local finance until the centralisation of banking in the 20th century eroded it, and we now have the chance to restore it.

Others have already recognised that if the pandemic is not to result in businesses that are too distressed to expand, short-term credit will need to morph into government-owned equity. But most advocates have envisaged government support as a central, passively held sovereign wealth fund — that would be a missed opportunity. Fortunately, we do not need to turn the clock back that far.

Until 1990, the UK had a viable postwar model in 3i, Europe’s most successful venture capital firm, and its precursor, the Industrial and Commercial Finance Corporation. It had a public purpose, just like nationalised industries that were later privatised to make them more competitive and vibrant.

It avoided their fate by decentralised and disciplined pluralism. It was decentralised through delegating authority to local branches, whose staff were expected to develop a real understanding of their client businesses. It built disciplined pluralism through shared ownership with a consortium of banks and the Bank of England. That protected ICFC from the short-term pressures of markets and politics, allowing it to stick to its purpose. Its commercial success came from growing with its borrowers, rather than profiting from them.

We need a new ICFC, but we haven’t got one. The new British Business Bank is centralised, politicised, distant from business and short-termist. But it can be reset.

The central government must face the reality that regional recovery cannot be managed from London. Letting go depends on trusting decentralised decisions to deliver. The role of Whitehall is to set the purpose, framework, values and skills of a reset BBB, and the criteria by which its success is judged. It must measure that success over decades not quarters, freeing the bank from short-term political and market pressures, but integrating the long-term public purposes of regional convergence and environmental sustainability. How much more centralised failure will it take before the temptation to micromanage is resisted?

To think of this plan as a sovereign wealth fund is misleading. Unlike countries that use their physical resources to amass “national wealth”, Britain’s publicly acquired equity would be matched by additional public debt. Nor would it really have a fund holding global public equity and bonds. The managers are not even “sovereign” in the sense of actively managing portfolios. As the UK accumulated its investments in SMEs through conversion of loans into equity, this new entity would be financed by current tax revenues, and it would delegate management down to very local, knowledgeable investment vehicles. In other words, it would act like a limited partner of a private equity arrangement in which the active management was done by a general partner.

The role of the BBB would be much like the ICFC’s in its day. As the intermediary between Whitehall and local centres of decision, it would set and supervise the purpose and necessary skills with which locally based funds could act from knowledge and engagement and focus on the growth of client businesses.

The UK government should do this now, before the new debts become a ball and chain around SMEs. Indeed, if it misses this opportunity, we may never get another.

We have a credible prospect of a reset that enables both a successful recovery from the pandemic and the levelling up that is fundamental to the future of the country. The financing model of the past three decades has not worked for the SMEs in the regions, and there is no basis for expecting it to do so in the more hostile environment after coronavirus. Whitehall faces a choice: a leap into letting go, or a failure so manifest that the usual cover-ups will leave it naked.

Paul Collier, a professor of economics and public policy at Oxford university’s Blavatnik School of Government, also contributed

This article was first published at https://www.ft.com/content/49584a34-95c7-11ea-899a-f62a20d54625

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The Markets Today