I have not yet touched on quantitative easing, and I will try to shorten my remarks, but the point is this: having lived through this era where the money supply

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tripled through new lending, the whole system, of course, blew up—the real world caught up with this fiction of a monetary policy—and so QE was engaged in. A paper from the Bank of England on the distributional effects of monetary policy explains that people would have been worse off if the Bank had not engaged in QE—it was, of course, an emergency measure. But one thing the paper says is that asset purchases by the Bank

“have pushed up the price of equities by as least as much as they have pushed up the price of gilts.”

The Bank’s Andy Haldane said, “We have deliberately inflated the biggest bond market bubble in history.”

Mr Jim Cunningham (Coventry South) (Lab): What is the hon. Gentleman’s view of QE? How does he see it fitting into the great scheme of things?

Steve Baker: As I am explaining, QE is a great evil; it is a substitute for proper reform of the banking system. But this is the point: if the greatest bubble has been blown in the bond markets and equities have been pushed up by broadly the same amount, that is a terrible risk to the financial system.

Mr MacNeil: Surely there is a difference depending on where the QE goes. In an economy that has a demand deficit and needs demand to be stimulated, if QE goes into the pockets of those who are going to spend the money, surely QE can create some more motion in the economy, but if QE goes into already deep pockets and makes them larger and deeper, that is a very different thing.

Steve Baker: Again, the hon. Gentleman touches on an interesting issue. Once the Bank legitimises the idea of money creation and giving it to people in order to get the economy going, the question then arises: if you are going to create it and give it away, why not give it to other people? That then goes to the question: what is money? I think it is the basis of a moral existence, because in our lives we should be exchanging value for value. One problem with the current system is that we are not doing that; something is being created in vast quantities out of nothing and given away. The Bank explains that 40% of the assets that have been inflated are held by 5% of households, with 80% held by people over 45. It seems clear that QE—a policy of the state to intervene deeply in money—is a deliberate policy of increasing the wealth of people who are older and wealthier.

Mr MacNeil: One word the hon. Gentleman used was “moral”, and he touches on what the economist Paul Krugman will say: some on the right see the recession and so on as a morality play, and confuse economics and morals. Sometimes getting things going economically is not about the straightforward “morality” money the hon. Gentleman has touched on. That could be one reason why the recovery is taking so long.

Steve Baker: I am conscious that I have already used slightly more time than I intended, and I have a little more to say because of these interventions. All these subjects, as my bookshelves attest, are easily capable of

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being explained over hundreds of pages. My bottom line on this is: I want to live in a society where even the most selfish person is compelled by our institutions to serve the needs of other people. The institution in question is called a free market economy, because in a free market economy people do not get any bail-outs and do not get to live at somebody else’s expense; they have to produce what other people want. One thing that has gone wrong is that those on the right have ended up defending institutions that are fundamentally statist.

Douglas Carswell (Clacton) (UKIP): I congratulate the hon. Gentleman on bringing this important subject to the attention of the House. Does he agree that, far from shoring up free market capitalism, the candy floss credit system the state is presiding over replaces it with a system of crony corporatism that gives capitalism a bad name and undermines its very foundations?

Steve Baker: I am delighted to agree with my hon. Friend—he is that, despite the fact I will not be seeing Nigel later. We have ended up pretending that the banking system and the financial system is a free market when the truth is that it is the most hideous corporatist mess. What I want is a free market banking system, and I will come on to discuss that.

I wanted to make some remarks about price signals, but I will shorten them, and try to cover the issue as briskly as I can—it was the subject of my maiden speech. Interest rates are a price signal like any other. They should be telling markets about people’s preferences for goods now compared with goods later. If they are deliberately manipulated, they will tell entrepreneurs the wrong thing and will therefore corrupt people’s investment decisions. The bond and equity markets are there to allocate capital. If interest rates are manipulated and if new money is thrown into the system, prices get detached from the real world values they are supposed to be connected to—what resources are available, what technology is available, what people prefer. The problem is that these prices, which have been detached from reality, continue to guide entrepreneurs and investors, but if they are now guiding entrepreneurs and investors in a direction that takes them away from the real desires of the public and the available resources and the technology, we should not then be surprised if we end up with a later disaster.

In short, after prices have been bid up by a credit expansion, they are bound to fall when later the real world catches up with it. That is why economies are now suffering this wrecking ball of inflation followed by deflation, and here is the rub: throughout most of my life, the monetary policy authorities have responded to these corrections by pumping in more new money—previously through ever cheaper credit, and now through QE. This raises the question of where this all goes, and brings me back to the point my hon. Friend the Member for Stone (Sir William Cash) provoked from me: that this might be pointing towards an end of this monetary order. That is not necessarily something to be feared, because the monetary order changed several times in the 20th century.

We have ended up in something of a mess. The Governor said about the transition once interest rates normalise:

“The orderliness of that transition is an open question.”

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I believe the Governor is demonstrating the optimism appropriate to his role, because I think it is extremely unlikely that we will have an orderly transition once interest rates start to normalise. The problem is basically that Governments want to spend too much money. That has always been the case throughout history. Governments used to want to fund wars. Now, for all good, moral, decent, humanitarian reasons, we want to fund health, welfare and education well beyond what the public will pay in taxes. That has meant we needed easy money to support the borrowing.

What is to be done? A range of remedies are being proposed. Positive Money proposes the complete nationalisation of the production of money, some want variations on a return to gold, perhaps with free banking, and some want a spontaneous emergence of alternative moneys like Bitcoin.

I would just point out that Walter Bagehot is often prayed in aid of central banking policy, but his book “Lombard Street” shows that he did not support central banking; he thought it was useless to try to propose any change. What we see today is that, with alternative currencies such as Bitcoin spontaneously emerging, it is now possible through technology that, within a generation, we will not all be putting our money in a few big mega-banks, held as liabilities, issued out of nothing.

I want to propose three things the Government can practically do. First, the present trajectory of reform should be continued with. After 15 years of studying these matters, and now having made it to the Treasury Committee, I am ever more convinced that there is no way to change the present monetary order until the ideas behind it have been tested to destruction—and I do mean tested to destruction. This is an extremely serious issue. It will not change until it becomes apparent that the ideas behind the system are untenable.

Secondly, and very much with that in mind, we should strongly welcome proposals from the Bank’s chief economist, Andy Haldane, that it will commission “anti-orthodox research”, and it will

“put into the public domain research and analysis which as often challenges as supports the prevailing policy orthodoxy on certain key issues.”

That research could make possible fundamental monetary reform in the event of another major calamity.

Thirdly, we should welcome the Chancellor’s recent interest in crypto-currencies and his commitment to make Britain a “centre of financial innovation.” Imperfect and possibly doomed as it may be, Bitcoin shows us that peer-to-peer, non-state money is practical and effective. I have used it to buy an accessory for a camera; it is a perfectly ordinary legal product and it was easier to use than a credit card and it showed me the price in pounds or any other currency I liked. It is becoming possible for people to move away from state money.

Every obstacle to the creation of alternative currencies within ordinary commercial law should be removed. We should expand the range of commodities and instruments related to those commodities that are treated like money, such as gold. That should include exempting VAT and capital gains tax and it should be possible to pay tax on those new moneys. We must not fall into the same trap as the United States of obstructing innovation. In the case of the Liberty Dollar and Bernard von NotHaus, it

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seems that a man may spend the rest of his life in prison simply for committing the supposed crime of creating reliable money.

Finally, we are in the midst of an unprecedented global experiment in monetary policy and debt. It is likely, as Philip Coggan set out, that this will result in a new global monetary order. Whether it will be for good or ill, I do not know, but as technology and debt advance, I am sure that we should be ready for a transformation. Society has suffered too much already under the present monetary orthodoxy; free enterprise should now be allowed to change it.

11.45 am

Mr Michael Meacher (Oldham West and Royton) (Lab): I, too, strongly congratulate the hon. Member for Wycombe (Steve Baker) on securing this debate, which everyone recognises is vital and which has not been debated in this House for 170 years, since Sir Robert Peel’s Bank Charter Act 1844. The hon. Gentleman drew that fact to my attention when we were last speaking in a similar debate. That Act prohibited the private banks from printing paper money. In light of the financial crash of 2008-09 and the colossal expansion of money supply that underpinned it—no less than a twenty-two-fold increase in the 30 neo-liberal years between 1980 and 2010—the issue is whether that prohibition should be extended to include electronic money.

It is unfortunate that it is so little understood by the public that money is created by the banks every time they make a loan. In effect, the banks have a virtual monopoly—about 97%—over domestic credit creation, so they determine how money is allocated across the economy. That has led to the vast majority of money being channelled into property markets and the financial sector. According to Bank of England figures for the decade to 2007, 31% of additional money created by bank lending went to mortgage lending, 20% to commercial property, and 32% to the financial sector, including to mergers and acquisitions and trading and financial markets. Those are extraordinary figures.

Mr Jim Cunningham: Given what my right hon. Friend has just said, is there not an argument, in this situation of unlimited credit from banks, for the Bank of England to intervene?

Mr Meacher: My hon. Friend anticipates the main line of my argument, so if he is patient I think I will be able to satisfy him. Crucially, only 8% of the money referred to went to businesses outside the financial sector, with a further 8% funding credit cards and personal loans.

Mr MacNeil: I hear what the right hon. Gentleman says about money going into building, housing and mortgages, but is that not because the holders of money reckon that they can get a decent return from that sector? They would invest elsewhere if they thought that they could get a better return. One reason why the UK gets a better return from that area than, say, Germany is that we have no rent controls. As a result, money is more likely to go into property than into developing industry, which is more likely to happen in Germany.

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Mr Meacher: I very much agree with that argument. Again, I assure the hon. Gentleman that I will return to that matter later in my speech. He is absolutely right that the reason is the greater returns that the banks can get from the housing and rental sector. Our rental sector, which is different from that in Germany and other countries, is the cause of that.

It is only this last 16%—the 8% lent to businesses and the 8% to consumer credit—that has a real impact on GDP and economic growth. The conclusion is unavoidable: we cannot continue with a system in which so little of the money created by banks is used for the purposes of economic growth and value creation and in which, instead, to pick up on the point made by the hon. Member for Na h-Eileanan an Iar (Mr MacNeil), the overwhelming majority of the money created inflates property prices, pushing up the cost of living.

In a nutshell, the banks have too much power and they have greatly abused it. First, they have been granted enormous privileges since they can create wealth simply by writing an accounting entry on a register. They decide who uses that wealth and for what purpose and they have used their power of credit creation hugely to favour property and consumption lending over business investment because the returns are higher and more secure. Thus the banks maximise their own interests but not the national interest.

Secondly, if they fail to meet their liabilities, the banks are not penalised. Someone else pays up for them. The first £85,000 of deposits are covered by a guarantee underwritten by the state and in the event of a major financial crash they are bailed out by the implicit taxpayer guarantee—

Steve Baker rose—

Mr Meacher: Let me finish, and I will of course give way.

The banks have been encouraged by that provision into much more risky, even reckless, investment, especially in the case of exotic financial derivatives—

Mr Jim Cunningham rose—

Mr Meacher: Members are beginning to queue up to intervene, but let me finish my point first.

The banks have been encouraged even to the point at which after the financial crash of 2008-09 the state was obliged to undertake the direct bail-out costs of nearly £70 billion as well as to provide a mere £1 trillion in support of loan guarantees, liquidity schemes and asset protection arrangements.

Steve Baker: I wholly agree with the right hon. Gentleman. The moral hazard problem is absolutely enormous and one of the most fundamental problems. However, the British Bankers Association picked me up when I said it was a state-funded deposit insurance scheme and told me it was industry-funded. I think the issue now is that nobody really believes for a moment that the scheme will not be back-stopped by the taxpayer.

Mr Meacher: As always, I am grateful for the intervention from the hon. Gentleman—let me call him my hon. Friend, as I think that on this issue he probably is.

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Mr Jim Cunningham: On the question of banks investing in the property market, does my right hon. Friend think we could learn anything from the United States and the collapse of Fannie Mae? Are we in a similar situation?

Mr Meacher: Again, that takes me down a different path, but there is considerable read-across.

Douglas Carswell: The right hon. Gentleman has been absolutely magnificent in diagnosing the problem, but when it comes to the solution and passing power away from banks, rather than passing the power upwards to a regulator or to the state, would he entertain the idea of empowering the consumer who deposits money with the bank? Surely the real failure is that the Bank Charter Act 1844 does not give legal ownership of deposits to the person paying money into the bank. The basis of fractional-reserve banking is the legal ownership the bank has when money is paid in. If we tackle that, the power will pass from the big state-subsidised corporations and banks outwards to the wider economy.

Mr Meacher: I have great sympathy with what the hon. Gentleman is saying—

Ms Diane Abbott (Hackney North and Stoke Newington) (Lab) rose—

Mr Meacher: One at a time, please. I was going to say a little bit more than that I had sympathy with what the hon. Member for Clacton (Douglas Carswell) said.

I will argue that the capacity to regulate an increasingly and exceedingly complex financial sector is not the proper way, and I will propose an alternative solution. I am strongly in favour of structural changes that enable people to achieve greater control over the money that they have contributed.

Ms Abbott: I was intrigued to hear my right hon. Friend mention depositor protection. Is he saying that he is against any form of depositor protection?

Mr Meacher: The protection of deposits is up to £85,000 and is underwritten by the state.

Ms Abbott: Is my right hon. Friend against?

Mr Meacher: I am neither for nor against. I am making the point that the arrangement encourages the banks to increase their risk taking. If they are caught out, for each depositor £85,000 is guaranteed by the state. I agree with the hon. Member for Wycombe that we need much wider structural change. It is not a question of tweaking one thing here or there.

The question at the heart of the debate is who should create the money? Would Parliament ever have voted to delegate power to create money to those same banks that caused the horrendous financial crisis that the world is still suffering? I think the answer is unambiguously no. The question that needs to be put is how we should achieve the switch from unbridled consumerism to a framework of productive investment capable of generating a successful and sustainable manufacturing and industrial base that can securely underpin UK living standards.

Two models have hitherto been used to operate such a system. One was the centralised direction of finance, which was used extremely successfully by several Asian countries, especially the south-east Asian so-called tiger

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economies, after the second world war, to achieve take-off. I am not suggesting that that method is appropriate for us today. It is not suited to advanced industrial democracies. The other method was to bring about through official “guidance” the rationing of bank credit in accordance with national targets and, where necessary, through quantitative direct controls. In the post-war period, that policy worked well in the UK for a quarter of a century, until the 1970s when it was steadily replaced by the purely market system of competition and credit control based exclusively on interest rates. In our experience of the past 30 or 40 years, that has proved deeply unstable, dysfunctional and profoundly costly.

Since then there have been sporadic attempts to create a safer banking system, but these have been deeply flawed. Regulation under the dictates of the neo-liberal ideology has been so light-touch—by new Labour just as much as by the other Government—that it has been entirely ineffective. Regulation has been too detailed. I remind the House that Basel III has more than 400 pages, and the US Dodd-Frank Bill has a staggering 8,000 pages or more. It is impossibly bureaucratic and almost certainly full of loopholes. Other regulation has been so cautious—for example, the Vickers commission proposal for Chinese walls between the investment and retail arms of a bank—that it missed the main point. Whatever regulatory safeguards the authorities put in place faced regulatory arbitrage from the phalanx of lawyers and accountants in the City earning their ill-gotten bonuses by unpicking or circumventing them.

Mr Ronnie Campbell: My right hon. Friend is always very good on these subjects. Would I be going too far if I were to suggest that we should nationalise the City, nationalise the banks and run ourselves a Government on behalf of the people?

Mr Meacher: Public ownership of the banks is a significant issue, but I am not going to propose it in my speech. It would be a mistake to return RBS and Lloyds to the private sector, and the arguments about Barclays and HSBC need to be made, but not in this debate. I shall suggest an alternative solution that removes the power of money creation from the banks and puts it in different hands to ensure better results in the national interest.

Against that background, there are solid grounds for examining—this is where I come to my proposal—the creation of a sovereign monetary system, as recommended by several expert commentators recently. Martin Wolf, who, as everyone in this House will know, is an influential chief economics commentator for the Financial Times, wrote an article a few months ago—on 24 April, to be precise—entitled “Strip private banks of their power to create money”. He recommends switching from bank-created debt to a nationalised money supply.

Lord Adair Turner, the former chair of the Financial Services Authority, delivered a speech about 18 months ago, in February 2013, discussing an alternative to quantitative easing that he termed “overt money finance,” which is also known as a from of sovereign money. Such a system—I will describe its main outline—would restrict the power to create all money to the state via the central bank. Changes to the rules governing how banks operate would still permit them to make loans, but would make it impossible for them to create new money in the

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process. The central bank would continue to follow the remit set by the Chancellor of the Exchequer, which is currently to deliver price stability, which is defined at the present time as an inflation target of 2%. The central bank would be exclusively responsible for creating as much new money as was necessary to support non-inflationary growth. Decisions on money creation would be taken independently of Government by a newly formed money creation committee or by the existing Monetary Policy Committee, either of which would be accountable to the Treasury Committee. Accountability to the House is crucial to the whole process.

Mr Jim Cunningham: Going back to the question I asked my right hon. Friend earlier, what would be the role of the Bank of England?

Mr Meacher: I will come on to explain that. The Bank of England has an absolutely crucial role to play. If my hon. Friend listens to the last bit of my speech, he will get a full answer to that question.

A sovereign money system thus offers—if I may say this—a clear thermostat to balance the economy, which is notoriously lacking at present. In times when the economy is in recession or growth is slow, the money creation committee would be able to increase the rate of money creation, to boost aggregate demand. If growth is very high and inflationary pressures are increasing, it could slow down the rate of money creation. That would be a crucial improvement over the current system, whereby the banks either produce too much mortgage credit in a boom because of the high profit prospects, which produces a housing bubble and raises house prices, or produce too little credit in a recession, which exacerbates the lack of demand.

Lending to businesses is central to this whole debate.

Derek Twigg (Halton) (Lab): I want to take my right hon. Friend back to when he mentioned accountability to Parliament and the Select Committee. Could he enlarge on that point? On accountability, what powers would Parliament have to ensure that his proposal was being followed through properly and the rules were being laid down?

Mr Meacher: The purpose of accountability to the Treasury Committee would be to enable Parliament fully to explore the manner in which the money creation committee or the Monetary Policy Committee was working. I would anticipate a full three-hour discussion with the leading officials of those committees before the Treasury Committee, and if necessary they could be given a hard time. Certainly, the persons in this House who are most competent to deal with the matter would make clear their priorities, and where they thought the money creation committee was not paying sufficient attention to the way in which it was operating, and they would suggest changes. They would not have the power formally to compel the money creation committee to change, but I think the whole point about Select Committees, which are televised and discussed in the media, is that they have a very big effect. That would be a major change compared with what we have at present. Like all systems, if it is inadequate it can be modified, changed and increasingly enforced.

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Sir William Cash: With reference to the Treasury Committee, does the right hon. Gentleman see a potential role for some form of joint Committee, perhaps with the Public Accounts Committee, whose origins are to do with taxation and spending? Does he think that broadening scrutiny a little in that direction might be helpful so that we get the full benefit of the all-party agreement of both Committees?

Mr Meacher: That is a helpful intervention. Although it is a relatively big part of what I am proposing, it is not for me to suggest exactly what the structure of accountability should be. I would be strongly in favour of increasing it as the hon. Gentleman proposes. Until this House is content that it has a proper channel of accountability which is effective in terms of the way our financial system is run, we should bring in further changes to the structure of accountability as may be necessary, such as along the lines that he suggests.

On lending to businesses, the experience that we have had in the past half-decade has been very unsatisfactory. Under a sovereign monetary system, the central bank would be empowered to create money for the express purpose of that funding role. The money would be lent to banks with the requirement that the funds were used for productive purposes, whereas lending for speculative purposes—for example, to purchase pre-existing assets, either financial or property—would not be allowed. The central bank could also create and lend funds to other intermediaries—the hon. Member for Wycombe referred to this—such as regional or publicly owned business banks, which would ensure that a floor could be placed under the level of lending to businesses, which would be a great relief to British business, guaranteeing support for the real economy.

To avoid misunderstanding, I should add that within the limits imposed by the central bank on the broad purposes for which money may be lent, lending decisions would be entirely at the discretion of the lending institutions, not of the Government or the central bank.

I believe that a sovereign monetary system offers very considerable advantages over the current system. First, it would create a better and safer banking system because banks would have an incentive to take lower levels of risk, as there would be no option of a bail-out or rescue from taxpayers and thus moral hazard would be reduced. Secondly, it would increase economic stability because money creation by banks tends to be pro-cyclical, as I explained, whereas money creation by the central bank would be counter-cyclical. Thirdly, sovereign money crucially supports the real economy, whereas under the current system 83% of lending does not at present go into productive investment. I underline that three times.

Ann McKechin: My right hon. Friend said that the aim would be to reduce risk and for banks to be more cautious, but if we are to encourage innovation in manufacturing, would we not require an investment bank at state level that could fund the riskier levels of innovation to ensure that they get to market, because they are not at the point where they would be commercially viable?

Mr Meacher: That is an extremely important point and, again, I strongly support it. The current Secretary of State for Business, Innovation and Skills has been

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struggling to introduce a Government-supported business investment bank and has recently announced something along those lines. I think that should be greatly expanded. The book by Mariana Mazzucato, which I hope most of us have read, “The Entrepreneurial State”, shows the degree to which funding for major innovation, not just in this country but in many other countries which she cites, has been financed through the state because the private sector was not willing to take on board the risk involved. One understands that, but one does need to recognise that the role of the state is extremely important, and under a Labour Government I would like to see something like this being brought in.

Ian Murray (Edinburgh South) (Lab): My right hon. Friend makes a tremendous case for money creation and what we should be considering in this House, but I wonder whether there is also a cultural issue. Many businesses and lenders tell me that there is a cultural problem in the United Kingdom for businesses, particularly entrepreneurial businesses that we have heard about from my hon. Friend the Member for Glasgow North (Ann McKechin), with regard to giving away equity rather than creating debt—funding businesses through equity rather than debt. Other countries throughout Europe that are incredibly successful at giving away equity rather than creating debt have much more growth in their entrepreneurial economy.

Mr Meacher: That is perfectly true, and my hon. Friend makes an important point. The proposals that I am making would support that. There is a very different climate in this country, largely brought about by the churning in the City of London where profits have to be increased or reach a relevant size within a very short period, such as three or six months. Most entrepreneurial businesses cannot possibly produce a decent profit within that period, so the current financial system does not encourage what my hon. Friend wants. These proposals would make money creation available to those we really want to support much more fully than at present.

Fourthly, under the current system, house price bubbles transfer wealth, as we all know, from the young to the old and from those who cannot get on the property ladder to existing house owners, which increases wealth inequality, while removing the ability of banks to create money should dampen house price rises and thus reduce the rate of wealth inequality.

My fifth and last point, which I think is very important, is that sovereign money redresses a major democratic deficit. Under the current system, around just 80 board members across the largest five banks make decisions that shape the entire UK economy, even though these individuals have no obligation or mandate to consider the needs of society or the economy as a whole, and are not accountable in any way to the public: it is for the maximisation of their own interests, not the national interest. Under sovereign money, the money creation committee would be highly transparent—we have discussed this already—and accountable to Parliament.

For all those reasons, the examination of the merits of a sovereign monetary system is now urgently needed, and I call on the Government to set up a commission on money and credit, with particular reference to the potential benefits of sovereign money, which offers a way out of

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the continuing and worsening financial crises that have blighted this country and the whole international economy for decades.

12.13 pm

Mr Peter Lilley (Hitchin and Harpenden) (Con): It is a pleasure, as always, to follow the right hon. Member for Oldham West and Royton (Mr Meacher), who gave us a characteristically thoughtful and radical speech. I do not necessarily start from the same premises as him, but what he says is an important contribution to the debate, on the securing of which I credit my hon. Friend the Member for Wycombe (Steve Baker). He has done the House and the country a service by forcing us to focus on the issue of where money comes from and what banks do. He did so in an insightful way. Above all, he showed that he sees, as our old universities used to see, economics as a branch of moral sciences. It is not just a narrow, analytical, economic issue, but a moral, philosophical and ultimately a theological issue, which he illuminated well for the House.

A lot has been made of the ignorance of Members of Parliament of how money is created. I suspect that that ignorance, not just in Members of Parliament but in the intellectual elite in this country, explains many things, not least why we entered the financial crisis with a regulatory system that was so unprepared for a banking crisis. I suspect that it is because people have not reflected on why banks are so different from all other capitalist companies. They are different in three crucial respects, which is why they need a very different regulatory system from normal companies.

First, all bankers—not just rogue bankers but even the best, the most honourable and the most honest—do things that would land the rest of us in jail. Near my house in France is a large grain silo. After the harvest, farmers deposit grain in it. The silo gives them a certificate for every tonne of grain that they deposit. They can withdraw that amount of grain whenever they want by presenting that certificate. If the silo owner issued more certificates than there was grain kept in his silo, he would go to jail, but that is effectively what bankers do. They keep as reserves only a fraction of the money deposited with them, which is why we call the system the fractional reserve banking system. Murray Rothbard, an Austrian economist much neglected in this country, said very flatly that banking is therefore fraud: fractional reserve banking is fraud; it should be outlawed; banks should be required to keep 100% reserves against the money they lend out. I reject that conclusion, because there is a value in what banks do in transforming short-term savings into long-term investments. That is socially valuable and that is the function banks serve.

We should recognise the second distinctive feature of banks that arises directly from the fact that they have only a fraction of the reserves against the loans they make: banks, individually and collectively, are intrinsically unstable. They are unstable because they borrow short and lend long. I have been constantly amazed throughout the financial crisis to hear intelligent people say that the problem with Northern Rock, RBS or HBOS, or with the German, French, Greek and other banks that ran into problems, was the result of their borrowing short and lending long, and they should not have been doing it, as if it was a deviation from their normal role. Of course banks borrow short and lend long. That is what

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banks do. That is what they are there for. If they had not done that they would not be banks. Banking works so long as too many depositors do not try to withdraw their funds simultaneously. However, if depositors, retail or wholesale, withdraw or refuse to renew their short-term deposits, a bank will fail.

If normal companies fail, there is no need for the Government to intervene. Their assets will be redeployed in a more profitable use or taken over by a better-managed company. But if one bank fails, depositors are likely to withdraw deposits from other banks, about which there may also be doubts. A bank facing a run, whether or not initially justified, would be forced to call in loans or sell collateral, causing asset prices to fall, thereby undermining the solvency of other banks. So the failure of one bank may lead to the collapse of the whole banking system.

The third distinctive feature of banks was highlighted by my hon. Friend the Member for Wycombe: banks create money. The vast majority of money consists of bank deposits. If a bank lends a company £10 million, it does not need to go and borrow that money from a saver; it simply creates an extra £10 million by electronically crediting the company’s bank account with that sum. It creates £10 million out of thin air. By contrast, when a bank loan is repaid, that extinguishes money; it disappears into thin air. The total money supply increases when banks create new loans faster than old loans are repaid. That is where growth in the money supply usually comes from, and it is the normal situation in a growing economy. Ideally, credit should expand so that the supply of money grows sufficiently rapidly to finance growth in economic activity. When a bank or banks collapse, they will call in loans, which will reduce the money supply, which in turn will cause a contraction of activity throughout the economy.

In that respect, banks are totally different from other companies—even companies that also lend things. If a car rental company collapses, it does not lead to a reduction in the number of cars available in the economy. Its stock of cars can be sold off to other rental companies or to individuals. Nor does the collapse of one rental company weaken the position of other car rental companies; on the contrary, they then face less competition, which should strengthen their margins.

The collapse of a car rental company has no systemic implications, whereas the collapse of a bank can pull down the whole banking system and plunge the economy into recession. That is why we need a special regulatory regime for banks and, above all, a lender of last resort to pump in money if there is a run on the banks or a credit crunch, yet this was barely discussed when the new regulatory structure of our financial and banking system was set up in 1998. The focus then was on consumer protection issues. Systemic stability and the lender-of-last-resort function were scarcely mentioned. That is why the UK was so unprepared when the credit crunch struck in 2007. Nor were these aspects properly considered when the euro was set up. As a result, a currency and a banking system were established without the new central bank being given the power to act as lender of last resort. It has had to usurp that power, more or less illegally, but that is its own problem.

This analysis is not one of those insights that come from hindsight. Some while ago, Michael Howard, now the noble Lord Howard, reminded Parliament—and

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indeed me; I had completely forgotten—that I was shadow Chancellor when the Bill that became the Bank of England Act 1998 was introduced. He pointed out that I then warned the House:

“With the removal of banking control to the Financial Services Authority…it is difficult to see how…the Bank remains, as it surely must, responsible for ensuring the liquidity of the banking system and preventing systemic collapse.”

And so it turned out. I added:

“setting up the FSA may cause regulators to take their eye off the ball, while spivs and crooks have a field day.”—[Official Report, 11 November 1997; Vol. 300, c. 731-32.]

So that turned out, too. I could foresee that, because the problem was not deregulation, but the regulatory confusion and the proliferation of regulation introduced by the former Chancellor, which resulted from a failure to focus on the banking system’s inherent instability, and to provide for its stability.

This failure to focus on the fundamentals was not a peculiarly British thing. The EU made the same mistakes in spades when setting up the euro, and at the very apogee of the world financial system, they deluded themselves that instability was a thing of the past. In its “Global Financial Stability Report” of April 2006, less than 18 months before the crisis erupted, the International Monetary Fund, no less, said:

“There is growing recognition that the dispersion of credit risk by banks to a broader and more diverse group of investors, rather than warehousing such risk on their balance sheets, has helped to make the banking and overall financial system more resilient…The improved resilience may be seen in fewer bank failures and more consistent credit provision. Consequently, the commercial banks…may be less vulnerable today to credit or economic shocks.”

The supreme irony is that those at the pinnacle of the world regulatory system believed that the very complex derivatives that contributed to the collapse of the financial system would render it immune to such instability. We need constantly to be aware that banks are unstable, and are the source of money. If instability leads to a crash, that leads to a contraction in the money supply, and that can exacerbate and intensify a recession.

Bob Stewart (Beckenham) (Con): I am listening carefully to my right hon. Friend. Does that mean that the banks are uncontrollable, as things stand?

Mr Lilley: No; they can and should be controlled. They are controlled both by being required to have assets, and ultimately by the measures that Government should take to ensure that they do not expand lending too rapidly. That is the point that I want to come on to, because a failure to focus on the nature of banking and money creation causes confusion about the causes of inflation and the role of quantitative easing.

As too many people do not understand where money comes from, there is confusion about quantitative easing. To some extent, the monetarists, of whom I am one, are responsible for that confusion. For most of our lifetime, the basic economic problem has been inflation. There have been great debates about its causes. Ultimately, those debates were won by the monetarists. They said, “Inflation is caused by too much money—by money growing more rapidly than output. If that happens, inevitably and inexorably, prices will rise.” The trouble was that all too often, monetarists used the shorthand

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phrase, “Inflation is caused by Government printing too much money.” In fact, it is caused not by Government printing the money, but by banks lending money and then creating new money at too great a rate for the needs of the economy. We should have said, “Inflation follows when Governments allow or encourage banks to create money too rapidly.” The inflationary problem was not who created the money, but the fact that too much money was created.

The banks are now not lending enough to create enough money to finance the growth and expansion of the economy that we need. That is why the central bank steps in with quantitative easing, which is often described as the bank printing money. Those who have been brought up to believe that printing money was what caused inflation think that quantitative easing must, by definition, cause inflation. It only causes inflation if there is too much of it—if we create too much money at a faster rate than the growth of output, and therefore drive up prices—but that is not the situation at present.

Mr MacNeil: The right hon. Gentleman is giving a very good explanation of the different circumstances in which money is created. He has spoken about the morality, and about quantitative easing. When there is demand, what is his view of the theory of helicopter money, and where that money gets spread to?

Mr Lilley: As a disciple of Milton Friedman, I am rather attracted to the idea of helicopter money; I think it was he who introduced the metaphor, and said that it would be just as effective if money were sprayed by a helicopter as if it were created by banks. Hopefully, as I live quite near the helicopter route to Battersea, I would be a principal recipient. I do not think that there is a mechanism available that would allow us to do that, but I am not averse to that in principle, if someone could do it. My point is that the banks, either spontaneously or encouraged by the central bank through quantitative easing, must generate enough money to ensure that the economy can grow steadily and stably.

Mr MacNeil: Could it not be argued that increasing welfare payments would be a form of helicopter money, because the people most likely to spend money are those with very little money? If we put money in the pockets of those who have little money, it would be very positive, because of the economic multiplier; the money would be spent, and would circulate, very quickly.

Mr Lilley: There are far better reasons for giving money to poor people than because their money will circulate more rapidly—and there is no evidence for that; I invite the hon. Gentleman to read Milton Friedman’s “A Theory of the Consumption Function”, which showed that that is all nonsense. There are good reasons for giving money to poor people, namely that they are poor and need money. Whether the money should be injected by the Government spending more than they are raising, rather than by the central bank expanding its balance sheet, is a moot point.

All I want to argue today is that we should recognise that the economy is threatened as much by a shortage of money as it is by an excess of money. For most of our lifetimes the problem has been an excess, but now it is a shortage. We therefore need to balance on either occasion

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the rate of growth of money with the rate of growth of output if we are to have stability of prices and stable economic activity. I congratulate my hon. Friend the Member for Wycombe on bringing these important matters to the House’s attention.

12.30 pm

Austin Mitchell (Great Grimsby) (Lab): I welcome this debate and congratulate hon. Friends on securing it, because we have not debated this matter for over 100 years, and it is time we did so. This House and the Government are obsessed with money and the economy, but we never debate the creation of money or credit, and we should, because, when it comes to our present economic situation and the way the banks and the economy are run, that is the elephant in the room. It is time to think not outside the box, but outside the banks; it is time to think about the creation of credit and money.

I speak as a renegade social creditor who is still influenced by social credit thinking; I do not pledge total allegiance to Major Douglas, but I am still influenced by him. As has just been pointed out, 93% of credit is created by the banks, and a characteristic of what has happened to the economy since the ’70s is the enormous expansion of that credit. I have here a graph from Positive Money showing that the money created by the banks was £109 billion in 1980. Thanks to the financial reforms and the huge increase in the power of the banks since then, by 2010 that figure had risen to £2,213 billion, whereas the total cash created by the Government—the other 3%—had barely increased at all. Since 2000 we have seen the amount of money created by the banks more than double.

That has transformed the economy, because it has financialised everything and made money far more important. It has created debt-fuelled growth followed by collapse. It is being controlled by the banks, which have directed the money into property and financial speculation. Only 8% of the credit created has been lent to new businesses. The Government talk about the march of the makers, but the makers are not marching into the banks, because the banks are turning them away. Even commercial property is more important than makers. That has created a very lop-sided economy, with a weak industrial base that cannot pay the nation’s way in the world because investment has been directed elsewhere, and a very unequal society, which has showered wealth on those at the top, as Piketty shows, and taken it away from those at the bottom.

A very undesirable situation is being created. We have built an unstable economy that is very exposed to risk and to bubble economics, thanks to the financialisation process that has gone on since 1979. The state allocates all credit creation to the banks and then has to bail them out and guarantee them, at enormous expense and with the creation of debt for the public, when the bubble bursts and they collapse.

Some argue—Major Douglas would have argued this—that credit should therefore be issued only by the state, through the Bank of England. That would probably be a step too far in the present situation, given our present lack of education, but we can and should create the credit issued by the banks. We can and should separate the banks’ utility function—servicing our needs, with cheque books, pay and so on—and their speculative

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role. The Americans have moved a step further, with the Volcker rule, but it is not quite strong enough. In this country we tend to rely on Chinese walls, which are not strong at all. I think that only a total separation of the banks’ utility and speculative arms will do it, because Chinese walls are infinitely penetrable and are regularly penetrated.

We can limit the credit creation by the banks by increasing the reserve ratios, which are comparatively low at the moment—the Government have been trying to edge them up, but not sufficiently—or we could limit their power to create credit to the amount of money deposited with the banks as a salutary control. We could tax them on the hidden benefit they get from creating credit, because they get the signorage on the credit they create. If credit is created by banknotes and cash issued by the Government, the Government get the profit on that—the signorage. The banks just take the signorage on all the credit they issue and stash it away as a kind of hidden benefit, so why not tax that and give some of the profit from printing money to the state?

Martin Wolf, in an interesting article cited by my right hon. Friend the Member for Oldham West and Royton (Mr Meacher), has argued that only central banks should create new money and that it should be regulated by a public credit authority, rather like the Monetary Policy Committee. I think that that would be a solution and a possible approach. Why should we not regulate the issue of credit in that fashion?

That brings us back to the old argument about monetarism: whether credit creation is exogenous or endogenous. The monetarists thought that it was exogenous, so all we have to do is cut the supply of money into the economy in order to bring inflation under control. That was a myth, of course, because we cannot actually control the supply of money; it is endogenous. The economy, like a plant, sucks in the money it needs. But that can be regulated by a public credit authority so that the supply matches the needs of the economy, rather than being excessive, as it has been over the past few years. I think that that kind of credit authority needs to be created to regulate the flow of credit.

That brings me to the Government’s economic policy. The Government tell us that they have a long-term economic plan, which of course is total nonsense. Their only long-term economic plan is slash and burn. The only long-term economic planning that has been done is by the Bank of England.

Mr MacNeil: To quote Harry S. Truman, the worst thing about economists is that they always say, “On the other hand”. The hon. Gentleman talks about limiting and regulating how much money is to be sucked in by the economy, but who would decide that? The difficulty is that although the economy might be overheating in a certain part of the country, such as the south-east of England, it could be very cool in others, such as the north of Scotland. What might be the geographical effects of limiting the money going into the economic bloodstream if some parts of the plant—I am extending his metaphor—need the nutrients while other parts are getting too much?

Austin Mitchell: The hon. Gentleman often asks tricky questions, but this one is perfectly clear-cut. The credit supply for the peripheral and old industrial parts of the

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economy, which include Scotland, but also Grimsby, has been totally inadequate, and the banks have been totally reluctant to invest there. I once argued for helicopter money, as Simon Jenkins has proposed, whereby we stimulate the economy by putting money into helicopters and dropping it all over the country so that people will spend it. I would agree to that, provided that the helicopters hover over Grimsby, but I would have them go to Scotland as well, because it certainly deserves its share, as does the north of England. However, I do not want to get involved in a geographical dispute over where credit should be created.

The only long-term plan has been that of the Bank of England, which has kept interest rates flat to the floor for six years or so—an economy in that situation is bound to grow—and has supplemented that with quantitative easing. We have created £375 billion of money through quantitative easing. It has been stashed away in the banks, unfortunately, so it has served no great useful purpose. If that supply of money can be created for the purpose of saving the banks and building up their reserve ratios, it can be used for more important purposes—the development of investment and expansion in the economy. This is literally about printing money. Those of us with a glimmering of social credit in our economics have been told for decades, “You can’t print money—it would be terrible. It would be disastrous for the economy to print money because it leads to inflation.” Well, we have printed £375 billion of money, and it has not produced inflation. Inflation is falling.

Steve Baker rose—

Austin Mitchell: I am sorry—I am mid-diatribe and do not want to be interrupted.

It has proved possible to print money. The Americans have done it—there has been well over $1 trillion of quantitative easing in the United States. The European Central Bank is now contemplating it, as Mr Draghi casts around for desperate solutions to the stagnation that has hit the eurozone. The Japanese, surprisingly, did it only last week. If all can do it, and if it has been successful here and has not led to inflation, we should be able to use it for more useful and productive economic purposes than shoring up the banks.

If we go on creating more money through quantitative easing, we should channel it through a national investment bank into productive investment such as contracts for house building and new town generation. Through massive infrastructure work—although I would not include HS2 in that—we can stimulate the economy, stimulate growth, and achieve useful purposes that we have not been able to achieve. This is a solution to a lot of the problems that have bedevilled the Labour party. How do we get investment without the private finance initiative and the heavy burden that that imposes on health services, schools, and all kinds of activities? Why not, through quantitative easing, create contracts for housing or other infrastructure work that have a pay-off point and produce assets for the state?

I mentioned the article in which Martin Wolf advocates the approach of the Monetary Policy Committee. That is how we should approach this. I welcome this debate because it has to be the beginning of a wider debate in

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which we open our minds to the possibilities of managing credit more effectively for the better building of the strength of the British economy.

12.44 pm

Zac Goldsmith (Richmond Park) (Con): I want to put on record my gratitude to my hon. Friend the Member for Wycombe (Steve Baker) for having initiated this debate, and to his supporters from various parties. Having heard his speech—or most of it; I apologise for being late—I am even more satisfied that it was right to cast my vote for him to join the Treasury Committee.

My hon. Friend has introduced an incredibly important debate. As we have heard, this issue has not been debated here for well over a century. We would not be having it were it not for the fact that we are still in the midst of tumultuous times. We had the banking crash and the corresponding crash in confidence in the banking system and in the wider economy, and now, partly as a consequence, we have the problem of under-lending, particularly to small and medium-sized businesses. This subject could not be more important.

The right hon. Member for Oldham West and Royton (Mr Meacher)—I will call him my right hon. Friend because we work together on many issues—pointed out at the beginning of his speech that this issue is not well understood by members of the public. As I think he said later—if not, I will add it—it is also not well understood by Members of Parliament. I would include myself in that. I suspect that most people here would be humble enough to recognise that the banking wizardry we are discussing is such a complex issue that very few people properly understand it.

Bob Stewart: I totally associate myself with my hon. Friend’s comments about ignorance and include myself in that. It seems to me that the system is broken. The banks will not lend money because the Government have told them that they have to keep reserves. We do not like quantitative easing because that means that the banks are not lending. There is something very wrong with the system. It is not a case of “if the system isn’t broke, don’t fix it”, but “the system is broke, and someone’s got to fix it”.

Zac Goldsmith: My hon. Friend makes a valuable point that I will come to later.

If Members of Parliament do not really understand how money is created—I believe that that is the majority position, based on discussions that I have been having—how on earth can we be confident that the reforms that we have brought in over the past few years are going to work in preventing repeated collapses of the sort that we saw before the last election? In my view, we cannot be confident of that. The problem is the impulsive position taken by ignorant Members. I do not intend to be rude; as I said, I include myself in that bracket. For too many people, the impulse has been simply to call for more regulation, as though that is going to magic away these problems. As my hon. Friend the Member for Wycombe said, there are 8,000 pages of guidance in relation to one aspect of banking that he discussed. The problem is not a lack of regulation; it is the fact that the

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existing regulations miss the goal in so many respects. Banking has become so complex and convoluted that we need an entirely different approach.

When we talk to people outside Parliament about banking, the majority have a fairly simple view—the bank takes deposits and then lends, and that is the way it has always been. Of course, there is an element of truth in that, but it is so far removed from where we are today that it is only a very tiny element.

Steve Baker: My hon. Friend mentions the idea of straightforward, carry-through lending. When people talk about shadow banking, they are usually talking about asset managers who are lending and are passing funds straight through—similarly with peer-to-peer lenders. I am encouraged by the fact that when people are freely choosing to get involved with lending, they are not using the expansionary process but lending directly. Whereas the banks are seen simultaneously to fail savers and borrowers, things like peer-to-peer lending are simultaneously serving them both.

Zac Goldsmith: That is a really important point. There is a move towards such lending, but unfortunately it is only a fringe move that we see in the credit unions, for example. It is much closer to what original banking—pure banking or traditional banking—might have looked like. We even see it in some of the new start-ups such as Metro bank; I hesitate to call it a start-up because it is appearing on every high street. Those banks have much more conservative policies than the household-name banks that we have been discussing.

Most people understand the concept of fractional reserve banking even if they do not know the term—it is the idea that banks lend more than they can back up with the reserves they hold.

Guy Opperman (Hexham) (Con): My hon. Friend mentioned Metro, whose founder is setting up a bank—in which I should declare an interest—called Atom in the north-east. It is one of some 22 challenger banks of which Metro was the first. I missed the opening of the debate, so I have not heard everything that has been said, but I do not accept that it is all doom and gloom in banking. Does he agree that these new developments are proof that the banking system is changing and the old big banks are being replaced with the increased competition that we all need?

Zac Goldsmith: I certainly agree with the sentiment expressed. I am excited by the challengers, but I do not believe that it is enough. Competition has to be good because it minimises risk. I know that my hon. Friend the Economic Secretary has dwelt on and looked at this issue in great detail.

Even fractional reserve banking is only the start of the story. I will not repeat in detail what we have already heard, but banks themselves create money. They do so by making advances, and with every advance they make a deposit. That is very poorly understood by people outside and inside the House. It has conferred extraordinary power on the banks. Necessarily, naturally and understandably, banks will use and have used that power in their own interests. It has also created extraordinary risk and, unfortunately, because of the size and interconnectedness of the banks, the risk is on us. That

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is why I am so excited by the challengers that my hon. Friend has just described. As I have said, that is happening on the fringe: it is right on the edge. It is extraordinary to imagine that at the height of the collapse the banks held just £1.25 for every £100 they had lent out. We are in a very precarious situation.

When I was much younger, I listened to a discussion, most of which I did not understand, between my father and people who were asking for his advice. He was a man with a pretty good track record on anticipating turbulence in the world economy. He was asked when the next crash would happen, and he said, “The last person you should ask is an economist or a business man. You need to ask a psychiatrist, because so much of it involves confidence.” The point was proven just a few years ago.

The banking system and the wider economy have become extraordinarily unhinged or detached from reality. I would like to elaborate on the extraordinary situation in which it is possible to imagine economic growth even as the last of the world’s great ecosystems or the last of the great forests are coming down. The economy is no longer linked to the reality of the natural world from which all goods originally derive. That is probably a debate for another time, however, so I will not dwell on it.

Mr MacNeil: The hon. Gentleman is making a good point that we should remember. It was brought home to me by Icelandic publisher Bjorn Jonasson, who pointed out that we are not in a situation where volcanoes have blown up or there have been huge national disasters, famines or catastrophes brought on by war; as a couple of the hon. Gentleman’s colleagues have said, this is about a system failure within the rules, and it is worth keeping that in mind. Although there is much gloom in relation to the banking system, in many ways that should at the same time give us some hope.

Zac Goldsmith: The hon. Gentleman is right, but a growing number of commentators and voices are anticipating a much larger crash than anything we have seen in the past few years. I will not add to or detract from the credence of such statements, but it is possible to imagine how such a collapse might happen, certainly in the ecological system. We are talking about the banking system, but the two systems are not entirely separate.

We had a wake-up call before the election just a few years ago. My concern is that we have not actually woken up. It seems to me that we have not introduced any significant or meaningful reforms that go to the heart of the problems we are discussing. We have been tinkering on the edges. I do not believe that Parliament has been as closely involved in the process as it should be, partly because of the ignorance that I described at the beginning of my speech.

I want to put on the record my support for the establishment of a meaningful monetary commission or some equivalent in which we can examine the pros and cons of shifting from a fractional reserve banking system to something closer to a full reserve banking system, as some hon. Members have said. We need to understand the pros and cons of such a move, how possible it is, and who wins and who loses. I do not think that many people fully know the answers.

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We need to look at quantitative easing. I think that hon. Members on both sides of the House have accepted that it is not objective. Some believe that it is good and others believe that it is bad, but no one believes that it is objective. If the majority view is that quantitative easing is necessary, we need to ask this question: why not inject those funds into the real economy—into housing and energy projects of the kind that Opposition Members have spoken about—rather than using the mechanism in a way that clearly benefits only very few people within the world of financial and banking wizardry that we are discussing?

The issues need to be explored. The time has come to establish a monetary commission and for Parliament to become much more engaged. This debate is a very small step in that direction, and I am very grateful to its sponsors. I wish more Members were in the Chamber—I had intended to listen, not to speak—but, unfortunately, there have not been many speakers. This is a beginning, however, and I hope that we will have many more such debates.

12.55 pm

Mark Durkan (Foyle) (SDLP): I rise to endorse the very significant points made by hon. Members. In particular, I pay tribute to the hon. Member for Wycombe (Steve Baker) for securing the debate and for opening it so strongly. From hearing him speak in Public Bill Committees on banking reform and related questions, I know that he is dubious about our having almost feng shui arguments on the regulatory furniture when there are fundamental questions to be asked about the very foundations of the system. He amplified that point in his speech.

My right hon. Friend the Member for Oldham West and Royton (Mr Meacher) made the point that the whole approach to quantitative easing—several Members have questioned it at a number of levels—proves that the underlying logic of sovereign money creation is feasible and workable. It is strange that some of the people who would dispute or refute the case for sovereign money creation sometimes defend quantitative easing in its existing form and with its current features.

In many ways, quantitative easing has shown that if we are to use the facility of the state—in this situation, the state’s main tool is the Bank of England—to alter or prime the money supply in a particular way, we could choose a much better way of doing so than through quantitative easing. It is meant to have increased the money supply, but where have people felt that in terms of business credit, wages or the stimulus that consumer power can provide?

When we look back at the financial crash and its aftermath, we can see evidence—not just in the UK, but in Ireland and elsewhere—showing that much of what we were told about the worth or the wealth of various sectors in the economy up until the crash has turned out to be vacuous, while the poverty lying in its trail has been vicious. The worth or the wealth was not real, but the poverty is real. People in organisations such as Positive Money in the UK or Sensible Money in Ireland are therefore saying, rightly, that politics—those of us charged with overseeing public policy as it affects the

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economy—need to have more of a basic look at how we treat the banking system and at the very nature of money creation.

As someone who grew up in Northern Ireland, I am very used to the idea of having different banknotes—banks issuing their own money—but we do not think much about that, because we think that all that happens in the Bank of England or under its licence. As a member of the Financial Services Public Bill Committee and the Financial Services (Banking Reform) Public Bill Committee, it seems to me that although it has been recognised that some regulatory powers should go back to the Bank of England, the arrangements for regulation and the Bank of England’s role are still very cluttered.

In fact, in trying to correct the regulatory deficiencies that existed before the crash, there is a risk that we have perhaps created too many conflicting and confusing roles for the Bank of England. Given the various personages, different roles and job descriptions that attach to some of those committees, it seems to me that there is potential for clutter in the Treasury. The common denominator and reference point in the range of different committees and bodies and the things they do, is the Treasury. When the Treasury exercises its powers, influences judgments, and informs the criteria and considerations of those different committees under the Bank of England, there is not enough scrutiny or back play through Parliament.

I endorse the points made by other hon. Members about ensuring more accountability, whether through more formal reference to the Treasury Committee or some other hybrid, as suggested in an intervention on the right hon. Member for Oldham West and Royton. There should be more parliamentary insight—and definitely parliamentary oversight—on these matters. We cannot suddenly be shocked that all the confidence in various regulatory systems turned out to have been badly placed. That was our experience the last time, when people who now criticise the previous Government for not having had enough regulation were saying that there was too much regulation and calling for more deregulation.

If we in this Parliament have produced a new regulatory order, we must be prepared to face and follow through the questions that arise. It is not good enough to ensure that the issue returns to Parliament only the next time there is a crisis, when we will have to legislate again. We should do more to be on our watch. The hon. Member for Wycombe and other hon. Members who secured this debate have done us a service. We want more of a parliamentary watch window on these issues.

There is a necessary role for banks in the creation of money and quantitative easing, but we must entrust them with the right role and with the appropriate controls and disciplines. That is fundamental. It is not good or strong enough that we leave it to the whims of the banks and their lending—supposedly reinforced and stimulated by quantitative easing—to profile the performance of the economy.

If quantitative easing works on the basis of the Bank of England, through the asset purchase facility, essentially using money that it creates under quantitative easing to buy gilts from a pension fund whose bank account is with RBS—which in essence is owned by the Bank of England—then RBS’s bank account with the Bank of England goes up by the value of that gilt purchase. Simultaneously, the bank account of the pension fund

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goes up by that amount, and we are told that the UK money supply has increased. Yes, in theory the pension fund can purchase other assets—is that what is happening?—but while 1% of the big money holders and players appear to have been advantaged through quantitative easing, where is the trickledown to the rest of the economy? It is not there.

The sovereign money creation model seems to be primed much more specifically on a view of the total economy and providing a broad, stable and more balanced approach to stimulus and economic performance. We have had the slowest recovery coming out of a recession with quantitative easing. I do not say that to get some voice-activated reaction from the Government about how good the recovery and performance is, but in broader historical terms it is the slowest recovery, which also leaves questions about quantitative easing.

We heard from the Prime Minister about red warning lights on the dashboard of the world economy, and I wonder whether he would ever say that, to his mind, those warning lights include the degree to which global banks are now playing heavily in derivatives again, and there needs to be more action. That raises issues not just of regulation at national level, but at international level.

1.5 pm

Catherine McKinnell (Newcastle upon Tyne North) (Lab): I congratulate the hon. Member for Wycombe (Steve Baker) on his thoughtful and thorough opening speech, as well as my right hon. Friend the Member for Oldham West and Royton (Mr Meacher) on his remarks. In their absence I also congratulate the hon. Members for Brighton, Pavilion (Caroline Lucas) and for Clacton (Douglas Carswell) on securing today’s important debate.

This debate follows a significant campaign by Positive Money, which has raised important issues about how we ensure financial stability, and how we as parliamentarians and members of the public can gain a greater understanding of the way our economy works, in particular how money is supplied not just in this country but around the world.

Some important questions have been highlighted in the debate, although not all have been answered. There are questions about how money is created, how money or credit is used by banks and others, how our financial system can be more transparent and accountable, and particularly how it can benefit the country as a whole. That latter point is something that Labour Members have been acutely focused on. How do we re-work our economy, whether in banking or in relation to jobs and wages, so that it works for the country as a whole?

It is worth reflecting on our current system and what it means for money creation. As the hon. Member for Wycombe set out eloquently in his opening speech, we know that currency is created in the conventional sense of being printed by the Bank of England, but commercial banks can create money through account holders depositing money in their accounts, or by issuing loans to borrowers. That obviously increases the amount of money available to borrowers and within the wider economy. As the Bank of England made clear in an article accompanying its first quarterly bulletin in 2014:

“When a bank makes a loan to one of its customers it simply credits the customer’s account with a higher deposit balance. At that instant, new money is created.”

Bank loans and deposits are essentially IOUs from banks, and therefore a form of money creation.

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Commercial banks do not have unlimited ability to create money, and monetary policy, financial stability and regulation all influence the amount of money they can create. In that sense, banks are regulated by the Prudential Regulation Authority, part of the Bank of England, and the Financial Conduct Authority. Those regulators, some of which are—rightly—independent, are the stewards of “safety and soundness” in financial institutions, especially regarding banks’ money-creating practices.

Banks are compelled to manage the liabilities on their balance sheets to ensure that they have capital and longer-term liabilities precisely to mitigate risks and prevent them from effectively having a licence to print money. Banks must adhere to a leverage ratio—the limit on their balance sheets, compared with the actual equity or capital they hold—and we strongly support that. Limiting a bank’s balance sheet limits the amount of money it can create through lending or deposits. There are a series of checks and balances in place when it comes to creating money, some of which the Opposition strongly supported when we debated legislative changes in recent years. It remains our view that the central issue, the instability of money supply within the banking system, is less to do with the powers banks hold and how they create money than with how they conduct themselves and whether they act in the public interest in other ways too.

We believe the issues relate to the incentives in place for banks to ensure that loans and debts are repaid, and granted only when there is a strong likelihood of repayment. When the money supply increases rapidly with no certainty of repayment, that is when real risks emerge in the economy. Those issues were debated at great length when the Financial Services (Banking Reform) Act 2013 made its way through Parliament, following recommendations from Sir John Vickers’ Independent Commission on Banking and the Parliamentary Commission on Banking Standards, which considered professional standards and culture in the industry. The 2013 Act created the Prudential Regulation Authority and gives regulators the power to split up banks to safeguard their future, to name just two examples of changes that were made. However, we feel that it did not go far enough.

The Opposition’s concern is that the Government’s actions to date in this area have fallen short of the mark. They have failed to boost sufficient competition in the banking industry to raise those standards and to create public confidence in the sector. As hon. Members with an interest in this area know, we tabled a number of amendments to try to strengthen the Bill, and to prevent banks from overreaching themselves and taking greater risks, by ensuring that the leverage ratio is effective. That goes to the heart of many of the issues we are debating today. The Government rejected our proposals to impose on all those working in the banking industry a duty of care to customers. That would help to reform banking so that it works in the interests of customers and the economy, and not solely those of the banks. Those are the areas on which we still feel that reform is needed in the sector.

It is clear from this debate that there is a whole range of issues to consider, but our focus is that the banks need to be tightly and correctly regulated to ensure that they work for the whole economy, including individuals

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and small and large businesses. That is the key issue that we face at present. Only when the banks operate in that way and work in the interests of the whole economy will we find our way out of the cost of living crisis that so many people are facing.

I thank hon. Members for securing this very important debate and for the very interesting contributions that have been made from all sides of the House. I am pretty certain that this is not the end of the conversation. The debate will go on.

1.12 pm

The Economic Secretary to the Treasury (Andrea Leadsom): I too congratulate hon. Members on securing this fascinating debate. It is long overdue and has allowed us to consider not just what more we can do to improve what we have but whether we should be throwing it away and starting again. I genuinely welcome the debate and hope that many more will follow. In particular, I pay tribute to my hon. Friend the Member for Wycombe (Steve Baker), who now sits on the Treasury Committee on which I had the great honour to serve for four years. I am sure that his challenge to orthodoxy will have been extremely welcomed by the Committee and by many others. I wish him good luck on that.

Steve Baker: May I just say how much I am enjoying my hon. Friend’s place on the Committee? I congratulate her on her promotion once again.

Andrea Leadsom: I am grateful to my hon. Friend.

My right hon. Friend the Member for Hitchin and Harpenden (Mr Lilley) gave a fantastic explanation that I would commend to anybody who wants to understand how money is created. He might consider delivering it under the financial education curriculum in schools. It was very enlightening, not least because it highlighted the appalling failure of regulation in the run-up to the financial crisis that is still reverberating in our economy today. All hon. Members made interesting points on what we can do better and whether we should be thinking again. I pay tribute to the right hon. Member for Oldham West and Royton (Mr Meacher) for his good explanation of the Positive Money agenda, which is certainly an idea worthy of thought and I will come on to it.

Money creation is an important and complex aspect of our economy that I agree is often misunderstood. I would therefore like quickly to set out how the system works. The money held by households and companies takes two forms: currency, which is banknotes and coins, and bank deposits. The vast majority, as my hon. Friend pointed out, is in the form of bank deposits. He is absolutely right to say that bank deposits are primarily created by commercial banks themselves each time they make a loan. Whenever a bank makes a loan, it credits the borrower’s bank account with a new deposit and that creates “new money”. However, there are limits to how much new money is created at any point in time. When a bank makes a loan, it does so in the expectation that the loan will be repaid in the future—households repay their mortgages out of their salaries; businesses repay their loans out of income from their investments.

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In other words, banks will not create new money unless they think that new value will also in due course be created, enabling that loan to be paid back.

Ultimately, money creation depends on the policies of the Bank of England. Changes to the bank rate affect market interest rates and, in turn, the saving and borrowing decisions of households and businesses. Prudential regulation is used if excessive risk-taking or asset price bubbles are creating excessive lending. Those checks and balances are an integral part of the system.

I agree fully that the regulatory system was totally unfit in the run-up to the financial crisis. We saw risky behaviour, excessive lending and a general lack of restraint on all sides. The key problem was that the buck did not stop anywhere. When there were problems in the banking system, regulators looked at each other for who was responsible. We all know that the outcome was the financial crisis of 2008. I, too, see the financial crisis as a prime example of why we need not just change but a better banking culture: a culture where people do not spend their time thinking about how to get around the rules; a culture where there is no tension between what is good for the firm and what is good for the customer; and a culture where infringements of the rules are properly and seriously dealt with.

I will touch on what we are doing to change the regulations and the culture, but first I will set out why we do not believe that the right solution is the wholesale replacement of the current system by something else, such as a sovereign monetary system. Under a sovereign monetary system, it would be the state, not banks, that creates new money. The central bank, via a committee, would decide how much money is created and this money would mostly be transferred to the Government. Lending would come from the pool of customers’ investment account deposits held by commercial banks.

Such a system would raise a number of very important questions. How would that committee assess how much money should be created to meet the inflation target and support the economy? If the central bank had the power to finance the Government’s policies, what would the implications be for the credibility of the fiscal framework and the Government’s ability to borrow from the market if they needed to? What would be the impact on the availability of credit for businesses and households? Would not credit become pro-cyclical? Would we not incentivise financing households over businesses, because for businesses, banks would presumably expect the state to step in? Would we not be encouraging the emergence of an unregulated set of new shadow banks? Would not the introduction of a totally new system, untested across modern advanced economies, create unnecessary risk at a time when people need stability?

Steve Baker: I do not actually support Positive Money’s proposals, although I am glad to work with it because I support its diagnosis of the problem. Of course, this argument could have been advanced in 1844 and it was not. I have not proposed throwing away the system and doing something radically new; I have proposed getting rid of all the obstacles to the free market creating alternative currencies.

Andrea Leadsom: I am grateful to my hon. Friend for pointing that out. I must confess that before the debate I was puzzled that such an intelligent and extremely

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sensible person should be making the case for a sovereign monetary system, which I would consider to be an extraordinarily state-interventionist proposal. I am glad to hear that is not the case. In addition, of course, bearing in mind our current set of regulators, presumably we would then be looking at a committee of middle-aged, white men deciding what the economy needs, which would also be of significant concern to me.

Mr Meacher: Before the Minister leaves the question of a sovereign monetary system, which she obviously totally opposes and to which she raised several objections that I cannot answer in an intervention, does she not believe that the system of bank money creation is highly pro-cyclical and has enormously benefited property and financial sectors to the disadvantage of the vast range of industries outside the financial sector?

Andrea Leadsom: As I said, I sincerely congratulate the right hon. Gentleman on raising this matter; it is certainly worthy of discussion, and I look forward to him responding to some of my arguments. I agree that where we were in the run-up to the financial crisis was entirely inappropriate, and I will come to some of the steps we have taken to improve—not throw away the baby with the bathwater—what we have now, rather than throwing it away and starting again.

I know that some of my hon. Friends and Opposition Members have a particular concern about quantitative easing—I have made it clear that I do too—specifically about how we might unwind it. However, they must agree that at least it can be unwound, unlike the proposal for “helicopter money”, which would seem to be a giant step beyond QE—a step where money would be created by the state with no obvious way to rein it back if necessary.

If the tap in my bathroom breaks, rather than wrenching the sink off the wall, I would prefer to fix the tap. As Martin Wolf said last week,

“nobody can say with confidence”

how a monetary system should be structured and what laws and regulations it should have. Given that and the economic tumult across the world, we should be devoting our energies to fixing the system we have—mending the problems but keeping what works. For that reason, the Government have taken significant steps to improve the banking sector, making sure it fulfils its core purpose of keeping the wheels of the economy well oiled.

We are creating a better, safer financial system, with the Financial Policy Committee, created in this Parliament, focused on macro-prudential analysis and action. As the hon. Member for Newcastle upon Tyne North (Catherine McKinnell) pointed out, the FPC has been given counter-cyclical tools to require more capital to be held and to increase the leverage ratio and the counter-cyclical capital buffers when the economy is over-exuberant in order to push back against it—as the previous Governor of the Bank of England said, to remove the punch bowl while the party is still in full flow. That is incredibly important. We are also reducing dependence on debt. Since the financial crisis, the UK banking system has been forced significantly to strengthen its capital and liquidity position, and it is continuing to do so.

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I must stress, however, that regulation alone will never be enough, which is why the Government are promoting choice, competition and diversity. I am delighted that 25 new banks are talking to the Prudential Regulatory Authority about getting a bank licence. We are also making strong efforts to promote the mutual sector; to enhance the capacity of credit unions to serve the real economy better; to enable booster funding for small businesses; to help families; and to improve customer service. We have put in place schemes to help the transmission of money from banks to customers, including the funding for lending scheme, which has lowered the price and increased the availability of credit for small and medium-sized businesses. As I think the hon. Member for Newcastle upon Tyne North said, we have also created the British business bank, which is helping finance markets work better for small firms, and are investing much resource and effort to build that up and help businesses in our economy.

We also have a programme of measures to increase competition in the SME lending market, including flagship proposals to open up access to SME credit information, which will help challengers to get in on the act, and to have banks pass on declined applications for finance to challenger banks. In addition, we now have an appeals process whereby small businesses turned down for funding can get a second chance, which has secured an additional £42 million of lending since its launch. These are all measures to help small businesses access finance. Then, to mitigate the problem of house price bubbles, we are putting in place supply-side reforms to promote home building and home owning, as well as measures enabling the PRA to limit the amount of lending that households can take on.

I agree with Members on both sides of the House, however, that we should not be content with the system as it stands. We must seek to improve it and make it function better. In Mark Carney, we have an excellent central banker who has the experience and knowledge to put the right reforms in place and see them through. As he says:

“Reform should stop only when industry and society are content, and finance justifiably proud.”

In the medium to long term, we need to create a culture where research and analysis do not shy away from going against the orthodoxy. As hon. Members across the House have said, we need to consider alternatives, and we should be having that discussion; it is healthy to do so, because that is how to make progress. For that reason, the call from Andy Haldane, the Deputy Governor of the Bank of England, for a broader look at new and existing monetary ideas is exactly right.

Mr Meacher: I am pleased the Minister thinks that alternative ways of improving the monetary system should be explored. Will she support the idea of a setting up a commission to examine the alternatives, as recommended by the hon. Member for Richmond Park (Zac Goldsmith), as well as by me—so there is some cross-part support on this? Is that not an idea whose time has come?

Andrea Leadsom: I think that an organisation such as the Treasury Committee, of which my hon. Friend the Member for Wycombe is a member, would be entirely the right place to have such a discussion, and of course

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we also had the Vickers commission, which looked at what went wrong and what measures could be put in place, and the Parliamentary Commission on Banking Standards, which specifically addressed the issue of incentives and motivations in banking. I would not normally advocate the establishment of great new commissions; we already have the bodies to look further at different orthodoxies, and as Andy Haldane has said, the Bank itself will be looking at, and encouraging, the exploration of alternative views.

Of course, we also need to continue embracing innovation, both in the “software” of how payments are made and in the “hardware” of new currencies, such as crypto-currencies and digital currencies—both could open up competition and give customers greater choice and access to funding—but we must do so with caution. In November, we published a call for information inviting views and evidence on the benefits and risks of digital currencies so that digital currency businesses can continue to set up in the UK and people can expect to use them safely.

I am the last person who could be described as statist, but I accept that we must always be ruthless in our determination to regulate new ideas that come to the fore, because as sure as night follows day, as new ideas come in, through shadow banking, new lending ideas and so on, some people will seek to manipulate new schemes and currencies for fraudulent purposes. I am absolutely alive to that fact. It is important, therefore, that the Government carry out the necessary research.

The Government believe that the current system, modified and improved with far greater competition, can service the economy best. However, reform is vital. Again as Andy Haldane puts it:

“Historically, flexing policy frameworks has often been taken as a sign of regime failure. Quite the opposite ought to be the case”.

We need banks to lend—to young families wanting to buy houses and repay out of future labour income rather than relying on the bank of mum and dad, and to businesses wanting to seize opportunities, gain new markets and create jobs and growth. We have an existing system that offers a forward-looking and dynamic framework in which tomorrow’s opportunities are not wholly reliant on yesterday’s savings and which builds on banks’ expertise in assessing risk and making the lending decisions we badly need. During my 25 years at

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the heart of the industry, I saw the sector at its best, but sometimes sadly also at its worst. We are trying to remedy the worst, but let us also keep the best.

1.29 pm

Steve Baker: This debate has been a joy at times, and I am extremely grateful to right hon. and hon. Members who helped me to secure it. The right hon. Member for Oldham West and Royton (Mr Meacher) made clear his support for sovereign money. One of the great advantages of such a system is that it would make explicit what is currently hidden—that it is the state that is trying to steer the monetary system—and if such a system failed, it would at least be clear that it was a centrally planned monetary order that had failed.

The hon. Member for Clacton (Douglas Carswell) talked about the ownership of deposits, and I was glad to support his private Member’s Bill. I am reminded of the intervention from the hon. Member for Hackney North and Stoke Newington (Ms Abbott), who talked about deposit insurance. One of the problems, as seen in Cyprus in the context of depositor “bail-ins”, is that deposits are akin to a share in a risky investment vehicle, so a little more clarity about what a deposit means and what risks depositors take could go a long way.

My right hon. Friend the Member for Hitchin and Harpenden (Mr Lilley) highlighted one of the greatest controversies among free marketeers—whether or not fractional reserve deposit taking is legitimate.

The hon. Member for Great Grimsby (Austin Mitchell) mentioned Major Douglas, which he will have seen put a smile on my face. Major Douglas was dismissed as a crank, even by Keynes who dismissed him in his writing as a “private”. This highlights the fact that the possible range of debate is enormous.

I would like to leave my final words with Richard Cobden, the Member representing Stockport back in the time when this was also a big issue. He said:

“I hold all idea of regulating the currency to be an absurdity; the very terms of regulating the currency…I look upon to be an absurdity”.

The currency, for him,

“should be regulated by the trade and commerce of the world.”

I wholeheartedly agree.

Question put and agreed to.


That this House has considered money creation and society.

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Devolution and the Union

[Relevant documents: Third Report from the Political and Constitutional Reform Committee, Session 2012-13, “Prospects for codifying the relationship between central and local government”, HC 656, and the Government response, Cm 8623; Fourth Report from the Political and Constitutional Reform Committee, Session 2012-13, “Do we need a constitutional convention for the UK?” HC 371; Oral evidence reported by the Political and Constitutional Reform Committee on 16 and 23 October and 6 and 10 November 2014, on “The future of devolution after the referendum”, HC 700.]

Madam Deputy Speaker (Mrs Eleanor Laing): I inform the House that none of the amendments has been selected. Many colleagues have indicated that they wish to participate in the debate, so given the limited time available, there will be a time limit on Back-Bench speeches of seven minutes.

1.32 pm

Mr Dominic Raab (Esher and Walton) (Con): I beg to move,

That this House recognises the outcome of the referendum on Scottish independence; welcomes the freely expressed will of the people of Scotland to remain British; notes the proposals announced by Westminster party leaders for further devolution to Scotland; calls on the Government and Her Majesty’s Loyal Opposition to bring forward proposals that are fair and reasonable for the whole of the United Kingdom, following a period of public consultation to enable people in all parts of the Union to express their views; and, in particular, calls on the Government to ensure such proposals include a review of the Barnett formula and legislative proposals to address the West Lothian question.

I begin by thanking the Backbench Business Committee and its formidable Chair, the hon. Member for North East Derbyshire (Natascha Engel), who is not in her place today, for the opportunity to have this debate. I would also like to thank the right hon. Member for Birkenhead (Mr Field) for making common cause in co-sponsoring the debate and the motion. I thank, too, the 81 hon. Members from four parties who signed in support of the motion.

The great Scottish inventor of the telephone, Alexander Graham Bell, coined the phrase:

“When one door closes, another opens”.

For my part, I thoroughly welcome the outcome of the Scottish referendum and the decision of the Scottish people to remain part of the United Kingdom, but I also recognise—I say this at the outset—the division and the divide it has left north of the border and the consequences that need to be picked up south of the border. In the spirit of Bell, I want to focus on the positive opportunities ahead—opportunities to give greater expression to the Scottish desire for self-determination short of secession, and indeed opportunities for a wider democratic renaissance across the whole of the United Kingdom.

In truth, we have made some progress under the coalition. As a result of the Scotland Act 2012, the Scottish Government will raise around 30%—up from 14%—of their own tax revenue. All parties now pledge further tax-raising powers and greater control over social security. I say to those representing Scottish seats who

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want further devolution beyond the current consensus that I am rather sympathetic, and I will look at and listen to their ideas with an open and sympathetic mind.

Of course, beyond the UK, devo-max, as it is termed, can draw on a variety of federal models, including those of Germany, Canada and even Spain. Scottish National party Members and others will have noted that this would take us well beyond what was promised in the vow of the main party leaders in the Daily Record on 16 September.

Mr Angus Brendan MacNeil (Na h-Eileanan an Iar) (SNP): The hon. Gentleman’s party leader, the Prime Minister, said during the referendum campaign that everything was possible and all was on the table. Does the hon. Gentleman disagree with that?

Mr Raab: This may be the easiest intervention I get today, but I do agree that everything is on the table and that everything is possible. In fact, if the hon. Gentleman listens closely as I develop my speech, he will find that I am rather sympathetic to taking further steps toward financial devolution, which the hon. Gentleman and his colleagues have proposed.

Equally, there needs to be recognition that with greater financial freedom and power, Scotland must expect to bear some additional responsibility. I am sure that as a matter of principle—regardless of the practicalities—all hon. Members would agree with that. A new deal for Britain must be fair to all parts of Britain. In my view, that means two things. First, if we went down the road of devo-max or fuller financial devolution, it would eventually render utterly untenable the Barnett formula used by the UK Government to subsidise the devolved Administrations. That formula is based on outdated spending patterns and population numbers and is already divorced from any objective assessment of real need across Britain. If Scotland now wants greater powers to tax and spend—as I said, I am sympathetic to that—it cannot expect the Union and taxpayers across the Union to keep subsidising them to the hilt on such an arbitrary basis, without fuelling resentment in other parts of the UK. I note that that is also the logic of the SNP submission to the Smith review. I have it here and will happily read it later.

Jonathan Evans (Cardiff North) (Con): Does my hon. Friend not find it curious to hear these sotto voce interventions of SNP Members defending the Barnett formula, which is recognised as unfair to Wales and is vehemently opposed by Plaid Cymru, the SNP’s allies in the House?

Mr Raab: As usual, my hon. Friend makes a cogent and eloquent point. That point is actually made by the SNP in its submission to the Smith review—that the logical consequence of full financial devolution would indeed mean the overhauling of the Barnett formula. I thus say to SNP Members that there may be potential for a nascent consensus on some of this—if it can be reached and grasped.

Hywel Williams (Arfon) (PC): Does the hon. Gentleman agree with the Prime Minister when he said in the Liaison Committee this morning that Barnett reform was “not on the horizon”?

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Mr Raab: I suppose it depends on how broad, far and deep is one’s horizon. [Interruption.] Let me pursue that a bit more, because I want to be clear about it. Today’s motion does not seek to ride roughshod over the vow. It calls for a review of Barnett without prejudice to what would follow. I do not see how anyone on any side of the debate could possibly refuse to countenance consideration of the impact of further financial devolution on the rest of the UK. That would have to entail a review of Barnett.

Mr Mike Weir (Angus) (SNP): There is almost a point of agreement here. In our proposals to the Smith review, we said:

“As part of any agreement, the Barnett Formula should continue to be used to determine Scotland’s resources during any transitional period”.

We are seeking full fiscal responsibility and in that event there would obviously have to be changes to Barnett.

Mr Raab: The hon. Gentleman—I was on the cusp of saying “My hon. Friend”—has made his point so powerfully that we are almost there.

Mr Michael McCann (East Kilbride, Strathaven and Lesmahagow) (Lab): Will the hon. Gentleman give way?

Mr Raab: I am going to make some progress before I give way again. I have been very generous so far.

We must also consider points south of the border, where many people bristle over the fact that Scottish public services already receive over £2,000 more investment per person each year than some parts of England. That investment does not just subsidise free prescriptions and university tuition; in proportion to its population, Scotland has twice as many nurses and ambulance staff as England, and 43% more police officers. However, this is not just a southern gripe. Scotland’s public spending per person on housing and community, for example, is twice as high as that of the midlands, Yorkshire or Humber and the north west, and by comparison with Scotland, Wales gets a poor deal too. I am sure that Members representing Welsh seats will want to make that point for themselves.

Ian Murray (Edinburgh South) (Lab): Will the hon. Gentleman give way?

Mr Raab: I am going to make a small amount of progress, but I will happily take an intervention a little later. I am conscious of the time restraints. I have been told that I have 15 minutes tops, and I want to respect that, because otherwise I shall get into trouble with you, Madam Deputy Speaker.

I know that colleagues in the Scottish National party will argue for the retention of North sea oil revenue in return. Rather than ducking that argument, I want to address it head-on before I give way again. I say to SNP Members that, personally, I accept that basic logic in principle, but it must surely take into account all the British taxpayers’ money that was originally invested in the extraction of the oil, and it also requires us to think far more seriously about the geographical allocation of financial resources across the board. I am sure that they will accept that logic, as it follows theirs. Given the new

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findings of shale gas across England and the draining of oil production from the North sea, I doubt that this is the lottery ticket on which the SNP is betting, but I cannot deny that it is a natural consequence of pursuing the constitutional logic of financial devolution.

Can we not agree, at this stage at least, to arrange the independent review of the Barnett formula for which the motion calls, in the light of proposals from the main parties and across the board, so that the implications for those in the rest of Britain can be examined? Surely their voice, their interests and their concerns cannot be locked out of the debate for ever. Can we not reasonably agree that, subject to areas of spending that will be devolved, the remaining revenue allocated across Britain should follow a needs-based approach, which is precisely how revenue is allocated internally in Scotland?

Mark Lazarowicz (Edinburgh North and Leith) (Lab/Co-op): Does not focusing the debate on the Barnett formula mean focusing it much too narrowly? If we are looking at expenditure, should we not look at the expenditure that the Barnett formula does not fully reflect? Should we not look at the income that the state receives, and the pooling and sharing of resources? If we are to have a review, let us look at the whole picture, rather than picking just one aspect of it.

Mr Raab: The hon. Gentleman has made a good point. I am certainly in favour of looking at the logical implications of financial devolution and following them to their natural conclusion. If we do not do that, we shall have a very “silo” debate.

Dr Sarah Wollaston (Totnes) (Con): Surely it cannot be right for someone who is living with, say, heart disease or cancer to suffer because an extra £203 per head has been allocated elsewhere owing to an accident of geography. Surely all Members want a settlement that is fair to individuals with long-term conditions, wherever they live in our United Kingdom.

Mr Raab: My hon. Friend—who chairs the Health Committee—is absolutely right, as usual. We must all agree that an accident of geography cannot mean that the voices and the needs of the elderly, the vulnerable, and NHS patients somehow count for less.

Mr MacNeil: Let me say something instructive to the hon. Gentleman. He has mentioned subsidies for Scotland a couple of times. If he is going to talk about subsidies, he should understand that referring to expenditure in Scotland in terms of the Barnett formula is cherry-picking. It represents only two thirds of spending, and that is just identified spending: there is another third of non-identified spending. Talking about the Barnett formula is a trick used by Tories and Labour Members to suggest that certain moneys are spent in Scotland. They are not talking about the whole pie; they are talking about two thirds of the pie. That is the trick.

Mr Raab: If the Barnett formula is not subsidising Scotland to the degree that concerns some of us, why is the SNP so averse to any review of it, let alone change? However, as was pointed out by the hon. Member for Edinburgh North and Leith (Mark Lazarowicz), this is not just about the Barnett formula. The second price of further devolution must be steps to bridge the democratic

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deficit between Scotland and the rest of the Union. As in the case of the Barnett formula, south of the border it smarts that Scottish MPs in Parliament still vote on matters concerning England—from social care to school reforms—that in Scotland have been devolved to the Scottish Government.

There are various ways in which we could address the so-called West Lothian question. Others will have different views, but I believe that, as a minimum, any new legislation should implement the common-sense plan presented in 2008 by my right hon. and learned Friend the Member for Rushcliffe (Mr Clarke) to restrict Scottish MPs from legislating at Westminster in Committee and on Report on issues that do not affect Scotland. I suspect that, far from creating deadlock—which is what has been put about—that would lead to a rather healthy spirit of compromise. A United Kingdom Government who were reliant on Scottish MPs would retain the power of initiative, and England would have a democratic shield to prevent such a Government from imposing their will on it without consent.

Tom Greatrex (Rutherglen and Hamilton West) (Lab/Co-op): As I am sure the hon. Gentleman knows, of the 460 pieces of primary legislation proposed by the Government since 2001—the year of the first post-devolution Parliament—eight have been England-only. “English votes for English laws” may suit a headline, but it does not address the real issue—the much more significant issue of the way in which power is distributed around the UK as a whole.

Mr Raab: The hon. Gentleman has made his point very calmly and sensibly, but it seems to me that if we managed to work out how to determine questions such as these for the Scottish Parliament and to enable Scottish devolution to take place, it is not beyond the wit of man or woman to work out how we can redress the balance for England, while also ensuring that the other constituent parts of the United Kingdom have an equal voice. I am sure that the hon. Gentleman would not want his words to be taken as suggesting that he does not believe in the principle of democratic equality. However, as he says, the implications of further Scottish devolution go well beyond England. I look forward to hearing the contributions from Welsh and Northern Irish colleagues, given their unique interests and special circumstances. I say, as an English MP, that their voices must be heard.

Thomas Docherty (Dunfermline and West Fife) (Lab): What about London?

Mr Raab: I think the hon. Gentleman will find that London is part of England, and will, by definition, be considered.

I must refer briefly to the amendment tabled by the Leader of the Opposition on behalf of the Labour party. The amendment, which was slipped on to the Order Paper at the last minute, strips out and opposes, in express terms—

Madam Deputy Speaker (Mrs Eleanor Laing): Order. The hon. Gentleman may wish to address the issues to which the amendment refers, but he cannot speak to it, because it has not been selected for debate.

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Mr Raab: Thank you, Madam Deputy Speaker. I bow to your instructions and guidance.

The proposal, as it was, strips out and opposes, in express terms, any consideration of the Barnett formula. It strips out and opposes, in express terms, any attempt to address the West Lothian question. The Leader of the Opposition seeks to entrench democratic inequality and financial unfairness, for the sake—I fear—of short-term electoral expediency. If we are looking together at a long-term deal for Britain that is good for the whole of Britain, that is utterly unsustainable. I think that our debate will have established, at the very least, that the formal position of the leadership of the Labour party—I recognise that there are diverse views among Back Benchers—is now crystal clear. The Leader of the Opposition is opposed to, and is blocking, reform that would ensure that the legitimate concerns of those who represent English seats were addressed.

Let us think beyond the nations. Devo-max could spur democratic reform well beyond devolution. We still have one of the most centralised systems in any western democracy. We still have what is effectively a system of “one size fits all” governance, magnifying the effects of bad policy and suffocating local innovation. I recognise that the coalition has taken steps in the right direction—for instance, it has established locally elected police and crime commissioners, and has given councils a bigger slice of the tax revenue from the sale of new homes—but Whitehall still grips 80% of the purse strings. In other advanced countries, an average of about half of local or regional government spending is financed by local tax revenue.

I think it is fair to say, on the basis of material from the Adonis review to the Heseltine report, that across the political spectrum there is now a groundswell of ideas on how to deliver stronger local democracy—by providing incentives for local business growth, by promoting home building, or, more broadly, by tailoring policy to local needs whilst ensuring that it is accountable to the taxpayers who will ultimately foot the bill. Bringing decisions on those key issues closer to those who vote and who pay for them might not be a silver bullet, but it will play an important part of rebuilding trust in our democracy.

We should all recognise that the no vote in September’s referendum will not end the Scots’ yearning for more control over their own lives, but, rather than those on either side resenting it, the rest of Britain should look on it as an opportunity for democratic renewal, which must take place across the whole Union. As Graham Bell put it,

“we often look so long and so regretfully upon the closed door that we do not see the one which has opened for us.”

I commend the motion to the House.

1.50 pm

Mr Roger Godsiff (Birmingham, Hall Green) (Lab): I congratulate the hon. Member for Esher and Walton (Mr Raab) on securing the debate. Like him, I welcome the result of the Scottish referendum. However, Members should be under no illusion. The way in which the UK is governed has changed, and we cannot change it back. These issues are more important than the Barnett formula. Promises were made about devolution max to the people of Scotland, and those promises have to be honoured.

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It would be inconceivable—and political suicide—not to do so. Once those promises have been honoured and powers have been transferred to Scotland, however, there will quite rightly be demands from the Welsh Assembly and the Northern Ireland Assembly for the same powers to be transferred to them. If those powers were not transferred, the people of Wales and Northern Ireland could rightly say that they were being discriminated against.

Jonathan Evans: May I caution the hon. Gentleman about saying that exactly the same powers should be offered to Wales? Wales is not Scotland. Speaking as the chairman of the Welsh Conservative party, I must tell him that the Conservatives are the official Opposition there. That is not the position in Scotland. We are two very different countries.

Mr Godsiff: I did not say that the powers would automatically be transferred. I said that they would have to be offered to the people of Wales and Northern Ireland, because if they were not, the people of those countries could rightly say that they were being discriminated against.

Once Scotland has been given devo max, if Wales and Northern Ireland choose to go down that path as well, there will in my opinion be an unstoppable momentum for an English Parliament to be set up. That is, and has always been, the logic of devolution, and we have to live with that. This raises other questions as well. If we have four Parliaments responsible for a whole range of services, the role of the Westminster Parliament will have to change. Westminster could of course retain its role in foreign affairs, defence and international trade matters, as well as a whole range of residual responsibilities, but such a change would automatically mean that there would be no need for such a large House of Commons, because many of the services would have been devolved. We would need a much smaller House of Commons.

As part of the new constitutional settlement, we are going to have to ask other questions. Would the Westminster Parliament continue to need two Chambers, the House of Commons and the House of Lords, or could we have a unicameral Parliament? Would we need to retain the House of Lords in its present form, or could it be abolished? If these changes were to happen, the four devolved Parliaments, together with the Westminster Parliament, would also have to decide on the role of the monarchy in the new constitutional settlement. On the front page of The Guardian newspaper today, Prince Charles’s spokesman is suggesting that King Charles III would have a much more activist role in British politics, so it might be appropriate to have such a discussion.

The Scottish referendum has changed politics in the United Kingdom completely, and we cannot turn the clock back even if we want to. Once we started down the road of devolved government in this country, we were always going to be faced with the prospect of referendums on independence. Such referendums will be won only by winning hearts and minds, as happened in the Scottish referendum. There will be more of them in future. The reason that nationalist parties exist—in Scotland, Wales and indeed in Northern Ireland—is to seek to achieve independence for their countries. That is

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perfectly reasonable and proper, but if that was not their objective when those parties were set up, they would have no future role whatever.

Like it or not, we are moving towards a federal structure in the United Kingdom. I believe that that holds considerable attractions, although others will disagree. The momentum is such that it is going to happen, however, and I believe that it will happen sooner rather than later.

1.57 pm

Mrs Anne Main (St Albans) (Con): I apologise for missing the first few remarks made by my hon. Friend the Member for Esher and Walton (Mr Raab). I should like to say that it was a pleasure to listen to the hon. Member for Birmingham, Hall Green (Mr Godsiff), but it kind of wasn’t, really. It was disappointing to hear the suggestion from the Opposition that the devolution of powers is a way of splitting up the Union by the back door. I do not believe that it ought to be, or that it was ever meant to be. Scotland voted to remain part of the Union, and I am very glad that it did so.

Powers have gone to Wales and Scotland, and quite rightly so. They should have a say over how they run certain important matters that are particular to them. This cannot be a one-way street, however. We cannot give powers back and not expect that to have an impact on the workings of this place. Inevitably, there will be subjects relating to Scotland and Wales that we will be expected not to vote on. Stamp duty could well be one of them. This is a subject that I am particularly passionate about, because Scottish Members could potentially vote on stamp duty in England. According to the latest figures, my constituency pays more stamp duty than Scotland and Wales put together, and I find it amazing that I would have no say over stamp duty in Scotland, yet Scotland could well have a vote on stamp duty in my constituency. That is rather bizarre.

The logical conclusion of our giving powers to Scotland is that we should recognise the democratic deficit that it has created in our own Parliament. That needs to be addressed. I accept that we have a united Parliament, but that does not mean that we cannot come up with a system that recognises the new arrangements. We do not need to create a whole new English Parliament, as the hon. Member for Birmingham, Hall Green suggested, but we need to observe custom and practice and say that there are certain things that hon. Members from Scotland or Wales should not participate in. That would be a fair situation.

Naomi Long (Belfast East) (Alliance): I remind the hon. Lady that Northern Ireland remains part of the United Kingdom, in case we are in any doubt. Does she agree that a similar approach should be taken when reserved and excepted matters for Northern Ireland that affect only Northern Ireland are voted on in this place? On those occasions, where Northern Ireland Members have agreed on a certain course of action we are often overruled by English MPs.

Mrs Main: The hon. Lady makes an interesting point, and I am certain that there would be no reason why, if the motion is carried today, everything could not be on the table for discussion. It would be up to her to make her case, but I think that what she describes is very

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different from what the hon. Member for Birmingham, Hall Green was suggesting, which was that we have to split up the whole of the Union into little tranches of competences. It would be unrealistic, and it would certainly result in a democratic deficit, to suggest that people in Scotland can have grabbed power for themselves, and rightly want to use it, but resist giving away any of their powers in this place. I know it suits the Labour party to try to keep those powers, but we have to make the case that it is not reasonable and not fair.

Lord Barnett has said the following about the Barnett formula:

“It is unfair and should be stopped, it is a mistake. This way is terrible and can never be sustainable, it is a national embarrassment and personally embarrassing to me as well.”

I do not believe we should scrap the Barnett formula, but we should certainly review it, and whatever comes out of that would be done with the will of the House. Far less money is spent on my constituents and I find it hard to justify to them that in my constituency, which contains areas of multiple deprivation, people get some 11% less than the UK average, 23% less than Scotland gets and 28% less than Northern Ireland gets.

Mr MacNeil: rose—

Mrs Main: I will not give way. I am sure that many MPs on the Benches around the hon. Gentleman want to make the case for the Scottish National party.

Because of the flaws I am outlining—[Interruption.] My constituency is not in London. St Albans is in a county above London, and we are not part of the London development system up there, but we have to pay a high price for our properties. My constituents do not understand why they are net contributors to the Chancellor’s coffers and do so badly when they are trying to get services—

Pete Wishart (Perth and North Perthshire) (SNP): Will the hon. Lady give way on that point? She cannot get away from it.

Mrs Main: I can get away from it—I can ask the hon. Gentleman to sit down. My constituents are as much in need of services as any other constituents. [Interruption.] If he wishes to make his speech when he gets to have his turn, fair enough, but please stop barracking me from the Opposition Benches. My constituents are entitled to expect a decent level of services, and it is hard to provide that when the formula is so skewed in the way that it is. We should look at it and review it.

Pete Wishart: On that point—

Mrs Main: I think I have made it clear to the hon. Gentleman that I do not intend to give way on the Barnett formula; my constituents are very exercised about it. St Albans city & district council—Conservative-led—has frozen council tax for the seventh year in a row, but people cannot expect to have money come out of nowhere. My constituents find it difficult when they see people north of the border having far more money spent on their services.

People have talked about respecting the views of Scotland when it voted on independence. It is a shame the SNP does not do that, because it seems as though

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this is a “neverendum” campaign—it is as though the vote never happened. It is as though it has just been a blip on the road to still delivering independence. So may I say to SNP Members that the vote was lost? They may not have noticed that. Its new leader—as of today—has said recently:

“I want this party of ours, this movement of which we’re so proud to belong, to keep making the case for Scotland being an independent country.”

As such a large amount of Scots’ money has been spent on this—about £14 million, I believe—may I suggest that we rest the matter for a while and now try to address the democratic deficit that has come out of it? The campaign for independence was lost and now we have to ask how we get a good deal for Scotland; as was promised.

The deal that was promised by all three leaders was that Scotland would have new powers and a fair deal under a Barnett formula or something like a Barnett formula—I do not know what it will be called. Inevitably, as has been said, times move on. The argument has moved on from all the power being here to the power being shared out by those who best know how to use it—I am sure the Scots would not object to that description—for their own local communities, so that shows that the argument has moved on from independence. It is time we drop the “neverendum” campaign, constantly dangling the prospect of independence, and say, “Let us get the right deal and the right formula.” That right formula must be obtained for constituencies such as mine, which say that it is not fair that people in Scotland who have no interest in the stamp duty in St Albans may have a say on it, whereas my constituency will have no say on stamp duty levels in Scotland. Let us recognise that democratic deficit. Let us ensure that we have a fair deal. I cannot see why anyone on the Opposition Benches would argue against a fair deal for their constituencies in England—they would have to explain to their own electorate why they would like to remain in an unfair scenario created as a result of the referendum vote.

2.5 pm

Mr George Howarth (Knowsley) (Lab): First, I thank the Backbench Business Committee for the opportunity to have this debate and the hon. Member for Esher and Walton (Mr Raab) for introducing the subject. I want to discuss city regions and, specifically, the Liverpool city region, but first I wish to make two brief general points. The first, which is largely accepted across the political spectrum, is that there has been over-centralisation in the UK, as a result of which our city regions—and, some would argue, our counties—have underperformed on productivity, investment, value added and many other things. The second is that, without doubt, there is public disenchantment with the Westminster-Whitehall model and an appetite, certainly in my constituency and in my city region, to ask what we can do for ourselves and whether we can do it better than central Government and the Westminster-Whitehall model.

I now wish to discuss how the Liverpool city region could move towards a better model in terms of fiscal powers and additional powers that currently are either with central Government or with other bodies that are not directly democratically elected. On fiscal devolution, I wish to make two points. First, as a result of fiscal devolution there is a need to enable city regions to

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retain local investment and local taxation; local finance bonds offer potential, and it is necessary to remove the restrictions currently on local government and, in particular, on combined authorities in the work they can do to support growth. I will not labour the second point, but there needs to be greater flexibility on borrowing. When there is a big strategic reason, such bodies should not have to go cap in hand to central Government, but instead operate a more prudential system to determine what is right.

Ann McKechin (Glasgow North) (Lab): My right hon. Friend is making a persuasive argument. Does he agree that, constitutionally, the role of local or regional government needs to be safeguarded, so that central Government, both here and in Scotland, do not dictate the level of council tax or revenue raised by local authorities, thereby hemming in their ability to react to local demands?

Mr Howarth: I am grateful to my hon. Friend. Given what I have said, it follows logically that I do agree with that.

I was going to say a word in response to the hon. Member for St Albans (Mrs Main) but she seems to have disappeared. [Hon. Members: “She has moved.”] Oh, I am sorry. She put forward an argument about the Barnett formula, but there is a different, less polarising way of expressing her points that actually supports her underlying argument. I do not personally—and neither, I am sure, do most colleagues, certainly on this side of the House—have any difficulty with the Barnett formula. What I want is a Barnett formula for England, or something equivalent, and others will make a strong case for something similar for Northern Ireland and Wales. The issue is how we get a fairer distribution of resources.

Mrs Main: Will the right hon. Gentleman give way?

Mr Howarth: I will not give way, because I have not got a lot of time, but I hope the hon. Lady will agree that what I am saying—

Mrs Main indicated assent.

Mr Howarth: The hon. Lady nods in assent, as what we are saying is very much along the same lines; I just put it in a slightly different way. I think we need a better system of distributing resources, certainly to areas such as mine where the need is great yet is not currently being addressed.

I want to talk briefly about some of the powers. This is not an exhaustive list, but it suggests the sort of areas we could move forward on: innovation, research and development, housing, skills, employment support, infrastructure and, in the longer term, transport, policing, waste disposal and fire and rescue services. Those are the areas we should be, and indeed are, talking about.

I hope we can have this discussion out in the open. What slightly disturbs me is that there are a lot of discussions going on behind closed doors. We need an open discussion about this.