By Daniel Freeman, Managing Editor and Deputy Editorial Director at the Institute of Economic Affairs

Britain has never truly recovered from the Great Financial Crisis (GFC), and the country is now approaching its third lost decade of economic growth. Understanding why requires a proper diagnosis — and that diagnosis begins in the City, London's financial district and the historic heart of UK banking.

Before 2008, the UK and US economies expanded at nearly identical rates. Per capita trend growth stood at 2.3 per cent in the UK, marginally above the 2.1 per cent recorded in the US. When the financial crash struck, both nations — along with much of the developed world — absorbed significant economic damage. The critical difference is what happened next: the US returned to its pre-crisis growth trajectory, and the UK did not.

This divergence lies at the heart of Britain's underwhelming economic performance and explains why growth has become such a politically charged issue. From the City to Carlisle, the consequences of stagnation are tangible — in weaker wage growth, fewer job opportunities, and declining living standards. Politicians have, over the past five years, finally acknowledged the problem and placed growth atop their agendas, yet meaningful change remains elusive.

Ruling Out the Usual Suspects

Several popular explanations fail to withstand scrutiny. The first — and perhaps laziest — assumption is that financial crises inevitably cast long shadows, and that a severe crisis naturally produces a prolonged downturn. This does not account for the gap between the UK and the US. Moreover, economist Tyler Goodspeed has examined evidence from 300 years of recessions on both sides of the Atlantic and reached the opposite conclusion: deeper economic contractions are typically followed by steeper rebounds.

A second common explanation, favoured by many on the political left, points to austerity. Yet this too cannot explain the divergence with the United States. America pursued a comparable programme of fiscal retrenchment and spending cuts. US government spending peaked at 40 per cent of GDP following the GFC but had been reduced to 34 per cent by 2015. In the UK, government expenditure remained at 42 per cent of GDP in 2015 and has since climbed back to 45 per cent.

A third set of explanations, preferred by many on the right, cites Britain's restrictive planning regime and an overly burdensome tax system. Both undeniably act as brakes on growth and should be priorities for reform. However, neither adequately accounts for the specific post-GFC divergence from America, primarily because both conditions predated the crash.

The Banking Regulation Hypothesis

So how can we best explain why the UK is today approximately 40 per cent poorer than the US, when in 2008 it was closing the gap? How is it that, after sixteen years, Britain would rank as the poorest US state as measured by GDP per capita?

In a new briefing for the Institute of Economic Affairs examining Britain's Great Stagnation, Tyler Goodspeed argues that the decisive difference between the two economies lies in the impact of banking regulation. Goodspeed served as a senior economist on the Council of Economic Advisers during the Trump administration and now teaches at the University of Oxford, bringing direct experience of US policymaking to the comparison.

Following the crash, policymakers enacted a severe tightening of bank capital, leverage, and liquidity rules. Successive Basel Accords after 2009 — particularly the Basel III framework agreed in late 2010 and phased in over the following years — required banks above certain size thresholds to hold more capital and pass more rigorous stress tests. Under these rules, sovereign debt carries a zero-risk weight, while lending to a small manufacturer in Sheffield does not. Liquidity coverage requirements compelled banks to hold government bonds against thirty days of projected outflows. From 2010, Britain compounded the problem with a bank levy that taxed bank lending but exempted liabilities backed by gilts.

The cumulative effect was to make lending to the state cheap while making lending to businesses expensive and more difficult. Although similar regulatory changes were implemented on both sides of the Atlantic, they had a far greater impact on Britain's economy, which is far more dependent on bank financing.

In the UK, businesses rely on banks for over 60 per cent of their external financing. In the US, that figure falls below 40 per cent, with the majority of external funding sourced through non-bank channels including venture capital and private equity. Additionally, many smaller US banks avoided the harshest effects of the Basel Accords because they did not meet the asset-size thresholds at which the new regulations kicked in.

Credit and Consequences

Growth trend lines for the UK and US during this period mirror the trajectories of credit flowing to private business sectors. In the US, private-sector credit returned to its pre-GFC level by mid-2013. In the UK, it remains 15 per cent below pre-GFC levels.

When politicians responded to the GFC, their primary instrument was financial regulation. That regulation effectively required economies to function with reduced access to a critical input for which there are limited substitutes — bank credit. Before the crisis, small and medium-sized British firms saw 80 to 90 per cent of loan applications approved. By 2024, that approval rate had dropped below half. Without access to credit, many small and medium-sized businesses struggle to scale, stripping the UK economy of a vital engine of growth.

Today, the average family is approximately £10,000 per year worse off than they would have been absent these policy choices. With a clearer understanding of what caused Britain's great stagnation, the right solutions can be found.