From Rishi Sunak’s ‘Plan for Jobs’ to the Coalition’s unrealised plans for a Northern Powerhouse, successive governments have promised a return to Britain’s manufacturing prowess of days gone by.

These promises come after decades of deindustrialisation and have been fairly useful political tools, allowing politicians to appeal to both nationalist pride in Britain’s former place as the workshop of the world while also promising hope for disaffected communities outside of the south of England.

However, if the government is to get serious about re-industrialising, then it needs to confront one of the major factors holding back British manufacturing: the size of the UK financial sector.

The UK finance sector ballooned in size following the ‘Big Bang,’ its rapid deregulation in the 1980s. This removed fixed commissions for trades, allowed foreign firms to own British brokerages and ended the separation between traders and investment advisors.

This paved the way for the rapid expansion of the City of London, turning it into the true rival of Wall Street. It also saw a massive transfer of money into financial mechanisms such as mortgages and stocks. This is part of why so much of the UK’s growth in wealth over the past four decades has been in house prices and pension pots.

By the 1980s, sustained inflation had been ensured. This had nothing to do with frivolous government spending as was argued at the time, but rather was caused by the oil shocks of the preceding decade. When the energy source you use to power most production and transport increases in price, inflation is pretty much guaranteed.

What the Big Bang did was to change the type of inflation the UK was experiencing, from the rise in price of consumer goods to asset price inflation, the rise in value of capital goods. This had disastrous consequences for British manufacturing.

Following the Brexit referendum, the Nobel laureate Paul Krugman pointed out that the falling value of the British pound could actually be a good thing, both for manufacturing and for more generally overcoming the effects of ‘Dutch Disease’.

Dutch Disease is a phenomenon where the emergence of one extremely valuable resource within an economy can have adverse effects on other sectors such as manufacturing. It was first discussed by The Economist in the early 1970s, in relation to the discovery of major natural gas reserves in the Netherlands.

This had served to increase the value of the Dutch Guilder, as foreigners needed it in order to buy Dutch gas. This made Dutch manufacturing less competitive and subsequently more and more investment in the Netherlands was diverted away form the manufacturing sector and towards the new energy industry.

A similar story has played out in Britain, as the finance sector has grown to become the key organ of the British economy. Allowing foreign ownership of UK brokerages opened the door for vast quantities of foreign capital to be invested on the London Stock Exchange, which has driven up the value of the pound.

As with the Netherlands in the 1970s, this has made British manufacturing less competitive on international markets. And as with the Netherlands, this has diverted much of Britain’s resources to the new, highly profitable industry, at the expense of the rest of the economy.

In particular, talented individuals have been diverted to careers in the City of London, while vast salaries are now paid to senior bankers even as investment and other real wages stagnate across the rest of the economy.

However, the case of UK financialisaton is not necessarily the same as the discovery of Dutch gas. For one, natural gas is useful (if environmentally ruinous). While the Dutch manufacturing and agriculture sectors suffered decline, there was some broad benefit to the emergence of a burgeoning Dutch energy sector.

By contrast, much of the UK financial sector is completely separated from the real economy, the activities which actually create value. Former Governors of the Bank of England Mark Carney and Mervyn King have both condemned the ‘socially useless activity’ of City Banks. This means that there has been little positive benefit accrued as a result of Britain’s Dutch Disease.

The effects of this phenomenon have been startling. As British financial markets liberalised, new investment was diverted into the assets which were most profitable, including housing and stocks. This was likely the driving factor behind the housing bubble which burst in 2007, as profit maximising bankers and traders diverted more and more money into these areas, fuelling sustained asset price inflation.

This process meant that manufacturing and other sectors lost out, as private capital (intended to replace state investment) was invested elsewhere. In 2015, the OECD identified that the UK economy was suffering as a result of a sustained lack of investment in infrastructure; while compared to EU countries, the UK has consistently underinvested in healthcare infrastructure. This has had serious adverse effects for the real economy, as a lack of investment has predictably harmed long-term growth.

This lack of investment has not affected each part of the country equally. While the erstwhile British economy had manufacturing centres dotted around the country, the new financial economy has been focused on the City of London.

Even large investments into the mortgage market has been directed towards the South of England, where the growth of house prices has risen at a far higher rate than in other parts of the country. As a result, this lack of investment has been most strongly felt in the same areas which suffered the worst deindustrialisation, particularly in the North of England.

There are a large number of measures which could be taken to improve British manufacturing, not least of which would include government investment, improvements in education and improvements in transport links.

However, if any government is to achieve reindustrialisation, it will need to accept the need to downsize the British financial sector. This would allow resources to be better employed in the real economy and for a weaker pound to make British goods more competitive in international markets.

There may be an opportunity here. As Britain leaves the European Union, transaction costs coupled with a lack of access arising from a lack of regulatory alignment will place a new burden on the British banking sector. Should this be embraced rather than fought, Britain could systematically downsize its financial sector and strategically improve the real economy.