Let's go back to raising real capital for the real world

If you want to see financial Armageddon in all of its savagery, forget Wall Street, London or even Reykjavik, and go instead to Edinburgh. The Scottish capital, home to both collapsed RBS and HBOS, is at the heart of the disaster that has overtaken British banking, and will never again be the dynamic wealth-creating centre that enabled it to dominate the UK banking business. Edinburgh was the financial hub that funded the Scottish industrial revolution in the 19th century, full of thrifty, shrewd businessmen - "canny" was the word they applied to themselves - and when Scottish heavy industry went bad in the 20th century, it reinvented itself as the centre of what we now call the "financial services industry".

It is a mirror of the great disaster that has overtaken global finance, and a role model for how not to run a financial system. Until it went wrong, it was peopled by proper merchant bankers. These formidable executives tapped the financial savings market for resources to channel into real business projects - large-scale industrial and commercial development, infrastructure projects and transport systems. They were investing in physical reality - and you can see and touch a bridge, or a wharf, or a coal mine - but not a collateralised debt obligation.

Some time in the 1980s, merchant bankers seem to have disappeared as a species, to be replaced by investment bankers. Essentially a US phenomenon, these financial rocket scientists became the masters of the universe, capable of turning dross into gold, it seemed, and armed with an intellectual arrogance that was breathtaking. If you did not understand their "products", it was sneeringly implied, you just were not smart enough.

With hindsight, it was all largely spurious. The "financial services industry" was not an industry at all, its "products" have turned out to be worthless, or toxic, and its bonus-fixated "workers" have led the world down the bonfire path to financial ruin. Some 20 per cent of US economic activity is related to financial services. The proportion was bigger in the UK before it went through the current convulsions and - though figures are not readily available - probably of a similar proportion in the UAE; and before the crisis, it was growing.

Worse still, by persuading the rest of us that they were indeed an "industry", they led us to neglect real industry. Executives who wanted to raise money for infrastructure projects or commercial expansion were regarded as quaint and old-fashioned. Why bother to fund real business when you could invent another "smart" piece of paper that would help ensure you got the annual bonus? The history of the UAE - and especially Dubai - should persuade us of the attractions of the more traditional "merchant" banking model. Until the world got hooked on financial services, Dubai's economy had developed by the practical and pragmatic application of capital to physical business opportunities. The use of Kuwaiti funds to dredge Dubai Creek in the 1960s, or the partnership between the Dubai Government and the British Bank of the Middle East (now subsumed within HSBC) that extended the trade-credit system to Dubai merchants, are both good examples of finance working in partnership with commerce.

Since those days, merchant capital continued to play a crucial role in Dubai's economic boom, providing the funds to develop the city's infrastructure and physical assets - the hotels, malls, transport and leisure facilities - that made Dubai Inc a successful and dynamic operating company. Some time around the turn of the millennium, the priorities were changed. Seeing the glittering success of the great financial centres such as New York, London and Hong Kong, Dubai decided it should go the financial services route too, and launched the Dubai International Financial Centre (DIFC) to get it on the bandwagon.

The founders of the DIFC saw that the Gulf region needed a financial hub to channel its vast energy revenues from oil and gas. Dubai was to be that hub, they decided. There is a nugget of logic at the heart of this proposition, and a bustling financial centre is both a wealth creator and wealth attractor in its own right - but surely it has gone too far in the financial services direction. The largely western financial institutions that have been enticed into DIFC are the same ones that have served up the current global disaster.

The time is right for a recalibration of the Dubai financial model, to get back to the earlier version of a system designed to raise real capital for real businesses. Project finance, venture capital and "angel" investors are the priority. It does not need "smart" paper - it needs tangible investment in real sectors, just like construction, property, energy and transport. Otherwise, it could all end up looking like poor old Edinburgh.