One of the fears surrounding Brexit is that the City – i.e. the core of Britain’s financial sector – will suffer. If the UK is no longer the gateway to Europe, then leading firms will quit London for Paris, Frankfurt or Luxembourg. There’s not much sign of that so far – despite Theresa May handling the Brexit negotiations with what no one is calling aplomb.
But what if the City does shrink? Would that be a disaster for the UK? Not everyone thinks so – indeed, as ‘Schumpeter’ points out in The Economist, the notion that Britain’s financial sector is too big is “gathering momentum.”
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The article focuses on a book by a “former contributor to The Economist,” Nicholas Shaxson. Despite this connection, the anonymous author of the article mostly disagrees with him.
Of course, there’s little doubt that the sector is an elephant in the room of the UK economy:
“Financial firms from around the world are drawn to the British capital; the assets in the country’s financial system are ten times its GDP.”
However, for the rest of the country, this isn’t always a happy living arrangement:
“Many Britons suspect that the City succeeds at everyone else’s expense. That view is decades old, but the financial crisis of 2007-08 intensified it greatly. The crisis brought the economy to its knees; the state spent £140bn ($220bn) bailing out banks.”
While inner London is disproportionately rich – other parts of the country are disproportionately poor – with 2016 EU figures showing that the UK has six of the poorest ten regions in Northern Europe.
It is suspected that London, and especially London’s financial sector, is sucking talent, investment and opportunity out of the rest of the country:
“Mr Shaxson provocatively compares Britain’s situation to that of Angola, a country where oil makes up over 95% of exports. Oil should bring widespread prosperity to Angola, but it does not. Brainy Angolans flock to the oilfields rather than to the civil service or health care. Floods of foreign capital raise the value of the currency, making non-oil industries uncompetitive.”
Schumpeter disputes the comparison – and clearly there are differences between a dominant sector centred around the extraction of a single natural resource and one that offers deep expertise across of a wide range of specialised services. However, there is a significant concession to Shaxson’s argument:
“…the City does encourage foreign investment in British firms and property. That pushes up both wages and rents in London, and probably the pound too, making it harder for other, price-sensitive export industries to thrive.”
Schumpeter also notes that “relative to its economy, Britain sees 50% more mergers and acquisitions than America”.
As, I’ve written about before, an influx of foreign capital for speculative purposes generates juicy fees for middlemen and money handlers, but little in the way of genuinely productive activity. Furthermore, if it’s a net influx then it will push up the value of the currency and widen the current account deficit.
The new British disease – i.e. a debt-ridden, low-productivity economy prone to asset bubbles and extremes of inequality – is the natural consequence.
But if that’s the problem, what’s the solution? Certainly not one achieved with a blunt instrument. Seeking to shrink the financial sector without distinguishing between speculative and productive investment (and the expertise that enables the latter) would risk doing more harm than good.
The real answer can be seen from the sheet glass windows of the city’s statement architecture. Look down and you can see it: the river Thames.
Had it been left to its own devices, London’s great river would be wide and shallow – spreading out to where it wasn’t wanted or needed. It would also flood on a regular basis, causing catastrophic damage. But over the centuries, the Thames has been tamed. Bridges have been built; the river embanked; and a great barrier put in place to hold back the tidal surges.
As with water, so with money. We needn’t reduce the volume of finance flowing through London, but we must do more to direct it – or at least direct it away from where it does no good. Speculation, especially in land, must be discouraged – with the tax and regulatory framework favouring productive investment instead.
Speculative investment is lazy investment – requiring no great knowledge or expertise. A country does not require a sophisticated financial sector to suffer property booms. asset bubbles and Ponzi schemes. It just needs more money than sense.
Therefore, constraining finance from following its own worst instincts need not sap its energy. A properly regulated financial sector, like an soundly embanked river, would flow faster and deeper than it did before.