Britain aspires to a second Big Bang in financial services such as the one famously unleashed by Margaret Thatcher in the 1980s. But the point of a Big Bang is that it happens only once.
Earlier this month, chancellor Jeremy Hunt unveiled the so-called Edinburgh Reforms, an ambitious loosening of financial regulations aimed at restoring some of the international competitiveness lost by the UK in recent years. This includes easing the ring-fencing separating retail and investment banking, scrapping the cap on bankers’ bonuses, overhauling the regime that makes senior managers responsible for infractions and repealing aspects of European Union rules. Officials also want to lower taxes on asset managers and make it easier to raise capital in the UK.
The ruling Conservative Party had long promised a Big Bang 2.0. Unlike his predecessors, however, Hunt has toned down the claims about the Brexit dividend of cutting EU red tape. His caution is well warranted.
It is true that the UK’s economic outcomes have been historically linked to the global standing of the City of London as a financial hub. After London lost ground to New York at the start of the 20th century, the UK’s output growth per capita began a long period of underperformance against other rich nations that was only interrupted between the late 1980s and 2008. This resurgence is typically traced back to 1986, when the Thatcher government enacted a broad deregulation of the London Stock Exchange, including a switch from floor-based trading to an electronic system, which made UK markets internationally competitive.
The global financial crisis, by contrast, came with extra regulation that made financial firms, particularly so-called universal banks, structurally less profitable around the world. Ever since, economists have brooded about the “productivity puzzle” ailing the UK. The data points to weak productivity within most sectors, but the difference in average growth between the run up to 2008 and its aftermath is almost fully explained by three sectors: information and communications, or ICT, manufacturing and finance.
Of the three, finance is the only one in which productivity growth — measured as output per hour worked — sped up even as employment in that industry exploded, and then fell despite jobs cuts. Conversely, pre-crisis gains in manufacturing productivity were achieved partly by globalisation destroying all the less-competitive firms: Between 1980 and 2008, the sector went from accounting for a quarter of the British workforce to only 9%. Ever since, employment has fallen by less, and productivity has suffered. Likewise, the productivity slowdown in ICT coincides with hours worked increasing faster.
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Officials’ desire to reactivate the financial engine of growth is thus quite understandable.
However, the Big Bang happened in a very specific context: Eurocurrency markets had been set up in London in the 1950s and 1960s, capital controls had been taken down in 1979, the government championed broad-based deregulation and the Bank of England looked kindly upon big financial conglomerates. Globalisation concentrated gains at the top. It was an implicit — and partly unwitting — industrial policy favouring finance.
Most of these gains can only be reaped once, especially with globalisation now in a mild reversal. Indeed, the damage of Brexit after 2016 is likely greater than any benefit from deregulation, since it has limited how much London can sell financial services to the EU. While it remains the main financial hub in Europe, its importance for trading of shares and derivatives has declined. 7,000 finance jobs have moved to cities such as Paris and Amsterdam, EY estimates.
Also, the Bank isn’t on board this time around. Governor Andrew Bailey warned last week against making the financial system more fragile again. Many banking rules safeguarding against this, such as capital-ratio minimums for the biggest banks, are global, not just EU-wide.
To be sure, Britain’s post-crisis regulations, including the senior manager regime and the ring-fencing, were stricter than many of its peers’. Undoing this mistake could help: London’s natural comparative advantage in finance need not be actively undermined either.
Ultimately, though, it makes little sense for the UK to base its growth strategy around the sector that gained the most from globalisation right after leaving the world’s largest trading bloc, rather than expanding on those that lost from it, such as manufacturing. While some cosmologists have theorised that Big Bangs could actually happen in cycles every trillion years, they always require the prior destruction of the universe.
Write to Jon Sindreu at email@example.com
This article was published by The Wall Street Journal, a fellow Dow Jones Group title
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