It is surely a matter of national pride that a country with only 1 per cent of the world’s population who generate 4% of the world’s GDP can have such a large financial sector. Something like 17 per cent of the world’s international lending is arranged here, along with a similar proportion of the world’s insurance. The UK is also home to 10 per cent of the world’s trade, project and asset finance, 11 per cent of its asset management and private equity funds, 20 per cent of its hedge fund assets and 40 per cent of the turnover in derivatives. (The data comes from a report on “UK international financial services – the future”.)
In the context of the UK economy, the financial sector employs more than 1 million people, accounts for 8 per cent of GDP and generates 14 per cent of tax revenue. Faced with these numbers, how can I ask the question in the headline?
Furthermore, I am not a critic of financial services as such: in fact, I am a very good customer of them. Quite a large proportion of my income seems to go on fees and interest payments. I even think that sub-prime financial activity is a good idea – Robert Schiller in his book “The subprime solution” observes that microcredit of the kind pioneered by the Grameen bank, for which its founder Muhammad Yunus won a Nobel peace prize, is an example of subprime lending. Financial technologies are an essential part of an efficient modern economy.
No, the reason for the question lies not in the operation of the financial services industry, but in covering for it when things go wrong. One needs to be prepared not only for the good times but also the bad ones, when reserves and compensation funds are called upon. To provide for all that, on behalf of perhaps one sixth of the world’s financial services industry, the British people pay about 6 per cent of the world’s taxes. That’s the problem.
Arguably, this is a question that should have been asked two or three years ago before the current financial and economic crisis started, but unless you have confidence that any possible future crisis has already been averted (and you shouldn’t), this question is still worth asking now.
To complete the picture, let us understand why compensation arrangements are needed: (1) to encourage confidence in our financial services industry so that people will use it, and (2) as an expression of solidarity to people who might lose out when companies fail. The British taxpayer currently offers up to £50,000 to anyone who loses a deposit in a bank crash, for example. Other industries do not have their customers insured by the government in the same way.
For an extreme example of what I am concerned about, think of Iceland. Banks there crashed owing depositors in the UK and the Netherlands huge sums of money, far in excess of the ability of Icelandic government to cover in one go. (Iceland’s overseas assets were thought to be around 800 per cent of Icelandic GDP, such was the scale of banking in Iceland by the time it went under.) Those foreign depositors could be compensated because of loans made by the British and Dutch governments to Iceland, and negotiations are ongoing about how those loans will be paid back.
Negotiations are ongoing because the scale of the debt is vast. The repayments will amount to £3.4 billion, which represents 20 per cent of Icelandic GDP. This is a debt on the scale of that imposed on Germany after the first world war. A disaster in the financial markets, therefore, can be as economically damaging as losing a war. If federalists are concerned about preventing future wars, they should also be concerned about future financial crises, too.
So, what can be done? The UK cannot afford not to have a financial services industry – it is too valuable to our economy for that – but there needs to be some way to mitigate the financial exposure that comes with it.
The answer is an internationalisation of compensation arrangements, for which an internationalisation of regulation will be the price that has to be paid. That price is inevitable: why should any country offer guarantees to a third party without some kind of assurance about when that guarantee might be called upon? Weaker regulation might be seen as a source of national competitive advantage, attracting internationally mobile businesses looking for a home, but lax regulation will attract most of all the more marginal players in the market, marginal both financially and morally.
A further argument for internationalisation is this: what market are companies competing in anyway? Icelandic banks may have been operating financially under ultimate Icelandic supervision but they were marketing themselves in the UK and the Netherlands and competing with British and Dutch-based banks. In those circumstances, is it meaningful to draw distinctions between the Icelandic, British and Dutch markets in any case?
Overall, then, the case for some kind of internationalisation is strong. The current campaign by some in the City of London to resist EU regulation is mistaken. Or rather, it might be in the interests of the City of London but that does not necessarily make it in the interests of the UK as a whole.
But, if this should happen, where does this leave the UK, and its 8 per cent of GDP and 1 million jobs? One cannot dismiss this so blithely.
The answer is that the UK needs to and should remain a desirable location for financial services for reasons other than a simple undercutting of regulatory obligations. The cluster of skills and infrastructure represented by the City of London will continue to provide a basis for a thriving industry, along with its timezone and linguistic advantages. These are the kind of factors that appeal to any other export industry: why should one particular sector get a taxpayer guarantee for its riskiest ventures?
Like any advanced economy, the UK cannot afford not to have a financial services industry, but world leadership brings costs as well as benefits and those costs are becoming too great to be borne by a single country alone.