What will happen to the UK financial sector?

30 01 2009

The third section of my white paper on the UK after the recession deals with the weight of the UK financial sector and its various roles. The City of London played a key role in the world’s finances throughout the 80s and 90s. Any diminution in the weight of this role after the recession ends will impact on the future of the UK. 

If you missed the earlier sections, here they are:



This blog is very interested in the relationship between risk aversion and innovation. Today’s Times contains a good article by Camilla Cavendish on this theme.


The UK economy after the recession-Part 3

30 01 2009

3.The service economy and the financial sector’s key role in GDP

It is true that the reputation of both UK-based and US finance houses have been seriously affected by recognition of the processes leading up to the crunch, and inadequacies of the regulatory system in managing both the problems in the wholesale market and more general lending behaviour.’[1]

1. The main long term trend in the UK economy has been a shift away from manufacturing towards services. Services in total now make up 75% of the output (GDP) of the UK. In 1975 it was 55%. Manufacturing is down to 13% from 21% since 1986.[2]


2. Within the services sector there has been an increase in the weight of financial and business services. Between 1996 and 2006 business services and financial services together rose from 25% to 34% of GDP. Within the services sector financial services now represent 10% of GDP, up from 6% in 1996. [3]
3. Net exports of financial services have grown from £3b in 1991 to £23b in 2006 to become the largest part of services exports.[4] The UK is the global leader in the export of financial services, having 24.4% of the total. [5]
4. London holds the top spot as the world’s most important international financial centre, ahead of New York City. In all segments, including cross border lending, foreign equities turn over, foreign exchange turnover, exchange traded derivatives turnover, over-the-counter derivatives turnover, marine insurance net premium income, international bonds, fund management, hedge funds, private equity and IPO, London holds the largest share.[6]

The London effect

London depends heavily on the success of financial and business services, and the UK depends heavily on London, although Edinburgh, Glasgow, Leeds, Manchester, Birmingham and Bristol are also emerging as important financial centres.

London’s role as a financial hub for world finance is reflected in the weight it has within the UK economy. London has 12% of the UK population but produces 19% of GDP and 15% of UK jobs. London is a net contributor to the UK economy by around £15bn per annum and contributes 18% of all tax revenues.[7]
However the economy of London is heavily dependent on the health of the financial and business services sector. These services make up a third of all jobs in London, while all forms of manufacturing represent only 9%.The rest of London’s jobs are in different forms of support and personal services or in the public sector.[8]
What shape will the financial sector be in after the recession?

The UK economy depended on the growth of financial and business services for its dynamism in the past 10 years. Other sectors of the economy, particularly retail, benefited directly and indirectly from this. The UK government got deeper into debt on the strength of assuming that growth would continue indefinitely (no more boom or bust). Most of the extra jobs created in this period were business or financial services or in the public sector.

This means that a permanent decline in the importance of financial and business services would have a disproportionately hard impact on the UK economy. Bluntly, if growth in this sector goes backwards there is no other sector of the UK economy which could pick up the baton in terms of growth.

The City of London plays a key role in many aspects of international finance.A former Deputy Governor of the Bank of England summed up the City’s position as follows,

London benefits from English as an international language of commerce, and from its time zone, which means the working day overlaps with Asia in the morning and America in the afternoon. London also has well established financial infrastructure and telecommunication networks.Many of those surveyed point to the regulatory and legal environment. This is partly a matter of the regulatory style – the “risk based and proportionate” approach that the Financial Services Authority has adopted based on general principles where possible. It is partly the simplicity of dealing with a single regulator.English law, which is also the basis for financial services law in the United States, prevails here, with the added advantage that practitioners are less likely actually to invoke the legal system. And what has been called the Wimbledonisation of the UK financial markets – the sale of nearly all the British merchant banks and stockbrokers and the dominance of foreign players – gives confidence to prospective market participants that the competitive environment is genuinely open to all comers.London is also a growing centre for Islamic banking. Finally, London may be benefiting frommeasures elsewhere; certainly in the years since the Enron and WorldCom scandals, commentators have suggested that the application of the Sarbanes-Oxley legislation to foreign firms listing in New York may have encouraged some firms to list here instead.But the single most important factor is the first one suggested by economists: London’s comparative advantage lies in its skilled labour and financial know-how both in the financial firms and in the professions which support them.The free movement of labour within the European Union, and relative openness to immigration by those with specific expertise from outside it, has also meant that employers in the financial sector can access the world labour market. And the relative flexibility of the labour market here in the UK compared to others in Europe may also be a factor.That concentration of skilled labour has spurred competition and innovation. We have seen a very striking illustration of this in the last few years with the rapid growth of hedge fund management and private equity firms in London. Many have been established and are staffed by people who acquired their skills and earned their capital at the more established investment banks and fund management firms of the City. Being at the heart of world markets helped them spot the opportunities and assess the competition. Once they struck out on their own, they could draw on a network of former colleagues and contacts for staff, information and expertise.[9]

Some debate about London’s role as a financial sector has begun.[10]At this stage it is too soon to know to what extent the financial sector in London will recover. However in the short to medium term it is contracting and this will have a deleterious impact on the London economy in particular.


[1] London’s place In The UK economy LSE October 2008

[2] UK economy, analysis of long-term performance and strategic challenges march 2008 HM Treasury p5

[3] Globalisation and the Changing UK Economy BERR February 2008 p14

[4] The UK economy, analysis of long-term performance and strategic challenges march 2008 HM Treasury p47

[5] Globalisation and the Changing UK Economy BERR February 2008 p16

[6] http://www.financialexpress.com/news/uks-financial-services-share-rises-to-9.4-of-gdp-in-06/256893/

[7] London’s place in the UK economy Oxford Economics2007

[8] London’s place In The UK economy LSE October 2008


The City’s Growth: The Crest of a Wave or Swimming with the Stream?

26 March 2007

[10] For a fascinating discussion of this in relation to LIBOR see Donald Mackenzie London Review of Books 25 September 2008


29 01 2009

I have been very encouraged by the large number of people visiting this blog. I have added a subscribe button on the right which will send you an email alert when new content is added. I will do my very best to make sure that what you receive is worth reading!!  You can always unsubscribe if you find it is not.

Neither Boom Nor Bust

28 01 2009

Part 2 of my white paper on the UK After The Recession, below, shows with the aid of a few graphs that prior to the credit crunch the UK economy was indeed suffering neither from boom nor bust,as Gordon Brown claimed. Later we shall see what the basis was for the growth which took place during the past ten years, why it reversed so quickly into slump and why Brown’s claims to have abolished boom and bust now look so risible.

The UK After The Recession-Part 2

28 01 2009

 A stable but anaemic economy

As can be seen from the graph below, business investment growth in the UK has reached a lower plateau in the past ten years compared with the previous 20 years.[3] 

Total Business Investment percentage change, quarter on corresponding quarter of previous year


The UK economy grew for 63 quarters prior to the third quarter of 2008. GDP grew at this time at an average of 3%.  While this may look a respectable growth rate the growth has been increasingly debt financed and in unproductive sectors of the economy. Also bear in mind that the current fall of GDP growth to 7.5% in China is considered a potential crisis.
It is clear as well that there has been a flattening out of growth and retraction through this period. It is this flattening which Gordon Brown used to claim the end of boom and bust. Another way of looking at it is an economy which had no great engines in it to make it leap forward. This is what has been revealed as the case by the credit crunch.


Productivity has improved against western based competitors but remains at a lower rate.


Foreign Direct Investment

The UK is the second largest recipient for foreign direct investment in the world, behind the US. In the last year it was $224b.[5] A recent survey by KPMG predicts that the UK will be second preference for financial services investment, first for property and first for transport. It listed the factors involved in making these decisions in descending order as follows. [6]

Access to new Customers
 Political stability
Impartial rule of law
Regulatory climate
Tax regime
 Quality of labour

In the past year investment in UK technology, media and telecoms rose, mainly from the US, by three times to £12.6b due to low valuations. This compares to £40b at the height of the dot com boom in 2000.

 [3] http://www.statistics.gov.uk/CCI/nugget.asp?ID=258

[4]The UK economy, analysis of long-term performance and strategic challenges march 2008 HM Treasury p5

[5] FT 25 September 2008

Welcome to my blog

26 01 2009

Below I have posted the first part of a white paper I wrote at the back end of last year on the future of the UK economy. The purpose of publishing this is to encourage a discussion about the real problems facing the UK economy and how we can influence and enact change.  I will post the rest over the next few weeks and any feedback is welcome.

The UK economy after the recession-Part 1

26 01 2009

UK economy after the recession

The era of soaring borrowing and the associated boom in finance is over. The government should indeed act as borrower of last resort at this traumatic time. But the aim cannot be to tide the economy over until households start borrowing madly again. For the same reason, attempts to pump up the mortgage market, however understandable, are largely misguided. No sane person would borrow to buy houses whose prices are so likely to fall. Even if the government does get away with its heroic gamble, the longer-term path of the economy must be quite different from that of recent years. Do the government or the British people understand the implications of such a shift? I doubt it. [1]

When this recession comes to an end what kind of shape will the UK economy be in? While we cannot answer this question exactly, there have been some significant trends in recent years which will limit some possibilities and encourage some others. Some of these trends are economic and some are political.

What kind of crisis is this?

As Phil Mullan and others have pointed out, the current crisis hinges on the changed balance of global production. [2]  The decline of manufacturing in the west relative to the east has created a disequilibrium which underlies the global credit crisis. How this disequilibrium is resolved and over what period is impossible to predict. However, it seems unlikely that we will return to the status quo ante. Politics is concentrated economics and the changed nature of global production and the production of wealth has to cause changes in the distribution of world power. 

If we wanted to summarise what has happened to the UK economy in the past ten years it would be as follows.

  1. Investment and growth have remained relatively subdued, compared with previous periods and with more dynamic growth areas, while at the same time being fairly stable.
  2. The UK has benefited from high levels of foreign direct investment.
  3. The finance sector became more important to the UK in both an absolute and a relative sense, and both domestically and in relation to the world economy, while manufacturing continued its long term decline.
  4. Household wealth grew mainly as a result of the housing bubble and the rise in the stock market, which along with easy credit and cheap imports led to a boom in retail consumption.
  5. Total employment grew mainly as a result of the growth of the public sector, funded partly from the growth of the finance sector and partly from government borrowing.

Looked at like this we can see that the crisis has taken a form that presents almost the worst of all possible worlds for the UK. The recession has hit Britain hardest in its most exposed parts.

  1. The crisis began in the financial sector, the most dynamic part of the UK economy, leading to a knock on process through the rest of the economy.
  2. The crisis has become a crisis of credit, thus affecting the ability of businesses, homebuyers and individual consumers to continue to borrow.
  3. Public finances were already deep in the red, limiting the ability of the UK government to use fiscal policy to combat the crisis.

Before we look at each of these points in detail it should also be noted that the political response to the crisis has been shaped by the political culture of the past ten years as well, both from the point of view of governments and from the public.

In many ways this recession has been a crisis of politics as much as of the economy. We shall return to this in the conclusion.


[1] Martin Wolf Financial Times 24 November 2008

[2] http://www.spiked-online.com/index.php?/site/article/4244/