Forget rebalancing: the City is becoming even more important

PEOPLE, companies and countries should play to their strengths. They should do what they are good at. This is the principle of comparative advantage – the formal version of which states that we should specialise in what we can produce at a lower opportunity cost than our competitors. That doesn’t mean that we should not also seek out fresh areas in which we can excel – but it makes no sense to deliberately sabotage those in which we are already good at.

Britain has several such strengths. One lies in what the City specialises in: financial and professional services. Financial services accounted for 9.6 per cent of UK GDP in 2011, with professional services accounting for 4.9 per cent, making a combined 14.5 per cent share, according to research yesterday from TheCityUK.

These figures are remarkable, for several reasons. Financial services’ share of GDP is actually going up, not down: it was 9.4 per cent in 2010. Sure, it remains lower than the crazed, leverage-fuelled peak of 10.4 per cent in 2009 but not by much; financial services accounted for just 5.3 per cent of GDP in 2000. By contrast, manufacturing fell from 15.6 per cent to 10.8 per cent of GDP between 2000 and 2011. Financial and professional services employ 7.1 per cent of Brits; in London, these two industries account for 28.3 per cent of GDP and 14.8 per cent of jobs. They are essential to our prosperity.

Of course, the renaissance of the car industry is a great success story. Entrepreneurs need to be set free to grow other sectors, such as technology; and Britain boasts other comparative advantages. But it was always nonsense for the coalition to claim that it would “rebalance” the economy towards manufacturing. All viable parts of the economy need to grow – and the remaining financial firms still being disgracefully distorted by government guarantees need to be forced to stand on their own two feet.

Crucially, trade surpluses of £47.2bn in financial services and £8.3bn in professional services were larger than any other sector; financial firms’ earnings from direct investment overseas were ahead of foreign financial companies’ earnings from assets in the UK, generating a surplus of £4.1bn. Last but not least, the tax take of UK financial firms and their staff was worth £63.0bn in 2011/12, 11.6 per cent of UK tax receipts. The City needs to be responsible and well-managed – but it must prosper and thrive if the UK is to have any hope of paying for its way in the world.

JAMES BUCHANAN, RIP
A great man has died. James Buchanan, who won the Nobel Prize, used the tools of economics to understand governmental decision-making.

Traditionally, it was assumed that politicians and civil servants were uniquely disinterested and omniscient, and that the decisions they took would be in the public interest.

Buchanan and his colleagues saw that this was nonsense: politicians and officials are just as self-interested as anybody else. They suffer from insufficient knowledge and flawed incentives and inevitably fail to grasp the unintended consequences of their actions. Worst of all, political markets have far-fewer self-correcting mechanisms than commercial markets.

In the real world, the choice is between short-termist governments desperate for reelection who buy votes by handing out taxpayers’ cash or borrowed money to various groups; and imperfect entrepreneurs who sell goods and services to make money. Seen in that light, it’s no wonder that turning to politicians to solve a problem caused by the market so often ends up making it even worse.

allister.heath@cityam.com
Follow me on Twitter: @allisterheath

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