London – financial capital of the world?

By Raz Koroh

The City of London was the place to be for many of Britain’s brightest and most ambitious people, gathering in a pulsating mass of wealth creation.  That was before the 2008 financial crisis.  Today, it remains the driving force in the British economy, the motor behind the country’s economic recovery, and acknowledged to be Europe’s, and some said the world’s, premier financial services capital.  British Prime Minister David Cameron drives home this point in his ‘Stay in Europe’ campaign, hoping to persuade the British public that staying inside the EU is in their best interest as it ensures the global relevance of the City of London and therefore the survival of the British economy.  So, it looks like Britain’s whole future is heavily dependent on the City’s survival.  Couldn’t Britain survive without the City?

Here are several factors to consider.

Economic survival.  Britain did not take the opportunity to modernize its manufacturing industry during the relatively stable period in global economy after the Second World War, especially during the fixed exchange rate period under the Bretton Woods system.  After Bretton Woods ended, interest rates globally fluctuated and this led to competitions from abroad, especially that the pound sterling had been kept at a very high rate mainly due to the Bank of England maintaining a high interest rate as a way to bring British inflation rate under control.  The gradual demise of the British manufacturing industry inevitably led to knowledge sector as the only remaining option.  As life sciences and information technology are centered in the United States, financial services are the only remaining option for creating high-return service jobs in Britain.

Infrastructure.  London also provided the right combination of incentives for the financial industry to flourish, especially an unrivalled and well-developed infrastructure that includes an extensive network of tax havens, a deep pool of skills as a result of a more relaxed immigration policy compared to the United States and the EU freedom of movement laws.  Most bankers agree that intellectual capital can be built very easily in London; legal, accounting and management consultancy services are in ready supply and contribute to the critical mass that goes to make up a financial services center.  Privatization and digital technology had propelled Britain’s telecommunications services into the 21st century, and despite lengthening delays at Heathrow, London is a global transport hub reached easily from Europe, the U.S. and Asia.

Deregulation.  This is essential for Britain.  If Thatcherite reforms such as the abolition of exchange controls and the end of the stock exchange closed shop were not implemented, Britain would be bypassed as the world’s financial services industry modernized in the last quarter of the 20th century.  Britain followed the U.S. where banks that were tightly regulated since the Glass Steagall Act of 1933 in response to the Great Crash of 1929 were no longer restricted in their activities, so that in the last quarter of the 20th century, taking advantage of the development of new financial products such as derivatives and securitization, deposit-taking banks and investment banks were no longer kept apart.  Although this drastically changed the character of corporate Britain, from passive long-term support for management to proactive shareholder activism, and the consequent short-termism not conducive to building the country’s long-term industrial competitiveness in the global marketplace, London became a paradise for foreign corporate raiders and merchant bankers, not to mention also pension funds and private equity.

The combination of the right push and pull factors have driven Britain to financial center pre-eminence, a feat that arguably no other European, Asian or North American country can ever match.

Comments welcomed.