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Is the financial sector bad for Britain?


2:02 pm - April 12th 2011

by Left Outside    


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Following on from a series of posts recently by me on the financial sector, VoxEU has published an article supporting the broad thrust of my argument; finance is too big, too powerful and needs to be shrunk.

Our results show that the marginal effect of financial development on output growth becomes negative when credit to the private sector surpasses 110% of GDP. This result is surprisingly consistent across different types of estimators (simple regressions and semi-parametric estimations) and data (country-level and industry-level).

The threshold at which we find that financial development starts having a negative effect on growth is similar to the threshold at which Easterly et al. 2000 find that financial development starts increasing volatility.


A very large financial sector like we have in the UK is not necessarily a good thing even if it appears to be our “comparative advantage” as Timmy is wont to argue.

A large financial sector can increase volatility. One effect of this is that volatility depresses investment. If you have the option to invest but the future is uncertain it makes more sense to wait and see.

The preponderance of finance and the UK’s low rate of investment may be linked.

A good financial sector helps to improve the quality of investment, but that does not seem to be operating at the moment, finance appears to be system for the enrichment of a minority and the majority’s expense. Perhaps it is time for the banking commission to pull the plug on large bank’s right to exist.

Matters are complicated because such a large share of the City’s activities are exported and this makes a comparison between the UK’s financial industry and the UK’s GDP more difficult.

But, it seems that finance is at the same time too concentrated in a few firms, too indebted to positively contribute to growth, too risk tolerant due to subsidy and too arrogant to see this.

Anybody else sick of these guys?

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About the author
Left Outside is a regular contributor to LC. He blogs here and tweets here. From October 2010 to September 2012 he is reading for an MSc in Global History at the London School of Economics and will be one of those metropolitan elite you read so much about.
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Reader comments


So who will pay all the tax you like spending?

2. Luis Enrique

[either pedantry or important point, as you prefer]

research shows marginal effect turns negative after 110%. This does not mean having 110% credit/GDP is “bad” for the economy, it means further increases in credit/GDP start to reduce the benefit of the financial sector. i.e. having a large (110%+) financial sector may be “good” for the economy, but expanding beyond 110% starts to reduce the goodness.

Or another way to express it is the law of diminishing returns.

@1, almost certainly not the tax-evading, sorry, avoiding banks..

research shows marginal effect turns negative after 110%. This does not mean having 110% credit/GDP is “bad” for the economy, it means further increases in credit/GDP start to reduce the benefit of the financial sector. i.e. having a large (110%+) financial sector may be “good” for the economy, but expanding beyond 110% starts to reduce the goodness.

No, The US and UK are both doign relatively well by historic standards, and so on. That couldn’t be the case were the financial services actively harmful.

So who will pay all the tax you like spending?

I call Strawman. Who says I want to spend loads of taxes?

And of course the answer would be, a different sector which is less prone to causing massive macroeconomic collapses.

We subsidise the Financial Services by a substantial amount. Depending on who you believe, the bank of england or the royal bank of scotland this subsidy is annually £6 billion or £57 billion, according to the IBC’s Interim Report.

How about Britain develops a comparative advantage in an industry not heavily subsidised and not prone to causing mania, panics and crashes?

So who will pay all the tax you like spending?

That said, the financial services do contribute a lot to the treasury and this is a BAD THING, which everybody, from low tax liberals to anti-finance lefties should agree on. It is only good for the powerful.

How about Britain develops a comparative advantage in an industry not heavily subsidised and not prone to causing mania, panics and crashes?

I wouldn’t start from here, if I were you. Old joke, but seriously.

Saying “it would be great if the UK were Germany and had a comparative advantage in making clever and highly skilled bits of heavy machinery” (which I’m assuming, given the lack of other comparators, is what any comment along these lines is making: nobody in their right mind would want to be Japan, the US is a largely self-sufficient internal trading bloc, Canada and Australia are mines with countries attached, and France’s income is pretty much in line with ours) requires a route from “we are the UK, we are good at making *very* clever and highly skilled bits of machinery, but not at the mid-level bits that Germany excels at. We are awesome at media, financial services and business services, we’re rather good at consumer goods, although mostly the branding and marketing side, and we’re mediocre at everything else” to “we are Germany”. What’s yours?

We’re basically held to ransom by the banks. The future generations will look at them as we now look at the unions of the ’70s. What’s needed is some shock therapy for the finance sector, a la the industrial relations “reforms” of Thatch – will never happen, too many vested interests. So it goes.

NB it’s also worth considering, whilst bearing all the other things in mind, that the things the UK is good at are also the things which people in China and India are unlikely to become good at in my lifetime (I’m 32, and I don’t drink or smoke *that* much), whereas the things that Germany is good at are things which China and India will naturally become good at.

Not my problem John, I’ll leave that to entrepreneurs to find out because that is what they are for. But stopping propping up finance, splitting retail and investment banking, and improving the way finance funds things in the real economy rather than other bits of the financial sector would all be a good way to level the playing field.

At a push I would choose tertiary education and pharma, but that’s idle speculation (which in fact is the UK’s leading sector).

NB it’s also worth considering, whilst bearing all the other things in mind, that the things the UK is good at are also the things which people in China and India are unlikely to become good at in my lifetime (I’m 32, and I don’t drink or smoke *that* much), whereas the things that Germany is good at are things which China and India will naturally become good at.

Nah, the UK was once the workshop of the world, things change (Schumpeter passim). China and India will end up more like the US you describe than a MASSSSIIVVVE Germany.

12. Planeshift

“China and India are unlikely to become good at in my lifetime”

Given the amount of maths graduates being churned out by both India and China, I don’t see why they couldn’t develop a competitive financial industry.

@ 4 Neil

Banks do pay tax when they make a profit. They don’t just make profits in the UK though, but they do report their headline numbers here (like Barclays for example). THis is why UKuncut gets themselves in such a pickle.

Apart from that though, the massive majority of tax banks pay is via their employees. Do you want all of them to start moving abroad and paying their taxes there?

“the UK is good at are also the things which people in China and India are unlikely to become good at in my lifetime”

Interesting and optimistic observation!

Which things exactly do you mean, and why won’t China and India compete effectively?

Given the amount of maths graduates being churned out by both India and China, I don’t see why they couldn’t develop a competitive financial industry.

Two reasons, one structural, one cultural.

Structurally, a maths degree from a Chinese university is a joke, due to the massive entrenched corruption in the Chinese university system. So any skilled Chinese mathematician who wants to be taken even slightly seriously needs to do their PhD overseas, at which point they’re playing in the global labour market, not the Chinese labour market (and so will only work in Beijing for the same disposable money they’d get in London or New York).

Culturally, because clever geeks with models aren’t enough – you need a wider concept of “a clue”. And Chinese and Indian educational systems are terrible at that concept, whereas it’s where Anglophone educational systems excel. I know from repeated and painful experience that the concept of “making a judgement based on having a clue” as opposed to “following processes” simply doesn’t exist among graduate-level Chinese and Indian workers who haven’t worked or studied in the west.

That’s our advantage. That’s what we should be building on. And – importantly – it’s why we thrive in FS, PS, media and niche hardcore engineering.

Perhaps some might consider how come Britain came to have a comparative advantage in financial services and a comparative disadvantage in most manufacturing – apart from manufacturing armaments, that is, seeing as how BAE Systems is Britain’s largest manufacturing company.

17. Mr S. Pill

@10

“…idle speculation (which in fact is the UK’s leading sector).”

That’s what we should do, try & find ways of making money out of idle specula… oh hang on! 😉

18. AnotherTom

I remember my left-leaning professor lecturing us politics post-grads on how finance does nothing for London. He then asked with a rhetorical flourish, exactly how many people we knew that actually benefitted from the eurobond market (the issue of the day).

As I worked in the eurobond market, I put up my hand. He looked sheepish.

Re the OP I’m not terribly convinced he / she knows how or why ‘the City’ earns so much, and why it is here.

“How about Britain develops a comparative advantage in an industry not heavily subsidised and not prone to causing mania, panics and crashes?”

How about inane commentary? We seem to have plenty of it.

“How about inane commentary? We seem to have plenty of it.”

Ooo-ooo, passive aggressive handbag time!

20. Chaise Guevara

@ 16 Bob B

“Perhaps some might consider how come Britain came to have a comparative advantage in financial services and a comparative disadvantage in most manufacturing”

I don’t know why we’re such a big FS player, although I reckon it’s got something to do with Britain having a big economy to start with. As for manufacturing, it’s probably due to labour laws making us uncompetitive. It’s just harder to run a factory when you can’t pay your workers 20p an hour and chuck them in a river when some badly-designed bit of machinery kills them.

21. AnotherTom

I just find it exasperating. The previous government did a deal hoping that the big state could be paid for with big finance. It failed. And now we’re meant to line up in praise of the big state and accuse finance of being evil. Not convinced.

@20: “I don’t know why we’re such a big FS player, although I reckon it’s got something to do with Britain having a big economy to start with. As for manufacturing, it’s probably due to labour laws making us uncompetitive.”

C’mon. Compared with Britain, Germany – with the largest economy in Europe – has a relatively smaller FS sector but it certainly has a comparative advantage in global markets in a range of manufacturing – think: cars, printing machinery, machine tools, consumer electronics (Braun, Bosch).

German companies have to comply with the same EU employment regulations that British manufacturers have to and, if anything, business regulations in Germany tend to be more pervasive and restrictive than in Britain – for example:

“Shopping days and opening hours in Germany were previously regulated by a federal law, the ‘Shop Closing Law’ (Ladenschlußgesetz), first enacted in 1956 and last revised on March 13, 2003. The federal government has however since handed over the authority to regulate shopping hours to the sixteen states with effect from 7 July 2006. Since then, states have been allowed to pass their own law regulating opening hours. Should a state decide not to pass its own law, the federal Ladenschlussgesetz will continue to be valid within that state.”
http://en.wikipedia.org/wiki/Shopping_hours

I suspect that Germany’s comparative advantage in manufacturing has had more to do with its better infrastructure for training in vocational skills coupled with the inflow of skilled refugees from Eastern Europe in the 1950s, mitbestimmung in company management, universal banks being more important sources of company finance than the national stock market, higher rates of business investment as a percentage of national GDP and the Bundesbank, a long-independent central bank which maintained far better monetary discipline than did the Bank of England under “democratic” political control by governments 1946-97.

23. Chaise Guevara

@ Bob B

Well, yeah. That’s why we fare poorly against Germany, labor laws are part of the reason we fare poorly against developing countries. Yeesh. Questions like “why is the UK’s manufacturing sector relatively weak?” tend to have more than one answer. If you were specifically talking about Western Europe, you shoulda said.

Isn’t there an argument that the a job in the City pays so much more than say engineering that it has a tendency to swallow up the brightest and the best graduates. Thus sucking the tallent out of those sectors?

We now live in a country that appears to be incapable of competently engineering anything. Which if you consider that this country once produced the likes of Brunel or George Stephenson is quite a turnaround.

Oh! I forgot to mention that governments in West Germany never made the fetish of using fiscal policy to manage demand that governments in Britain did from 1945 through to the 1970s. JCR Dow – a Treasury insider – concluded in his seminal study: Management of the British Economy 1945-1960 (Cambridge UP) that demand management had contributed to instability of the economy.

Btw another paradoxical fact is that the German and Japanese economies in the periods of high growth experienced more instability than did Britain’s economy. One interpretation is that to an extent economic instability is a mechanism for shifting productive resources from inefficient producers to more efficient producers thereby enhancing economic growth but at the cost of more social pain in the short period – about this, try Nicholas Woodward: The management of the British economy 1945-2001 (2004), and:
http://www.users.globalnet.co.uk/~semp/bdecline.htm

There’s much to be said on behalf of evidence-based policy IMO.

26. Chaise Guevara

@ 24 Graham

“We now live in a country that appears to be incapable of competently engineering anything”

What’s your basis for saying that?

@24: “Isn’t there an argument that the a job in the City pays so much more than say engineering that it has a tendency to swallow up the brightest and the best graduates. ”

Absolutely. A few years back, academia in British was complaining about the City poaching the best theoretical physicists from university departments to work as “rocket scientists” in financial institutions with salaries and bonuses which universities could never hope to match.

“We now live in a country that appears to be incapable of competently engineering anything. Which if you consider that this country once produced the likes of Brunel or George Stephenson is quite a turnaround.”

But this pecking order from last year of average graduate salaries gives some insights into which degree subjects are most currently in demand:
http://www.independent.co.uk/news/education/higher/table-what-do-graduates-earn-1675502.html

I suspect the problems of Britain’s engineering companies have much to do with the chronic shortages of technician skills.

Contribution of manufacturing to Germany’s GDP – nearly 24% in 2007 on the latest accessible figures:
http://www.tradingeconomics.com/germany/manufacturing-value-added-percent-of-gdp-wb-data.html

Recent analysis from the department of Business, Innovative and Skills (BIS):

“In 2009, the UK manufacturing sector generated some £140bn in gross value added, however over the period 1990 to 2009, manufacturing as a share of UK GDP has fallen steadily from 22% to just over 11%.”
http://www.bis.gov.uk/assets/biscore/business-sectors/docs/m/10-1334-manufacturing-in-the-uk-supplementary-analysis.pdf

@26

“We now live in a country that appears to be incapable of competently engineering anything”

What’s your basis for saying that?

Well, perhaps you could ask what has happened to our domestic motor industry, shipbuilding industry, train rolling stock industry amongst many others for example. The Germans still have all of these things, but we barely do any more.

@29: “The Germans still have all of these things, but we barely do any more.”

And that certainly isn’t because the Germany has little regulation of employment or business and associated bureaucratic red tape – and it is also an enthusiastic and supportive member of the EU.

What Germany does have is a much better legacy of technical skills as a result of an embedded tradition of industrial apprenticeships and a flourishing sector of small and middle-sized engineering enterprises providing apprenticeships.

The more prosperous southern länder in Germany don’t have those hang ups about maintaining the academic gymnasium schools either. Try:

A machine running smoothly : German companies great and small are making the most of globalisation. Their success owes more to judgment than to luck
http://www.economist.com/node/18061718?story_id=18061718

Vorsprung durch exports
http://www.economist.com/node/18061550

In Britain, we tend to overlook the importance of SMEs:

“Small and medium-sized enterprises (SMEs) together accounted for more than half of the employment (58.7 per cent) and turnover (51.1 per cent) in the UK.”
http://www.dtistats.net/smes/200612/SMEstats2005pr.pdf

As I keep suggesting hereabouts – it’s a good idea to look over the barricades from time to time to compare government policies in other west European countries.

Of course, more and supported industrial apprenticeships are nowhere nearly exciting as running wars with “British forces in action” hitting the TV news. But then as Gordon Brown admitted while he was still PM, Britain had up to then spent £18bn on wars in Afghanistan and Iraq – which could have done much for industrial apprenticeships. The trouble is that without the wars,Tony Blair wouldn’t have had nearly as many ego-boosting trips flying to distant capitals.

Btw one of the reasons why the Bundesbank – the independent central bank of west Germany – has a much better narrative than Britain to relate on curbing inflation is because it pursued a variation on monetarism throughout the post-war period. Over the long run, control of the money supply evidently does control inflation – although one of the difficulties with that is recognising which of the many definitions of money applies.

Oh dear! Evidence-based policy is a harsh task-master.

31. Chaise Guevara

@ 29 Graham

“Well, perhaps you could ask what has happened to our domestic motor industry, shipbuilding industry, train rolling stock industry amongst many others for example. The Germans still have all of these things, but we barely do any more.”

We’re no longer a leader in manufacturing. Some of that is due to things like us having workers rights, and some is probably down to education and similar. That’s no reason to insult every damn engineer in the country, though.

32. gastro george

@31

Partly agree. We have some fine engineers in this country. But you missed the part where we have crap management at a company and government level. We fail to develop products, or provide the infrastructure to enable coherent and consistent product development.

We certainly do have fine engineers – like James Dyson and Jonathan Ive and we tend to forget about the ARM chip:
http://en.wikipedia.org/wiki/ARM_architecture

Perhaps a more productive question is to ask why British companies like ICL or Marconi don’t thrive:
http://news.bbc.co.uk/1/hi/in_depth/uk/2000/newsmakers/1527551.stm

There’s no doubting the commercial success of BAE Systems, Britain’s largest manufacturing company and the world’s largest military contractor by sales in 2008 but should we count that as a national triumph and duly celebrate?

Btw the Japanese car manufacturing companies in Britain – Nissan, Toyota and Honda – are making a go of it and even exporting cars back to Japan so Britain can’t be that adverse a location for manufacturing. But is their essential ingredient Japanese styles of management, production methods and industrial relations?

I think people make a mistake when they speak about the financial sector and the City interchangeably. As can be seen from this chart the financial sector in the UK as a share of GDP only surpassed the German share around the time of the millennium. If finance is properly counted the UK share is no larger than the French share.

http://2.bp.blogspot.com/_tvshDVnXSLc/TGMgs2BpWDI/AAAAAAAADY8/AkTeaa87_LM/s1600/share+of+fin+sector+gdp.jpg

What the UK does have that the others lack is a global financial centre and on most measures it is the world’s dominant finance hub. It is a fair question not easily answered whether that is a net good for the UK. Without a doubt in many respects the City is a huge earner for the UK. The City does not just churn UK capital. Every part of the globe sends capital through London. When the Middle East are recycling their petrodollars the money ends up passing through City institutions. The Peoples Bank of China send much of their US Treasury bill buying through third parties in the City. So the capital in the City is not just UK savings. It is the world’s savings and the activity does generate overseas earnings for the UK and tax revenue for the Treasury.

Where the City may damage the UK is through drawing in some of the best graduates from the universities. The major financial institutions trawl the universities looking for ‘ talent ‘ and the ‘ talent ‘ are attracted by the salaries. Arguably the big fiance houses are full of over qualified staff who should be doing something more productive with their skills.
http://4.bp.blogspot.com/_tvshDVnXSLc/THPVN-2vqeI/AAAAAAAADZU/xhZg3RcxRVM/s1600/bank+bonus+humancap.jpg

Some of the PhD maths graduates who have appeared over the last two decades are positively dangerous as they can only think in straight lines. Abolishing risk with writing equations always seemed an unlikely prospect. A lot of the mess from the FC was the handiwork of clever maths graduates. They can write a helluva equation, not so good with lateral thinking.

Sweeping up graduates from all over the UK causes a bit of an internal brain drain leading to regional imbalances. Less economic activity in other parts of the UK means there are less opportunities for young people leaving school etc. Those who can move in search of opportunities move and that leads to further economic decline of the region. One ends up with an area where it is only the low-skilled and elderly who are left. The City is not entirely to blame for that but it does contribute. Moreover, it is probably a London phenomenon rather than just the City. Businesses like agglomeration as it does offer advantages so London centralisation is not going to end any time soon.

Overall, one could make the facts to fit the argument and show a case either way. I think the UK comparative advantage in global finance is a net good. However, there are significant invisible costs.

Which kind of confirms my original point. Namely that many of the brightest and best brains, which could probably be better employed in science or industry, are instead being put to use dreaming up elaborate gambolling schemes for the City casinos. Something which is of little value or benefit to anyone outside a charmed elite.

I would say that the City is bad for the UK in a number of ways.

1) The City has sucked life out of other sectors, and turned the UK economy into a one horse show. And as we all know any economy which is overly dependant upon one sector is a hostage to fortune.

2) The economic power of the City is toxic for democracy, because we have little else to fall back on, the financiers can blackmail any government who attempts to regulate it or make it pay sensible tax, by threatening to leave. Meaning they are effectively beyond the control of elected governments.

3) The City is of little benefit to any part of the UK outside London and the southeast. It not only sucks the lifeblood out of other sectors but of all the regions outside London. It would probably be fair to say that people in Newcastle or Wales for example are positively harmed by the dominance of the City. This was offset a bit in the Labour period by the taxes paid by the City paying for a large public sector, (now being cut back) which dominated employment in poorer regions. But this was hardly a good substitute for having a viable local economy.

4) Meanwhile you could probably also argue that it is harmful for people on low incomes in London and the southeast, because the large bonuses paid by the city contribute to the high house prices and higher living costs

Either way it is certainly not healthy to have an economy so lopsided.

Two comments:

The discussion here puts too much emphasis IMO on the City absorbing maths and physics (post)grads and not nearly enough on the sad fact that only half of 16 year-olds can reach the benchmark of 5 good GCSEs, including maths and English, let alone maths and English with the three sciences. Just 1 in 6 reaches the new English baccalaureate target:
http://www.bbc.co.uk/news/education-12163929

The emerging market economies have vast, mostly untapped reserves of low-cost, unskilled labour with only basic education: Britain can only compete as a location for manufacturing on the basis of a skilled and productive workforce. Ford has stopped making cars in Britain but still makes cars in other west European countries, despite often paying higher wage rates.

As for the City benefiting only London, that’s demonstrable nonsense. The fact is that in pre-crisis times, London and the SE region were the only regions making net fiscal contributions to the national exchequer – in other regions, identifiable public spending exceeded generated tax revenues. Try this map:
http://www.thisislondon.co.uk/news/article-23416323-the-real-north-south-divide-how-the-south-east-is-bankrolling-britain.do

The under-pinning research is here:
http://www.oef.com/free/pdfs/finance_report(oct07).pdf

The tax revenue generating capacity of the City is probably why governments tend to nurture the City, that and because Britain does have a comparative advantage in financial services and strangling the City is rather too masochistic. Britain is the world’s largest exporter of services after America.

Btw whatever happened to Silicon Glen?
http://en.wikipedia.org/wiki/Silicon_Glen

Well, perhaps you could ask what has happened to our domestic motor industry, shipbuilding industry, train rolling stock industry amongst many others for example. The Germans still have all of these things, but we barely do any more.

It’s already been noted that this is untrue for cars: certainly up until 2008, the UK was making as many cars per year as it did in the 1960s and 1970s. It’s also untrue for trains: the majority of new trains entering UK rail service last year, this year and next year will have been designed and built at the former BREL works in Derby.

The owning company is in Japan/Canada, respectively, but so what? The cars and trains are designed and built in the UK – and even in the supposed golden days of UK carmaking, the two leading brands were always foreign-owned.

Ships, not so much, although we are currently in the process of building two of the Biggest Ships Ever.

A point about the City that’s been missed so far is that – unlike Wall Street, which largely extracts value from the US economy – the City largely extracts values from overseas. Foreign companies use London to raise capital. When a German company is looking to raise money to finance its expansion, it does so in London, ensuring that a commission from that company’s success goes to the UK economy. Which is awesome.

This is why the whole “many of the brightest and best brains, which could probably be better employed in science or industry” thing is such utter bullshit. If the City is able to pay them more, that’s because it generates more revenue. If it generates more revenue, that means that they’re economically employed there.

If they decide that they’d rather take a pay cut and feel like they’re doing something worthwhile, then that’s awesome. My sister’s physics PhD fiance quit his investment banking job to become a physics teacher, and good luck to him, but it’s ridiculous to suggest that *society as a whole* is better off if someone paying enough tax to fund 1.5 physics teachers (solely out of income tax and NI, so this works even if you assume the firm employing him is dodging tax completely, there’s no other economic benefit created by the City and there’s no trickle-down effect) instead becomes one.

As various people have pointed out above, the UK’s domestic (which is what the paper is about) financial sector isn’t really out of line with other places.

It’s the export sector, The City, which is. And that’s where the comparative advantage comes in. And this is much more deep rooted than some political decision of the last few decades. As I never tire of pointing out, the last time we had an international division of labour (1880 ish to 1914) the UK did international finance and Germany did heavy industry again.

Do note that comparative advantage doesn’t really mean “we’re better than this than Germany so this is what we should do”. Nor does it mean “we’re worse than this at Germany so we shouldn’t do it”….for finance and manufacturing repectively.

Rather, the real question is “which are we least bad at, international finance or manufacturing?”. And as I continually say, it looks like we’re least bad at finance.

Why? No, this isn’t a result of detailed study, just a feeling in the water. The why is our legal system. That old Common Law commercial code. International finance is one of the most innovative industries in the world (and yes, not all innovations are beneficial) and a legal system which says “Do anything you want that we’ve not already made illegal” is, I submit, more likely to foster innovation than the alternative, Roman derived “you can only do what the law says you can”.

I really do think there’s something in that.

40. Luis Enrique

does it make sense to say that success in one sector sucks life out of other sectors? If we had a thriving manufacturing industry, would we be complaining about it sucking life out of the financial services industry?

does it make sense to say that success in one sector sucks life out of other sectors?

I don’t see why not, to some extent at least. Just one example, I know good many people with PhDs in mathematics, and a large proportion of them are now working in finance. Maths PhDs are moderately rare commodities, and if lots of them end up in finance, I’d have thought it means there are fewer to go around (at least in the short term) other industries where they might also come in handy.

Given the amount of maths graduates being churned out by both India and China, I don’t see why they couldn’t develop a competitive financial industry.

Legal systems. A simple commercial dispute can take up to 25 years to resolve in India. As long as there is no credible legal framework in India they’ll struggle to dominate in the financial services. It may be special pleading, but I’d be inclined to go with Tim W’s instinct.

”a legal system which says “Do anything you want that we’ve not already made illegal” is, I submit, more likely to foster innovation than the alternative, Roman derived “you can only do what the law says you can””

Civil law is not the code napolean! That isn’t how legal systems work on the continent, it simply isn’t.

Civil law involves statutes being interpreted by courts, common law involves statutes and presedents (sp?) Being interpreted by courts.

In fact, some scholars think common law can be worse for growth in some cases than common law. There’s a paper by guinanaen (spelled a bit like that), going over the advantages of civil law foir corporation law vis a vis common law because of the uncertainty case law introduces.

43 – this is a slightly old paper, but would seem to indicate the opposite:

In this paper, I present evidence that common law countries experienced faster economic growth than civil law countries during the period 1960-1992. I suggest that the difference reflects the common law’s greater orientation toward private economic activity and the civil law’s greater orientation toward government intervention.

http://www.ppge.ufrgs.br/giacomo/arquivos/eco02237/mahoney-2000.pdf

45. Luis Enrique

Larry

sorry yes, I phrased that poorly. Yes, resources are scarce and workers being in one sector mean they can’t be in another. What I meant was more like: it’s not obvious that spreading things like maths PhDs across sectors is better than concentrating them in certain sectors. The “sucking life out of” phrase puzzled me, because any allocation of resources to one sector “sucks life out of” other sectors, which seems an odd objection to make in general. But we are not talking about a generality, we’re talking about a specificity of finance, and as it happens, I think we would be better off with fewer talented people allocated to finance, which I think does too much “rent seeking”, so I going to back away unobtrusively now.

Perhaps a more productive question is to ask why British companies like ICL or Marconi don’t thrive:
http://news.bbc.co.uk/1/hi/in_depth/uk/2000/newsmakers/1527551.stm

ICL because it relied too much on the mainframe business and the public sector?

Btw whatever happened to Silicon Glen?
http://en.wikipedia.org/wiki/Silicon_Glen

What’s wrong with it? Clearly the part that is in competition with overseas fabs will suffer and has suffered for obvious reasons. The other bits are doing well IIUC.

@ 36:

> As for the City benefiting only London, that’s demonstrable nonsense. The fact is that in pre-crisis times, London and the SE region were the only regions making net fiscal contributions to the national exchequer – in other regions, identifiable public spending exceeded generated tax revenues.

Graham @35 addressed that:

> This was offset a bit in the Labour period by the taxes paid by the City paying for a large public sector, (now being cut back) which dominated employment in poorer regions. But this was hardly a good substitute for having a viable local economy.

Note that last sentence.

@46: “ICL because it relied too much on the mainframe business and the public sector?”

Fair comment except that ICL digested much supportive initial state aids to get going – as did Britain’s pioneering nuclear energy industry – and ICL did try, like IBM, to move out of hardware into software and computer services but IBM made a successful transition.

Besides, BAE Systems also relies on public sector purchasing as the legitimate private market for military hardware is very limited ! For some reason, there has been an inordinately high failure rate of successive public sector computer services contracts – virtually all the big name computer services companies are implicated – it makes sense to avoid big computer services contracts whenever feasible.

As for Silicon Glen, it’s nowhere near what it was or the hugely promoted vision and despite hundreds of millions of state aids poured in to attract inward investment.

I make this point to show that (sadly) Britain has been noticeably unsuccessful at a proactive industrial policy – ? unlike France – the conspicuous exception being the Japanese car makers in Britain and Toyota and Honda were attracted without state aids.

The implication is that it may be a great deal easier to strangle the City, with its international markets, than to foster an alternative comparative advantage in another industry with the tax revenue generating capacity of the City.

FWIW I don’t think that the Banking Commission’s report does go far enough:

– the additional capital requirements will prompt more risky behaviour on the part of banks as they seek profits to attract the additional equity capital

– the proposals alone won’t reduce the possibility of a sufficiently large investment bank or hedge fund failing to rock the financial system, like Lehman Bros, or imprudent mortgage lending by a retail bank like Northern Rock

– the proposal of Lord Turner and others for discretionary regulatory powers to vary the capital requirements of banks contra-cyclically seems to have got lost in the post – in other words, regulatory authorities should have the powers to increase the capital requirements of banks in boom times or when a prospective asset-price bubble develops as the result of bank lending – the challenging problem being that of distinguishing when there is a bubble and when there isn’t.

Bob B,

@46: “ICL because it relied too much on the mainframe business and the public sector?”

Fair comment except that ICL digested much supportive initial state aids to get going – as did Britain’s pioneering nuclear energy industry – and ICL did try, like IBM, to move out of hardware into software and computer services but IBM made a successful transition.

Not without struggle, though – IBM haemorrhaged jobs in the early 90s and (apparently) moved from low margin to high margin product. OTOH ICL carried on pouring resources into products that people weren’t interested in – there’s only so long you can carry on with that!

For some reason, there has been an inordinately high failure rate of successive public sector computer services contracts – virtually all the big name computer services companies are implicated – it makes sense to avoid big computer services contracts whenever feasible.

The madness here is that we know the main causes for failure but don’t seem to learn from it. The billions of pounds that have been wasted…

There may be hope.

@UKLiberty

To its immortal credit, Computer Weekly, the premier mag for computer and IT professionals, has waged a tireless, strident campaign to publicise the scandalous waste of public expenditure on successive government computer projects of which this CW piece is but one, fairly recent example:

Only 30% of the government’s technology-based projects are a success, a government expert has revealed.

The figures come at a time when taxes are funding a £14bn annual spend on IT – equivalent to 7,000 new primary schools or 75 hospitals a year. [21 May 2007]
http://www.computerweekly.com/Articles/2007/05/21/223915/Only-a-third-of-government-IT-projects-succeed-says.htm

Despite that – and the problem is of much older vintage than 2007 – the waste has continued. I suspect that we need to look into the sociology of bureaucracies and politics to try to understand the root causes and longevity of the government’s problem with computer project failures – but also to note that the problem is by no means exclusive to governments:

“City in 275m pounds computer fiasco: Stock Exchange chief resigns after Taurus shares system is scrapped, threatening 1,000 jobs” [12 March 1993]
http://www.independent.co.uk/news/city-in-275m-pounds-computer-fiasco-stock-exchange-chief-resigns-after-taurus-shares-system-is-scrapped-threatening-1000-jobs-1497069.html

Part of the problem, but only part, is from naive government procurement staff who don’t really understand the projects or the technology and get easily persuaded by supplier excuses about why the project isn’t working just yet even in prototype form. However, as mentioned, virtually all the big name companies in computer services are implicated in failed projects so independent observers naturally inclined to wonder: how come?

In the mid 1990s, I had a discussion with one of Britain’s leading computer science academics at one of the ancient unis – he is a Turin Prize winner. There is huge competitive pressure to gain undergrad places at this university but when I said something which implied that there would be no problem attracting quality undergrads at his uni, he stopped and corrected me by saying that my assumption was incorrect. They did have a problem in attracting applications from sufficient quality candidates for undergrad places to read for computer science degrees. It’s fairly common knowledge among academics with memories going back decades that uni engineering departments have had continuing problems filling undergrad places. Much the same A-level subjects and minimum grades are needed to gain uni places to read for degrees in physics, maths, stats, astronomy, engineering and computer science. For whatever reason, there has been greater pressure to read for physics and maths degrees, but not for engineering and computer studies. For comparison, PPE at Oxford has one of the highest rejection rates !

For interest, try this report in The Economist of 14 October 2004 about concerns there expressed over government computer projects:
http://www.economist.com/node/3291010?story_id=E1_PNJTDTD

As said, this is an old, old story – which is why it is so worrying for taxpayers.

Bob B,

Only 30% of the government’s technology-based projects are a success, a government expert has revealed.

Yes – I quote that on my page about government IT failures.

What are the common causes of government IT project failure?

Lack of clear link between the project and the organisation’s key strategic priorities, including agreed measures of success.
Lack of clear senior management and Ministerial ownership and leadership.
Lack of effective engagement with stakeholders.
Lack of skills and proven approach to project management and risk management.
Lack of understanding of and contact with the supply industry at senior levels in the organisation.
Evaluation of proposals driven by initial price rather than long term value for money (especially securing delivery of business benefits).
Too little attention to breaking development and implementation into manageable steps.
Inadequate resources and skills to deliver the total portfolio.
– Source: Office of Government Commerce

… note that the problem is by no means exclusive to governments:

True. I believe the OGC or NAO looked at corporate projects as well, and came to similar conclusions as in the list above. Other studies, by other organisations and in other countries, come to similar conclusions. But the public purse doesn’t (usually) suffer when, say, British Gas cocks up its accounting system migration – I suffer as a customer and eventually become compensated (if I’m tenacious), but NPower and EDF customers don’t suffer. So there is a distinction there. And if billions of pounds are to be spent, I’d rather they were spent on health and education etc than thrown in the money-pit. I know you’re not saying otherwise, but government should hold itself to a higher standard than that of incompetent companies.

Part of the problem, but only part, is from naive government procurement staff who don’t really understand the projects or the technology and get easily persuaded by supplier excuses about why the project isn’t working just yet even in prototype form.

It seems imperative that government opens up, becomes more transparent, and takes on board disinterested expert advice and scrutiny. Reading evidence to Parliamentary committees and suchlike, there is little indication that Ministers value disinterested experts unless they happen to agree with the Government. I began with sympathy for ministers and civil servants who might be bamboozled by computer salesmen, but ‘confirmation bias’ , the Dunning-Kruger effect and suchlike quickly become apparent. They even resist scrutiny and criticism from the NAO! What hope is there when government cannot work with itself?

virtually all the big name companies in computer services are implicated in failed projects so independent observers naturally inclined to wonder: how come?

Because they are ‘big’ projects only big companies can take them on. And the risk is huge, so any failure will be relatively catastrophic – can I have another ten million pounds, please?

One of the intentions of the coalition is to facilitate the involvement of SMEs and allow them to contract directly with government rather than be subcontracted to a big supplier. But you have to parcel the work. That might not be possible in all cases – but then it’s worth looking at the project to see if it’s necessary for it to be so ‘big’.

This site about the NPfIT is very informative.

Bob,

For interest, try this report in The Economist of 14 October 2004 about concerns there expressed over government computer projects:
http://www.economist.com/node/3291010?story_id=E1_PNJTDTD

It says,

“… Computer Weekly, a trade publication with a history of exposing IT disasters, claimed that the Department of Health’s internal estimates said that the cost of the project could rise to more than £18.6 billion, and possibly as high as £31 billion—far above the project’s current budget of £6.2 billion. ”

It is worth noting that the initial guesstimate was £2.3bn!

I had to laugh when Lord Warner said the reason the guesstimate had increased to £20bn was that the £6.2 billion budget did not cover the cost of things like training people to use the new systems…

54. AnotherTom

The scale of waste around failed government IT and defence procurement dwarfs the cost of the state subsidy of finance.

However, only one of these is easy for people to make political capital out of.

@54: “However, only one of these is easy for people to make political capital out of.”

True enough – and the scale of lost GDP as the result of the financial crisis from autumn 2007 through to 2009 dwarfs all.

But the wasteful spending on IT and defence ARE significant in relation to the public spending cuts currently being made by the government – the NHS is being pressed to make £20 billion worth of “efficiency savings” over the next four years in the context of an annual national exchequer spend on the NHS of about £105 billion.

The fact is that for years there have been many warnings about the failings in MOD procurement and overstretch, along with the holes in MOD budgets, as well as wasteful spending on failed government IT projects – just as there have been umpteen comments about falling productivity in the NHS and the need to reform the NHS after the tripling of public spending on the NHS 1997-2010.

I can recall conversations in the margins with politicians going back c.30 years about how public spending on computer projects got nodded through because few understood what the projects were about and were bashful about showing their ignorance. Similarly, few politicians are inclined to question in public the estimates of defence expenditure – or expenditure on the NHS – for fear of being dubbed appeasers or uncaring about our troops and the welfare of the infirm and aged.

56. Richard Leon

Let’s be clear about this – the City is a leech, not a benefit.

The costs of the City include:

Outrageous asset inflation. Property prices in the South East are some of the most inflated in the developed world. And when they regularly go pop, chaos results.

Corrosive failures of democracy. The City has a stranglehold on the UK’s economic and social policy. Democracy isn’t about votes, it’s about policy, and ordinary oiks who don’t work for VeryImportantBank PLC have no policy input – even though we’re the ones with the insight to understand that (e.g.) austerity is disastrous suicidal economic tosh.

Erosion of general prosperity and the collapse of the tax base. The cultural influence of the City makes it extremely difficult for SMEs to prosper. Innovation always seems to happen as a bit of a surprising accident, rather than as something that could be nurtured, developed and financed, if only the culture supported it. Without the SMEs, the UK has become a managerial monoculture. (And clever grads and engineers do indeed spend their time playing with numbers when they could be doing something useful.)

Lack of accountability. When financial institutions can’t be allowed to fail – and banks wail about how accountability will “make it more expensive for them to borrow” – risk is underwritten by the public sector, which is pretty damn expensive for everyone else.

Elitist “values.” This is possibly the biggest problem in the UK. The Old School Tie network defines the UK’s cultural values, and the values taught to future managers and board members are frankly disordered and narcissistic, with an apparently limitless belief in personal entitlement based on nothing more than who one knows and who one’s parents are. It’s ironic that the Righties like to bash the unions for this when its their own cohorts who (privately) extol its virtues most blatantly.

The bottom line is that the City costs the rest of the UK a vast amount in lost economic opportunities, which it doesn’t come close to returning in taxes.

Without the City the UK would be a cheaper, more diverse, better run, more inventive, more productive, and far more prosperous place to live and work.

So if VeryImportantBank PLC and Posh-Name-With-Serifs Hedge Fund want to go elsewhere – let’s all hope they do exactly that.


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