The UK has lost out on a “staggering” £4.5 trillion over the course of two decades because of an oversized financial sector, a new study has found.
The “gravitational pull” of the City of London has damaged economic growth by sucking talent and investment from other productive uses such as manufacturing and research while inflating asset prices, particularly property, a paper from The Sheffield Political Economy Research Institute concluded.
Between 1995 and 2015 this “finance curse” has lowered cumulative GDP by 14 per cent compared to what it would have been with a leaner financial services sector, the researchers found.
They drew on previous academic studies from economists at the International Monetary Fund among others, who observed that as the level of credit to the private sector increases it generally boosts the economy as funds are allocated to people and businesses that need it.
However, once credit to the private sector reaches about 90 to 100 per cent of GDP this correlation begins to reverse, and further rises begin to drag on the economy.
According to the new research, the UK, which has a very large financial sector, has foregone a “staggering” £4.5 trillion of economic growth – equivalent to two and a half years of GDP or £67,500 per person.
The researchers concede that the results are approximate and that further work is needed to confirm the size of this effect in the UK and its causes. But they posit that the largest contributory factor is a misallocation of resources, notably the “crowding out” of other industries which causes those industries to wither and die over time.
In the UK, the vast sums of money being created as banking, fund managers and other financial businesses boomed has created a brain drain that pulled people from other industries.
In the 30 years following Margaret Thatcher’s deregulation of the City in the mid-1980s, financial workers were overpaid by around £280bn, when compared to people of a similar educational background in other jobs, according to the research. Meanwhile, financial services firms reaped an estimated £400bn in excess profits.
These booming profits and salaries pushed up the relative value of the UK’s currency, making manufactured goods and agricultural products more expensive to overseas buyers. Because the price of those goods is set internationally some businesses in those sectors have become less competitive or even unviable.
“Too much finance” also inflicts the costs of recurrent crises, which the study puts at £1.8 trillion between 1995 and 2015.
Professor Andrew Baker, co-author of the report and professorial fellow at the University of Sheffield, said the numbers hint at a “deep underlying problem” caused by the UK’s financial sector.
“UK economic strategy in a post-Brexit world needs to make addressing this the central challenge, recognising that where finance is concerned, more can sometimes be less, and less could be more,” he said.
John Christensen, a director at the Tax Justice Network who helped develop the framework for the research, witnessed the effects of the “finance curse” in his former role as economic adviser to the island of Jersey.
“This new evidence overturns the entrenched orthodoxy that what is good for the City of London must be good for the rest of Britain,” Mr Christensen said.
“For decades City interests have been inflicting a finance curse on the UK economy, inflating the exchange rate, slowing growth of the productive sectors, and lobbying governments into deregulating financial services, which led directly to the 2008 banking crisis.
“UK productivity has fallen dramatically behind most EU member states, and excess household and corporate debt is holding back growth.”
To solve the problem we must loosen the City of London’s “leaden grip on our economy” by strengthening regulation and increasing taxes on the financial sector, Mr Christensen said.
This will free up local businesses and allow hardworking citizens to prosper and flourish, he added.