The notion that the City needs to shrink is gathering momentum

MEASURES of the attractiveness of global financial centres, rough and ready as they are, are consistent: only New York can vie with London for the title of top dog. Financial firms from around the world are drawn to the British capital; the assets in the country’s financial system are ten times its GDP. Yet little of the Square Mile’s bountiful wealth seems to trickle out. The gap between Britain’s richest and poorest parts is perhaps the biggest in Europe. Britain’s productivity growth is woeful.

Many Britons suspect that the City succeeds at everyone else’s expense. That view is decades old, but the financial crisis of 2007-08 intensified it greatly. The crisis brought the economy to its knees; the state spent £140bn ($220bn) bailing out banks. Public services have been squeezed in the years since; living standards have stagnated. Yet bankers still earn royal ransoms. As Britain prepares to fall out of the European Union’s single market after Brexit—thereby weakening the City’s appeal—some wonder whether it is time to rethink Britain’s economic model. Jeremy Corbyn, the leader of the opposition Labour Party, boasts that he is a “threat” to bankers, who, he says, “should not run our country”. Now a new book by Nicholas Shaxson, a writer (and a former contributor to The Economist), in effect argues that Britain would indeed be better off with a smaller financial sector.

Mr Shaxson provocatively compares Britain’s situation to that of Angola, a country where oil makes up over 95% of exports. Oil should bring widespread prosperity to Angola, but it does not. Brainy Angolans flock to the oilfields rather than to the civil service or health care. Floods of foreign capital raise the value of the currency, making non-oil industries uncompetitive. Angola, in wonk-speak, suffers from a “resource curse”, in which plentiful natural resources lead to worse economic growth. Mr Shaxson worries that Britain suffers from something similar, with financial services playing the role of oil.

The comparison is unwarranted. Since the City’s deregulatory “Big Bang” of 1986, GDP per person has grown faster in Britain than the average for rich countries. The claim that Britain’s financial industry sucks the best people from elsewhere is dubious. The share of economic output accounted for by finance is much higher than the share of university graduates in the sector.

True, some of these brainy folk do things that could fairly be described as socially useless: who really benefits from speculation on a derivative which is the fifth-cousin-once-removed of an interest rate? But many in the industry have studied hard, or moved to London from abroad, precisely to excel in finance. If their jobs left the City, they would surely follow them rather than set up an engineering firm in the provinces.

It is also hard to firm up Mr Shaxson’s claim that Britain’s large financial sector makes other industries uncompetitive. True, the City does encourage foreign investment in British firms and property. That pushes up both wages and rents in London, and probably the pound too, making it harder for other, price-sensitive export industries to thrive. But dynamic industries squeeze out sluggish ones everywhere: try being a steel-processor in the Bay Area. And the City is not to blame for some deep-rooted British shortcomings. The trade-weighted value of sterling has been declining for 50 years. Britain’s manufacturing exports as a share of the global total have been falling since the 1860s, long before the City became as powerful as it is today. Manufacturing’s share of output began falling in the 1950s, when financial regulation was extremely strict. Governments have tried countless times to arrest this decline, without success.

Against these uncertain costs can be set more certain benefits. Surveys suggest that Britain’s small and medium-sized enterprises find it easier to get hold of finance than the average European firm. Britain’s burgeoning peer-to-peer lenders help. London has a vibrant fintech scene partly because of proximity to the City’s pools of expertise and money.

Britain runs a large overall trade deficit but last year the surplus in financial services was 3% of GDP. From that, some may conclude that Britain is over-reliant on finance. But it may simply be a sign of strength. Nor, despite appearances, is finance confined to the City. Two-thirds of its jobs are outside London. Finance also contributes around a tenth of Britain’s total tax take.

Monopoly money

That reliance on finance can cause trouble is not in doubt. The crisis of 2007-08 is Exhibit A. Another worry is that an oversized financial sector has turbocharged the recent trend across rich countries for industries to be dominated by ever fewer big companies. Investment bankers get juicy fees when firms merge, so encourage them to do so. Relative to its economy, Britain sees 50% more mergers and acquisitions than America, where the financial sector is less powerful. Finance may play some part in Britain’s wider competition problem.

But in preventing both crises and monopolies, regulation is a better way forward than shrinking finance. Banks must already hold more equity than they did before the crisis. By next year they must put a “ring-fence” between retail and investment banking. Supervisors could go further—demanding yet more capital or doing more to discourage frothy property lending. Tightening antitrust policy, meanwhile, would help to ensure that mergers did more good than harm.

There is no need to be “sizeist”, in other words. Finance is big in Britain because Britain is good at it. Mr Shaxson is right that parts of finance are socially useless. He is also right that the City is too welcoming to dirty money (see article). Nevertheless, forcing finance to leave Britain is the road to a smaller economy and less tax revenue for the exchequer. Especially with Brexit looming, running down a successful commercial cluster looks like folly.