The UK’s financial services industry is a significant source of jobs and tax revenues for the country. The government is introducing reforms to boost the sector, but whether this will translate into economic growth is uncertain. Meanwhile, Brexit is harming the City’s global competitiveness.
In the Chancellor’s recent ‘mini budget’ speech, he said that ‘a strong UK economy has always depended on a strong financial services sector’. Indeed, the fear of global banks taking their business from London to Frankfurt, Paris or New York was his justification for removing the cap on bankers’ bonuses.
Kwasi Kwarteng also promised further deregulatory reforms in the months to come. In addition, the proposal to reduce the top rate of income tax to 40% – which has now been reversed – may have been partly driven by the hope of attracting talent into the UK’s financial services sector.
What do we mean by the City?
The City is shorthand for the UK’s financial services sector. Economists use the expression because, as Figure 1 shows, over 53% of financial services output in the UK is in London. Most of that is concentrated in the square mile that is the City of London. Indeed, 19% of London’s total economic output comes from the City (Hutton, 2022).
Figure 1: Regional financial services output by country and region, 2020
Source: Hutton, 2022
The financial services sector includes a gamut of institutions including banks, insurers and investment fund managers. A broader definition of the sector includes related professional services such as accounting, legal services and management consultancy.
What does the City contribute to the UK economy?
London has been a global financial capital since the 17th century (Neal and Quinn, 2001). In the 19th century, US railroads and emerging economies issued their securities on the London stock exchange and London’s banking system was at the heart of the global monetary system.
London financed and facilitated global trade, and insurance companies based there insured lives, property and shipping around the world. Despite the vicissitudes of world wars and bouts of deglobalisation, London remains one of the world’s leading financial centres.
In terms of economic output, the UK financial services sector contributed £174 billion or 8.3% of total UK gross value added in 2021. If we add in the related professional services that support the industry, the totals rise to £261 billion and 12.5% (TheCityUK, 2022). The financial services sector is therefore an important part of the economy in terms of output.
Figure 2: Share of economic output from financial services industry, 1990-2021
Source: Hutton, 2022
Over the past three decades, the City has become much more important to the UK economy in terms of its contribution to economic output. As Figure 2 shows, the majority of this growth happened in the run-up to the global financial crisis of 2007-09.
The financial services sector is a major source of employment. In 2021, 1.1 million people were employed in the industry, which constitutes 3.3% of all UK jobs. These figures rise to 2.2 million and 7.4% when related professional services are included (TheCityUK, 2022).
Although the financial services sector has grown over recent decades, it employs the same number of people and a smaller proportion of the UK workforce than it did 30 years ago (Hutton, 2022).
The industry has been a big adopter of new technology, with the result that it can produce more output with less labour. This means that financial services have one of the highest levels of labour productivity of any sector in the UK. The output per hour in the sector in 2020 was £83.30 compared with £39 for the whole economy (TheCityUK, 2022).
The financial services sector is also a major contributor to the nation’s tax income. In 2019/20, the UK financial sectors contributed about £75 billion of tax or just over 10% of the government’s total tax receipts for the year (see Figure 3).
Figure 3: Tax contribution of UK financial services
How is Brexit affecting the City?
The UK has historically been a major exporter of financial services. This is still the case today, with the trade surplus generated by the financial services industry being £45 billion in 2021 (see Figure 4). If we add related professional services, this trade surplus doubles in size.
To put this in perspective, the financial services trade surplus is equal to the combined surpluses of the next two leading economies – the United States and Singapore. It is also greater than the trade surplus of all other UK industries that produce one (TheCityUK, 2022).
The worrying feature in Figure 4 from a trade surplus perspective is that exports of financial services have been falling since 2019. How much of this decline has been due to Brexit?
As part of the European Union’s (EU) single market, UK financial services firms had market access to the rest of the EU through ‘passporting’. In other words, a firm’s UK licence to operate as a financial institution allowed it to operate in EU member states without the need for further authorisation. From the end of 2020, UK institutions lost their passporting rights and had to apply for a licence to operate in each and every EU country (Shalchi, 2021).
In 2019, 40% of UK financial services exports went to the EU. By 2021, this figure had fallen to 33% (Hutton, 2022). Comparing the first quarter of 2020 with the same period in 2022, financial services exports to the EU had fallen by 17%. Brexit appears to have hurt the UK’s largest producer of a trade surplus.
Figure 4: UK trade in financial services
This context goes some way to explaining the Chancellor’s desire to stimulate growth of the City. Another reason may be to boost the City’s competitiveness.
Each year, the Global Financial Centre Index measures the competitiveness of leading financial centres. Since the Brexit referendum, London has fallen from first to second place and it has suffered a large drop in its rating (see Table 1). At the same time, Amsterdam, Frankfurt and Paris have made major strides and are moving up the rankings.
Table 1: Global Financial Centres Index, 2016 and 2022
Source: Z/Yen, 2022
Can the City hurt the economy?
A long-standing argument going back many decades says that the City has failed to finance UK industry adequately because it is preoccupied with directing funds overseas rather than towards UK entrepreneurs (Edelstein, 1976; Kennedy, 1987). Increasingly, studies have been finding that there is less and less evidence to support these claims (Capie and Collins, 1992; Campbell et al, 2021).
The City can also stoke speculation and provide the finance that fuels asset bubbles (Quinn and Turner, 2020). The bursting of these bubbles can cause major economic problems, as witnessed during the banking crisis of 2007-09.
Finally, there is a debate as to whether a country can have too much finance in that its financial development reaches a point where it causes a fall rather than a rise in economic growth (Law and Singh, 2014; Arcand et al, 2015; Cho and Eberhardt, 2022). The negative effects on growth can come from financial crises or the recessions that follow credit-induced booms. They may also come from the fact that the financial sector diverts talent away from more productive sectors of the economy (Tobin, 1984).
The UK’s financial services sector as a percentage of the overall economy is 8% (Hutton, 2022). Only three OECD countries have a higher ratio than the UK – the United States, Switzerland and Luxembourg.
The City is important to the UK economy. It provides many well-paying jobs, it contributes handsomely to the country’s economic output, it is a major export earner and it contributes nearly 10% to government tax revenue.
The Chancellor’s attempts to boost the City may well boost the UK’s economic growth. But a question remains as to whether the relationship between the UK’s financial system and its growth will continue to be positive.
Where can I find out more?
- The Global Financial Centres Index: The Financial Centres Futures report for 2022.
- Key facts about UK-based financial services: 2022 report by TheCityUK on the state of UK financial services.
- Financial services: Contribution to the UK Economy: House of Commons Library research briefing on UK financial services.
- Too much finance?: A VoxEU article examining whether finance can be bad for growth.
- Little evidence for ‘too much finance’: A VoxEU article arguing that there is little evidence to support the too-much-finance hypothesis.
- Bankers’ bonus cap: Recent survey of top European economists about the potential effects of removing the cap on bankers’ bonuses on economic growth, financial stability and the global competitiveness of the City.
Who are experts on this question?
- Jagjit Chadha
- Michael Moran
- John Wilson
- Barbara Casu