Financial sector has been UK's undoing

During the heyday of Anglo-Saxon capitalism, London championed global finance. In fact, London enjoyed a lion's share in bond markets and dominated foreign exchange trade. Of late, however, with the Anglo-Saxon model under a shadow, the flaws inherent in Britain's growth story are becoming more obvious. The future prospects for London's sprawling financial services industry appear gloomy.

Indeed, the gloom in London's financial services draws from a broader, longer fall that Britain has not been able to reverse. Britain's overall influence, including economic might, has declined over nearly five decades. An entire generation has passed since Oxford and Cambridge have lost their pre-eminence as the world's leading centres of learning and path-breaking research, to take just one example.These were also the decades when Britain's industrial prowess almost disappeared. Britain's unmatched positions in shipbuilding, textile and steel were the first to fade in the 1960s and 1970s. In the 1980s, Britain was almost out of the automotive industry. More recently, Britain's leadership in oil and gas and pharmaceuticals also took a hit.

It might still appear that Britain's success in the financial sector during the 1990s compensated for its decline on other fronts. But, in fact, financial services has brought upon a precipitous fall — it got Britain accustomed to the cushion of growing incomes, but those income increases were hinged on legacy skills, rather than on sustained robustness.

RIDING ON A BUBBLE

Britain's legacy advantage drew from the fact that during the 1990s, when world trade looked up, there emerged a need for global-level administrative skills. The rest of the world also needed to trade in a language that trading partners were acquainted with. And, for heightened commerce to gain ground, a common law drawn out of “rights”-based principle was in order. Britain readily fulfilled these requirements, and London emerged as the world's lead financial broker.

To be fair, there is nothing wrong in leveraging on legacy skills, if one is clear that the ensuing reward arises out of circumstantial providence. Britain, however, interpreted the growing income from “legacy effects” as a legitimate reward. The net result: London bloated over a financial services bubble for well over a decade.

Policymakers and corporate strategists must pay closer attention to quality of growth, rather than growth itself. Financial services, real estate and other low-end services operate on very little innovation and social equity, and are prone to destabilising effects.

No matter what merit is cited in favour of financial services, in the end it doesn't get beyond arbitrage exploitation. Lending, for example, operates on the premise that it is good to lend as long as it is profitable — leaving unaddressed the broader, more serious challenge of avoiding the unhealthy rise in money supply. Very often, credit availability does exceed the need for useful credit — when a surfeit of credit ends up creating a bubble. Since the initial gains from a bubble build-up are either apparently attractive or not wholly noticeable, the policy machinery typically ends up promoting it. In short, bubbles get to acquire considerable staying power by drawing from both the demand as well as supply sides. If the less ambiguous “lending” can cause and sustain bubbles with relative ease, it is needless to emphasise what other complex financial instruments like hedges can do.

INNOVATION, SOCIAL EQUITY

However, there have always been natural checks and balances in technologically-driven growth models, dating all the way back to the Industrial Revolution. In fact, the very arrival of a certain technology implies innovation, productivity expansion and social equity. For example, when the railways and electricity came along they enhanced productivity and social equity; more recently, when mobile phones and the internet arrived, they bolstered new levels of cost-efficiencies.

In sum, macroeconomic policies must aim at fostering social equity by harnessing the power of innovation. In order to stay away from bubbles, exposure to legacy effects must be minimised. Legacy effects must not advance faster than the progress made towards social equity and innovation. It is of paramount significance to get the order right, as a reversal can exacerbate a bubble build-up. Growth by itself doesn't confer innovation. At best, when put to proper use, growth can play a facilitating role, but not substitute for social equity or creativity. That is why when policies put innovation and social equity first, they lead to well-balanced growth.

Hence, Britain's reliance on easy money from financial services has inhibited it from dealing with the issues that are at the core of sustained equitable growth. Yet, British policymakers and intellectuals are bending backwards to defend their financial sector. Britain's recent parting of ways with the EU — made clear by UK's rigid position at Brussels for exempting Financial Transactions Tax (FTT) — was made with an eye to preserve London's financial services.

Keeping the bubble of financial services going will adjourn the resolution of an age-old problem. However, Britain's promise for dynamic growth lies in deflating the bubble and doing what it had mastered in its days of glory: nurturing a broader-based, innovation-led enterprise. Britain's experience is seminally instructive to economies the world over.

(The author works with an MNC.)

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