"The boom in the output of the financial sector was a boom in productivity. This has been stopped in its tracks by bureaucracy and regulation."
Happily, the Great Recession of 2008-09 is now being discussed in the past tense. Growth of national output last year was almost 3 per cent, taking the level of output to somewhat about its previous peak in 2008. Some commentators are even projecting steady expansion of over 2 per cent a year through to the 2020s, much in line with Britain’s typical record since the start of the Industrial Revolution.
But in one key respect recent performance has been much worse than the historical norm. Although national output is again reaching all-time peaks, output per head (or “productivity”) is still slightly lower today than it was seven years ago. The recovery from the Great Recession has seen healthy growth in employment. The trouble is that, on average, we are producing less per person than before the crisis began. A seven-year period with no gain in productivity is unprecedented and suggests that something fundamental has gone wrong. (Elsewhere in this issue, Martin Wolf of the Financial Times describes this “stagnation of labour productivity” as such a disappointing feature of the current recovery as to be “remarkable”.)
The halt to productivity growth is widely regarded as a bit of a puzzle. However, in some parts of the economy it is easy to identify the causes at work. Indeed, in one important, conspicuous and politically contentious sphere—financial services and the City of London—the check to output per head is readily explained.
In the 1960s and ’70s the City of London became the premier centre for “offshore finance”, financial activity in dollars that people and companies preferred to do outside the US, deals in Swiss francs that savers and investors wanted to have completed outside Switzerland, and so on. The volume of business rose rapidly, with the move to London largely motivated by attempts to avoid regulation and tax. In the 1980s and ’90s the ability to conduct transactions—quickly, effectively and for a global marketplace—was facilitated by dramatic advances in telecommunications and information technology.
These developments enabled those engaged in international financial services—bankers, dealers, analysts, fund managers, underwriters and brokers—to increase turnover per head several-fold. Although margins tended to be squeezed in highly competitive markets, revenues and output per head also climbed. Whereas in the 1960s the typical City income was perhaps 25 per cent above the national average (with the banks offering “London weighting” to offset the higher cost of living), by the late 1990s it was three times the national average.
Needless to say, high incomes in London’s financial sector caused resentment in the rest of the country, but even under New Labour the City’s dynamism received official blessing. Exports—exports, let it be emphasised—of financial services more than doubled as a share of national output between 1987 and 1997, and then almost doubled again in the ten years of the Blair premiership to 2007. (I have emphasised that the boom was in exports to refute a claim by Adair Turner, former chairman of the Financial Services Authority. Lord Turner has argued that the UK’s large financial sector is “too large” and “socially useless” because it constitutes “distributive rent extraction” between citizens of the same nation. This is ridiculous, as it overlooks that most of the City’s customers are not British.)
The boom in the output per head of those employed in the financial sector was, of course, a boom in productivity. By 2007 (when Blair resigned and the Great Financial Crisis began) the UK’s exports of financial services were only 3.4 per cent of GDP, but if insurance and a range of legal and finance-related service exports were added in, and allowance were made also for UK customers of these activities, the financial services cluster accounted for about a tenth of the British economy. The growth in productivity in this cluster over the 20 years to 2007 was so strong as to make a disproportionate contribution to the growth in the productivity of the UK. The evidence was clear in, for example, the enormous bonuses of a lot of people working in the City.
But since 2008 the UK’s exports of financial services have gone sideways, the UK’s share of international financial service business has started to decline and the surge in financial-sector productivity has stopped. One reason has been the imposition of new controls and regulations (including direct restrictions on the size of bonuses), often at the behest of such opinion-formers as Adair Turner and Martin Wolf. They should perhaps think harder about what they wish for. Do they need to be told that, if the productivity of a tenth of the economy stagnates after a period in which it had been growing by 5 per cent a year, the annual increase in productivity at the national level is 0.5 per cent lower than before?