Read more: "a radical prescription"—Andrew Haldane on John Kay's new book
There are good reasons to be sceptical about how much the financial sector contributes to Britain. It is an area in which Britain has competitive strengths, including language and time zone. Private profit without public benefit is a policy problem everywhere in finance, but a particularly acute British dilemma. About 1.1m people work in finance and insurance in Britain. This is 3.7 per cent of the labour force, less than in the United States (4.7 per cent) but more than in France (3.1 per cent) and Germany (2.8 per cent).
Most people in finance do clerical tasks in bank branches, call centres and insurance offices. Four hundred thousand people work in “the City,” the area round the Bank of England that is headquarters to most British financial institutions. Of these, 150,000 work for financial institutions.
Around 200,000 people work in London’s finance sector outside the City itself, many in Canary Wharf or the hedge fund centre in Mayfair, and another 250,000 are employed in the south-east region. Edinburgh is Britain’s second financial centre; 85,000 people in Scotland work in finance.
English law is widely used in financial contracts, even for transactions that have no connection with the UK—the result of the flexibility of its common-law basis, the English language and the perceived impartiality of English courts. And then there are the employees of sandwich bars and the London Transport staff who enable city folk to get to work. A reasonable guess might be that between 100,000 and 150,000 people in Britain are finance professionals who work in “the City,” and two to three times that number support them.
Around the time of the Second World War, a group of economists—notably Simon Kuznets, James Meade and Richard Stone—set out the principles for measuring the economic contribution of a commercial activity. We assess the car industry by its added value: the difference between the selling price of the car and the cost of the steel, rubber and other materials that went into it. That added value is the sum of the earnings of the people who build the car and the operating profit (before financing costs) of the business. We measure the value of a play by adding up what people pay for the tickets. These procedures may be crude, and mercenary, but they give a relatively objective answer.
But these methods don’t really work for finance. Few financial services are paid for in the direct way that cars and theatre tickets are paid for. The profits of finance businesses come largely from the difference between the rates at which they buy securities, or borrow money, and the rates at which they sell securities, or lend money. Interest costs, which are not deducted in computing the operating profits used in national accounts, are the principal costs that banks incur. Insurance companies make profits by taking premiums months or years before they pay claims and may lose money on underwriting while being profitable overall as a result of their investment income. The profits of the financial sector are partly a return to risk, and (as with accounting for risk in financial statements more generally) the adjustments necessary to reflect a true and fair view are complex and unsatisfactory. These difficulties mean that simple application of standard national accounts procedures gives nonsensical answers when applied to the financial sector.
Financial services pose a special problem. Different approaches yield very different answers, and the appropriate treatment has been extensively discussed among national accounts statisticians for several decades. There is now international agreement on a common approach, based around a set of concepts known as FISIM—financial intermediation services indirectly measured. By unfortunate coincidence, Britain agreed to implement FISIM in 2008, just as the global financial crisis hit, and that crisis blew out of the water some of the assumptions on which FISIM was based. In a survey of the problems of measuring financial services output, analysts at the Bank of England have noted that the reported share of financial services in GDP reached its highest ever level—at around 9 per cent—in the fourth quarter of 2008 and the calendar year 2009, when the banking sector was in collapse and the problems of finance had thrown the UK economy into recession. Figures for the contribution of the finance sector to national income should be taken with a pinch of salt.
The best way to judge the value of finance to the economy is to start with questions: what is the finance sector doing for households and businesses, by facilitating payments, managing personal finances, allocating capital and controlling risk? However, it is very difficult to turn that qualitative assessment into the numbers needed to compare finance output with car output.
A harder figure is the export contribution. Net UK sales of financial services to the rest of the world in 2013 were £38bn, more than 2 per cent of GDP and equivalent to more than 10 per cent of British exports of manufactured goods. It is perhaps unnecessary to ask further questions about the value of an activity if we know that people outside the UK are willing to pay for it. But this is hardly conclusive. Many people would hesitate to be shareholders in a world-leading manufacturer of snake oil, both for ethical reasons and perhaps from concern about the long-run viability of the business. And the international dimension raises a question that Robert Reich, the American political economist and Secretary of Labor under Bill Clinton, famously phrased as “Who is us?”
Britain is a global financial centre that attracts firms and talented individuals from around the world. Most financial business done in London is by firms that are not UK-resident, or which have parent companies that are not UK-resident. The activity of these companies is treated in the national accounts as productive activity undertaken in the UK and included in GVA (gross value added) and GDP (gross domestic product)—or would be if they were accurately measured, which for reasons explained above, they are not.
The profits of foreign-owned firms are not, however, included in gross national income (GNI), which is probably a better measure of the welfare derived from productive activity. GNI reports the incomes accruing to UK residents rather than the income generated in the UK, which is what determines GDP. GNI therefore recognises that there is no benefit to the UK from profits earned in London by Goldman Sachs or Deutsche Bank and repatriated to the home country of these companies (or to some other jurisdiction with a benign tax and regulatory regime).
These foreign companies, like their British-owned counterparts, are liable to UK corporation tax. But they do not pay much of it. Corporation tax paid by all banks (domestic and foreign) in the UK reached a peak of £7.3bn in 2006–7 but, as a result of the global financial crisis, this figure had fallen to £1.6bn in 2013–14. The combination of public anger directed at banks and the smallness of that tax figure has brought changes. Measures were announced in 2014 to restrict the ability of banks to use past corporation tax losses to diminish liabilities on future profits, and a “bank levy,” now 0.21 per cent of liabilities of banks operating in the UK, was introduced in 2011. The “bank levy” currently yields £2.2bn. All these numbers should be seen in the context of overall UK tax revenues of over £550bn.
The contribution of finance to the British economy is from pay rather than profits. Some people in finance are paid a lot, and a few are paid astronomical sums. Although finance accounts for less than 4 per cent of UK employment, it accounts for more than 7 per cent of UK income from employment. At Barclays, in 2013, there were around 530 “code staff” (a regulatory term for those with executive responsibilities), who were paid an average of £1.3m each. It is unlikely that many of these people would earn comparable sums in other activities, and this “economic rent’” derived by well-paid employees is central to any measure of the economic significance of finance. The income tax and national insurance payable on their remuneration is substantial. The banking sector alone yielded £17.6bn in income tax in 2013–14, almost 12 per cent of total income tax revenue. Income tax on the pay of financiers, rather than tax on financial institutions, matters to the UK exchequer.
But Reich’s “Who is us?” question arises here too. Many City employees are not UK citizens. Their tax positions are complex, and demonstrate all the possible combinations of status that residence, ordinary residence and domicile, permit. Some pay full UK tax; others do not. Some go home for the weekend to Paris, or New York; others picnic in the parks or attend concerts. The presence of many highly educated foreigners helped make London the most vibrantly cosmopolitan city in the world in 2014—possibly the most vibrantly cosmopolitan city that has ever existed. Yet a British citizen in those parks or auditoria, or on a Friday evening transatlantic flight or Eurostar train, must wonder—who is us? How, if at all, should the UK value the UK earnings of foreign firms and of individuals from around the world who are temporarily resident in London?
It is worth emphasising again that most people who work in banking, and in financial services generally, undertake relatively mundane clerical tasks and are not well paid. While 1,443 (in 2013) employees at Barclays earned more than £500,000 per annum, more than half the staff earned less than £25,000: it is likely that the best-paid 3,000 of the 150,000 staff at Barclays received more than half of total employee remuneration. The unbalanced structure of pay raises wider policy questions. For three decades a high proportion of the ablest graduates in the country have been attracted by startlingly large salaries into activities of little value to business or society. Activities that did little to develop their skills, or intellectual capacity, except in the narrowest of areas. How might their lives, and Britain’s economy and society, have differed if this financialisation had not occurred?
There are many people in high positions in financial services who plainly relish their roles and would want to continue such work even if they were paid much less. For Warren Buffett, the multi-billionaire investor, happiness is “tap dancing to work every day,” and he still does it at the age of 84. But Buffett is, as so often, the exception. If you talk to very well-paid barristers, or doctors, or actors, or footballers, you find that mostly, like Buffett, they love their jobs and recognise the double good fortune of a wonderful job and a massive financial reward. But less so in finance, where many people derive little intrinsic satisfaction from their work, do not undertake it for any reason other than the money and look forward to having accumulated enough to retire from the City. Although many find that the amount they perceive themselves as needing to be able to retire comfortably grows as rapidly as the amounts they have accumulated. What might these individuals have done if they had not been offered the prospect of huge rewards? Built businesses? Made scientific discoveries? Written poetry?
The most casual pub conversation reveals a popular resentment of the high pay of bankers that is not applied to the earnings of—say, Wayne Rooney or Bill Gates. This is hardly surprising: Rooney and Gates are people of exceptional talent, and it is obvious what they contribute to society. The resentment of earnings in finance is stoked by a well-founded combination of doubts about its utility, and a recognition that the global financial crisis revealed that many people in the finance sector were not, even within their own frame of reference, very good at their jobs.
All inequality is to some degree socially corrosive, but inequality which seems unconnected to deserts is particularly corrosive. The most disturbing downside of the global success of the City of London is the corrupting effect on society at large of a depreciation of ordinary morality and human values. The ethical standards associated with parts of the finance sector have been deplorable. Read the email exchanges among those responsible for fraudulent interest rate submissions, or the observations of the Lloyds Bank employees who falsified returns in order to attract more money from the government’s bail-out scheme for the bank. What were these people thinking?
The abuse of sex, alcohol and drugs by young people who suddenly found themselves in possession of too much money, the attractiveness of London to oligarchs and corrupt foreign politicians who buy mansions with money stolen from their domestic populations: British society cannot be proud of these things. Yet many of the same things might have been said—were said—of ancient Athens and Rome or Renaissance Florence or Venice. There is a price—perhaps a high price—to be paid for being at the centre of the world.
This extract is taken from John Kay’s new book “Other People’s Money”
There are good reasons to be sceptical about how much the financial sector contributes to Britain. It is an area in which Britain has competitive strengths, including language and time zone. Private profit without public benefit is a policy problem everywhere in finance, but a particularly acute British dilemma. About 1.1m people work in finance and insurance in Britain. This is 3.7 per cent of the labour force, less than in the United States (4.7 per cent) but more than in France (3.1 per cent) and Germany (2.8 per cent).
Most people in finance do clerical tasks in bank branches, call centres and insurance offices. Four hundred thousand people work in “the City,” the area round the Bank of England that is headquarters to most British financial institutions. Of these, 150,000 work for financial institutions.
Around 200,000 people work in London’s finance sector outside the City itself, many in Canary Wharf or the hedge fund centre in Mayfair, and another 250,000 are employed in the south-east region. Edinburgh is Britain’s second financial centre; 85,000 people in Scotland work in finance.
English law is widely used in financial contracts, even for transactions that have no connection with the UK—the result of the flexibility of its common-law basis, the English language and the perceived impartiality of English courts. And then there are the employees of sandwich bars and the London Transport staff who enable city folk to get to work. A reasonable guess might be that between 100,000 and 150,000 people in Britain are finance professionals who work in “the City,” and two to three times that number support them.
Around the time of the Second World War, a group of economists—notably Simon Kuznets, James Meade and Richard Stone—set out the principles for measuring the economic contribution of a commercial activity. We assess the car industry by its added value: the difference between the selling price of the car and the cost of the steel, rubber and other materials that went into it. That added value is the sum of the earnings of the people who build the car and the operating profit (before financing costs) of the business. We measure the value of a play by adding up what people pay for the tickets. These procedures may be crude, and mercenary, but they give a relatively objective answer.
But these methods don’t really work for finance. Few financial services are paid for in the direct way that cars and theatre tickets are paid for. The profits of finance businesses come largely from the difference between the rates at which they buy securities, or borrow money, and the rates at which they sell securities, or lend money. Interest costs, which are not deducted in computing the operating profits used in national accounts, are the principal costs that banks incur. Insurance companies make profits by taking premiums months or years before they pay claims and may lose money on underwriting while being profitable overall as a result of their investment income. The profits of the financial sector are partly a return to risk, and (as with accounting for risk in financial statements more generally) the adjustments necessary to reflect a true and fair view are complex and unsatisfactory. These difficulties mean that simple application of standard national accounts procedures gives nonsensical answers when applied to the financial sector.
Financial services pose a special problem. Different approaches yield very different answers, and the appropriate treatment has been extensively discussed among national accounts statisticians for several decades. There is now international agreement on a common approach, based around a set of concepts known as FISIM—financial intermediation services indirectly measured. By unfortunate coincidence, Britain agreed to implement FISIM in 2008, just as the global financial crisis hit, and that crisis blew out of the water some of the assumptions on which FISIM was based. In a survey of the problems of measuring financial services output, analysts at the Bank of England have noted that the reported share of financial services in GDP reached its highest ever level—at around 9 per cent—in the fourth quarter of 2008 and the calendar year 2009, when the banking sector was in collapse and the problems of finance had thrown the UK economy into recession. Figures for the contribution of the finance sector to national income should be taken with a pinch of salt.
The best way to judge the value of finance to the economy is to start with questions: what is the finance sector doing for households and businesses, by facilitating payments, managing personal finances, allocating capital and controlling risk? However, it is very difficult to turn that qualitative assessment into the numbers needed to compare finance output with car output.
A harder figure is the export contribution. Net UK sales of financial services to the rest of the world in 2013 were £38bn, more than 2 per cent of GDP and equivalent to more than 10 per cent of British exports of manufactured goods. It is perhaps unnecessary to ask further questions about the value of an activity if we know that people outside the UK are willing to pay for it. But this is hardly conclusive. Many people would hesitate to be shareholders in a world-leading manufacturer of snake oil, both for ethical reasons and perhaps from concern about the long-run viability of the business. And the international dimension raises a question that Robert Reich, the American political economist and Secretary of Labor under Bill Clinton, famously phrased as “Who is us?”
Britain is a global financial centre that attracts firms and talented individuals from around the world. Most financial business done in London is by firms that are not UK-resident, or which have parent companies that are not UK-resident. The activity of these companies is treated in the national accounts as productive activity undertaken in the UK and included in GVA (gross value added) and GDP (gross domestic product)—or would be if they were accurately measured, which for reasons explained above, they are not.
The profits of foreign-owned firms are not, however, included in gross national income (GNI), which is probably a better measure of the welfare derived from productive activity. GNI reports the incomes accruing to UK residents rather than the income generated in the UK, which is what determines GDP. GNI therefore recognises that there is no benefit to the UK from profits earned in London by Goldman Sachs or Deutsche Bank and repatriated to the home country of these companies (or to some other jurisdiction with a benign tax and regulatory regime).
These foreign companies, like their British-owned counterparts, are liable to UK corporation tax. But they do not pay much of it. Corporation tax paid by all banks (domestic and foreign) in the UK reached a peak of £7.3bn in 2006–7 but, as a result of the global financial crisis, this figure had fallen to £1.6bn in 2013–14. The combination of public anger directed at banks and the smallness of that tax figure has brought changes. Measures were announced in 2014 to restrict the ability of banks to use past corporation tax losses to diminish liabilities on future profits, and a “bank levy,” now 0.21 per cent of liabilities of banks operating in the UK, was introduced in 2011. The “bank levy” currently yields £2.2bn. All these numbers should be seen in the context of overall UK tax revenues of over £550bn.
The contribution of finance to the British economy is from pay rather than profits. Some people in finance are paid a lot, and a few are paid astronomical sums. Although finance accounts for less than 4 per cent of UK employment, it accounts for more than 7 per cent of UK income from employment. At Barclays, in 2013, there were around 530 “code staff” (a regulatory term for those with executive responsibilities), who were paid an average of £1.3m each. It is unlikely that many of these people would earn comparable sums in other activities, and this “economic rent’” derived by well-paid employees is central to any measure of the economic significance of finance. The income tax and national insurance payable on their remuneration is substantial. The banking sector alone yielded £17.6bn in income tax in 2013–14, almost 12 per cent of total income tax revenue. Income tax on the pay of financiers, rather than tax on financial institutions, matters to the UK exchequer.
But Reich’s “Who is us?” question arises here too. Many City employees are not UK citizens. Their tax positions are complex, and demonstrate all the possible combinations of status that residence, ordinary residence and domicile, permit. Some pay full UK tax; others do not. Some go home for the weekend to Paris, or New York; others picnic in the parks or attend concerts. The presence of many highly educated foreigners helped make London the most vibrantly cosmopolitan city in the world in 2014—possibly the most vibrantly cosmopolitan city that has ever existed. Yet a British citizen in those parks or auditoria, or on a Friday evening transatlantic flight or Eurostar train, must wonder—who is us? How, if at all, should the UK value the UK earnings of foreign firms and of individuals from around the world who are temporarily resident in London?
It is worth emphasising again that most people who work in banking, and in financial services generally, undertake relatively mundane clerical tasks and are not well paid. While 1,443 (in 2013) employees at Barclays earned more than £500,000 per annum, more than half the staff earned less than £25,000: it is likely that the best-paid 3,000 of the 150,000 staff at Barclays received more than half of total employee remuneration. The unbalanced structure of pay raises wider policy questions. For three decades a high proportion of the ablest graduates in the country have been attracted by startlingly large salaries into activities of little value to business or society. Activities that did little to develop their skills, or intellectual capacity, except in the narrowest of areas. How might their lives, and Britain’s economy and society, have differed if this financialisation had not occurred?
There are many people in high positions in financial services who plainly relish their roles and would want to continue such work even if they were paid much less. For Warren Buffett, the multi-billionaire investor, happiness is “tap dancing to work every day,” and he still does it at the age of 84. But Buffett is, as so often, the exception. If you talk to very well-paid barristers, or doctors, or actors, or footballers, you find that mostly, like Buffett, they love their jobs and recognise the double good fortune of a wonderful job and a massive financial reward. But less so in finance, where many people derive little intrinsic satisfaction from their work, do not undertake it for any reason other than the money and look forward to having accumulated enough to retire from the City. Although many find that the amount they perceive themselves as needing to be able to retire comfortably grows as rapidly as the amounts they have accumulated. What might these individuals have done if they had not been offered the prospect of huge rewards? Built businesses? Made scientific discoveries? Written poetry?
The most casual pub conversation reveals a popular resentment of the high pay of bankers that is not applied to the earnings of—say, Wayne Rooney or Bill Gates. This is hardly surprising: Rooney and Gates are people of exceptional talent, and it is obvious what they contribute to society. The resentment of earnings in finance is stoked by a well-founded combination of doubts about its utility, and a recognition that the global financial crisis revealed that many people in the finance sector were not, even within their own frame of reference, very good at their jobs.
All inequality is to some degree socially corrosive, but inequality which seems unconnected to deserts is particularly corrosive. The most disturbing downside of the global success of the City of London is the corrupting effect on society at large of a depreciation of ordinary morality and human values. The ethical standards associated with parts of the finance sector have been deplorable. Read the email exchanges among those responsible for fraudulent interest rate submissions, or the observations of the Lloyds Bank employees who falsified returns in order to attract more money from the government’s bail-out scheme for the bank. What were these people thinking?
The abuse of sex, alcohol and drugs by young people who suddenly found themselves in possession of too much money, the attractiveness of London to oligarchs and corrupt foreign politicians who buy mansions with money stolen from their domestic populations: British society cannot be proud of these things. Yet many of the same things might have been said—were said—of ancient Athens and Rome or Renaissance Florence or Venice. There is a price—perhaps a high price—to be paid for being at the centre of the world.
This extract is taken from John Kay’s new book “Other People’s Money”
