|By Professor Patrick Minford CBE |
An OpEd for the CityUnited Project
An important omission by those obsessed with EU passporting and equivalence, is failure to understand the underlying economics that will drive the City’s future success.
The City’s Future Size
After Brexit, the City is likely to expand as EU protection of agriculture and manufacturing is removed and UK resources move towards the UK’s central area of comparative advantage – traded services with the City as the prime element of these. Our research, based on a world trade model (Minford et al, 2015), suggests that the City is likely to expand on the order of 10% over a decade or so purely on the basis of economic fundamentals.
It is mistaken to think that the size of the City depends on demand for its services; it depends instead on the availability of UK resources, especially of skilled labour (it uses relatively little unskilled labour) and available office sites, as capital can flow in from around the world. Think how the City expanded after Big Bang; this happened because new powerful banks and other operators moved into London, boosting available supply and lowering its cost base. Brexit will also redirect resource supply to the City.
The Distance and Gravity Debate
There are those Remainers that continue to argue for a ‘gravity’ view of trade that the most important trade is with one’s neighbours, in our case the EU; and that diverting trade to distant markets, eg through trade agreements, is a weak strategy.
However, our work testing trade models based on comparative advantage versus those embracing this gravity approach shows that the gravity elements are rejected by the facts of UK trade – Minford and Xu (2018) – while our trade model based on comparative advantage fits these facts well. The City’s trade across the world is an obvious example of how trade that has nothing to do with distance or gravity flourishes in the UK.
Regulation Pre and Post-Brexit
A key element in the City’s ability to supply the right services at low cost is the regulative system it faces. What often is missing in the discussion about Passporting and attendant suggestions that the City should attempt to maintain its Single Market status in one form or other, is the negative impact that future EU regulatory actions would have been likely to have on its ability to prosper and compete with its real competitors – New York, Singapore, and Hong Kong. EU regulations brought in over the past ten years or so have been of uneven quality.
Now that the traditional regulative authority over the City – the Bank of England – has been restored, much better regulation than that from the EU is likely to be forthcoming. The EU in fact threatened the City with a variety of hostile actions such as the Financial Transactions Tax, which is still alive and kicking. Its bonus caps have also been a nuisance, while in general it has a fussy and over-prescriptive approach, as illustrated by the series of Mifid regulations. Brexit will therefore strengthen the quality of regulation, an essential element in the expansion we predict for the City.
Potential Trade Diversion by the City
Last and by no means least, there is the position of the City in world markets to be considered. As mentioned earlier, the size of the City depends on its available supplies, not on its potential demands. The latter are virtually infinite compared with the City’s size, remembering that the UK while one of the world’s larger economies only has around 4% of world GDP, and none of its sectors – including the City – can as a whole supply a whole lot more than this fraction of the world’s markets for their products.
If the EU employs protection to reduce UK financial services sales in its countries, the UK financial services not sold there will be diverted in the long term to other world markets – a process known as ‘trade diversion’. So the UK can supply more to its other markets at the same world prices. While there are some adjustment costs involved, these are short term and are relatively trivial when set against the massive, long term, permanent gains to the City from Brexit (see Reynolds (2016) and Minford (2016)).
The City’s Future Role as a World Financial Centre
For all the reasons explained above, the City will thrive after Brexit, continuing as the world’s leading financial centre and expanding further – see also Reynolds,2016.
The Bank of England should have the confidence to grasp the regulative challenge and simply ignore EU protectionist threats; these have little credibility and, in any case, if carried out would lead only to losses within the rest of the EU. Such actions reduce their ability to access the most competitive financial services.
This notion of serving as a World Financial Centre establishing its own regulatory regime compatible and competitive with global financial services markets is the key to understanding the City’s future.
By Professor Patrick Minford CBE
Professor of Applied Economics at Cardiff Business School, Cardiff University
04 Mar 2021
Minford, Patrick, with Gupta, S., Le, M., Mahambare, V., and Xu, Y. (2015): ‘ Should Britain leave the EU? An economic analysis of a troubled relationship’, chapter 4, second edition, December 2015, Edward Elgar.
Minford, Patrick (2016): Trading places – consumers versus producers in the new Brexit economy. Downloadable at www.politeia.co.uk.
Minford. P. and Xu, Y. (2018): Classical or Gravity? Which Trade Model Best Matches the UK Facts?’, Open Economies Review, 29 (3), No 4, 579-611.
Reynolds, Barnabas (2016): ‘A blueprint for Brexit: The future of global financial services and markets in the UK’. Downloadable at www.politeia.co.uk.