We have heard an awful lot about markets and the finical sector, most recently catapulted back to the front page by the Euro bailout talks and the St Paul’s protest. This week we saw concerns about FTSE pay rises in excess of 40% and the PM again defending the City of London financial district. It seems timely to look at the facts and figures behind Financial Services. Interestingly it is very hard to obtain figures on the value of this sector –perhaps why politicians feel so free to proclaim it as considerable.
If we look at GVA (basically the economic output of a country – about £1.35 trillion in the UK – I’m not going to go into the differences between gross value added and gross domestic product – these are just technicalities) we see that services account for 77% of this! Clearly an important sector. But what do we mean by services? Well basically everything that isn’t the other 23% that is manufacturing and power and goods (manufacturing being 11.6%). So retail, hotels, cafes, education, health, banks, etc. What we are interested in is of course finance and banking. The Telegraph recently quotes a figure of 14% - but it is not clear where this comes from. Business Services in its broadest sense the sector amounts to about 32% of GVA, but this includes everything from bookkeepers and banks to hedge funds and estate agents. With the greatest respect I wouldn’t image the village bookkeeper considers themselves to be part of ‘City Finance’, nor has much by way of bail out been directed to them. Looking at financial intermediaries and banking only the percentage comes down to 9%.
So ‘The City’ amounts to about 9% of GVA (similar to the USA). A significant amount undeniably. What is worth considering is the amount this relies on retail banking and the amount that relies on loose regulation, after all this is where the debate lies. Just as it is difficult to establish sales in the absence of advertising and marketing it is difficult to establish what would happen if the rules were tightened – in both case sales and banking/intermediary activity would continue. In other words this 9% value includes all finical services and banking – so everything from my daughter’s savings account to the most exotic of hedge funds. Clearly a significant proportion of this relates to retail banking and the more mundane stock market activity and traditional investment banking.
So, to put some £s to it, we can suggest that this sector contributes approximately 9% of the country’s £1.35 trillion GVA, or about £120 billion per year (this is not the same as asset base which is considerably higher at about 500% GDP). That’s a considerable amount of course; after all it is 9% of all activity. The question is though, leaving aside lost revenue linked to a slowdown in demand and recession, what is the cost of the UK bailout to date? Estimates range from half a trillion to a trillion. In other words between five and ten years worth of gross activity by that sector, and considerably longer when looked at in terms of tax receipts. Just as a comparison, and an industry I have no special links with, the creative arts industry employs “2 million people in Britain and contribute £60 billion to the economy each year, 7.3 percent of UK GDP” (there is a slight discrepancy between the value of these two industries due to data sources but the order of magnitude is clear enough) (Creative Britain).
With even such conservative papers as the Telegraph accept that this is a recession caused by the financial sector that sector’s activities and costs need to be considered carefully. For example, it is estimated that about 600 of RBS’ staff were involved in high risk banking. This is a very small percent of their then 130,000 total. In other words we can estimate that of this 9% contribution to GVA a small fraction is linked to casino banking (for example in 2005 banking and financial intermediaries accounted for 5.4% of the EU GDP). This then begs the question as to why we are so scared of regulating these type of activities to prevent reoccurrence. Or if you prefer a free-market approach, why we are wary of allowing moral hazard to return and forcing banks to take downside risk. Government money has been used to bail out so-called capitalist businesses instead of allow market forces to act and now we seem unable or unwilling to act to prevent a repeat of the crisis.
We now seem to be in a situation where considerable effort and capital is deployed caring for a sector that represents at best a couple of percent of GDP (assuming that like every other country in the world we would have a banking and financial sector even if we ceased pandering to the casino side of this industry). There are clearly two simple choices to be offered: regulation or separation of activities to allow for moral hazard. After all what is capitalist in handouts or being too big to fail? I am not sure what Giovanni Medici would make of this and certainly Schumpeter would wonder where the storm has gone.