The City of London's tumble
After the fall
Nov 29th 2007 From The Economist print edition
KOBAL
Britain's most spectacular moneymakers have tripped up. Over the next year or so, the fall will hurt not just them but Gordon Brown and the rest of the country too
“I WOULD rather see finance less proud and industry more content,” said Winston Churchill in 1925, shortly before he took the fateful decision to subject Britain's northern manufacturing heartland to an overvalued pound by returning to the gold standard. Over the past decade finance has seldom been more proud—and nowhere more so than in the booming City of London. Once again industry has been the poor relation, suffering from the strength of sterling, while northern regions have fallen further behind a more prosperous south.
This autumn the proud City has taken a fall. Bank shares have fallen by nearly 20% since the summer as investors worry about potential losses linked to dodgy mortgages in America. Banking jobs are being axed and financiers are no longer looking forward to the usual Christmas cheer of bumper bonuses. Yet in a bleak irony, the biggest casualty to date has been in Newcastle, the north-eastern base of Northern Rock. The mortgage lender's woes have undermined confidence in the ability of one of Britain's poorest regions to build a post-industrial future.
No one can gauge yet quite how serious the City setback will be or how long it will last. Although a prolonged banking crisis, such as the one that crippled the Japanese economy in the 1990s, cannot be ruled out, the current difficulties are still most likely to be a temporary reverse. Yet the impact over the next year or so will be painful, not only for those who work in the City but also for the economy and the public finances. As the shockwaves ripple out from London's financial district, they could undermine the regional foundations of Labour's long electoral hegemony.
Over the past decade, financial services have grown much faster than the economy as a whole, whereas manufacturing has barely grown at all (see chart). At the start of this decade, the financial sector—banking and securities, insurance and specialist services like shipbroking—made up 5.5% of national output; by 2004 that share had jumped to 8.3%. Over the same period manufacturing dwindled from 17.9% to 14.1%. The financial sector's expansion has continued apace: by 2006 it made up 9.4% of the economy, according to provisional official estimates.
Finance is more important to the economy in Britain than it is in other countries. What makes the difference is the City's role as a global financial hub, where leading banks and moneymen congregate to do business with one another. As a centre for international finance, London heads the league. Its foreign-exchange markets are huge, with over twice New York's share of trading; it dominates off-exchange dealing in derivatives; and last year it hosted the most new share issues, by value. London's specialist wholesale financial services and markets, which now extend well beyond the historic “square mile” round St Paul's Cathedral to encompass Canary Wharf in the east and Mayfair in the West End, make up a third of Britain's financial sector.
The recent City-led expansion of finance in Britain has meant that a sector worth almost a tenth of the economy has been responsible for 30% of overall GDP growth over the past three years. The unpleasant corollary is that the financial crisis will apply the brakes. National output is expected to expand by about 3% in 2007. But according to CEBR, an economic consultancy that monitors the City, GDP growth will decrease in 2008 to 1.4%, its slowest since 1992, as banks curb their lending and trading activities.
Although most other forecasters are less gloomy, the government has good reason to worry about a finance-led economic downturn. In the past decade Britain's financial sector has contributed about 30% of all corporation-tax revenues. For all the attention devoted to how some escape their fair share of taxes, the taxman has also reaped handsome returns from the City's high fliers, who make up many of the top 1% of earners contributing 22% of income-tax receipts. The fiscal dividend has been vital in paying for Labour's big public-spending increases.
But now the deteriorating fortunes of the financial sector threaten the health of the public finances. Alistair Darling, the chancellor of the exchequer, conceded in October that borrowing would overrun by £4 billion ($8.3 billion) in 2007-08 and £6 billion in 2008-09, raising the total budget deficit to £38 billion and £36 billion respectively. But these higher estimates, representing the Treasury's first stab at the impact of the banking crisis, may still be too optimistic. The government has got its sums wrong about revenues from the financial sector before, points out Robert Chote, director of the Institute for Fiscal Studies, a think-tank. It was wrongfooted by the dotcom crash in Labour's second term, when revenues fell by more and for longer than it had expected.
Changing the mixA finance-led downturn will have wider social consequences too. London acts as a huge turntable, sucking in migrants from abroad but spinning out existing residents to the rest of the country. As the City slows, so too will its demand for foreign labour. After several years in which national immigration figures have been higher than expected, next year's may surprise by coming in lower than expected. “It is pretty certain that if the London economy does hiccup there will be a slowdown in immigration to Britain,” says John Salt, head of the Migration Research Unit at University College London.
London may also become less popular with rich foreigners, who have given it an increasingly plutocratic feel in recent years. With less money to be made, some may be put off staying by the prospect of having to pay a special annual charge of £30,000 from April 2008 if they claim non-domicile status, which protects foreign income from taxation so long as it is not remitted to Britain. The “non-dom” tax will affect only those who have lived in Britain for seven or more years but it already seems to be affecting sentiment.
The most important effect of the City slowdown may be to change the regional balance of economic advantage, which poses a potent political threat to the current government. After Labour's fourth successive defeat at the polls in 1992, Giles Radice, then one of its MPs, wrote an influential pamphlet called “Southern Discomfort” arguing that the party would continue to fail so long as it stayed stuck in its northern strongholds and put off the aspirant voters of the south. Tony Blair got the message and won a landslide in 1997 by wooing southern voters still smarting from the economic pain of the housing crash in the early 1990s. He won another thumping victory in 2001, as London and the south thrived in Labour's first term.
The surge in southern prosperity over the past decade has been greatest in London. In 1995 output per person in the capital was 28% higher than the British average; by 2005 it was 36% greater. Only two other regions gained ground: the south-east (11% above the national average in 1995; 15% above it in 2005) and the south-west (8% below the national average in 1995; 6% below it in 2005). Scotland, Wales, Northern Ireland and the other six regions in England (essentially the Midlands and the north) all lost ground (see map).(n/a)
Not only is London one of Europe's most prosperous regions, but also it is one of the biggest city economies in the world. In a recent ranking by PricewaterhouseCoopers (PWC), an accountancy firm, its GDP was sixth highest—ahead of several national economies, including Sweden's and Switzerland's. Southern regions outside the capital have gained from its dynamism. For example, Reading, in the heart of the Thames Valley to the west of London, boasts the highest income per person among the 55 biggest towns outside London. The local economy is buoyed by a thriving IT sector including the British headquarters of Microsoft and Oracle; it has also attracted big financial companies such as Prudential and ING. “Overseas, people assume that the Thames Valley is London,” argues Christina Howell of the local chamber of commerce.
The south has also gained in wealth through its booming housing market. Over the past decade house prices have risen most in the south-west and London (after Northern Ireland, a special case thanks to the return of peace) and least in Scotland. International money and big City bonuses have pushed up property prices in choice areas of the capital to the highest in the world, according to a recent study by Knight Frank, an estate agency. The golden touch of City chequebooks has extended far beyond London, causing, for example, astonishing rises in the cost of holiday homes in favoured resorts on the coast of Cornwall in the south-west.
When Mr Blair pulled off an historic third-term victory in 2005, southern voters were grumpier: there was an unexpectedly sharp swing against Labour in constituencies around the capital. One reason was the deteriorating quality of life for many people caused by traffic congestion and overcrowding on commuter trains. A second was that public services in the south face greater strains than in the rest of Britain because public payscales are in the main set nationally, and London's higher cost of living makes it hard to attract staff.
The third and most important reason for their discontent was that the early years of this century were not so good for the London economy: the City was hit by the downturn in international finance after the dotcom crash. Research by John Hawksworth, an economist at PWC, has unveiled a stark difference in performance between the second half of the 1990s and the first half of the current decade. Over the ten years to 2005, disposable incomes grew fastest in London. But that was because the capital did so well in the late 1990s; between 2000 and 2005 income growth in London trailed a bit behind the national average.
These figures do not include the effects of the City's boom in the past couple of years. But they suggest that there may be another political backlash if London now suffers as the economic brakes are slammed on. Since the capital's economy has generally outpaced GDP growth over the past decade, the slowdown to 1.4% that CEBR is forecasting for it next year—in line with the economy as a whole—will be especially painful. Even when London was outstripped by the rest of Britain in 2001, it still managed to expand by 2.0%.
Furthermore house buyers in and around the capital will be pummelled by rising mortgage costs arising from the credit crunch, a blow that will hit them hard since housing costs already gobble up a bigger share of their household budgets than in the rest of the country. And they can expect no consolation prize in terms of housing-market gains, since house-price growth will slow to zero both nationally and in the south by this time next year, according to Fionnuala Earley, an economist at the Nationwide Building Society.
The ripple effectLondon may have outstripped the rest of the country in the past decade but this has not been at the latter's expense. Rather, the capital's economic vigour has boosted growth elsewhere in a number of ways. For one thing, there is extensive trade between London and the regions. About half of it is in business and financial services. In 2003 London sold £66 billion of such services to the regions but also bought some £42 billion of them, according to a recent report by the Centre for Cities, a think-tank. Trade links are strongest with the south-east, but they are significant with other regions especially the Midlands.
Provincial Britain also benefits as the capital's high rents and labour costs push routine activities out into less expensive locations. This is happening all the time, points out Ian Gordon, professor of human geography at the London School of Economics (LSE): “Given London's high costs, firms are constantly looking for ways to move work out to places where it can be done more cheaply.”
Many of the moves are to the south-east, but firms also move farther afield such as to the north-west of England. “If you don't need to do operations in London, why would you?” asks Ivan Royle of Bank of New York Mellon, which opened a big office in Manchester two years ago. Expanding in Canary Wharf, where the bank has its main operation in Britain, would have meant higher rents, pricier services and a tighter market for talent. Manchester's cheaper costs and big pool of graduates (its university is Britain's largest) clinched the deal. Nor are these all “back office” jobs: the bank's 750-strong Manchester staff includes postgraduates.
Jobs in finance now loom larger in the economies of nearly all big towns than they did a decade ago, especially those that have direct transport links to London. The shift is devoutly sought by local leaders anxious to emulate the capital's winning economic formula. “Regional city bosses have adopted a London-lite strategy,” explains Tony Travers, a local-government guru at the LSE. They, too, want to fire up their economies by attracting jobs in financial and business services and by encouraging knowledge-intensive activities linked to local universities.
One worry is that the best and the brightest still seem to be lured to the capital. A recent study based on the 2001 census showed that the flow of professionals and managers to London from Britain's 26 next largest cities was considerably more than the traffic in the opposite direction. Indeed, the capital's share of recent graduates seems to be rising. Ms Howell of the Thames Valley Chamber of Commerce explains that a stint with a London firm is seen as the best start to a career in many occupations such as law and banking.
On the other hand, London still spins out many more people to the rest of the country than it attracts in domestic migration. Some of these are retirees, but moves, often to the countryside rather than cities, are also triggered when people start families and need more space and better public services. Those who leave have acquired knowledge and experience during their stay in the capital, which “creates a hugely beneficial skill transfer from London to the rest of the country,” says Douglas McWilliams, the head of CEBR.
These migration patterns are closely tied to the housing market, which also helps to spread prosperity across the country. Typically a boom in the capital's economy pushes up local house prices. This prompts Londoners to move out of the capital with bulging wallets, which in turn pushes up house prices in the rest of Britain. This pass-the-baton pattern has been repeated over the past decade.
Newspapers are full of financial woes these days, and there are doubtless more to come. But despite the gloom of the moment, history suggests that the overall economy and the City will both bounce back. London has been buffeted before in its post-war resurgence as an international financial centre. In the mid-1970s, for example, there was a serious banking crisis. In the early 1990s banks made big losses and midway through the decade Barings, a centuries-old bank once dubbed the sixth great power of Europe, collapsed.
Put out more flagsThe City's capacity to roll with such punches and then regain the upper hand suggests not only that it is in the fortunate position of operating in a buoyant sector—as international finance expands in response to globalisation—but also that it enjoys some prized natural advantages. Global financial businesses tend to throng together in just a few cities where they can be sure of drawing upon a big and highly skilled specialist workforce. Once a leading financial centre is established—and the City has had centuries of experience—its position tends to be self-reinforcing, since businesses and talent are attracted to the cluster like bees to pollen.
There is a more specific reason why London's economy may prove resilient this time: the impact of the £9 billion that is being spent on preparations to host the Olympic games in 2012. The building work for the games, spread over the next few years, will help to offset the likely curtailment of some commercial-property developments elsewhere in the capital. This specific boost to the metropolitan economy will come at a time when northern regions, which have especially benefited from Labour's big-spender ways, will be feeling the pinch as public budgets tighten.
The longer-term outlook for London remains bright, according to PWC, whose study projects that it will become the world's fourth biggest city economy by 2020, driven in particular by strong growth in business and financial services. That will be welcome to politicians who have found that the capital's clout enables them to punch beyond Britain's weight. “The City's lustre has burnished Labour's image,” says Mr Travers. But others will worry about the capital's increasing dominance. It has come to seem, for many people, a sort of laboratory in which a rawer, less-cohesive Britain is emerging; a crowded, hustling place of vaulting earnings for the rich and of widening income disparities, which drains talent and wealth from the rest of the country.
Despite these fears, those who cheer as the City falters, will be wrong. The gains from London's position as a global financial hub, a source of envy to other countries, outweigh the losses. Every economy needs an engine-room: better one manned by bankers than none at all.
After the fall
Nov 29th 2007 From The Economist print edition
KOBAL
Britain's most spectacular moneymakers have tripped up. Over the next year or so, the fall will hurt not just them but Gordon Brown and the rest of the country too
“I WOULD rather see finance less proud and industry more content,” said Winston Churchill in 1925, shortly before he took the fateful decision to subject Britain's northern manufacturing heartland to an overvalued pound by returning to the gold standard. Over the past decade finance has seldom been more proud—and nowhere more so than in the booming City of London. Once again industry has been the poor relation, suffering from the strength of sterling, while northern regions have fallen further behind a more prosperous south.
This autumn the proud City has taken a fall. Bank shares have fallen by nearly 20% since the summer as investors worry about potential losses linked to dodgy mortgages in America. Banking jobs are being axed and financiers are no longer looking forward to the usual Christmas cheer of bumper bonuses. Yet in a bleak irony, the biggest casualty to date has been in Newcastle, the north-eastern base of Northern Rock. The mortgage lender's woes have undermined confidence in the ability of one of Britain's poorest regions to build a post-industrial future.
No one can gauge yet quite how serious the City setback will be or how long it will last. Although a prolonged banking crisis, such as the one that crippled the Japanese economy in the 1990s, cannot be ruled out, the current difficulties are still most likely to be a temporary reverse. Yet the impact over the next year or so will be painful, not only for those who work in the City but also for the economy and the public finances. As the shockwaves ripple out from London's financial district, they could undermine the regional foundations of Labour's long electoral hegemony.
Over the past decade, financial services have grown much faster than the economy as a whole, whereas manufacturing has barely grown at all (see chart). At the start of this decade, the financial sector—banking and securities, insurance and specialist services like shipbroking—made up 5.5% of national output; by 2004 that share had jumped to 8.3%. Over the same period manufacturing dwindled from 17.9% to 14.1%. The financial sector's expansion has continued apace: by 2006 it made up 9.4% of the economy, according to provisional official estimates.
Finance is more important to the economy in Britain than it is in other countries. What makes the difference is the City's role as a global financial hub, where leading banks and moneymen congregate to do business with one another. As a centre for international finance, London heads the league. Its foreign-exchange markets are huge, with over twice New York's share of trading; it dominates off-exchange dealing in derivatives; and last year it hosted the most new share issues, by value. London's specialist wholesale financial services and markets, which now extend well beyond the historic “square mile” round St Paul's Cathedral to encompass Canary Wharf in the east and Mayfair in the West End, make up a third of Britain's financial sector.
The recent City-led expansion of finance in Britain has meant that a sector worth almost a tenth of the economy has been responsible for 30% of overall GDP growth over the past three years. The unpleasant corollary is that the financial crisis will apply the brakes. National output is expected to expand by about 3% in 2007. But according to CEBR, an economic consultancy that monitors the City, GDP growth will decrease in 2008 to 1.4%, its slowest since 1992, as banks curb their lending and trading activities.
Although most other forecasters are less gloomy, the government has good reason to worry about a finance-led economic downturn. In the past decade Britain's financial sector has contributed about 30% of all corporation-tax revenues. For all the attention devoted to how some escape their fair share of taxes, the taxman has also reaped handsome returns from the City's high fliers, who make up many of the top 1% of earners contributing 22% of income-tax receipts. The fiscal dividend has been vital in paying for Labour's big public-spending increases.
But now the deteriorating fortunes of the financial sector threaten the health of the public finances. Alistair Darling, the chancellor of the exchequer, conceded in October that borrowing would overrun by £4 billion ($8.3 billion) in 2007-08 and £6 billion in 2008-09, raising the total budget deficit to £38 billion and £36 billion respectively. But these higher estimates, representing the Treasury's first stab at the impact of the banking crisis, may still be too optimistic. The government has got its sums wrong about revenues from the financial sector before, points out Robert Chote, director of the Institute for Fiscal Studies, a think-tank. It was wrongfooted by the dotcom crash in Labour's second term, when revenues fell by more and for longer than it had expected.
Changing the mixA finance-led downturn will have wider social consequences too. London acts as a huge turntable, sucking in migrants from abroad but spinning out existing residents to the rest of the country. As the City slows, so too will its demand for foreign labour. After several years in which national immigration figures have been higher than expected, next year's may surprise by coming in lower than expected. “It is pretty certain that if the London economy does hiccup there will be a slowdown in immigration to Britain,” says John Salt, head of the Migration Research Unit at University College London.
London may also become less popular with rich foreigners, who have given it an increasingly plutocratic feel in recent years. With less money to be made, some may be put off staying by the prospect of having to pay a special annual charge of £30,000 from April 2008 if they claim non-domicile status, which protects foreign income from taxation so long as it is not remitted to Britain. The “non-dom” tax will affect only those who have lived in Britain for seven or more years but it already seems to be affecting sentiment.
The most important effect of the City slowdown may be to change the regional balance of economic advantage, which poses a potent political threat to the current government. After Labour's fourth successive defeat at the polls in 1992, Giles Radice, then one of its MPs, wrote an influential pamphlet called “Southern Discomfort” arguing that the party would continue to fail so long as it stayed stuck in its northern strongholds and put off the aspirant voters of the south. Tony Blair got the message and won a landslide in 1997 by wooing southern voters still smarting from the economic pain of the housing crash in the early 1990s. He won another thumping victory in 2001, as London and the south thrived in Labour's first term.
The surge in southern prosperity over the past decade has been greatest in London. In 1995 output per person in the capital was 28% higher than the British average; by 2005 it was 36% greater. Only two other regions gained ground: the south-east (11% above the national average in 1995; 15% above it in 2005) and the south-west (8% below the national average in 1995; 6% below it in 2005). Scotland, Wales, Northern Ireland and the other six regions in England (essentially the Midlands and the north) all lost ground (see map).(n/a)
Not only is London one of Europe's most prosperous regions, but also it is one of the biggest city economies in the world. In a recent ranking by PricewaterhouseCoopers (PWC), an accountancy firm, its GDP was sixth highest—ahead of several national economies, including Sweden's and Switzerland's. Southern regions outside the capital have gained from its dynamism. For example, Reading, in the heart of the Thames Valley to the west of London, boasts the highest income per person among the 55 biggest towns outside London. The local economy is buoyed by a thriving IT sector including the British headquarters of Microsoft and Oracle; it has also attracted big financial companies such as Prudential and ING. “Overseas, people assume that the Thames Valley is London,” argues Christina Howell of the local chamber of commerce.
The south has also gained in wealth through its booming housing market. Over the past decade house prices have risen most in the south-west and London (after Northern Ireland, a special case thanks to the return of peace) and least in Scotland. International money and big City bonuses have pushed up property prices in choice areas of the capital to the highest in the world, according to a recent study by Knight Frank, an estate agency. The golden touch of City chequebooks has extended far beyond London, causing, for example, astonishing rises in the cost of holiday homes in favoured resorts on the coast of Cornwall in the south-west.
When Mr Blair pulled off an historic third-term victory in 2005, southern voters were grumpier: there was an unexpectedly sharp swing against Labour in constituencies around the capital. One reason was the deteriorating quality of life for many people caused by traffic congestion and overcrowding on commuter trains. A second was that public services in the south face greater strains than in the rest of Britain because public payscales are in the main set nationally, and London's higher cost of living makes it hard to attract staff.
The third and most important reason for their discontent was that the early years of this century were not so good for the London economy: the City was hit by the downturn in international finance after the dotcom crash. Research by John Hawksworth, an economist at PWC, has unveiled a stark difference in performance between the second half of the 1990s and the first half of the current decade. Over the ten years to 2005, disposable incomes grew fastest in London. But that was because the capital did so well in the late 1990s; between 2000 and 2005 income growth in London trailed a bit behind the national average.
These figures do not include the effects of the City's boom in the past couple of years. But they suggest that there may be another political backlash if London now suffers as the economic brakes are slammed on. Since the capital's economy has generally outpaced GDP growth over the past decade, the slowdown to 1.4% that CEBR is forecasting for it next year—in line with the economy as a whole—will be especially painful. Even when London was outstripped by the rest of Britain in 2001, it still managed to expand by 2.0%.
Furthermore house buyers in and around the capital will be pummelled by rising mortgage costs arising from the credit crunch, a blow that will hit them hard since housing costs already gobble up a bigger share of their household budgets than in the rest of the country. And they can expect no consolation prize in terms of housing-market gains, since house-price growth will slow to zero both nationally and in the south by this time next year, according to Fionnuala Earley, an economist at the Nationwide Building Society.
The ripple effectLondon may have outstripped the rest of the country in the past decade but this has not been at the latter's expense. Rather, the capital's economic vigour has boosted growth elsewhere in a number of ways. For one thing, there is extensive trade between London and the regions. About half of it is in business and financial services. In 2003 London sold £66 billion of such services to the regions but also bought some £42 billion of them, according to a recent report by the Centre for Cities, a think-tank. Trade links are strongest with the south-east, but they are significant with other regions especially the Midlands.
Provincial Britain also benefits as the capital's high rents and labour costs push routine activities out into less expensive locations. This is happening all the time, points out Ian Gordon, professor of human geography at the London School of Economics (LSE): “Given London's high costs, firms are constantly looking for ways to move work out to places where it can be done more cheaply.”
Many of the moves are to the south-east, but firms also move farther afield such as to the north-west of England. “If you don't need to do operations in London, why would you?” asks Ivan Royle of Bank of New York Mellon, which opened a big office in Manchester two years ago. Expanding in Canary Wharf, where the bank has its main operation in Britain, would have meant higher rents, pricier services and a tighter market for talent. Manchester's cheaper costs and big pool of graduates (its university is Britain's largest) clinched the deal. Nor are these all “back office” jobs: the bank's 750-strong Manchester staff includes postgraduates.
Jobs in finance now loom larger in the economies of nearly all big towns than they did a decade ago, especially those that have direct transport links to London. The shift is devoutly sought by local leaders anxious to emulate the capital's winning economic formula. “Regional city bosses have adopted a London-lite strategy,” explains Tony Travers, a local-government guru at the LSE. They, too, want to fire up their economies by attracting jobs in financial and business services and by encouraging knowledge-intensive activities linked to local universities.
One worry is that the best and the brightest still seem to be lured to the capital. A recent study based on the 2001 census showed that the flow of professionals and managers to London from Britain's 26 next largest cities was considerably more than the traffic in the opposite direction. Indeed, the capital's share of recent graduates seems to be rising. Ms Howell of the Thames Valley Chamber of Commerce explains that a stint with a London firm is seen as the best start to a career in many occupations such as law and banking.
On the other hand, London still spins out many more people to the rest of the country than it attracts in domestic migration. Some of these are retirees, but moves, often to the countryside rather than cities, are also triggered when people start families and need more space and better public services. Those who leave have acquired knowledge and experience during their stay in the capital, which “creates a hugely beneficial skill transfer from London to the rest of the country,” says Douglas McWilliams, the head of CEBR.
These migration patterns are closely tied to the housing market, which also helps to spread prosperity across the country. Typically a boom in the capital's economy pushes up local house prices. This prompts Londoners to move out of the capital with bulging wallets, which in turn pushes up house prices in the rest of Britain. This pass-the-baton pattern has been repeated over the past decade.
Newspapers are full of financial woes these days, and there are doubtless more to come. But despite the gloom of the moment, history suggests that the overall economy and the City will both bounce back. London has been buffeted before in its post-war resurgence as an international financial centre. In the mid-1970s, for example, there was a serious banking crisis. In the early 1990s banks made big losses and midway through the decade Barings, a centuries-old bank once dubbed the sixth great power of Europe, collapsed.
Put out more flagsThe City's capacity to roll with such punches and then regain the upper hand suggests not only that it is in the fortunate position of operating in a buoyant sector—as international finance expands in response to globalisation—but also that it enjoys some prized natural advantages. Global financial businesses tend to throng together in just a few cities where they can be sure of drawing upon a big and highly skilled specialist workforce. Once a leading financial centre is established—and the City has had centuries of experience—its position tends to be self-reinforcing, since businesses and talent are attracted to the cluster like bees to pollen.
There is a more specific reason why London's economy may prove resilient this time: the impact of the £9 billion that is being spent on preparations to host the Olympic games in 2012. The building work for the games, spread over the next few years, will help to offset the likely curtailment of some commercial-property developments elsewhere in the capital. This specific boost to the metropolitan economy will come at a time when northern regions, which have especially benefited from Labour's big-spender ways, will be feeling the pinch as public budgets tighten.
The longer-term outlook for London remains bright, according to PWC, whose study projects that it will become the world's fourth biggest city economy by 2020, driven in particular by strong growth in business and financial services. That will be welcome to politicians who have found that the capital's clout enables them to punch beyond Britain's weight. “The City's lustre has burnished Labour's image,” says Mr Travers. But others will worry about the capital's increasing dominance. It has come to seem, for many people, a sort of laboratory in which a rawer, less-cohesive Britain is emerging; a crowded, hustling place of vaulting earnings for the rich and of widening income disparities, which drains talent and wealth from the rest of the country.
Despite these fears, those who cheer as the City falters, will be wrong. The gains from London's position as a global financial hub, a source of envy to other countries, outweigh the losses. Every economy needs an engine-room: better one manned by bankers than none at all.
Is Britain's economy heading for the perfect storm?
Sean O'Grady, The Independenat Economics Editor Published: 05 December 2007
The storm clouds are gathering over the jobs market; the climate on the high street is growing distinctly chilly; a typhoon of bad debt is buffeting the banks. Could a "perfect storm" be about to hit the British economy?
The signs couldn't be much bleaker. The switchback in sentiment since the credit crisis began in the summer has been violent. The Nationwide Consumer Confidence Index recorded its largest drop yesterday, and joins the GfK/NOP survey earlier this week in suggesting that a wave of pessimism not seen for years is washing over the economy.
House prices have begun to fall, albeit slightly; commercial property is seemingly on the brink of collapse on a par with that seen in the early 1990s. The buy-to-let market is vulnerable. The Bank of England has, unprecedentedly, voiced concerns about the grim prospects for real estate. And the Financial Services Authority has warned of the "very real prospect" of the global credit crunch getting much worse. It is that bad.
Shopkeepers are looking forward to a black Christmas. Sir Philip Green, the boss of Top Shop and BHS, said last night on Sky TV that "business is very, very tough". The British Retail Consortium says that sales grew only marginally in November, having slowed markedly in October. JD Sports, ScS furniture and Greene King are the latest household names warning of setbacks. About 4.4 million credit-card customers still haven't cleared debts they ran up last Christmas, according to MoneyExpert.com.
We're less ready to spend, particularly on "big ticket" items – furniture, fridges, cars and so on. We're more pessimistic about our finances. We don't want to take on more debt and we want to rebuild our savings. The credit markets are seizing up again. That means banks are becoming much, much choosier about who they lend to, and are charging ever higher rates, despite the efforts of the authorities to keep money markets functioning normally. No lending; no spending.
That unwillingness to lend – the credit crunch – has started to affect businesses too, though firms remain generally more upbeat than consumers. Manufacturing firms, and in particular those in the car industry, are happy, a veritable ray of sunshine. However, manufacturing makes up only 15 per cent of the economy. In the financial sector, responsible for more than half of the recent growth in the UK's GDP, the mood is glum.
After months defying gravity, share prices have suffered some dramatic falls. City bonuses will be cut this year – and next – along with recruitment and investment. Barclays, HSBC and other banks have reported billions in losses, while the future of Northern Rock is uncertain.
Growth in the construction sector eased to a 14-month low in November, according to the Chartered Institute for Purchasing and Supply. The gentle rise in unemployment over the past 18 months may accelerate. The accountants KPMG say that "what we are seeing is that the credit crunch is tightening its grip over the economy... an underlying weakening, with both demand for permanent staff and vacancies down on the levels earlier this year."
Everyone from the Treasury to the IMF has trimmed their forecasts for UK growth; from close to 3 per cent for 2008, down to nearer 2 per cent. The IMF says that even this is now too optimistic. Is it time to start talking about the "R-word" – recession, and the possibility that the economy might shrink?
The difficulty is that the credit crisis is a process that feeds on itself rather than an event that can be declared "over". It began with the collapse of the US sub-prime mortgage market and the housing crash there, problems which are intensifying. As more sub-prime customers default – because of the credit crunch – more banks record losses and stop lending, and more properties are dumped on to the depressed US housing market. That depresses confidence and spending, and the screw turns again.
On this side of the Atlantic we feel the chill because our banks are exposed to sub-prime and because the US economy is the world's biggest. If it slows, it drags us down with it. And the mood of economic gloom – Northern Rock, headlines on house-price crashes, higher prices for fuel at forecourts and food at checkouts – is reinforcing itself. Confidence is the magic ingredient in any economy; it is evaporating fast. There's no knowing how bad it could get.
The most pernicious aspect of this downturn is how it could turn not so much into a recession, but into "slowflation" – slow growth plus inflation. A depressed economy can co-exist with high inflation, as the world found in the 1970s. Low demand and high input costs (such as oil at $100 [£48] a barrel; wheat prices at record highs) squeeze profits and employment and cut the real value of wages. It also makes it tougher for the Bank of England to allow interest rates to drift lower.
But the really bad weather would arrive if the Chinese economy stumbled. Next year, more than half the world's growth will derive from China, India and other emerging economies. Were they to falter – say because the Shanghai stock market bubble burst – the world would almost certainly lurch into recession.
In all events, the worst of the slowdown will hit us towards the end of 2008, going into the spring and summer of 2009; the point when a general election is due. By then the public finances would be well out of control, though that may be the least of ministers' worries. Gordon Brown might not have sowed the seeds of the coming economic storm, but he may well reap the whirlwind.
Business as usual?
Keith Bowan: Equity analyst at Hargreaves Lansdown Stockbrokers
"There is an air of unease among stockbrokers at the moment. In recent weeks the market has been trying to factor in the credit crisis and what it means going forward. Obviously this has affected the bankers most, but it has trickled down to other areas. People in property have been severely hit, as have house building stocks. But further down, even the pub operators have faced trouble. There's certainly an air of caution that has descended on investors ever since Northern Rock – there's no doubt about that – and I'd say the mood is still cautious going into 2008. The stock market acts as a barometer of where things will be in the next six to twelve months, so investors must broadly expect conditions going forward to be difficult."
Ron Turnbull: Finance director of SCS Upholstery, Sunderland
"Clearly our sales have been worse this year than we forecast, and significantly down on the same period last year. We've been suffering for some time from the interest rate increases, and these are now filtering through to the customer.
"The effect of turmoil in the American sub-prime sector has had a big influence on the confidence of consumers over here. But it's not just that they're feeling more anxious because they see savers queuing up outside Northern Rock; they've actually got much less disposable income than they've had for a long time."
"Banks are less willing to lend to customers, even cutting down on lending to each other. Meanwhile essential spends like utility costs and council tax are rising way above the rate of inflation. All of this is coming together to make consumers much more cautious with their spending, and it is businesses like ours, which are vital to a healthy economy, that are suffering the consequences."
Barnaby Stutter: Store worker, Brixton Cycles Co-operative
"Like any other, our business is not 100 per cent recession- proof. But partly because we're a workers' co-operative, and partly because we've got a lot of fluidity, I think we'll survive any coming troubles. We can move from selling bikes to fixing them; pubs and restaurants, who really are suffering, don't have that sort of option.
"There's a snowball effect: the more people worry about it, the worse it becomes. Our culture seems to thrive on anxiety and people are ready to panic about what they're told to panic about. But retailers on the high street expecting a big Christmas bonanza are going to be disappointed.
"Realists always sleep well at night, and being realistic about the forthcoming festive season means lowering our expectations of it."
Carl Lester: Birmingham fashion boutique manager
"People do seem to be spending less at the minute. I've got two branches selling designer clothes in Birmingham, and overall the business is down.
"I think people who might once have shopped here once a month are coming more like once every two. Also, customers seem to be thinking more about what they already have before they spend.
"We've talked ourselves into a recession, and all of a sudden it seems like we're going to get one. I'm not too worried, as my business survived the same thing happening in the 90s."
Tony Brooks: Owner of the Cluny pub and restaurant, Newcastle
"I'm in no doubt that this is the start of the worst trading conditions in the 28 years I've worked in the industry. If you read the trade papers they're full of terrifying figures about the difficulty of the current climate. But in reality it's even worse than they make out.
"The pub trade in particular is coming under heavy attack from the Government on several fronts. Supermarkets selling ridiculously cheap alcohol make it impossible for us to compete, while the smoking ban has been a massive drain on our appeal. And new planning regulations are so tough it's proving harder than ever for us to make money. Some weeks, pubs are down 20 to 30 per cent on the same period last year.
"The broader economic conditions are making our life hell. Higher interest rates and unaffordable mortgages mean that disposable incomes are fast shrinking. Every consumer has priorities; our industry relies on there being some change in people's pockets after those priorities have been met. Today that spare change is disappearing.
"I'm not exaggerating in saying the next few weeks are going to be very painful, and 2008 will be the worst year ever for our industry, with more than 2,000 pubs almost certain to close."
Peter Clayton: Chief executive of the Association of Professional Recruitment Consultants
"As with any sector, there are noticeable trends in recruitment that are an indication of the health (or sickness) in our present condition. What we've seen over the past few months is a move to contract placements rather than permanent placements, which is a sure sign that employers are feeling shaky. Permanent placements have dropped by about 30 per cent in the last quarter – a massive shift.
"These trends haven't been such a prominent factor in the recruitment sector for several years. Employers on the whole are feeling very anxious and less willing to increase their payrolls by expanding staff numbers. Businesses are starting to recruit themselves rather than through agencies which, again, is a sign of anxiety.
The signs couldn't be much bleaker. The switchback in sentiment since the credit crisis began in the summer has been violent. The Nationwide Consumer Confidence Index recorded its largest drop yesterday, and joins the GfK/NOP survey earlier this week in suggesting that a wave of pessimism not seen for years is washing over the economy.
House prices have begun to fall, albeit slightly; commercial property is seemingly on the brink of collapse on a par with that seen in the early 1990s. The buy-to-let market is vulnerable. The Bank of England has, unprecedentedly, voiced concerns about the grim prospects for real estate. And the Financial Services Authority has warned of the "very real prospect" of the global credit crunch getting much worse. It is that bad.
Shopkeepers are looking forward to a black Christmas. Sir Philip Green, the boss of Top Shop and BHS, said last night on Sky TV that "business is very, very tough". The British Retail Consortium says that sales grew only marginally in November, having slowed markedly in October. JD Sports, ScS furniture and Greene King are the latest household names warning of setbacks. About 4.4 million credit-card customers still haven't cleared debts they ran up last Christmas, according to MoneyExpert.com.
We're less ready to spend, particularly on "big ticket" items – furniture, fridges, cars and so on. We're more pessimistic about our finances. We don't want to take on more debt and we want to rebuild our savings. The credit markets are seizing up again. That means banks are becoming much, much choosier about who they lend to, and are charging ever higher rates, despite the efforts of the authorities to keep money markets functioning normally. No lending; no spending.
That unwillingness to lend – the credit crunch – has started to affect businesses too, though firms remain generally more upbeat than consumers. Manufacturing firms, and in particular those in the car industry, are happy, a veritable ray of sunshine. However, manufacturing makes up only 15 per cent of the economy. In the financial sector, responsible for more than half of the recent growth in the UK's GDP, the mood is glum.
After months defying gravity, share prices have suffered some dramatic falls. City bonuses will be cut this year – and next – along with recruitment and investment. Barclays, HSBC and other banks have reported billions in losses, while the future of Northern Rock is uncertain.
Growth in the construction sector eased to a 14-month low in November, according to the Chartered Institute for Purchasing and Supply. The gentle rise in unemployment over the past 18 months may accelerate. The accountants KPMG say that "what we are seeing is that the credit crunch is tightening its grip over the economy... an underlying weakening, with both demand for permanent staff and vacancies down on the levels earlier this year."
Everyone from the Treasury to the IMF has trimmed their forecasts for UK growth; from close to 3 per cent for 2008, down to nearer 2 per cent. The IMF says that even this is now too optimistic. Is it time to start talking about the "R-word" – recession, and the possibility that the economy might shrink?
The difficulty is that the credit crisis is a process that feeds on itself rather than an event that can be declared "over". It began with the collapse of the US sub-prime mortgage market and the housing crash there, problems which are intensifying. As more sub-prime customers default – because of the credit crunch – more banks record losses and stop lending, and more properties are dumped on to the depressed US housing market. That depresses confidence and spending, and the screw turns again.
On this side of the Atlantic we feel the chill because our banks are exposed to sub-prime and because the US economy is the world's biggest. If it slows, it drags us down with it. And the mood of economic gloom – Northern Rock, headlines on house-price crashes, higher prices for fuel at forecourts and food at checkouts – is reinforcing itself. Confidence is the magic ingredient in any economy; it is evaporating fast. There's no knowing how bad it could get.
The most pernicious aspect of this downturn is how it could turn not so much into a recession, but into "slowflation" – slow growth plus inflation. A depressed economy can co-exist with high inflation, as the world found in the 1970s. Low demand and high input costs (such as oil at $100 [£48] a barrel; wheat prices at record highs) squeeze profits and employment and cut the real value of wages. It also makes it tougher for the Bank of England to allow interest rates to drift lower.
But the really bad weather would arrive if the Chinese economy stumbled. Next year, more than half the world's growth will derive from China, India and other emerging economies. Were they to falter – say because the Shanghai stock market bubble burst – the world would almost certainly lurch into recession.
In all events, the worst of the slowdown will hit us towards the end of 2008, going into the spring and summer of 2009; the point when a general election is due. By then the public finances would be well out of control, though that may be the least of ministers' worries. Gordon Brown might not have sowed the seeds of the coming economic storm, but he may well reap the whirlwind.
Business as usual?
Keith Bowan: Equity analyst at Hargreaves Lansdown Stockbrokers
"There is an air of unease among stockbrokers at the moment. In recent weeks the market has been trying to factor in the credit crisis and what it means going forward. Obviously this has affected the bankers most, but it has trickled down to other areas. People in property have been severely hit, as have house building stocks. But further down, even the pub operators have faced trouble. There's certainly an air of caution that has descended on investors ever since Northern Rock – there's no doubt about that – and I'd say the mood is still cautious going into 2008. The stock market acts as a barometer of where things will be in the next six to twelve months, so investors must broadly expect conditions going forward to be difficult."
Ron Turnbull: Finance director of SCS Upholstery, Sunderland
"Clearly our sales have been worse this year than we forecast, and significantly down on the same period last year. We've been suffering for some time from the interest rate increases, and these are now filtering through to the customer.
"The effect of turmoil in the American sub-prime sector has had a big influence on the confidence of consumers over here. But it's not just that they're feeling more anxious because they see savers queuing up outside Northern Rock; they've actually got much less disposable income than they've had for a long time."
"Banks are less willing to lend to customers, even cutting down on lending to each other. Meanwhile essential spends like utility costs and council tax are rising way above the rate of inflation. All of this is coming together to make consumers much more cautious with their spending, and it is businesses like ours, which are vital to a healthy economy, that are suffering the consequences."
Barnaby Stutter: Store worker, Brixton Cycles Co-operative
"Like any other, our business is not 100 per cent recession- proof. But partly because we're a workers' co-operative, and partly because we've got a lot of fluidity, I think we'll survive any coming troubles. We can move from selling bikes to fixing them; pubs and restaurants, who really are suffering, don't have that sort of option.
"There's a snowball effect: the more people worry about it, the worse it becomes. Our culture seems to thrive on anxiety and people are ready to panic about what they're told to panic about. But retailers on the high street expecting a big Christmas bonanza are going to be disappointed.
"Realists always sleep well at night, and being realistic about the forthcoming festive season means lowering our expectations of it."
Carl Lester: Birmingham fashion boutique manager
"People do seem to be spending less at the minute. I've got two branches selling designer clothes in Birmingham, and overall the business is down.
"I think people who might once have shopped here once a month are coming more like once every two. Also, customers seem to be thinking more about what they already have before they spend.
"We've talked ourselves into a recession, and all of a sudden it seems like we're going to get one. I'm not too worried, as my business survived the same thing happening in the 90s."
Tony Brooks: Owner of the Cluny pub and restaurant, Newcastle
"I'm in no doubt that this is the start of the worst trading conditions in the 28 years I've worked in the industry. If you read the trade papers they're full of terrifying figures about the difficulty of the current climate. But in reality it's even worse than they make out.
"The pub trade in particular is coming under heavy attack from the Government on several fronts. Supermarkets selling ridiculously cheap alcohol make it impossible for us to compete, while the smoking ban has been a massive drain on our appeal. And new planning regulations are so tough it's proving harder than ever for us to make money. Some weeks, pubs are down 20 to 30 per cent on the same period last year.
"The broader economic conditions are making our life hell. Higher interest rates and unaffordable mortgages mean that disposable incomes are fast shrinking. Every consumer has priorities; our industry relies on there being some change in people's pockets after those priorities have been met. Today that spare change is disappearing.
"I'm not exaggerating in saying the next few weeks are going to be very painful, and 2008 will be the worst year ever for our industry, with more than 2,000 pubs almost certain to close."
Peter Clayton: Chief executive of the Association of Professional Recruitment Consultants
"As with any sector, there are noticeable trends in recruitment that are an indication of the health (or sickness) in our present condition. What we've seen over the past few months is a move to contract placements rather than permanent placements, which is a sure sign that employers are feeling shaky. Permanent placements have dropped by about 30 per cent in the last quarter – a massive shift.
"These trends haven't been such a prominent factor in the recruitment sector for several years. Employers on the whole are feeling very anxious and less willing to increase their payrolls by expanding staff numbers. Businesses are starting to recruit themselves rather than through agencies which, again, is a sign of anxiety.
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