If you’ve been following British politics at all, you’ll know that we’re on the horns of a dillemma at the moment. The City of London, home to the financial services industry, is both hugely profitable and hugely destructive. It makes up a sizeable percentage of Britain’s GDP, but also cost us billions in bailouts. The government frequently threatens to discipline the City, but doesn’t dare, because they are afraid that the bankers will move to New York or Frankfurt.
The debate is now rather divided between ‘bash the bankers’ polemic on one side, and cautious encouragement on the other. Those who are against the City are told that they are simply envious, and that we should put up with the excesses of a few for the good of the economy overall. I disagree, and here are five reasons why the City of London is not socially useful:
1. Brazilian democracy
In 2002 Luis ‘Lula’ da Silva of the Worker’s Party emerged as a leading candidate in Brazil’s presidential elections, battling it out against Social Democrat Jose Serra. Lula promised change and reform, but he was also seen as a leftist and a populist. Fearing that a Lula victory would mean worse conditions for the Brazilian economy, and possibly even a default on the country’s debts, speculators pulled their money out of the Real. The value of the Real plummeted to a new low of R4 to $1 as the currency went into crisis.
Lula won anyway, but the Brazilians had been punished for voting left, and it’s little wonder that Lula’s promised reforms never really materialised. Here’s the opening line from a Bloomberg article in 2006, when Lula stood for a second term: “Brazil’s Real rose to a three-week high on speculation presidential candidate Geraldo Alckmin, who favors lower taxes and spending cuts, may overtake President Luiz Inacio Lula da Silva in opinion polls in coming weeks.” So here’s point one: the City directly undermines democracy.
2. Iceland
“Iceland’s 300,000 citizens have become some of the world’s wealthiest people by opening up their economy and cutting taxes” – Wall Street Journal, March 2007
“Since the country’s banks went bust in October, unemployment has soared and is heading towards 10% and the currency has collapsed, losing more than one third of its value in a matter of months. Inflation is close to 20% and interest rates have hit 18%.” The Times, January 2009
“For decades to come, the Icelanders will regret their foray into international finance.” Wall Street Journal, January 2010
As traders ripped their investments away, they didn’t stop to think that behind Iceland’s ‘Nordic tiger’ image were real people with jobs and houses, and they are the ones left to pick up the pieces. The same thing happened to Malaysia and Thailand in the 90s. It could still happen to us – a financial industry that took a decade to build can literally evaporate overnight.
3. The commodities crisis
According to the UN, the world index of food prices rose by 9% in 2006, 23% in 2007 and 54% in 2008. Millions of people went hungry as food prices rose beyond their means, and dozens of countries experienced food riots. Behind these rises were droughts and failed harvests, demand for biofuels, and rising oil prices, but a fourth factor was in play: commodity speculation.
Fresh from the collapse of the financial derivatives market, investors were looking for somewhere to put their money. Derivatives may come and go, but everyone needs to eat, and everyone needs oil. Hedge funds bought up oil and grain futures in droves. The greater the shortage, the higher the prices, and traders playing the commodity markets made fortunes while millions of people went hungry. “Everyone and their mother is piling into commodities” wrote Ian MacWhirter in the New Statesman. “It is the great bull market of the Noughties. The trouble is that if you are one of the 2.8 billion people, almost half the world’s population, who live on less than $2 a day, you may pay for these profits with your life.”
4. Tax havens
As one of the world’s most dynamic economies, India receives a lot of foreign investment. Here are the top four sources of foreign direct investment since 2000:
- Germany: $2.14 billion
- US: $7.59 billion
- UK: $7.72 billion
- Mauritius: $35.18 billion
How can Mauritius, with its population of 1.2 million people, account for 43% of India’s direct investment? The simple answer is that Mauritius has a corporation tax of 3% (compared to the UK’s 30%). Companies channel money into India via ‘the Mauritius route’ to avoid paying tax.
That’s just one of many tax loopholes that allow the richest corporations and individuals to avoid paying what they owe. A full half of global trade is routed through tax havens, many of which are British protectorates. The City excels at tax avoidance, squirming every which way to dodge the taxes it ought to be paying the British government, only to come cap in hand to that same government when it runs into trouble.
5. Bad money drives out good
As if it wasn’t enough that the financial services industry undermines democracy, destabilises the global economy, profits from misery and doesn’t pay its fair share, it also undercuts the real economy with every passing year. Because financial speculation delivers much higher returns than any other form of investment, it becomes the natural choice for investors. If I won the lottery tomorrow, why would I invest in something useful like renewable energy if I could double my money by taking a punt on the rising oil prices?
The profitability of financial derivatives makes real industry uneconomic. Even companies that have made their names in manufacturing might have a speculative wing. As Andrew Simms and David Boyle point out in their book New Economics, last year Porsche make six times as much money on the stock market than they did from selling cars. As Britain is discovering, a profitable financial services sector is easily prioritised over more real industries, even though more jobs are created in the latter.
In short, the City is great at generating massive wealth, mainly for itself. If you’re only interested in that wealth and its contributions to GDP figures, you can turn a blind eye to everything else. If you look beyond the numbers for even a second, it turns out the City is hugely destructive. Britain cannot break its dependence on the City fast enough.
The Earthbound Report 
Very informative, it is worth to read. Thank you for sharing Jeremy.
Awesome post and very informative. Thank you for sharing jeremy