Why City gunslingers deserve their millions

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The Independent Online
THERE are, perhaps, a couple of thousand people in the City who will have made a million dollars this year, and several hundred who have made a million pounds. For most people outside the world of finance this will seem bizarre - that there should be such an enormous difference between earnings in financial services and in other trades. For some people, who for whatever reason dislike or distrust the City, it will seem outrageous.

But it is a fact, and understanding why this should happen is to understand in part the sort of grand economic changes that increasingly will engulf mature developed countries such as Britain as we move into the next century.

People who have made it big in the City this year fall into three main groups: performers, owners and hangers-on. The groups, it should be made clear, are not mutually exclusive, for quite a few of the performers, not to mention the hangers-on, also happen to be owners, or rather part-owners of the businesses in which they work. Intellectually, though, the groups are distinct.

The performers are the most interesting and important of the City's high earners. London is to international finance what Hollywood is to the film business: the largest export centre in the world. If you want to make money in the film business, you go to Hollywood; if you want to make money in international finance, you come to London. Moreover, finance, like films, is a business in which the contribution of talented people to profitability can be measured quite accurately. Accordingly, these people command incomes that are tied to the amount of profit they actually earn. Hire a star for, say, dollars 10m and this guarantees that the film will receive a certain amount of publicity, which in turn ensures a certain gross return.

In the City, the link between earnings and performance is often even more explicit. An acquaintance who runs one of the top merchant banks told me that they have one dealer who reliably makes pounds 3m- pounds 8m a year of profit for the firm. The deal is that, after deduction of his costs - about pounds 500,000 a year, including communications charges and an allocation of the firm's capital - he keeps one-third of the profit. The more they have to pay him, the more delighted they are - a bad year is when they only have to pay him a million.

A friend who runs the investment banking subsidiary of a clearing bank similarly reckons that they have at least half a dozen people, perhaps a dozen, who would earn more than a million pounds this year. He was slightly bemused by this, for it was vastly more than he - or even the chairman of the entire group - would receive. But these earnings were related precisely to the amount of profit earned for their employer. If this particular group did not offer an acceptable split, these people would move elsewhere.

It is important to appreciate that there is no moral issue here. Morally, it may be hard to feel comfortable about Hollywood stars who have made their fortunes by portraying gunslingers or happen to be adept at taking off their clothes. Equally, it is hard to feel comfortable about paying people millions for being adept at dealing in currencies, swaps, futures, options or whatever. But that is the reality: be it Hollywood or the City, the top players have rare skills. And they are paid for them.

There is a second group of high-earners who may or may not be competent, but make their money by owning part of the firm in which they work. The City is often thought of as a monolithic organisation, but it is in fact made up of what would, by industrial standards, be quite small firms, often organised as partnerships. At the top are large investment banks such as the US-based Goldman Sachs, where perhaps 100 partners will have received bonuses of dollars 1m or more. But at the bottom are small private client stockbrokers, investment advisers, Lloyd's syndicates, merchant banking 'boutiques' and so on, some of which employ only a dozen staff. In a good year - and with the exception of some (not all) Lloyd's underwriters, this has been a very good year - these businesses can be extremely profitable. Those profits are not needed for reinvestment in the business, so the owners share out most of the loot.

Then there is the third group, the hangers-on - people who contribute little, but happen to be in the right place at the right time. Because financial markets have done exceptionally well, more because of the fall in inflation and interest rates than because of any strong performance of the world economy, many financial firms have also done well. Anyone close to the honeypot will take some of the honey.

If this were all, then this year's City bonuses might be seen as an oddity related to the strong financial markets. But that would be to miss the importance of the City's role in the changing world economy.

There a number of things that advanced industrial countries do that cannot be done by the newly industrialised nations. These include the entertainment industry broadly defined, with the 'performance skills' of people such as Pavarotti and Gazza; the fashion industry, which relies on the performance skills of people such as Ralph Lauren; and the most innovative stars of new industries such as computer software, with Microsoft's Bill Gates as perhaps the best example. All such performers need support staff, but essentially what pulls the whole industry along is the talent of a small number of people with rare skills.

Finance is one of those industries that both relies on the talent of a small number of people, and so far has yet to be challenged by competition from the newly industrialised countries. London, for a variety of reasons, some of which go back several centuries, happens to be the most important export centre in that industry. Newly industrialised countries can compete in industries that need good general education, lowish wages, hard work, and not too much imagination. They cannot compete when these rare performance skills are required.

The moral is that we may, not just in Britain but in the West in general, have to become accustomed to living in a world of higher differentials: economies that have a few highly paid stars and a lot of other lower-paid people who provide them with goods and services. It is difficult to feel comfortable with this, just as it is hard to feel comfortable with the million-dollar bonuses of the City, but it may be the shape of things to come.

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