London will stay a world centre

Announcements of job losses in the City make grim reading, but its long-term prospects as the best international centre are good, say authors Richard Roberts and David Kynaston. But that depends on globalisation, free trade and free capital

London has been the world's main international financial centre since the arrival of the Euromarkets in the Sixties, UK plc's greatest success story. It provides 320,000 well-paid jobs (double the national average earnings) and perhaps twice as many in support and services. Its overseas earnings make a crucial contribution to the UK's balance of payments, largely offsetting the trade deficit. City workers generate taxes of £9.8bn, which is 8 per cent of the national total, a massively disproportionate contribution to national coffers.

London has been the world's main international financial centre since the arrival of the Euromarkets in the Sixties, UK plc's greatest success story. It provides 320,000 well-paid jobs (double the national average earnings) and perhaps twice as many in support and services. Its overseas earnings make a crucial contribution to the UK's balance of payments, largely offsetting the trade deficit. City workers generate taxes of £9.8bn, which is 8 per cent of the national total, a massively disproportionate contribution to national coffers.

But recent job losses in the financial services industry (Canary Wharf as well as the Square Mile) come almost as a daily event. A forecast of 20,000 job losses was doing the rounds by the end of the summer, before the attacks in America. Indeed, if the job losses turn out to be on the scale of the downturn in the early Nineties, 60,000 would be the ultimate tally. So the immediate outlook is not auspicious, but is the spate of job losses merely a cyclical blip, or does it herald something more fundamental?

There are two schools of thought about the City's long-term prospects. The optimists foresee a continuation of the growth of the past three decades – averaging 7 per cent a year – because the underlying driving forces continue to apply. Most fundamental is the relentless growth of demand for financial services due to economic development and globalisation. As the leading inter- national financial centre, business in London has been boosted by the expansion of world trade, capital flows and investment, and the conduct of "offshore" financial business.

London also benefits disproportionately from so-called "external economies of scale" and "economies of scope". There are many reasons why a larger centre is a more advantageous operating environment, particularly in the quality of its financial markets, competition and innovation.

Empirical support for the proposition that London has actually enhanced its primacy in recent decades includes its share of world foreign exchange dealing, which rose from 26 per cent in 1989 to 32 per cent in 1998, and cross-border bank lending, up from 17 per cent to 20 per cent.

The City's leading position has made it a magnet for foreign banks. Partly through high-profile acquisitions of indigenous merchant banks, but even more so by organic growth, in the Nineties they came to dominate the landscape. At the beginning of that decade perhaps a quarter of the City's workforce worked for foreign institutions; today more than half do. In the process, the major players became the US investment banks.

The pre-eminence of the US "bulge bracket" banks in the City has given rise to the pessimist view of the City's prospects. These leviathans, looking to New York as their head office, potentially cast London and every other financial centre into the position of branch offices. This has been called the "hub and spoke" model, with New York as the hub and London et al. as satellites at the end of a spoke. London on this model finds itself transformed from the epicentre of the industry to just another subordinate, a much diminished relative status.

It is a well-known phenomenon of multinational enterprises that branch offices are more vulnerable to cutbacks than head office. Hence the pessimists have predicted that, come the next bear market, London rather than New York will bear the brunt of the firings.

That downturn has well and truly arrived, so how are the pessimists' predictions faring? Not very well. So far the global investment banking industry has shed an estimated 25,000 jobs, but the bulk of sackings have been in the US, where the reduction in activity has been more severe than in Europe. Indeed, several investment banks have indicated that they will continue to build operations in Europe, where they anticipate significant long-term scope from the quickening integration of the market. In fact, the number of dismissals on Wall Street would be higher by now but for deferrals caused by the hijack attacks.

By targeting New York's financial district, the terrorists caused the loss of life of around 4,000 individuals working in the financial services industry or support activities. And many survivors are suffering psychological problems. Less tragic, but more disruptive, has been the disablement of 40 per cent of Wall Street office space. Many firms have moved to New Jersey, Connecticut or further. There has also been a transfer of operations to other offices, notably London.

So the combination of this out-of-the-blue event and promising opportunities in Europe has confounded the pessimists. Does this mean the optimistic scenario is correct? Possibly, even probably, but there are clouds on the horizon.

Over most of them the City has little or no control. Take transport; the muddle and political points-scoring of the past few years hardly encourages hopes of a properly functioning London Underground. Or taxation, where the Government's take of 45 per cent of the City's GDP is bound to rise if recession bites at a time of ambitious public spending commitments. Then there is regulation, where the draconian powers of the Financial Services Authority make many practitioners worried about increasing cost and inflexibility. In all three areas, London's competitive advantage could be eroded easily.

There is also the euro. So far it has probably benefited London, highlighting the City's distinctiveness from European rivals. But if Britain became part of Euroland in, say, 2003, our best guess is that this would damage London, which has achieved its remarkable pre-eminence through being an outward-looking, internationally-minded global portal. Such an outcome would mean – if rather late in the day – that one of the Treasury's five key tests for membership of the euro had not been fulfilled.

One final cloud. As we have seen, the world economic downturn is far from reducing London to branch-office status vis-à-vis New York, but it could still be peculiarly bad news, given that London is the most international of the main financial centres. Since the near-universal abolition of exchange controls, it has flourished in a rapidly globalising world of free trade and free capital flows.

We expect London to continue to flourish financially, but any retreat from that liberal international economy would impact more severely here than anywhere else.

The authors' new book 'City State: How the Markets Came to Rule Our World' is published by Profile Books. £17.99. David Kynaston is also author of 'The City of London. Volume IV. A Club No More', 1945-2000, published this year by Chatto. £30.