Treasury cannot face new global reality

The following comment by me appeared in the latest Fund Strategy (11 May).

The Treasury’s report on the future of British-based international financial services contains a strong dose of ­wishful thinking. Its authors seem to find it hard to grapple with the significance of developments over the past few months; let alone decades.

Its authors hope to ensure the City will maintain its leading position as a global financial centre over the next 10-15 years. But the world has changed more than they realise and is likely to change further still in the coming years.

To understand why the City is likely to lose out in relative terms it is necessary to recognise the importance of two related global imbalances.

First, the imbalance between economic and political power. The world has changed substantially since institutions such as the International Monetary Fund and World Bank were founded in the mid-20th century. Asia has become enormously more important in economic terms, while Europe and America have suffered a relative decline. Yet the ­rising power of Asia is not yet reflected in international institutions.

Second, there is a massive imbalance between production and consumption. An increasing proportion of production is carried out in Asia, while the West has retreated from production. Britain is in line with other western countries in the shrinking importance of production in its economic output.

However, in Britain the retreat from production is particularly advanced. That is why the economy became so dependent on the City as an international financial centre. It was in effect taking a cut of the value produced elsewhere in the world rather than generating much value domestically.

The global financial crisis has therefore left Britain highly vulnerable. Sophisticated financial transactions, in which the City specialised, are viewed with considerable suspicion. It is hard to see the institutions that specialised in such activity making a quick recovery. It is also likely that Asian countries will develop their own financial expertise and often prefer to do business within their region.

Particularly telling is the report’s claim that Britain’s dependence on finance “is signficantly less than other modern service economies such as Singapore and Hong Kong”. The Treasury may not realise it but Hong Kong is part of China – rapidly becoming the workshop of the world and with 1.3 billion people. Singapore is a small island with a population of less than 5m and is a regional financial centre within an increasingly Asian-integrated economy. Britain has a population of 60m supported by a troubled City and a declining industrial base.

Britain’s elite seems scared to face up to the realities of the new century.