The City of London, long touted as the “crown jewel” of the UK economy, may in fact be hindering the country’s overall growth, according to a growing body of research. As Chancellor Rachel Reeves prepares to rub shoulders with the global elite at the World Economic Forum in Davos, she would be wise to take a more measured approach to courting the financial sector.
Studies have shown that once a country’s finance industry reaches a certain size, it begins to act as a drag on economic growth rather than a driver. The UK’s financial sector has long surpassed this threshold, with experts arguing that the resources it siphons away from other industries, such as science and technology, ultimately stunts productivity and innovation.
Reeves has so far taken a hands-off approach, sparing banks from a windfall tax in her November budget and even urging regulators to loosen capital requirements to boost lending. This move was welcomed by the likes of JP Morgan, which announced plans for a £3 billion headquarters in Canary Wharf.
However, economists warn that this strategy could backfire. Darius Wójcik of the University of Singapore has found that an oversized finance sector at the city level is detrimental to overall growth. Similarly, former Bank of England officials John Vickers and David Aikman argue that relaxing capital requirements is more likely to result in higher payouts to shareholders than increased lending to the real economy.
“We seem to be in a generation in which our politicians are trapped in the view that finance is one of the great things that the UK has to offer, and we really need to protect it and grow it,” says Alex Cobham of the Tax Justice Network. “Actually, the research really consistently shows that the UK is far past the point where we would maximise the benefits of finance. And actually it’s a drag on the economy, and has been for a long time.”
With little room for manoeuvre in public finances and risks lurking in the global economy, Reeves would be wise to heed these warnings. Rather than courting the financial elite, she should use the levers of tax and regulation to keep the City in check, ensuring the UK’s economic resources are deployed in a more productive manner.