New Economist

Forex: London still dominates

The City does not dominate all financial markets, but forex is one that it does. UK's foreign exchange market accounts for almost one-third of global turnover, with its share steadily edging higher - helping to strengthen the City's position as a financial centre, according to a report by International Financial Services London:

Average daily turnover on the UK's foreign exchange market reached $1.1 trillion in April 2006, up 41% from the previous year... There was also a further $102bn traded in currency derivatives. Growth of trading in the UK outpaced the 38% growth in global foreign exchange volumes which totalled a record $2.7 trillion in April 2006 ($2.9 trillion including currency derivatives). Key factors in the increase of foreign exchange trading were its growing importance as an alternative investment and an increase in fund management and hedge fund assets.

London consolidates lead in global foreign exchange markets, writes David Prosser in The Independent:

"The rapid growth in the volume of foreign exchange turnover over the past two decades reflects the continuing growth of international trade and expansion in global finance and investment," said Mark Maslakovic, the senior economist at IFSL. "The UK, and London in particular, is by far the largest global market for foreign exchange trading, well ahead of the US and Japan."

This year, deals transacted in London will account for 32.4 per cent of all foreign exchange trading, according to IFSL's analysis. The UK's market share is almost twice as high as the next biggest player, the US, which has 18.2 per cent of all currency trading. Japan, with 7.6 per cent, and Singapore, with 5.7 per cent, are the next most important currency exchange markets but lag considerably behind Western competitors.

...Mr Maslakovic said the UK had developed into the ideal centre for currency trading since Margaret Thatcher's newly elected Conservative government abolished exchange controls in 1979. Until then, foreign investors were almost entirely prevented from buying sterling unless doing so would benefit Britain's balance of payments figures. UK residents, meanwhile, were not allowed to buy foreign currency for investment purposes, unless the purchases were funded with the sale of existing overseas assets.

...the liberalisation has subsequently enabled the UK to cash in on its geographical position as a bridge between the US, Europe and the Far East.

IFSL said the UK had a string of additional advantages as a centre for foreign exchange trading. They include: a large fund management sector; a large number of investment banks and brokers; easy access to global markets combined with a tradition of welcoming foreign firms; high-quality professional services; efficient telecoms infrastructure; and the use of the English language.

 

The City: can it stay on top?

London has grown over the last two decades into the world's most successful financial centre, and Britain's most lucrative industry. This week the Economist has a leader on The City: How to protect an industry, which argues that the City of London's success shows that exposing it to foreign competition is the way to do it:

...On October 27th 1986, pressed by Margaret Thatcher's government, the City blew apart the closed shop of the London Stock Exchange in a reform known as Big Bang (see article). Out went minimum commissions and other restrictions, and in came a stampede of foreign firms. The government stood by and watched as they swallowed the old British firms that had previously dominated the City.

...The results are hard to argue with. London has kept its long-standing dominance of foreign-exchange trading; its share of the market for over-the-counter derivatives has increased from 27% in 1995 to 43% in 2004. A fifth of the world's hedge-fund assets (including 80% of Europe's) are managed out of London, compared with a tenth in 2002. Though London's insurance market has suffered from tax competition, the City has powered ahead in services such as the law and ship-broking. In equities, the business Big Bang was designed to secure, London has hosted 172 international listings so far this year, compared with 134 in regulation-bound New York.

There are threats, of course. This week the two Chicago derivatives exchanges merged to create the world's largest futures exchange (see article). There is a constant danger of over-regulation, either after the next scandal or from the European Union, which is tempted to burden wholesale markets with regulations designed for the small investor. And London's transport system is dismal and its property overpriced.

Yet Britain's politicians understand—or at least they say they understand—what the City needs. This week they have been queuing up to announce pro-City taskforces and reforms. The recipe is as straightforward in principle as it is hard to provide in practice: open industries to new talent and expertise and to constant innovation, and regulate lightly. Get it right, and clusters start to grow. Financial markets are a striking example of how buyers and sellers of skills and know-how crowd together; but the effect has worked in Britain in other industries, too, such as carmaking and design.

This is the lesson of Big Bang: to protect an industry, sacrifice your national champions. That brave decision 20 years ago brought wealth, jobs and cosmopolitan buzz to a once-sleepy City, and banished the overcooked cabbage for ever.

An accompanying piece, Capital City, considers the factors behind that success and how London can keep its lead:

The “Basil Fawlty Factor”

by Mark Thoma

Why are prices so high in the UK?

Tourists tell Britain: you’re a rip-off, by Jon Ungoed-Thomas, Times Online: ...[W]hy is Britain so phenomenally expensive and why on earth do Britons put up with it? So exercised have tourists and other visitors to Britain become that they have started an internet blog on the subject and the “Basil Fawlty factor” that some hold to be responsible.

Britain’s rip-off prices were confirmed last week by a Sunday Times survey that found we are indeed being overcharged for a wide range of everyday products and services.

Whether it is a meal out, a trip to the cinema or a weekend in the country, in Britain it typically costs about 30% more than in comparable countries. Our train fares are four times the global average.

But what perplexes tourists is not British prices per se but the reasons for them. ... Tyler Cowen, professor of economics at George Mason University ..., said: “England is not the wealthiest country in the world but it has some of the most outrageous prices. It’s an overcrowded country with high property prices, but it doesn’t explain why people have to pay so much.”

Cowen has prompted a lively internet debate on the subject on his economics blog, Marginal Revolution, under the heading: “Why is the UK so expensive?” ...

It is not just the goods and services bought by tourists that are sold at premium prices. From the cost of a mobile phone call to downloading a music track on iTunes or ordering a cup of coffee in a cafe, Britain regularly tops the world league table of the most expensive countries. Our transport costs are also among the highest....

Although London is well known for its spiralling prices, the problem is far from contained there. Anyone heading for the seaside is likely to find accommodation and food prices to rival the capital’s. ...

Daniel Kalt, head of economic research at UBS, said the strength of the pound and the housing boom contributed to the higher prices. He said the introduction of the euro in other EU countries had meant greater price competition there. Britain’s relatively high wage packets were another factor.

But contributors to Cowen’s website are not all convinced, not least because the boom in house prices has been a world-wide phenomenon. Britain is also well known for having benefited disproportionately from an influx of cheap eastern European labour that would normally be expected to keep prices down.

Instead they propose a more straightforward explanation. “British consumers are used to being mistreated and cheated,” says one contributor to the debate. “What surprises many American visitors is how seldom locals make a fuss about bad service or poor quality goods.”

Economists agree that the willingness of Britons to be charged higher prices may be a factor. Alena Kozakova, principal economist at the consumer magazine Which?, said: “Consumers are more demanding in the US and aren’t prepared to be overcharged. ...

However, Gary Goodman, marketing director of Pricerunner, said the ease with which British customers could now compare prices was likely to drive down high profit margins and there was already good news for customers. “If you look at the costs of CDs, DVDs and books, we are now actually nearly the cheapest in Europe,” he said.

Update: I just realized this was covered here already under "Nine reasons why London is so expensive."

Nine reasons why London is so expensive

Tyler Cowen at Marginal Revolution asks a good question: Why is the UK so expensive?

A loyal MR reader, Erik Alberts, writes:

I've made several trips to the UK in the past few months in preparation and it amazes me how much more things cost there (in London) then here in California. What I'm trying to understand is why.  I realize that some things like gasoline cost more in the UK due to taxes.  But for other things, it appears that prices in the UK are 40 to 50% higher.  How would you explain this?

...I realize that higher taxes and higher labor costs may be factors (although at my company UK labor is cheaper than it is in California), but I find it difficult to believe that this would explain a 50% difference.  Could this be a sign of currency imbalance like the big mac index, a supply and demand issue, or are UK consumers simply used to paying more?

I have wondered the same about Switzerland.  The standard explanation is that expensive countries are extremely productive with their tradables (North Sea oil and London finance?).  That appreciates their exchange rates and renders non-tradables quite dear.  This is the flip side of cheap barbers and prostitutes in Thailand.  But are the Brits really so productive?  If so, why can't they get both hot and cold water coming out of the same tap?  And aren't some of the expensive goods tradables rather than non-tradables?

One factor for sure is that American retailing is the most efficient and most productive in the world.  Perhaps the Brits are especially inept in this regard.

A further factor may be that foreigners, even those who are considering moving, sample British prices in biased fashion.  We see lots of hotel rooms, cab rides, and restaurants.  Fish and chips is still pretty cheap outside of London.  As for Marmite I could not say, but that is exactly the point.  Your preferred consumption basket will always look expensive in another country; just try getting Ocean Spray grapefruit juice in Western Samoa.

Your thoughts? 

Erik Alberts mentions two obvious candidates: higher taxes and labour costs.

1. Higher wages: More expensive living costs and a minimum wage well above the United States is reflected in higher wages. (Consolation: you don't have to tip).

2. High sales tax: VAT is 17.5%, well above what you would pay in most US states. It's in the purchase price, so you may not even know it's there.

Tyler mentions three more:

3. Strong sterling: The pound has long been quite buoyant, much to the annoyance of UK manufacturers. But it is particularly perky at the moment, reflecting both a quite robust British economy and an ailing greenback. (But the Euro isn't cheap for American tourists either. If you want your dollars to go further, try Asian countries pegged to the US dollar like China and Hong Kong). 

4. Retail competition. I don't think British retailers are "inept", as Tyler claims. But supermarkets account for a smaller market share, because of cultural preference and planning restrictions. And a country with one-third one-fifth the population obviously won't have the same economies of scale as in the US. So yes, retail margins are often higher, and so are prices.

5. Biased consumption bundle/information asymmetry.  Tourists do indeed "sample British prices in biased fashion". But their experience of feeling 'ripped off' also reflects information asymmetry. Tourists often catch black cabs or the Underground (rather than buses, which are half the price) because they don't know their way around. They rely on well-known chains because they don't realise the shop around the corner sells coffee or sandwiches for half the price of Starbuck's. They pay far too much for mediocre restaurant meals. Local knowledge saves money and time.

All of these are true. But while high wages, high sales taxes and  a strong currency all matter, the biggest single factor is almost certainly property prices.

6. Property prices: Tourists visiting London tend to cluster around Zone 1 in central London, where property prices are higher than Manhattan (thanks to height limits, heritage listing and other restrictions). The result? Very expensive hotels (by US standards), and retailers paying eye-bleeding rentals - which they inevitably pass onto you and I.

Three other factors are also worth mentioning:

7. Transport. In Britain it invariably takes longer or costs more to get to your destination than it should. Britain has fewer roads and trains than the rest of Europe; the result can be road congestion and exorbitant train fares. Many Britons find it easier and cheaper to holiday abroad than in their own country. Moaning about the transport system is a national past time. Incredibly, some now look back on the once-despised British Rail with nostalgia.

8. Weak consumerism. British consumers are used to being mistreated, lied to and cheated (think Basil Fawlty). What surprises many American visitors is how seldom locals make a fuss about bad service or poor quality goods. Consumer law and advocacy is weaker than in the US - fraud is widespread, enforcement can be patchy, and class actions are not allowed. Financial fraud is called 'mis-selling', as if it were just an accident! We have no Ralph Naders.

9. Inequality. London has more of the world's super-rich than anywhere else on the planet, and it shows. Luxury goods and services abound. The place is full of chauffeurs waiting around, 'ladies who lunch', Arabs spending up big, and City boys who think nothing of paying US$200 for a meal and drinks. Many Londoners are not price conscious; they're willing to spend a lot for positional goods. That affects prices. Sadly, it also means paying a lot won't guarantee good quality.

My advice to visitors to London? First, take the time to do some research. For hotels, TripAdvisor is generally reliable - you may not find the best hotel in London, but you will certainly avoid some of the worst. As for food, either ask a local, or try Square Meal or London Eating. And be on the alert for thieves and con artists.

Enjoy your stay!

Treasure island

The Guardian's G2 section has a long and illuminating feature by James Meek on the super rich: how Britain became a magnet for the world's super-rich.

It has exclusive shops, fabulously luxurious homes and a glamorous cultural scene, but this is not what has made London the destination of choice for the world's multi-billionaires. For the ultra-rich few, this country is now a virtual tax haven, which is why more and more princes, tycoons andoligarchs are making it their home. James Meek sets out to uncover the secrets of Britain's seriously wealthy.

Of course, this has both pros and cons. It has certainly created work for wealth managers, private banks and the rest of the City; helped sustain swanky hotels and restaurants; and created a ready market for luxury goods providers. You can get virtually anything in London if you have the money.

But if recent research on the comparison effects of income is valid, this abundance of super rich might be making other Londoners less happy. As yet another stretch limo cruises by, we must bear the pain of feeling like (relative) paupers for the greater economic good of the nation...

The article itself contains some interesting quotes. Here's an extract:

If there is more private wealth in Britain, and in London in particular, than ever before, where is it coming from? One explanation is that in the past few years London has become, even more than in the 1990s, the world's conduit of choice for private wealth. Its generous tax treatment of the mega-rich, particularly those born abroad, makes it in some ways a virtual tax haven.

The old snobberies of race and class have partly yielded to new snobberies of money and beauty. That, and its combination of attractions - political stability, relatively honest officials, a host of ingenious tax-avoidance specialists, an army of cheap immigrant labour, the luxury shops, restaurants and clubs that charge prices high enough to reassure the wealthy that they are special, the resident celebrities, the cultural energy, the existence of a vast City within the city dedicated to money - mean only New York is London's peer. And there, despite the Bush administration's income tax cuts that have gone disproportionately to the very wealthy, the US Inland Revenue Service and Wall Street regulators have a reputation for being fastidious with the rules.

"The IRS is perceived to be a much more burdensome tax regulator than the UK Revenue," says David Harvey. "The UK tax authorities take the approach that it's much better to fight over a small piece of a very large cake."

Seb Dovey, of the London-based wealth management consultancy Scorpio Partnership, says: "I wouldn't say as a professional centre for private banking London overtakes Switzerland, but it does punch higher than any of the other European countries ... if you're an emerging rich person or a multi-billionaire, London is the place to be. Those from the Middle East and India would use Switzerland as a bank-deposit location, and their active money in play would be managed out of the UK."

"I think the super-rich want to have two homes, one in New York and one in London," says a British hedge fund manager. "The bulk of the super-rich want to spend their lives in these two cities, but if they're based in New York, they would pay a lot more tax than here."

UK productivity: the London effect

For many years the UK government has pumped billions of pounds into depressed English regions in the hope it would help narrow their growth, employment and productivity gap with London and the South East. But new research by Martin Boddy and colleagues at the University of the West of England suggests that those large regional differences can largely be explained. Regional Productivity Differentials: Explaining the Gap (UWE discussion paper 05-15) argues that these differences "can be explained by a fairly limited set of variables", including travel-time from London.

Issues of productivity and competitiveness at a regional level have increasingly been a focus for both academic and policy concern. Significant and persistent differences in productivity are evident both in the UK and across Europe as a whole. This paper uses data relating to individual business units to examine the determinants of regional productivity differentials across British regions. It demonstrates that the substantial differences in regional productivity can be explained by a fairly limited set of variables. These include industry mix, the capital employed by the firm, business ownership and the skills of the local labour force. Also important are location-specific factors including travel-time from London and population density.

Taken together, these factors largely explain regional productivity differentials. The analysis extends those studies that have identified but not quantified the role of different ‘productivity drivers’ in a systematic fashion or that have focused on only a limited set of drivers. It has important policy implications particular in relation to the role of travel time and possible effects of density and agglomeration.

If they're right, the sensible public policy response might be to reduce regional assistance and spend the money on improving transport links with London instead.

Martin Wolf on globalisation

Those who are in London next week and are readers of Martin Wolf's columns in the Financial Times may like to attend A Critical Debate about the Nature of Globalisation with David Held at the LSE:

When: Thursday 12 January 2006, 6.30pm
Venue: Old Theatre, Old Building, London School of Economics (maps)
Speakers: Professor Martin Wolf, Professor David Held
Chair: Professor Michael Cox

One of the big debates in globalization theory is the controversy between Martin Wolf and David Held about the form and changing nature of globalization. Both authors agree, that “globalization” exists, but disagree over its exact form and consequences.

This event is free and open to all with no ticket required. Entry is on a first come, first serve basis [so get there early].

Markets and personal finance in Jane Austen's time

The bumber holiday edition of The Economist asks: What did early 19th-century literary characters live on? The piece, Percents and sensibility, reports that 

At the turn of the 19th century, wealth merited much discussion. Landed wealth, which dominated the 18th century, was being supplanted by monied wealth, which came to dominate the 19th. Between 1796, when Miss Austen began “Pride and Prejudice”, and 1817, when she died while writing “Sanditon”, land and money (or “funds” as Miss Austen's peers called their investments) stood in rough and uncomfortable equality. In this shifting balance lay the foundations both of the Anglo-Saxon world's commercial prosperity and much of the drama and humour of Miss Austen's books.

A fascinating piece, which is really about the emergence of robust financial markets in England dressed up as something more whimsical.

For those who want more on this era, I would heartily recommend What Jane Austen Ate and Charles Dickens Knew: From Fox Hunting to Whist - The Facts of Daily Life in Nineteenth-Century England, by Daniel Pool, Touchstone Books, 1994.

London: They're young, overpaid and over here

Hamish McRae explains why London is the world's financial centre, and is likely to remain so, in today's Independent on Sunday: They're young, overpaid and over here. And that's why London is thriving. London attracts more of the best financial talent in the world than New York, Tokyo or Frankfurt. His piece was prompted by last week's ONS earnings survey, which found that men working in Canary Wharf earned an average of more than £101,000 a year (US$176k):

These figures are of course a reflection of the pay in Britain's most successful industry, for though there are other employers, including three newspaper groups, financial services are the driver. This leads to a string of questions of which, from the economist's perspective, two stand out. Why are people paid so much? And how securely is this industry rooted in the UK?

The best way to get a handle on both questions is to look how well London does in this global business. The broad-brush answer is that as far as international finance is concerned it seems to be either level-pegging with its only real rival, New York, or pulling a little ahead of it. Both New York and London are increasing their lead over Tokyo, Frankfurt and Paris. The graph shows the national share of seven categories of international financial business, collated in a new paper this month from International Financial Services. The UK is ahead on four, the US on three and no other country is there at all.

The UK's leading four are: international banking, foreign equity trading, foreign exchange and one of the two types of derivative trading that's done outside organised exchanges. The three the US is ahead in are: exchange-traded derivatives, fund management and hedge funds.

These comparisons are a bit arbitrary, for some sectors are much larger than others: international banking is much larger than foreign exchange for example. They are also based on where the business is actually done, rather than on who owns the companies doing it. Thus the prime reason why London scores so high is that foreign commercial and investment banks do their international business out of London. That gives part of the explanation for the salary levels. These are global salaries, paid to attract the best people in the world.

London's financial workforce is multinational, well educated, and relatively young:

Harold Pinter turns 75

British playwright Harold Pinter, a self-professed "bit of a pain in the arse", turns 75 today. To celebrate BBC 3 are broadcasting a world premiere of his new radio play, Voices, at 9.30pm GMT.

Voices is a collaboration between Pinter and composer James Clarke, specially commissioned by Radio 3, and includes Roger Lloyd-Pack, Douglas Hodge, Andy de la Tour, Indira Varma and Harold Pinter himself in the cast.  Please note that the play contains some strong language. Voices will be available to listen again during the two weeks after the broadcast here...

For background, read Alice Jones's profile in last Friday's Independent,  Harold Pinter: Fighting cancer but still manages to produce a searing new play:

As he approaches his 75th birthday on Monday, Harold Pinter appears frail and gaunt, leaning heavily on a walking stick decorated, somewhat incongruously, with sparkly stickers. When we meet to celebrate the unveiling of his latest work, Voices, he tells me: "I'm exhausted, I'm at the end of my tether," and admits that he is "not writing anything much at the moment". His formerly stentorian stage voice is notably weakened - a consequence of his battle with cancer of the oesophagus over the last three years. But in Voices, a 29-minute musical-dramatic collaboration with the composer James Clarke, his creative voice rings out as powerfully as ever.

This latest work by the indefatigable playwright will be broadcast on BBC Radio 3 on his birthday. In February, Pinter appeared to herald his retirement as a playwright, announcing with characteristic terseness: "I think I've stopped writing plays now... I've written 29 plays, isn't that enough?"

Hat tip: Abbas Raza at 3 quarks daily