The City of London has long been the European Union's Wall Street. But Britain's impending divorce from the Continent has put the country's dominant financial sector in jeopardy. Major banks and firms are either fleeing or threatening to flee, and other major cities throughout Europe are eager to offer them a new home.
But the rest of Europe should be careful what they wish for. The virtues of London finance comes with a lot of vices.
Prior to the looming threat of Brexit, surveys ranked London as the most attractive financial hub in the world. It still boasts 360,000 banking jobs and exports over $75 billion a year in financial services. The British financial sector accounts for 8 to 10 percent of the country's economy. Internationally, it lends more than both Germany and France combined, and its hedge funds are 18 times as big as France's.
That financial boom was largely made possible by Britain's membership in the EU. The uniform regulatory and trading rules across the common market allowed British financial firms to seamlessly do business across the rest of the Continent.
Once Brexit arrives in March 2019, everything could change: New regulatory barriers and requirements will appear. The costs to British banks and financial outfits of doing business and trading across its border into the rest of Europe could go up substantially. When that happens, much of the London financial sector could jump ship. Major players like J.P. Morgan, Citibank, and Northern Trust are all either planning to move some operations already or are at least talking about doing so.
Frankfurt is probably at the top of the list. It's already the biggest finance hub in Germany and boasts the headquarters of the European Central Bank. But officials in Paris are also making it clear they'd love to snatch up the finance business that London loses. Milan, Amsterdam, Dublin, and Luxembourg all get honorable mentions as well.
They may want to reconsider their enthusiasm.
Yes, London was transformed into a glittering jewel of international finance. But it came with a price. Like America — the other prominent Western nation with a massive financial industry — Britain has a serious inequality problem. The top fifth of its households make six times what the bottom fifth does, and the top 10 percent own nearly half of all British wealth. Vertiginous housing prices and costs of living are a serious problem in London and other parts of the country. Wages have stagnated or fallen for years, and — once again, like America — Britain’s relatively low unemployment today isn't delivering the same kind of wage growth it once did. All of that is consistent with how a bloated financial sector extracts wealth from the rest of the economy.
A country that plays host to an unusually large number of mega banks will also inevitably play host to an unusually large amount of systemic risk. The dominance of financial firms could also produce a "brain drain" of sorts, sucking talented workers out of other sectors. Finally, when a country's exports are dominated so thoroughly by one white-collar services industry, it can distort exchange rates and run other manufacturing and blue-collar sectors into the ground. (However, that last point is more clearly a problem for Britain, which remains on the pound, than it would be for a city that's part of the much larger euro currency union.) London's financialization transformed it into a kind of city-state within Britain, distorting and short-changing the rest of the country's economy and workers.
The political culture of the finance sector also tends to favor balanced budgets and tight monetary policy. So it's probably not just a coincidence that London's financial rise accompanied the turn of British politics towards austerity. Finally, while the Brexit campaign was very much dominated by nativism, many of its most resonant complaints — stagnant jobs and wages, rising inequality, cuts to public services and a housing crisis — can all be traced back to these fundamental economic shifts. Brexit was a deeply perverse reaction to very real problems.
Should Frankfurt or Paris or Amsterdam or whomever take advantage of Brexit to become London's financial successor, they won't just be getting those flashy GDP numbers. They'll be importing the political culture and economic forces that played a key role in driving Britain to Brexit to begin with. In fact, French Prime Minister Edouard Philippe reportedly said his government would be happy to attract British banks and financial firms by offering tax breaks and other special conditions — threatening a repeat of the ugly race-to-the-bottom that U.S. cities and states just humiliated themselves with in order to land Amazon's second headquarters.
Of course, what will actually happen when Brexit hits remains anybody's guess.
Initial estimates were that anything from 75,000 finance sector jobs to an eye-watering 200,000 could leave London for other parts of Europe. After the initial shock of the vote wore off and analysts examined the transition period British Prime Minister Theresa May was trying to build into her Brexit deal, estimates came down to a much more modest 5,000 to 10,000 finance jobs lost. But that was then. Now that May's deal is on the brink of defeat, those higher job loss numbers seem increasingly likely.
If the worst really does happen, a European city might suddenly find itself awash in international capital. It will probably regret it.