A One-Time Occurrence: Big Bangs in Finance and the Universe

The United Kingdom is hoping to replicate the success of the financial services revolution that Margaret Thatcher initiated in the 1980s. However, it is important to note that a Big Bang of this magnitude only happens once.

At the beginning of this month, Jeremy Hunt, the British Treasury chief, presented the Edinburgh Reforms, a bold plan to relax financial regulations in order to bring back some of the U.K.'s international competitiveness that has been lost in recent years. This includes getting rid of the "ring-fencing" between retail and investment banking, abolishing the limit on bankers' bonuses, revamping the system that holds senior managers accountable for violations, and canceling certain European Union regulations. Additionally, officials are looking to reduce taxes on asset managers and make it simpler to raise capital in the U.K.

The Conservative Party had long promised a "Big Bang 2.0" but the current Prime Minister, Mr. Hunt, has been more measured in his claims about the potential "Brexit dividend" of cutting EU red tape. His more cautious approach is understandable.

The economic success of the U.K. has been closely tied to the global status of the City of London as a financial center. After London was surpassed by New York at the beginning of the 20th century, the U.K.'s output growth per capita lagged behind other wealthy countries for a long time, with the exception of the late 1980s to 2008. This resurgence is usually attributed to the Thatcher government's deregulation of the London Stock Exchange in 1986, which included a transition from floor-based trading to an electronic system, making U.K. markets more competitive on the international stage.

The global financial crisis brought with it additional regulations that made financial firms, particularly universal banks, less profitable on a global scale. Economists have been pondering the "productivity puzzle" that has been plaguing the U.K. The data shows a lack of productivity in most sectors, but the difference in average growth between the pre-2008 period and the post-2008 period can be attributed to three sectors: information and communications, manufacturing, and finance.

Finance is the only industry in which productivity growth increased even as employment rose, and then decreased despite job losses. In contrast, productivity gains in manufacturing were partially due to globalization eliminating less competitive firms. From 1980 to 2008, the sector went from making up a quarter of the British workforce to only 9%. Since then, employment has decreased at a slower rate and productivity has declined. Similarly, the productivity slowdown in ICT is concurrent with hours worked increasing at a faster rate.

It is understandable why officials are eager to get the economy back on track.

The Big Bang occurred in a unique setting: Eurocurrency markets had been established in London in the 1950s and 1960s, the removal of capital controls took place in 1979, the government was in favor of extensive deregulation, and the Bank of England was supportive of large financial conglomerates. Globalization resulted in a concentration of wealth at the top. This was an implicit, and to some extent unintentional, industrial policy that favored finance.

The advantages of globalization have been somewhat diminished in recent years, particularly in the wake of Brexit. This has had a particularly negative effect on London's financial sector, as it has limited the amount of services it can provide to the EU. Consequently, the city's importance in the trading of shares and derivatives has decreased, with EY estimating that 7,000 finance jobs have been relocated to cities such as Paris and Amsterdam.

The Bank of England (BOE) is not in agreement with the current situation. Governor Andrew Bailey cautioned last week against making the financial system more vulnerable. Numerous banking regulations that protect against this, like capital-ratio minimums for the largest banks, are international, not just limited to the European Union.

It is clear that the regulations imposed on Britain after the financial crisis were more stringent than those of many other countries. Reversing this decision could be beneficial, as it would not be necessary to actively hinder London's natural advantage in finance.

In the end, it does not make much sense for the U.K. to focus its economic growth on the sector that benefited the most from globalization after leaving the European Union, rather than investing in those that were negatively impacted, such as manufacturing. Although some cosmologists have speculated that Big Bangs could occur in cycles every trillion years, they always necessitate the prior destruction of the universe.