Thursday, 12 January 2012

The City and geography

This week The Economist featured Leaders and Briefing articles on the City of London. The term "the City" refers to the financial district and the articles described the changes in regulation and challenges from competitors that the City faces. I do not want to offer opinions on the regulatory debate, but did like the description of the forces of second nature geography in the articles. The strength of the City lies in a pooled labour market, suppliers of specialised services and knowledge spillovers that reinforce this agglomeration.

The City is not helpless in meeting this challenge. Incumbency is a powerful barrier in industries, such as finance, where there are strong network effects. Trading attracts liquidity and thus more trading. A steady supply of skilled financiers adds to the virtuous circle.

The use of English around the world gives London an edge over other European centres. London goes to work in the middle of the global trading day: the City day starts just as Asia’s financial markets are closing and its financiers are still at their desks when the New York market opens. That makes it an ideal spot for global asset managers. One-third of the £4.8 trillion of funds managed in Britain is on behalf of foreigners, according to TheCityUK. London is also an ideal place to strike deals between parties from different countries, because of its highly respected body of commercial law and experienced judges.

London’s lead in foreign exchange, as well as in interest-rate derivatives, grew out of its reinvention in the 1960s and 1970s as an offshore centre for dollar deposit-taking and lending, after sterling’s decline as a reserve currency. When the Bretton Woods system of fixed exchange rates broke down, London was quick to establish itself as a venue for trading currencies and hedging the risk of floating exchange rates. Twice as much foreign-exchange trading goes on in London as in New York and Tokyo combined. Having staked out this ground early and occupied it for so long, London would be hard to dislodge.

All this suggests that finance is not quite as mobile as some of its practitioners like to pretend. So far, only a few finance outfits, mostly hedge funds or commodity traders, have moved (usually to Switzerland) to escape higher taxes, onerous regulation and public hostility. The best hedge-fund traders are often contrarian thinkers, who might benefit from distance from the crowd. Not every business is quite as footloose. For outfits that raise capital and sell securities, it is much harder to operate efficiently at a distance from clients and complementary businesses.

Still, even long-established clusters are vulnerable to challenge. Some City bigwigs worry that a series of marginal decisions to locate business in other financial centres will add up over a decade to a loss of critical mass.

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