Can the UK do without over-reliance on banks to spur economic growth?

For decades, Britain's financial services industry has fueled the country’s economy. The offices and branches of HSBC Holdings, Lloyds, and Barclays dot London streets. Executives in black suits and black skirts hurtle out of Lombard Street and go straight into pubs to relax in the evenings.

The financial services industry accounts for around 12 percent of Britain’s economy, and some people argue that its growth has come at the cost of the manufacturing sector—the car and home appliance factories and the coal mines that once employed millions of British citizens.

As the UK election draws near, all eyes are on Labour Party’s Rachel Reeves, a favourite to become the next chancellor of the UK’s exchequer.

Reeves has said in the past that too much dependence on financial services spells trouble for Britain’s economy, rendering it vulnerable to the recurring bouts of turbulence in global markets.

The Labour Party enjoys a lead of more than 20 points over the Conservative Party, its closest electoral rival, which has controlled power for the last decade and a half in the world’s sixth-biggest economy.

“The era of reckless Tory economics is over. As your chancellor, I would make every penny count,” she said.

Once a great colonial power controlling one-quarter of earth’s land surface, the UK is now mostly a services-based economy. Agriculture contributes less than one percent to the UK’s GDP while the share of manufacturing is only 17 percent. Services constitute the bedrock of the UK’s economy with a share of over 80 percent.

London’s unique role in the international arena comes with major advantages and places the UK at the centre of global financial transactions, says John R Bryson, professor of economic geography at the University of Birmingham.

“A politician might want to encourage some form of diversification, but this will fail if it is not grounded in existing assets and capabilities,” he tells TRT World.

A disproportionately high contribution to GDP growth is a testament to London’s position as the hub of the global financial system. It’s home to some of the world’s biggest banks, insurance providers and investment firms. The UK attracted £2 billion in foreign direct investment in 2022—the highest across Europe in the category of financial and professional services.

“Without this role, the UK would be a relatively unimportant country given the size of its economy,” Bryson says.

Being the global face of British businesses, the sub-sector generated a trade surplus of roughly $105 billion in 2021—which was more than the combined surplus of all other UK industries that registered trade surpluses in that year, data shows.

He says government policy can do “very little” to diversify an economy. Economic activity does not occur out of context and always builds on a country’s existing strengths, he adds.

But such an international footprint also exposes the financial services industry—and the overall UK economy—to external shocks that range from the 2008 global financial crisis to China’s real estate crisis and Brexit.

That has led politicians like Reeves to call for a shift of the UK’s economy towards “broader-based, better-balanced, more productive and more sustainable” grounds.

She plans to close a $636 million tax loophole that benefits executives of Britain’s private equity industry, which consists of specialised investment funds that buy, restructure and sell troubled companies.

The bloating of the financial sector comes with a potentially steep price tag. Assets held by UK banks currently amount to over 560 percent of the country’s GDP. Such an oversized banking sector—which is overexposed to international headwinds that are beyond the control of central bank authorities—can be disastrous in the event of another global financial crisis.

Bailing out banks becomes increasingly challenging if they outgrow their governments in size, as in Iceland and Ireland.

In a research paper published by the Bank for International Settlements, economists Stephen G Cecchetti and Enisse Kharroubi show that the financial sector grows more quickly at the expense of the real economy when skilled labour works in finance. Financial growth disproportionately harms financially dependent and research-intensive industries while crowding out real economic growth, it said.

However, academics remain sceptical about the need as well as effectiveness of any intervention by the government to shift the focus of economic activity away from financial services.

“Having a strong financial service sector is not necessarily bad for the rest of the economy as it generates a lot of tax revenue and growth to support the rest of the economy,” Steve Coulter, political economist and visiting senior fellow at the London School of Economics, tells TRT World.

“The government is not going to do anything to undermine financial services. Instead, it will want to support financial services while also looking for ways to support other sectors through green investment in renewable industries and electric vehicles,” he says.