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For Rob Rooney, the impact of Brexit for the City of London is clear. “Frankfurt, Madrid, Milan and Paris are all doing better than they were. It has been at London’s expense. There is no question about that.”
In his time as Morgan Stanley’s top executive in London, Rooney led the US investment bank’s relocation of hundreds of bankers and billions of pounds of assets to Frankfurt to sidestep Britain’s shock EU departure. More than 440 other City companies followed suit, moving almost £1tn between them – roughly 10% of the entire UK banking system – to financial hubs across the EU.
“I have friends and family who moved to Barcelona, Madrid and Paris. And these cities are all booming.”
Before next month’s budget, the economics of Brexit are high on the political agenda. Rolling the pitch for big tax rises and spending cuts, Rachel Reeves has blamed the 2016 leave vote for Britain’s recent growth weakness and an expected downgrade in the public finances.
The chancellor is understood to have been handed a dramatically weaker productivity forecasts from the Office for Budget Responsibility (OBR), partly caused by Brexit, contributing to a shortfall of up to £40bn against her “iron-clad” fiscal rules.
Last month Reeves revealed that the Treasury watchdog would be “pretty frank” that growth since the 2016 leave vote had been worse than anticipated. After years of Labour downplaying the B-word, it was a marked shift, drawing it into the framing of her tax and spending plans.
Productivity growth has disappointed across the western world since the 2008 financial crisis. But the UK has notched a significantly worse performance than many of its peers on this metric of output for each hour of work – which is a vital driver of economic growth, wages and living standards.
For years the OBR has overestimated that growth could return closer to the 2.2% annual average recorded before the crash. In the spring it predicted annual productivity growth of about 1.25% by 2029-30, significantly above the estimates of other forecasters, including the Bank of England.
However, productivity is now falling. Since 2019, it has grown by just 1.5%, highlighting the deep impact of the Covid pandemic. While there are hopes for an artificial intelligence-powered turnaround, past performance is far from encouraging.
Taking all this into account, the OBR is expected to cut its forecast for trend productivity growth to about 0.9% instead. That might not sound like a big change, but this tiny spreadsheet tweak has a hefty price tag: adding roughly £21bn to government borrowing by the end of the decade.
Explaining this is a tough job. Productivity is tricky to forecast, in a task made significantly harder by unreliable jobs market data, while there are myriad reasons for Britain’s underperformance. Many economists label the sustained slowdown a “productivity puzzle” that defies easy explanation.
However, experts say it is increasingly clear that Brexit has played a significant role, exacerbating the post-2008 slump by hitting sectors with EU ties, and as the political turmoil led businesses to put investments on ice.
Erecting tougher trade barriers with the UK’s largest partner is expected to cut Britain’s long-term productivity by about 4% relative to a remain scenario. The OBR could update this estimate at the 26 November budget.
Since the end of the EU transition period at the end of 2020, UK exports have fallen significantly behind the G7 average. Cars, chemicals, pharmaceuticals, and food have all slumped in relative terms. But while services exports have outperformed, the finance sector has been hit as City firms lost easy access to EU clients.
The UK has been losing market share since 2016 to the Netherlands, Ireland, Spain and Italy. Government analysis shows Britain’s share of the global pie has slumped to 15%, down from 21% in 2010.
“You would have expected the UK – given the size of its finance sector – to have done at least as well, if not better, than other countries,” says John Springford, an associate fellow at the Centre for European Reform.
“But financial services output has been pretty weak since 2016. And there hasn’t been a great deal of investment in the sector either.”
City banks once drove UK productivity growth, with Britain recording the second-highest rate in the G7 pre-2008. In level terms it remains well above average. But since then, the rate of growth has collapsed into reverse – as one of the biggest sectors dragging down the UK’s overall performance.
The story is similar for the beating heart of finance: London. Despite levels of productivity well above the UK average, contributing to Britain’s position as one of the west’s most regionally unequal nations, the capital’s ability to drive its productivity higher has collapsed.
That might be hard to square with the gleaming towers, multimillion-pound mansions and bonus-wielding bankers. But the City has still suffered relative to other EU financial hubs.
“Walk around Canary Wharf and the City and you think: ‘Wow, this looks great, who said Brexit was going to bad?’ It is great. But arguably, it would have been even better without Brexit,” says William Wright, managing director of the New Financial thinktank.
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“The money machine, if you will, the biggest single contributor to tax receipts – one of single most important contributors to the UK economy – is misfiring.”
For Rooney, uprooting the EU-client-facing parts of Morgan Stanley’s London business involved shifting large swaths to Frankfurt. It also expanded its business in Dublin, Amsterdam, Madrid, Milan and Paris.
“This is true of all banks. You saw the Milan office, the Madrid office, Frankfurt office, the Paris office, the Nordic offices all grow,” he says. Barclays moved more than £100bn of assets to Dublin, turning the centuries-old London firm into Ireland’s third-largest bank overnight. Bank of America, HSBC, and Citi shifted operations to Paris, while Goldman Sachs and JP Morgan moved staff to Frankfurt.
Doing so has made financial services less efficient, as the fragmentation led companies to duplicate roles, alongside the extra red tape of dealing with post-Brexit rules and multiple regulators.
For Reeves, turning around the UK’s weak productivity performance has clear attractions, not least because it would increase the tax take. There would be benefits for workers, too: bumper productivity growth up to 2007 helped real wages to grow by 33% per decade on average. Since 2008, they have flatlined.
Facing the OBR’s productivity downgrade, the chancellor is expected to tell the watchdog that Labour’s policies can turn the tide. This will include flagging positive contributions from planning reforms, cutting business red tape, and trade agreements.
However, by blaming Brexit, Labour could run into trouble amid its refusal to entertain rejoining the EU single market or customs union.
“The problem is given the UK’s red lines this [blaming Brexit] can’t go much further,” says Anand Menon, the director of the UK in a Changing Europe thinktank. “The danger is, by talking about an issue, that you’re increasing its salience without having any sort of plan of how to deal with it.”
Still, the chancellor is defiant. Last month she told the Guardian that Labour’s readiness to build closer EU ties would boost productivity growth. “I think that we can defy the past and that we can do better.”
Rebooting the City is part of her plan. Outside the EU, some experts say this strategy is also easier to pursue. Financial services has been included in the government’s industrial strategy. Reeves is reducing City red tape, while her “Leeds reforms” are designed to boost competitiveness.
It does, however, create tensions for Labour. The party was burned by its close association with the 2008 crash, cosying up to bankers is anathema to many on the left of politics, and Reeves has been urged to tax the banks to tackle her budget shortfall.
Many economists issue a warning that the City’s pre-crisis productivity growth was built on unsustainable profits made via excessive risk-taking. Others warn that Britain has a “finance curse” from hosting a global industry that crowds out other sectors and stokes inequality.
For Rooney, however, London’s future as a financial hub is vital.
Since leaving Morgan Stanley three years ago, the American has taken over as the chief executive of Hyperlayer, a UK-based financial technology firm that works with big banks to provide personalised consumer accounts, rewards products and payments.
Last month it raised £30m in a funding round, valuing the firm at about £150m, highlighting how Britain is attracting a new breed of finance startup. The challenge, however, will be ensuring that Hyperlayer does not follow other UK startups by ultimately relocating to the much-bigger US market.
“You’ve got some terrific innovation here in the UK,” says Rooney. “But I think the question is, could there be more? Could it be faster? And I think that’s really what the chancellor has got to be trying to figure out.”
