Brad Setser sees the US losing its financial comparative advantage – RGE – One more sign we live in a new gilded age – Europe is once again the world’s financial center …:
In the new Gilded Age, America is once again drawing in capital from the old world.
Those funds are going to build houses, not railroads – but, well, that is the new way of the world. Those funds come, in aggregate, from Asia, Russia and the Middle East – not Western Europe. But Europe – strangely enough – is still the world’s financial intermediary.
That isn’t the way most economists here in the US see it. The US, they say, has a “comparative advantage” at finance, and specifically at generating financial assets the world wants to hold. I disagree. At least in part. The US certainly has a comparative advantage at selling debt to the world’s central banks. But Europe has had no trouble generating assets private investors want to hold. And Europe increasingly seems to have a comparative advantage at financial intermediation.
Brad bases his argument on the flows of funds:
Gross flows into both the UK and the eurozone topped gross flows into the US. The difference? The big inflows into the UK and Europe were used to finance equally big outflows, while the US used the vast majority of the funds coming in to finance its current account deficit. Put differently, Europe still saves enough to finance its own investment while the US has to import savings from the rest of the world to make up for its own lack of savings.
But there is more to the argument than financial flows. As the Economist put it recently in an article London as a financial centre:
London is a textbook example of an economic cluster, in which businesses locate close to one another because they gain from proximity. “The big warehouse of markets is in London,” says Pascal Boris, chief executive of BNP Paribas’s British operation. The distinctive feature of the City cluster is the pre-eminence of foreign financial firms. In this sense, London has become to finance what Wimbledon is to tennis: a place where the best international players come to compete.
Yet modern communications and information technology allow people and businesses to operate from virtually anywhere nowadays. And there are obvious disadvantages in locating at the heart of a metropolis. Property costs are extremely high in London by international standards. Public transport is overcrowded and often unreliable.
The City’s vibrancy shows that it offers compelling advantages that outweigh these drawbacks. Financial firms cluster in London because they derive external economies of scale. By thronging together, they create large, liquid markets that drive down trading costs and reduce risks by allowing large deals to be handled.
There are further benefits from locating in the cluster. Firms, large and small, can call upon all the external services needed to put together a complex financial deal, such as advice from lawyers and accountants, or the use of specialist markets. This in turn creates a fertile environment for innovation to flourish—a vital attraction for a global financial centre.
New York City understands the competitive pressure and is fighting back. Mayor Michael Bloomberg has appointed consulting firm McKinsey & Co. to examine why more international companies are choosing to raise money outside of New York. Many place the blame for the NYC financial district’s problems on increased regulation, such as the Sarbanes-Oxley Act, and tougher white-collar crime enforcement (notably by New York Attorney General Eliot Spitzer).
But, innovation and utilization of intangible assets are the keys to success in the financial industry – as the Chicago Mercantile Exchange found out in the 1950’s and as I have noted a number of times.
It will be interesting to see what the McKinsey study comes up with. If it is a simple rehash of the anti-regulatory line, you can put it on the shelf and forget about it. But if it really grapples with the issues of creating a self-sustaining cluster – and with the flow of funds issue that Brad Setser raises, then it will be a useful blueprint for NYC’s economic development. The report is due at the end of November. Stay tuned . . .