Immediate “tax cuts” are required but as part of a big policy push.

 

With the UK in the middle of choosing a new Prime Minister against a difficult economic backdrop of rising inflation, potential recession and troubling public finances, the focus of the candidates’ campaigns have increasingly been on whether there should be tax cuts now or sometime in the future.

I would advocate that the UK economy desperately needs lower taxes now. Why?

We unlike any other G7 country have raised taxes, so that combined with a substantial tightening of monetary policy our growth prospects are the worst of any country in the G7 according to the latest OECD forecast. Furthermore, as a result of the pandemic and a reluctance since of a populist government to cut back on the size of the public sector, taxes now represent the highest share of GDP in 70 years. People need to be reminded that the dynamism of an economy is impacted by a rising share of taxation –only private sector activity generates wealth. The former chancellor (one of the two remaining candidates to be PM) actually has raised taxes on National insurance contributions with a planned rise on corporation taxes from 19% to 25% (even though the US has reversed its plan to hike the rate). Such taxes will damage investment, employment and productivity, and ultimately depress growth. If we reversed these tax hikes, and paused the green levies (as recommended by the other remaining candidate) they would boost growth, raise tax revenues and ease the cost of living crisis. In any case, these tax cuts are quite small beer at some £30bn when compared with forecast errors  or in the context of a £2trn+ economy, particularly when one remembers the scale of fiscal drag with the freezing of various tax thresholds and the level of inflation which have boosted tax revenues without a matching rise in public spending. It hardly makes the advocate, a tax cut “slasher” or Laffer Curve supporter.

What of the public finances? Well thanks to the responsible policies of the previous two administrations before Brexit, this country has built up a lot of credibility in the market. Thus there is a strong case for treating the pandemic debt separately as like with War debt, which can be paid over many decades. In any case, our public debt burden at 88% of GDP compares favourably with other G7 countries, only being bettered by Germany at 71% of GDP – Canada 102%, France 113%, US 126%, Italy 151% and Japan 262%. Moreover the maturity of the debt is still very favourable at an average maturity of 14 years. Although with recent gilt sales, the gilt share owed to overseas investors has risen to 28%, this is still very manageable.

The strongest argument put forward against tax cuts has been the threat of a further boost to inflation, which on the CPI measure has already reached a 40-year high of 9.4% in June. (As an aside I warned back in my blog of February 2021 that we were set for a prolonged rise in inflation thanks to the impact of Quantitative Easing and pointed out later as a result of global supply issues that the UK and other G7 economies were set for double digit inflation without it falling back sharply in contrast to the majority of economists who thought it was transitory and had no monetary cause). It has been argued that tax cuts would raise aggregate demand and therefore increase inflationary pressures, ceteris paribus. However, if we cut taxes such as NICs and Corporation taxes, rather than say personal income taxes, they will increase aggregate supply so dampening any Keynesian demand pull inflation. Furthermore, subject to what happens in Ukraine and to wages in this county, inflation should subside in 2023 as a result of a substantial period of Quantitative tightening, notably in the US and the UK. 

Talk of a boost to aggregate supply moves me on to emphasising that tax cuts would be just one supply-side measure needed to drive the UK’s growth rate higher without raising inflation. This includes, lower and more suitable regulations post-Brexit, reform of a dysfunctional NHS, reform of a severely bloated civil service, the reining in of Trade Union power, increasing in immigration in sectors where more labour is required, and finally a comprehensive overhaul of energy policy.

So what about interest rates? Well they are headed higher than one would want thanks to the failures of the Bank of England to reverse QE earlier enough. However, despite the pain for some, interest rates should be raised to more normal levels. Low interest rates have been responsible for causing asset bubbles in property and equities, so causing intergenerational unfairness. Higher interest rates will help to take the heat out of the housing market, at last importantly reward savers a fair rate which will facilitate higher investment, and put Zombie companies under financial pressure.

Lies, damn lies and statistics - from covid to GDP data

 

In today’s blog I want to talk about the abuse of statistics in the media with a focus on UK GDP. We have got used to the media blasting us with statistics during the covid-19 pandemic, as journalists with little statistical knowledge use the data without interpreting or analysing them properly. The best example relates to the covid data, whether it is cases, hospitalisations or deaths. Much of the media has used them for their own agenda to attack the government to portray it as incompetent and the sole reason why in their eyes the UK has had a “bad pandemic”.

 

The reality which has become clearer over time is that there are a plethora of reasons for the UK’s experience including mistakes made by the UK government but also by the health authorities (NHS and PHE), by scientists and as a result of underspending on health over several decades. However there is also the health of the nation in respect of obesity and related diseases such as diabetes, cardiac disease, cancer, asthma etc with the UK considered one of the worst in Europe. Then there are non-health factors such as population density and global connectivity, where the UK and particularly London rank at the very top. And finally the data is not compatible on a country-by-country basis anyway with countries using different definitions of for example when a person dies of covid (think Spain with its very narrow definition of a covid death when compared with the UK or other European countries) or because a country is either incapable of recording all or the vast majority of deaths (think India, Mexico or Brazil or indeed most African countries) or deliberately under-records such data (think China, Russia, Iran or North Korea). The WHO estimates that up to 8 million deaths can be attributed to covid globally, which would represent a massive under-recording on the official 3.4 million death toll.

 

In the case of the UK, this under-recording is a relatively small number. In any case latest official data shows the UK does not even make the top 15 countries on deaths per capita, with many mostly East European, and some West European and Latin American countries comprising the top 15. And if we focus on excess deaths per capita which can overcome some of the data issues previously mentioned. the UK is not even in the top 25 worst performing countries for which data exists – The US, Russia, Brazil, Mexico, South Africa, Italy, Portugal and a plethora of East European and other Latin American countries are all above us!

 

However my blog today intended to concentrate on GDP and in particular in challenging the media consensus that the UK government’s “bad pandemic” was also reflected on the economy and in particular in GDP growth. One frequently still reads headlines saying that the UK economy was the worst performing country in the EU or the G7.

 

For 2020, official ONS data shows that UK GDP fell by 9.9%, which by the end of Q4 left the economy some 7.8% below its level prior to the pandemic at the end of 2019. This would represent a collapse without modern precedence – even during the Global Financial Crisis, UK GDP fell by a mere 4.3% in 2009. Moreover, Eurostat data shows us that EU GDP fell by an average 6.1% (and Eurozone GDP by 6.6%) with only Spain, down by 10.8%, worse affected than the UK. However the compilation of these statistics is not comparable as I will explain below. Once adjusted for a fairer comparison, GDP in the UK is estimated to have fallen by a more modest 7.5% leaving it in a better position than not only Spain, but a number of other EU countries including Italy, France, Greece and Croatia.

 

The need for a sizeable adjustment has arisen because of the different ways the UK and the EU treat so-called non-market output - approximately the output of the public sector. GDP, which for all its faults remains the single best summary of national economic activity, effectively measures the aggregate output of all sectors of the economy. This is easily measured in the case of the private sector where we can look at the turnover of a business. But in the public sector, particularly in health and education, it is very difficult to measure output. In the UK, the ONS overcomes this by looking at a wide range of detailed data such as the number of pupils attending school, the number of hours teaching in schools, the number of people visiting a GP, and the number of operations taking place. These measures were introduced to better measure not only output but to assess productivity in these sectors and whether the UK was getting good value for money for any increased government spending.

 

During the pandemic, schools were closed for a prolonged period and many operations were postponed. As a result we saw a big fall in the output of public services here in the UK. Indeed some 2.4 percentage points of the 9.9% fall in GDP in 2020 can be attributed to a fall in public sector output. Within public output we saw Education output fall 16.4% and Health & Social Work output by 8.2%. Nevertheless the UK data greatly exaggerated the fall in output so the ONS has been adding new indicators since to take account of pupils working from home as well as test & trace activity and covid vaccinations, although they are yet to be applied to 2020 data – only current monthly data

 

By contrast in many other countries such data is still not available or not used by national statistical agencies (despite the urging of various international institutions) so they estimate the output of such services by measuring the input ie looking at how much money was spent on them even if fewer services were provided. This is the approach taken by nearly all EU countries and meant we did not see the dip in the output of public services that genuinely did happen during 2020 throughout most of the EU.

 

Another useful measure to use that largely overcomes these intra-country comparison issues is nominal GDP growth, although they miss important volume movements seen in real GDP data. Nevertheless, we can see for the G7, the UK GDP fall is in fact less than in Germany, Italy and Canada, albeit higher than in France. In the US and Japan where the lockdowns were far less severe, overall economic activity was affected much less. So the bottom line is that UK GDP was badly affected by the pandemic particularly as our lockdown was notably long and tight, but the fall was not the worst by any means in the EU or G7.

 

In my next blog I will talk about UK GDP in 2021 and the expected sharp bounce-back in growth which is likely to be the fastest in the EU or the G7. 

Quantitative Easing and its dangers in an inflationary environment

Does a large budget deficit and the associated public debt burden really matter that much if the Bank of England finances it through asset purchases?

 

It is generally agreed during this pandemic that the government should spend vast sums of money to maintain income levels and prevent unemployment rising as much as possible so avoiding potential “scarring” of the economy ie a permanent reduction in productive economic output. There are also times dependent on the state of the economic cycle but also when investment in infrastructure and other forms of capital spending including on humans that means it may be appropriate to run a significant deficit.

 

If a budget deficit is financed through the issuance of government bonds which are purchased by investors (pension funds, insurance companies, households and overseas investors) then the degree to which one can do this successfully will depend on the existing policy credibility of the country, how much more is to be borrowed, the potential growth rate and the global background including the level of world long term interest rates. If a country has to borrow at very high interest rates (whether it is from abroad or not) then the debt burden could escalate and the interest payments will account for an ever higher portion of government spending so potentially squeezing out other spending.  Indeed a simple equation used in economics proves the debt burden will likely “snowball” ever higher if the (real) average interest rate of borrowing is greater than the (real) GDP growth rate.

 

In the UK, the government was in a very strong position to borrow coming into the pandemic aided by strong policy credibility thanks in part to its actions to tackle the deficit previously as well as by the very low global long term interest rates. Moreover, it has not had to borrow from abroad, and the borrowing has been very long-term so avoiding any rollover risk, reducing interest rate sensitivities and maximising the use of low borrowing rates now. Average debt maturities are around 13 years albeit on the decline.

 

It was conventional theory (as I learned it) that a country should borrow to fund any fiscal deficit (i.e. debt financing) if it can rather than finance it by printing money (ie monetary financing). Printing money was a sure way to generate inflation and lead to all the adverse consequences associated with inflation. The extremes of such a path which resulted in hyperinflation were of course seen in the Weimar Republic and in more modern times in Zimbabwe and Argentina.

 

However there are now new arguments which are complex and controversial, that says Bank of England purchases of assets, principally government bonds, known as Quantitative Easing (QE) may be a sort of free lunch. It is also referred to as “unconvential” monetary policy. As a result, increasingly, the UK deficit (and elsewhere) is being financed by QE. It still entails the creation of (electronic) money known as Reserve Money which is part of MO base or narrow money. However, it might not translate into M2 broad money (i.e. remaining largely within the financial sector) preventing it from largely entering the real economy and which is used to buy goods and services, and therefore affecting inflation. Such funding is approaching one-third of the gross public debt burden and being in the form of central bank reserves they only pay an interest rate of some 0.1% much lower than gilt yields.

 

The empirical evidence from the first big wave of QE after the global financial crisis (GFC) is that QE was not inflationary with M2 growth not growing excessively. However, the GFC was a deflationary phenomenon. And particularly important was that banks did not create new bank loans so preventing the operation of the classic money multiplier – they preferred to shore up their own balance sheets and regain profitability. 

 

However, there are real dangers that this will not be the case this time after the pandemic. The world is a potentially much more inflationary place after the initial deflationary impact of the pandemic itself. This reflects explicit coordination of expansionary monetary and fiscal policies (led by the US, but also the UK and the EU), the increased bias it seems of  central banks towards inflation including higher inflation targets (underpinned by a reluctance to raise bank rate given the massive amount of QE), the move back to de-globalisation (and no favourable China deflationary effect) and the disruption of international production chains. Indeed evidence is already concerning. Most notable and most importantly is the US, where M2 growth exceeds 20%yoy, input prices and commodity prices have surged, there are supply constraints and shortages (even in the labour market), and retail price inflation is also now picking up markedly. Nevertheless, some prominent economists still think inflation will not persist with classic “wage-price spirals” not taking off. I am not convinced.

 

So to sum up QE is really an experiment. Under the right circumstances it looks like it can play an important positive role, but we are now in different times than after the GFC and there is a real risk that inflation will not only rise to higher levels but stay there without tough action.

 

 

 

 

UK financial services post-Brexit

 

Prospects for the UK financial services sector remain rosy.

 

The UK financial services sector (including related professional services) accounted for over 10% of GDP and employed more than 2.3 million people at the end of 2019 (Source: CityUK). Moreover the financial services sector is the largest UK taxpayer (more than 10% of all tax revenues) and the biggest exporting industry generating a trade surplus of US$77bn in 2019 (including related professional services some US$102bn) - the largest in the world.

 

Yet in contrast to goods and manufacturing, and even the tiny fishing industry (accounting for 0.02% of GDP according to the ONS) there was barely a mention in the Trade and Co-operation Agreement (TCA) bar a Memorandum of Understanding which so far has largely been limited to derivatives so as to maintain EU market liquidity. This was no oversight. The EU has a large goods trade surplus amounting to £97bn in 2019 with the UK but a services deficit of some £18bn with us (rising to £44.3bn for financial and related services alone, according to the ONS). In fact over a third of our financial services exports currently go to the EU.

 

The EU countries have longed to see EU financial market business move within its sphere having viewed the City of London with suspicion and envy, and a belief that such activity should be in the core Eurozone. Its aim in the negotiations was if possible to avoid such agreement whether this would be in terms of mutual recognition or in some form of equivalence - other than dynamic alignment - so that it could chip away at London’s dominance of the European financial markets. (The City accounted for nearly 80% of its EU foreign exchange trading, three-quarters of derivatives trading, 85% of hedge fund activity, and 60% of capital market business). It has largely viewed this strategy as based on a zero sum game when in reality there are costs associated with such a policy of market fragmentation in terms of the loss of economies of scale, and of expertise and the knowledge that London has. The EU’s approach was greatly facilitated by a poor negotiating strategy by the Tory government under PM May and a “Remainer” Parliament (and other institutions) that resulted in the UK giving into the sequencing of negotiations preferred by the EU that resulted in the Withdrawal Agreement and the loss of our negotiating strengths including payment of the £40bn divorce bill, the effective splitting of the UK between GB and NI, and the granting of freedom of EU residents to reside in the UK.

 

Anyway the damage to the City has been nothing like most commentators had predicted, just like with Brexit more generally. Many typically forecast the loss of up to 100K or even 200K jobs. A London Stock Exchange Survey in 2016 concluded that 232K financial services could leave the UK. By contrast I suggested that it would be more like 10K and that the City would continue to prosper in various reports and speeches that I have made (eg Brexit and Financial Services 2017). The reality is that some 7.5K jobs had left according to the EY Financial Services Brexit Tracker at the end of 2020. It also states though that some £1.6trn assets had been transferred – a figure that has increased since.  Moreover the number of people working in the City has continued to rise since the referendum result. An FT Survey of 24 large international banks and asset managers in December found the majority had actually increased their London headcount over the past five years.

 

There will be further negotiations between the UK and the EU on access to financial markets in the coming months that may yield further agreements in areas such as reinsurance but they are likely to be modest. The EU will only agree to anything if it clearly benefits them. The EU’s preference is for the City of London to follow EU regulations very closely. But as Andrew Bailey the Bank of England governor recently said we should not become a rule taker, which would not only lead to us losing the opportunity for better and lower regulation but also as Michel Barnier, the EU’s Chief Brexit Negotiator said any access to EU financial services is a gift from Brussels than can be withdrawn freely – clearly one cannot operate under such a threat. We should be focusing on how we can protect our position as a global financial powerhouse. And anyway despite diverging from EU rules and the loss of passporting, international law protections will still allow financial institutions to provide certain cross border services to wholesale clients

 

The City of London is one of only two leading global financial centres (See the rankings in the Global Financial Centres Index produced by Z/Yen consultancy) and its future lies in being a global centre, being innovative and not hampered by unnecessary regulation and high taxation. We are competing against the likes of New York, Tokyo, Singapore, Shanghai and even Dubai or Bahrain. Not so much against Frankfurt, Paris, Amsterdam or Dublin, none of which can be viewed even as serious rivals as a leading European financial centre. For example in the rapidly growing fintech sector, our rivals are really only Silicon Valley, Hong Kong and Singapore.

 

The best approach is what Barney Reynolds of Shearman and Sterling LLP has dubbed the World Financial Centre Model where we go it alone and design a more attractive regulatory framework, freed of the EU’s restrictive policies and process-driven approach. In light of this, UK Chancellor Rishi Sunak is promising a “Big Bang 2.0”. While good governance remains paramount there is a desire to cut unnecessary red tape with changes to the EU rulebook such as on MIFID2, and Solvency 2 for insurance companies. Also recommended as by the Institute of International Affairs is that the UK form alliances with other major financial centres through multilateral mutual recognition. Switzerland and Singapore would be two obvious financial centres.

 

Pivotal to the success of the City going forward will be the Fintech sector. It is worth £7bn employing over 60K people in the UK and includes brands such as Monzo, Revolut and Starling Bank. An independent Review of the sector led by  Ron Kalifa was launched in the Budget of March 2020 to support the City’s competitiveness through “ensuring it has the resources to grow and succeed, conditions that are right for the widespread adoption of financial technology, and that the UK’s global reputation for innovation is maintained and advanced. Also important is Green Finance where again it is one of the world leaders alongside specialist financial centres Amsterdam and Zurich. Over the last three years the amount raised in green bonds has almost tripled from £8bn in 2017 to £22.4bn in 2020 with 139 listed on the London Stock Exchange. There are also now 22 green funds listed on the LSE. Furthermore the UK is leading the world in committing to reaching net zero carbon emissions by 2050. It has committed £12bn investment in green finance over the next 5 years among other things.

 

The City has a long history of resilience, adaptability and reinventing itself. It survived the 1930s and two world wars. It saw the rise of the Eurobond market in the 1960s as a result of US balance of payment controls. And it prospered after ‘Big Bang’ which was launched in October 1986 by the Thatcher government with its extensive market deregulation. Finally, it was unaffected by the UK’s decision to join the Euro. In any case despite the lack of agreement the City prepared well for Brexit and I have no doubt that the right steps will be taken to ensure its future prospects are rosy.

 

 

 

Tory election campaign failed not only politically but also from an economic perspective

The reasons for the failure of the Tory election campaign have been well rehearsed. They include the decision to make PM Theresa May the focus of their campaign while stressing the need for "strong and stable" government against the incompetence and extreme policies of Corbyn. But May lacks charisma, is unable to think on her feet and does not have a common touch. And the strong and stable mantra was an insult to the electorate's intelligence.  In contrast Corbyn was grossly underestimated as it was forgotten he is a veteran campaigner and was very comfortable in the election campaign and able to convince a  very impressionable younger generation of his supposed sincerity and caring for the poor.

This was reinforced by the respective manifestos, with the Tories being too honest of the challenges ahead but also failing politically to realise the electorate has had enough of austerity and desperately wanted change. They also failed to mention the need for social justice that May had dwelt on when elected Conservative Party leader. In contrast Labour judged the mood of the country better and got its populist, anti-austerity and generally more optimistic message over better  - through social media in particular - that there was a way forward even if their sums did not add up. On top of this the reversal of the so called dementia tax did nothing for the Tories strong and stable message. Finally, Labour managed to sideline the issue of Brexit, the original reason for the calling of yet another election.

But the Tory manifesto also failed from an economic perspective. While the Tories were honest in acknowledging some of the key economic challenges ahead such as the need to tackle social care, the need to deal with an aging population and also to promote fairer intergenerational equity (see blog 22 October) it failed overall by not fully abandoning austerity (despite recent loosening of balanced budget targets) and promoting a fiscal stimulus.

In a previous blog on 10 October I talked about monetary policy having been overworked, of low interest rates providing the opportunity for fiscal stimulus and the positive side effect of increased government spending on aiding redistribution of income. It would also raise growth at a time when GDP growth is finally slowing without the risk of the economy "overheating", and by prioritising infrastructure spending boost the supply side of the economy and raise very low productivity growth.

International financial market developments are also very supportive of a good old-fashioned Keynesian stimulus. Global bond yields have dipped again leaving real bond yields of advanced countries in the US, UK, Eurozone and Japan low or even negative. The reason for this is attributed to the so-called "safe asset shortage". The idea is that there is a large excess global demand for safe, liquid and highly tradeable government debt for whatever reason. It is thus argued these countries can raise spending without pushing up their own government bond yields rapidly, a sort of " free lunch". Eventually though yields will creep up not least because the shortage will erode as bonds issued rise to fund higher budget deficits.

Another factor in weakening the case for continued austerity is the demolishing of the now-infamous 2010 economic paper 'Growth in a Time of Debt" by Reinhardt and Rogoff. It claimed that a 90% government debt to GDP ratio is a critical threshold at which a fiscal crisis like seen in Greece could occur. But the data was proven to be flawed and most now argue that Greece is a special case among advanced countries.

With a number of years fiscal austerity, front-loaded into the 2009-2011 period, the fiscal deficit was brought down to around a third of what it was in 2009 so that it stands today at some 3.5% of GDP.  This has greatly boosted policy credibility and given the scope for significant fiscal easing without the need to raise taxes and so able to take advantage of favourable market trends. This may not last and certainly the UK must be cautious not to raise spending too rapidly or much on current spending which could damage credibility. It should be noted that the UK has not run a surplus since 2001 and it is much easier to raise spending than cut it. Remember also that the UK's debt to GDP ratio is still rising and approaching 90%, notwithstanding the improved debt maturity profile. While there are signs that the global economy is picking up, the next crisis or downturn may not be far away. For the UK the concern is the uncertainty of Brexit. However, for the UK and other advanced countries fiscal stimulus will give more scope to raise interest rates which will give space to cut rates in the next downturn.

So there is both an economic and political case for fiscal stimulus in the UK.

Economic madness to vote Labour

Only someone who is economically illiterate ( sadly the vast majority of the electorate) or supports the Marxist cause would rationally vote Labour these days. The release of the Labour manifesto for the general election on June 8th would take us back to the 1970s with hyperinflation, mass unemployment, regular strikes, an escalating debt burden, high interest rates and low or negative growth. In fact it would be worse than then. A fully fledged socialist agenda would be worse now in this globalised world when capital and labour can move where it wants. We saw in France, for example, how Hollande had to abandon his Socialist policies repeating Mitterand's mistakes in the 1980s.

One of Labour's most popular policies would be a massive increase in spending on the NHS. Forgetting this is not necessarily the solution to its problems, the sad fact is there would not be the money available in all but the short-term.  Sadly this commitment along with extra spending elsewhere totalling nearly £50bn will not be matched by the increased revenues. As I have said many times, and is corroborated by the highly respected and independent Institute for Fiscal Studies, tax increases from corporation tax and on personal incomes on those earning over £80k will yield very little in the short-term and probably a negative amount over the medium-term. Both capital and labour is ever more internationally mobile and will go to where these rates are lowest. It may have escaped you for example that corporation tax revenues have rocketed in the UK recently despite the tax rate falling.

On top of this, the manifesto confirmed that a Labour government would renationalise the railways, the Royal Mail and the National Grid and even Water, undoubtedly a superficially attractive policy given the various problems and issues there have been in these sectors.  This is despite the overwhelming evidence that nationalisation is far inferior to privatisation. The answer is clearly better regulation. Such a renationalisation plan would be a massive undertaking akin to implementing Brexit. The biggest concern however would be how it would be funded. It seems by borrowing! This would only add to the national debt and result in massive increases in interest payments (and less money for public spending)  and a  'crowding out' of private investment through higher interest rates. Such tax, spend and borrowing policies would be especially bad as we leave the EU and need to boost our competitiveness.

The polls may well narrow as some of the electorate become seduced by some of these unaffordable policies, especially among the idealistic young that do not remember the 1970s. But while Corbyn managed by an abused election system to become leader of the Labour party, he is very unlikely to become PM. The issue of his lack of competence  and of his senior shadow cabinet has been there for all to see in this election so far. Related to this too is the lack of economic credibility that has been built up from the disastrous spending policies - but far more modest than is planned now - of the Blair/Brown government years that was the underlying cause of the bad public finances that the coalition government inherited. And if this is not enough, Corbyn's ambivalence on use of Trident even though he would spend the money on renewing leaves grave doubts of his suitability for the top job. The electorate votes typically on the relative suitability of a party leader to be PM and on its party's economic credibility. It is no contest.

Brexit and financial services

There is no sector more important to the prosperity of the UK economy than the financial services sector. Together with related professional services like legal, accountancy and management consultancy, the sector accounts for 12% of UK GDP and employs 2.2 million people. It also accounts for some £67bn or 11% of total government revenues, and generates £77bn in net exports - making UK the world's largest net exporter of financial services.

The realisation that the government is pursuing a hard or as I prefer to call it clean Brexit that involves the UK leaving the single market (and customs union) has raised fears that financial services will be severely damaged especially if also there are no transitional arrangements.

But it may surprise many to know that there is no single market for services and certainly not in financial services. There is no single banking market, no single insurance market, no unified capital market, and no European stock exchange.

The issue of passporting has received a lot of publicity when discussing financial services post-Brexit. Passporting was designed to overcome the lack of a single financial services market by allowing a financial institution authorised in one EU member state to market financial products in other EU countries. It is open to non-members states too in theory at least, and after Brexit, UK and UK-based banks and finance companies would be free to set up subsidiaries (if they have not done so already) in the EU to trade throughout, though the presence would have to be meaningful, something to be debated. Another route to maintaining business in London will be so-called "equivalence" of regulation. This will be useful for the City in any transitional arrangements agreed, though I do think we should not be tied to this in the longer run, particularly as we will have no say on the regulations, and also that we will likely go down the path of greater deregulation.

Even under this passporting system, retail financial services remain virtually entirely national and heavily protected. So leaving the EU will have no impact here for the UK. With respect to the wholesale sector, banks do not need a passport to access the City's foreign exchange market or it's interbank market, while companies can buy reinsurance at Lloyd's or do business with corporate financiers in London. It has been estimated that just 20% to 25% of wholesale business is related to the EU and only part of that is facilitated by passporting.

So what about the issue of the settlement and clearing of euro-denominated instruments I here you ask? The trading of such business would stay in London, as this is where the liquidity and infrastructure is. Europe is just not a credible competitor. But the eurozone has long coveted the euro-denominated clearing business which - along with non-euro clearing - is dominated by the LCH clearing house in London. The European Central Bank previously attempted to take such activity back in a failed landmark legal case in 2015. But there are now potentially renewed attempts to do so. Yet there are real dangers to moving the business within the eurozone. Many experts have noted a forced repatriation of the clearing would increase systemic risk and substantially increase the costs of clearing.  Economies of scale allow for so-called "netting", a process that reduces margins. Also such denying of London the right to clear euros would have to be applied globally, but this would likely lead to retaliation especially from the US.

Despite the jostling among European cities including Paris, Frankfurt, Berlin, Luxembourg and Dublin, there is no real rival in Europe to London as a global financial centre. It's dominance is only threatened by New York as one can see in more detail From Z/Yen's excellent Global Financial Centres Index report. London is supported by its expertise and knowledge in financial services and key support services such as Law and accountancy; by the use of the dominant English language and the attractions of living in a vibrant and exciting city; by its infrastructure; by low taxation; and the sheer size, depth and liquidity of its financial markets. The biggest challenge remains from New York which is supported by a larger domestic economy, and could get a boost from new US President Trump's plans for greater deregulation including getting rid of Dodd-Frank which was imposed seven years ago, and by lower taxes.

There is a growing realisation in some quarters of the continent that trying to hurt the only large financial centre in Europe will damage the EU perhaps as much as the UK. Germany's finance minister Schauble warned against punishing the UK generally not least because of the unrivalled London financial centre. A leaked European report warned that failing to protect the City would indeed hit Europe's economy.

The City of London is very resilient, agile and great at adapting. It survived the 1930s and two world wars. It prospered after Big Bang and was unaffected by the UK's decision to not join the Euro, becoming the undisputed financial centre of Europe despite the fears of many. I remain optimistic even if the EU does its best to undermine it, that the City will remain pre-eminent being highly innovative and doing what is necessary to retain its competitiveness perhaps through lighter regulation and lower business taxation. It can escape EU regulation on Bankers' bonus caps and the financial transactions tax and perhaps impose lower capital buffers. It will be important however to remain open and in particular retain full access to talent overseas which has been acknowledged by the government, with even the Labour opposition realising this with its purported plans to introduce regional immigration plans.

There will certainly be some shifting of business but it will be on a small scale compared with the impact of other developments and evolving new areas of business and new products eg renminbi-related products or in the already thriving fintech (financial technology and innovation) industry.  London will remain one of the two global financial centres.