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Do bankers vote with their feet?

January 25, 2011

The political fallout surrounding the gradual conclusion of a two-year battle to curb bankers’ bonuses can obscure the long-term regulatory, political and financial future of the City of London – and means that its potential consequences for the UK as a whole are unclear. To borrow a phrase, the debate is generating much heat but little light. The departing chief of the Confederation of British Industry, Sir Robert Lambert, has gone as far as to warn of a lack of substantial thinking by the government on the UK’s future “economic eco-system”: saying, “when it comes to micro policy initiatives, politics appear to have trumped economics on too many occasions over the past eight months”, as the Independent reported on Monday.

When Barclays chief Bob Diamond was questioned by MPs over bonuses on Monday, the Guardian reports, he claimed repeatedly that “he wished he could ‘isolate’ bonuses from the rest of the business.” Current strategy seems to suggest that Whitehall may agree. Agreement on the true shape of ‘Project Merlin’, in which Barclays, HSBC, Lloyds Banking Group and Royal Bank of Scotland (RBS) are to contribute funds to the prime minister’s ‘Big Society Bank’ amongst other initiatives, has been delayed.  The BBC’s Robert Peston, responding to the news, suggested that the ‘Merlin’ decision may be delayed in order to coincide with the final settlement of the confrontation over bonuses. He has raised concerns that banks are essentially ‘too big to fail’: therefore, whether or not they have been recapitalised with public funds they have a de facto ‘taxpayer’s guarantee’.

A report from Sky’s business editor, Mark Kleinman, suggests that the four banks involved in the ‘Merlin project’, are unlikely to commit anything near the prime minister’s £200bn target for lending to the prospective Big Society Bank: “the final number is likely to be in the region of £65bn-£75bn”. Kleinman also explains that this issue is being considered separately from the hotly anticipated report of Sir John Vicker’s Independent Commission on Banking (ICB), set up to address such “structural issues” as “the complex issue of separating retail and investment banking functions” as well as “non-structural measures” to benefit consumers and businesses[1]. As other BBC coverage suggests, there is a certain divergence in understanding between government and banks in how the issue of bonuses relates to wider efforts to rein in the financial sector. The present point of concern for leaders of the ‘Merlin’ banks is governance: executives “argue that lending targets for what might be weaker businesses could breach rules that say any decision should be in the best interest of shareholders.”

PricewaterhouseCoopers’ Jon Terry warned last year that the implementation of European rules on bonuses “could make it more likely that banks move operations, or at least expand, outside of the European Union.” There is a clear echo here of a previous controversy over the regulatory framework more broadly. The outlines of this debate are found in a 2008 report for the City of London, which noted that “the existence of corporate tax differentials is now one of the few remaining significant distortions to the international allocation of capital.”[2] Amongst its conclusions was that should London “become uncompetitive on tax”, certain firms will, in certain circumstances, move their executive functions, capital base, or operations as a whole out of the City. However, the European Cities Monitor reports that London moved to second place in 2010 in terms of “the climate governments create through tax policies and availability of financial incentives”, edging out both Warsaw and Geneva[3]. This result is significant because Poland is widely considered to be the only European country to escape the recession, and is competing vigorously to lead Central Europe’s growing financial markets. Geneva was the destination of choice for employees of the hedge fund Bluecrest, in response to proposals for a windfall tax on the financial sector last year. As a report from the Guardian’s Heather Stewart suggested, too, departures from the city under the last government represented “a trickle rather than a flood”.

The public debate over tax reverberates, quietly, in academia. The model for tax competition dates back to the 1956 Tiebout hypothesis on local government: grossly simplified, it suggests that city residents vote with their feet when finding a suitable balance between public goods and taxation. As Wilson and Wildasin suggest without comment, it can be “applied, almost unaltered, to competition among jurisdictions for mobile firms”[4]. However, economists and political scientists are perplexed by lack of evidence of a ‘race to the bottom’ in tax rates on mobile capital amongst OECD countries. Trying to overcome the limits of these two perspectives, more recent research has argued that the assumption that capital owners react immediately or perfectly to changes in taxation is unconvincing, and also that political pressures on governments for fairness in the tax regime must also be taken into account[5].

Sir Richard Lambert urges that the government has proved “careless of the damage” recent policy “might do to business and to job creation”. This suggests that it is time to clarify exactly where regulatory reforms should be targeted. The surprisingly political tone of the departing CBI chief’s message is in marked contrast to the past position of the British Chambers of Commerce. Last year, it suggested that “regulation can penalise business by transferring resources needed away from business investment to employees or citizens in general.”[6] With fears over stagflation rising following recent GDP figures issued by the Office of National Statistics, there is a need for a substantial commitment to the real economy – instead of mobile capital – from both government and the financial sector.


[1] HM Treasury (2010), ‘Sir John Vickers to Chair the Independent Commission on Banking’, press release, 16th June.

[2] Butterworth, D., Moriarty, M. and Tilden, M. (2008), ‘The Impact of Taxation on Financial Services Business Location Decisions’, London: City of London.

[3] ‘European Cities Monitor 2010’, London: Cushman & Wakefield, p. 19.

[4] Wilson, J.D., and Wildasin, D.E. (2004), ‘Capital tax competition: bane or boon’, Journal of Public Economics 88, p. 1067.

[5] Plumper, T., and Troege, V.E. (2009), Why is there no race to the bottom in capital taxation?, International Studies Quarterly 53, p. 766.

[6] Ambler, T., Chittenden, F. and Miccini, A., (2010), ‘Is regulation really good for us?’, London: British Chambers of Commerce, p. 15.

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