Transcript - Episode 5: Devising a future vision for Financial Services with economics

Laura Gatz: Hello and welcome to a new episode of our Economics in Business podcast series. My name is Laura Gatz and I will be hosting our 5th episode taking over from Hannah Audino.

Today we will be talking about a topic very close to the essence of the theme of this podcast series. How can economics help and form business in practice? I am joined here by Nick Forest who leads on Financial Services in economics consulting. Hi Nick!

Nick Forest: Hello!

Laura: And we are going to be talking today about how Nick and his team have recently drawn an economic theory and methods, to devise a new strategy for the UK Financial Services sector. Nick, could you tell us little bit about what your study was?

Nick: Sure, thank you! So we were working with the City UK and they are the trade association that oversees all of the UK's financial services and related professional services firms and as you said here, Brexit very much dominates everything that’s going out at the moment but actually they wanted to get beyond that and look more into the medium term: what’s the right vision for the sector after Brexit. So we were delighted to support them with that work and it involved lot of interviewing of senior executives in the industry and outside the industry, analysing all of data around the UK's performance and bringing that together into an overall vision.

Laura: That sounds fascinating. What exactly is that vision?

Nick: Yes, the vision is set out in the report on our websites, condenses down into three main pillars.

The first pillar is around how the industry needs to transform itself to be highly digitised, innovative and customer centric. And that’s because when we looked at how the industry is currently performing there are some gaps in service provision, like the 1.5 million people who don’t have a bank account, like the advice gap for people going into retirement and some of the challenges around trust the industry currently faces. And so we did do things the industry does need to change from its current place, embracing new technologies and placing customers first.

The second pillar is around London, so London currently has a great ecosystem, the breadth and depths of the services offered in London are huge and globally leading and we do think London needs to retain that position of international leadership, simply because there is not really another sector in the economy that can quite provide that amount of exports and performance and thirdly we do think there is an opportunity for regional and national financial centres, to play a more prominent role in UK wide financial services and that’s not just back office or lower value, parts of the value chain, but actually becoming specialist centres in their own rights and fully supporting the UK. So that’s the three parts of the strategy.

Laura: Very interesting, and quite a challenging vision I think, how did you use economics to support this project and generate that vision?

Nick: Sure, there there’s two areas where economics really came into its own and of course it was supported by a range of specialists and the two economic areas were:

Firstly the frameworks around international competitiveness. There is a lot in the literature around this, and Michael Porter has very good book on this topic. He identified four broad areas of competitive advantage and he looked at demand conditions and the size of the domestic economy, he looked at the supply side and all the factors that really support the economy also the enabling industries.

And then lastly the kind of the competiveness rivalry within the industries. So we used that kind of framework to look at the UK and measure how well it was doing compared to international peers.

Now secondly we also used a Computer General Equilibrium model, and this is a model we are more frequently using in our economics work, that allows us to look at the sort of full effects of policy changes throughout the whole economy so that is, all the follow on knock on effects and that gives a quantification for how we think strategy might increase your economic activity in the UK.

Laura: That general equilibrium model sounds quite complex, can you give us an example how it works?

Nick: Yes, if you think about improving the efficiency of the financial sector, so through digital technology if you can make it more productively efficient then as long as competition in the market, those gains will be fairly short lived and will be competed away, so actually that benefits transfers to the rest of the economy through lower cost of financial services, whether that’s for households or firms, they become more productive and therefore the gains in the rest of the economy are far more substantial and the computer general equilibrium model can take account of those kind of cross sectorial effects, in working out the overall economic gain to the UK.

Laura: So what was your final result? What could be the impact of achieving your vision in 2025?

Nick: So we looked at three levers, we looked at the cost efficiency in the sector, overall productivity and new services and international competiveness, and we think by 2025, we can increase annual GDP in the UK by 43 billion pounds using this modelling approach and interestingly about 70% of that is outside of the Financial Services sector. So this is a good strategy for Financial Services but it’s also a good strategy for UK even more so, and most of our gain is also outside the London,  so it’s very much gains being spread across the whole of the UK.

Laura: Through that reallocation of economic activity.

Nick: That’s right

Laura: Oh! wow that’s quite a substantial gain, so we have established this as quite an  interesting and ambitious vision and you have shown us how economics in qualitative and quantitative methods led you to get to this vision, but how can we actually implement this vision in practice?

Nick: Great question, that’s really important and throughout this work we didn’t want to have just a nice vision, we wanted to have an executable strategy for how to get there and that’s why the report has 35 recommendations for what we can do to get there, and that covers both government regulators and firms acting each to do their bits in a coordinated way in line with the strategy. I won’t go through all 35, and do have a look at those on the reports on the website, but picking out few examples, one was around digital skills. A lot of executives really talk about the importance of talent in the UK, and whether that is domestically home grown through our skills in universities, or just having access to the best talent around rest of the world, both those sources are critical for the sector. So we do think we need to look at the visa system, particularly how it captures measures, digital skills which aren’t really captured very well in traditional academic qualifications. So colleagues of ours are looking at the digital skills visa and how that can be used to really attract those really critical digital skills that the sector needs. That’s one of the areas of recommendation, and another one is around addressing unmet social needs. I talked earlier about the 1.5 million people who don’t have a bank account, and the advice gap.  Those challenges are really where the sector can do more for citizens and actually, by including them on the financial system that can help improve our UK wide productivity, so these are some of the specific recommendations around some of those gaps the sector currently faces.

Laura: Interesting you mentioned productivity there, that’s obviously been a widely discussed topic as of late, the Office of Budget Responsibility just revised down the productivity forecast for the UK and has shown that historically that’s even been overestimated. So what has been the picture here in the Financial Services?

Nick: So we have seen a very similar picture in UK Financial Services. Post crisis productivity has essentially flat lined, mirroring the challenges in the economy. A number of reasons have been given for that whether that is the lower skill levels at the bottom end of the labour market, whether it is firms deciding to hire rather than invest into capital plant equipment or zombie firms being kept alive in a lower interest rate environment. There are plenty of reasons.

I think the FS sectors has similar reasons along those lines, I think post crisis it’s been focussed on a period of recovery, reform and restructuring, complying with new regulations, which will in longer term provide a more stable financial system but in the short term has deviated some of the resources away from innovation, new ideas and new products and services. So I think longer term through the strategy where we can move forward from that kind of period of flat lining.

Laura: How does your strategy propose to address this?

Nick: So we talked about the unmet social needs and we talked about the skills, the last one to pick out is the regional piece, so it earns an opportunity here for regions to grow their role either in specialist areas, possibly through linkages with the local universities and create that kind of support to London as part of the whole ecosystem, that is more cost efficient, a lot more efficiency is to be gained there but also creates more vibrant, more equal financial system. I think that will also lead to both efficiency and productivity.

Laura: Thanks very much for explaining this in more detail Nick and thanks for also showing us how you have come up with such a great vision for Financial Services in 2025, it’s also been very great to hear how you have used economic methods both quantitative and qualitative to inform your analysis and for the making of the strategy.

So thanks for coming to talk to us, it’s been very interesting on a very topical issue. Thanks also for listening, if you like to read more about this study, head over to our website at pwc.co.uk and please subscribe to our channel for future podcasts.