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Despite declarations that geography no longer matters, finance centers are vying for supremacy.
Alan Rappeport, CFO Magazine
October 1, 2007
When the towering Shanghai World Financial Center is completed next year, it will not only rank among the world's tallest skyscrapers but will also embody Shanghai's bid to become a major financial center. (Indeed, the smoke pouring from the building during a mid-August fire could have been read as a sign of China's overheating economy.) Despite its planned 1,600-foot-plus height, though, the tower is destined to fall short of Taipei 101. Owned by the Taipei Financial Center Corp., that already-finished skyscraper is a 101-story symbol of Taiwan's financial aspirations. Meanwhile, work has begun in lower Manhattan on the even taller 1,776-foot Freedom Tower, the centerpiece of the rebuilt World Trade Center complex. But withhold the superlatives, because Burj Dubai, expected to be completed in 2008, will reach more than 2,000 feet into the desert sky.
In a literal race to the top, cities in emerging economies are scrambling to stake their claim as the world's next great center of finance even as existing centers fight to maintain their status as capitals of capitalism. Some would argue that such efforts are wasted. Today, more than ever, distance seems to disappear as work can be accomplished remotely by broadband, cell phone, and video. If geography no longer matters, goes the theory, people should disperse to cheaper pastures. Why spend $1 billion on the newest tallest-ever when transactions can be conducted electronically and far-flung colleagues can convene online?
Distance has been declared dead before. After more than 25 million people emigrated from Europe to the United States between 1880 and 1910, people hailed the "annihilation of distance," according to Harvard University historian Niall Ferguson. In the 1970s, the philosopher Martin Heidegger wrote of "uniform distanceless," noting that, "All distances in time and space are shrinking." And in 1997, Frances Cairncross, formerly of The Economist (a sister publication of CFO), wrote The Death of Distance, a book arguing that cities as we know them may cease to exist.
But reports of their demise may be exaggerated. Although manufacturing towns have seen their populations thinned by cheaper transport and communications, people still flock to centers of finance and innovation.
From earliest times, financial centers began by first following capital and then becoming magnets for more of it. Traders naturally congregated by ports or shipping routes, although now — as Dubai has shown — even the desert will do. The first financial center dates back to the 13th century, when merchant-bankers in Florence, Italy, organized expeditions to purchase wool and collect papal contributions from England. Well positioned to deal with both northern Europe and the maritime economies developing in Genoa and Venice, Florence's banks prospered until the 1340s. Then England's Edward III failed to repay his debts and the Black Death of 1348 stifled people's willingness to spend.
Although the Medici family ultimately revitalized Florence's banking, Genoa became the country's credit capital in the 16th century. The city held quarterly exchange fairs, where Spanish dealers sold silver for gold and delivered it as payment to Spanish troops fighting in Antwerp. Genoese merchant-bankers became experts at international currencies and credit flows as they traded precious metals from Europe to Asia. Their innovations for managing debt became known as early versions of swaps and securitization.
As transportation improved and new types of securities developed, other financial centers emerged. In a new study on the evolution of financial centers, Michelle Fratianni, of Indiana University's Kelley School of Business, marks the 1688 "Glorious Revolution" in England as the beginning of London's emergence as a financial center. A new Parliament made property rights a priority and the Bank of England was formed, selling government debt as securities. As the East India Company and the South Sea Company went public, shares became more "marketable and liquid." Good institutions, an ideal harbor, and a central location put London on pace to become the center of the financial world.
The handoff from London to New York began around 1815, explains Charles Kindleberger in his landmark book The Formation of Financial Centers: A Study in Comparative Economic History. When the War of 1812 ended, the British dumped their supplies in New York. Once they had left, merchants from around the United States flocked to New York to bid in auctions for the leftover goods. When one of the merchants started a liner service to ship goods to Liverpool, New York became a major hub for cotton traders. Financial institutions and corporations followed.
Face Time Matters
Abroad, Paris, Berlin, and Zurich all had their moments as Europe's financial capital. In 1842, Hong Kong began to emerge as an Asian financial center when China ceded control of the island to Britain under the Treaty of Nanking.
New York's importance became especially clear during World War I, when J.P. Morgan and other U.S. banks provided credit and loans to the French government. By 1914, with Europe engulfed in war, most English bankers agreed that New York needed to "carry the load for financing the world's commerce," says Kindleberger.
Ideas still develop best in close quarters, and the complexity of financial innovation magnifies this effect. When Kindleberger wrote in the 1970s, the place-shifting power of the Internet was decades away. But his argument for the importance of face time still holds true: "Clustering develops when the high risks of an activity can be reduced by continuous interchange of information. Many financial functions involving uncertainty are better performed face to face."
Finance has never been riskier than it is today, and companies pay high prices for proximity. Many argue that London is retaking its position as the world's financial center. Perhaps Shanghai or the desert emirate will follow. Although the vast improvements in the speed and cost of transportation have depleted manufacturing cities and back offices, such innovation helps financial capitals thrive. "Once backroom operations can be separated from the front roomÂÂÂ the attractions of London, New York, and Tokyo are no longer diluted by the expense of office space for clerical activities," wrote Nicholas Crafts and Anthony Venables, economists at the University of Warwick and Oxford, in their 2001 paper on economic geography.
So finance centers keep rising, popping up in new time zones like glittering trophies of financial nationalism. However, the substance behind such developments remains unclear. Kindleberger called the history of financial centers a "Darwinian evolution" in which banks lacking either caution or prime location were wiped out. Shanghai and Dubai will surely be tested by future newcomers. But soothsayers preparing the obituary of the financial center should not bank on it.
Alan Rappeport is a reporter for CFO.com.
The Emergence of Financial Centers
1815: New York
Sources: "The Evolutionary Chain of Financial Centers," by Michelle Fratianni, Kelley School of Business, Indiana University. The Formation of Financial Centers: A Study in Comparative Economic History, by Charles Kindleberger.