The City shows the way to an off-shore future

SO EDDIE George, governor of the Bank of England, thinks the City is doing better with the pound out of the euro. Of course it is early days still for the euro, and pretty undistinguished days at that. But it is clear that the worst fears that business might walk to Frankfurt or Paris are unfounded. Some business has moved, but on balance the City seems to be gaining market share rather than losing it.

To anyone familiar with the City this should have come as no surprise. The resurgence of London as an international financial centre during the Sixties was as a result of learning how to use foreign currencies rather than sterling, initially mostly dollars but later the European currencies and the yen. Since the Bank of England played a crucial role in helping develop the three markets that led the resurgence, the Eurodollar market, the Eurobond market and the Eurocurrency syndicated loan market, its judgement now deserves note.

But of course it is not just the Bank that is making the point that the City can probably do better outside the euro. Lord Levene, the former Lord Mayor, started his term of office as an ardent pro-euro advocate and ended it admitting that the City was doing fine outside. Chancellor Gordon Brown has evidently changed his mind about the balance of advantage, partly because of the City's continued success but also because industry is now coping much better with the present level of sterling. Exports are booming in volume terms, as well as value, as demand from Europe has recovered.

The City's experience that to be offshore is better, leads to a further intriguing possibility. Maybe most businesses are becoming more like the financial services industry. If that is right, maybe offshore is better for the economy as a whole.

If you look at the particular characteristics of financial services you can see these apply more and more to other types of business too. Finance is very mobile. The money moves instantly and the people will move quite fast too, witness the flood of young Europeans working in the City. Finance depends enormously on human capital - people with particular, rare and highly rewarded skills. And finance's output is weightless, for its loans and investments are delivered over the wires instantly. They don't have to be put into a ship or an aircraft. As a result it is at the forefront of using the latest communications techniques.

But this is what is happening to the whole of the new economy, isn't it? The City was new economy before we thought of such a distinction. Think of the new Internet businesses. They are immensely mobile for, in theory at least, they can be located anywhere on the globe. They depend enormously on human capital, and the human beings that have the appropriate skills are certainly highly rewarded. Their output is mostly weightless, for a software package or a video game can be downloaded over the Net. And almost by definition these new businesses are at the frontiers of the communications revolution.

The Government's stated aim is to make Britain a leader, maybe the leader, in the new economy. But how? Fortunately there is a road map. The Government has to do for the whole economy what the Bank has done for the City. The Bank might beg to differ, but here is my assessment of its five golden rules.

Rule one: create a light but effective regulatory regime. It is a myth that business loves no regulation. What it needs is stable, flexible and wise regulation: just enough to keep business honest and not so much as to take up scarce management time. If the Government wants to make the UK a centre for e-commerce it needs to create a reputation for honest and flexible dealing.

The UK probably has a comparative advantage in its legal system, for British law is becoming a global standard for settling international disputes - it is cheaper and more predictable than US law. That is a base. As e-business develops we need to develop codes for trading, so that businesses choose to locate here to take advantage of the reputation for straight dealing.

Rule two: have an open-doors policy to foreign capital, both financial and human. Foreign banks have long been welcome in London, which is why there are more here than any other place. Foreign nationals have been able to take advantage of flexible tax rules, too. The Bank did a lot of the work from the Sixties onwards giving help and advice to would-be entrants: everything from finding premises to helping hire local staff and sort out the entry documents for foreign ones. As a country we are quite good at attracting foreign financial capital, but sub-optimal at coping with foreign human capital. We have an open-doors policy to EU nationals but we make it difficult for would-be entrants from the US, and in some cases Australia and Canada - two other key sources of English- speaking talent.

Rule three: maintain a tax advantage. The fact that the Eurobond market came here as a result of the US imposing a withholding tax, the Interest Equalisation Tax, has been widely noted. The IET was similar to the tax that Europe seeks to impose on the UK, but while that particular threat seems to have been fought off for the time being, the threat will continue to overhang the UK. We have already lost a lot of the fine-art business to New York, thanks to the EU's requirement of VAT on the sale-rooms. There is a further threat there from an EU regulation imposing royalties on the resale of works of art, which would drive even more business away from London.

Maintaining a tax advantage is not the same as having no tax at all - something that some countries do to attract new manufacturing investment. The "right" level of tax is simply a function of market forces. But in the case of e-commerce, because it is so mobile, that "right" level is very low.

At the moment we have a modest tax advantage over continental Europe at a personal and business level, and we are about square with the US. But there are signs that the tax base of developed countries in general will be eroded by e-commerce, so we may well find that international pressure pushes our taxes down further in the coming years. If that happens, the trick will be to stay a bit ahead of the curve, cutting tax rates just a bit ahead of other developed countries. I suspect that this Government has not fully taken on board the revenue implications of the new economy and I am sure that most continental European governments have no inking of the gale that is about to sweep over them. If they did, they would not be trying to tax the London Eurobond market, but trying to reform their own tax systems to be more friendly to e-commerce in general.

Rule four: get the infrastructure right. The key infrastructure in the new economy is not the trains, buses and cars that have entangled poor John Prescott. That is old economy. The key infrastructure of the new economy is telecommunications, with a subsidiary nod to airlines. In the case of the City, the phone system was one of the most serious problems in the late Seventies and early Eighties. So the Bank set up a ginger group to sort things out, which it did very effectively, checking the need to bribe BT workers to put in kit on time and bringing in competition in international business. Result: City communications are fine, not as good as New York but better than most of continental Europe. Next step: bring the rest of the country up to best world standards.

And rule five? Rule five is to know the limits of government action. The Bank was deeply aware of that during the early days of the City's revival. It listened and helped, but it never planned because it knew that if it planned it would get things wrong. Instead, whenever there was a problem it fixed it.

Indeed the whole City strategy has been one of not planning but listening to what the market is saying and then responding to any market signal with ruthless ferocity.

That is not a bad strategy for any government wanting to make a success of the new economy: don't try to micro-manage - just identify each problem and fix it.