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 Even worse, according to a new paper from the Bank for International
Settlements (http://www.bis.org/publ/work490.pdf), this likely
happens in part because we have too many clever bankers who would be
producing more of value as aerospace designers or drug researchers.
Good thing then, that we have complex mortgage products to divert us
while we are suffering from uncured diseases and not riding in
faster, cheaper and quieter jets.
Over the past 35 years or so there has been a clear correlation
between the growth of finance, as a share of the economy, and weaker
growth in productivity, the measure of how much we create given the
resources we put in. While the study looks at data from 15 advanced
economies, the U.S. experience is a good illustration. Profits from
the financial sector now run at about 20 percent of the whole, about
double the level from World War II to the 1970s. By one measure,
productivity since 1970 has grown at less than half the 1945-1969
rate, implying a massive shortfall in growth.
That growth in finance has been a drag on productivity, according to
the study, while also distorting how resources are invested and what
comes out the other end.
"Where skilled labor works in finance, the financial sector grows
more quickly at the expense of the real economy. We go on to show
that consistent with this theory, financial growth
disproportionately harms financially dependent and R&D-intensive
industries," Stephen Cecchetti of Brandeis University and Enisse
Kharroubi of the BIS write.
Amazing, if not surprising, then, is the way in which the finance
industry has attracted and maintained subsidies. Finance benefits
massively from the tax-deductibility of debt and through direct and
indirect means because of government support in times of stress.
Maintaining these and other subsidies through lobbying and other
kinds of suasion is certainly part of how the scads of clever people
drawn into the financial industry are deployed.
At the center of the problem seems to be the way in which an
overdeveloped financial sector seems to distort the allocation of
resources.
AGENTS AND PATIENTS
In part this is because finance, by its nature, will tend to favor
projects with lots of collateral to claim back if things go wrong
but with lower prospective results if successful. Real estate
development is a good example. Real estate features land and houses
to be pledged against loans, making it appear a safer bet than
backing the Apple or Tesla of tomorrow. Housing, and other
low-productivity sectors, usually win out, according to the study.
This may help to explain why construction-driven booms, like the
sub-prime bubble, are often associated with rapid growth in finance.
Taking talent into account can magnify the effect, with bankers
getting better at making loans and reclaiming collateral but
entrepreneurs having less incentive to swing for the fences and hire
the best.
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Better, in other words, if you are an entrepreneur to gamble with
borrowed money while hiring brick-layers than employing
Harvard-trained physicists in an aerospace project. That physicist,
as we saw in the last boom, becomes a financial engineer instead.
The implication to this pattern, as it is played out across an
economy over a long period, is that more and more resources are
dedicated to lower-yield projects and fewer to higher-payoff ones.
The study estimates that a sector with a high research and
development requirement with the bad luck to be in a country whose
financial system is growing rapidly will grow 1.9 to 2.9 percentage
points a year slower than one with low R&D needs in a country with a
slow-growing financial sector.
And this is all before we consider the ways in which the finance
sector is gamed by its workers to their own advantage. Medical
research and aerospace offer far fewer ways for workers to exploit
their own greater understanding of the field than that of their
bosses. Bankers and fund managers are forever claiming to have come
up with superior products and strategies which only blow up some
time later, often after the designer has pocketed a fortune and left
the building.
Observing this state of play, even demonstrating that it is
happening, is not enough.
The real struggle has to come in designing regulation that, gently
but firmly, shrinks the financial sector, preferably slowly.
There was a time, from the imposition of Glass-Steagall banking
legislation in 1933 to the 1970s, when banking was boring and its
practitioners a bit dull.
Our wealth, health and wellbeing may depend on driving the brilliant
out of banking.
(At the time of publication James Saft did not own any direct
investments in securities mentioned in this article. He may be an
owner indirectly as an investor in a fund. You can email him at
jamessaft@jamessaft.com and find more columns at http://blogs.reuters.com/james-saft)
(Editing by James Dalgleish)
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