The question that I have been asked to answer is whether we can build the common good – or the conditions that promote human flourishing for all – with “money”. I shall take that to mean “finance” which is somewhat different but what I think is intended.
Certainly, it is very difficult to promote human flourishing for all without a financial sector. What does finance do? For the most part, it intermediates. It ensures that I can save for a rainy day, insure against serious risks, provide for my family in retirement, and so on, reasonably cheaply and reasonably safely.
You may think that the financial crisis proved that not to be true, but the financial crisis was really the exception that proved the rule. Without banks, pension companies, unit trust managers and so on, households would have to search themselves for reliable businesses that needed capital, the costs of which would be enormous; without liquid deposits in banks or securities markets people would not be able to cash in their investments; without financial institutions people would not be able to spread their risks over, literally, thousands of investment projects.
Really, it is quite simple. Without a sophisticated financial system, all but the very rich would rely on friends and family in times of distress and old age.
In fact, there is quite a lot to be said for systems of family and fraternal support in times of need but, if they are the only means of support, then there will be many who are left in destitution – the widows and orphans mentioned throughout the Bible, to give just one example.
I would argue that we under-value the financial sector. People often suggest that the financial sector is important only insofar as it provides capital to what is often called the “real” economy: that is not true. The financial sector is important for the services it provides for households. Jobs in the financial sector are socially useful – indeed, they are essential.
So that, perhaps, leaves three questions. Is the financial sector a den of self-serving thieves that needs regulating? Would it be better if financial institutions were more human? And would it be better if the financial sector were smaller?
I will answer those in reverse order.
Is the financial sector too big?
People argue that the financial sector in the UK is too big. Apparently, we should make more stuff and stop selling each other services. We should be more like Northern Italy or Germany. They say that a financial sector that is too big leads to greater inequality and leads to the tail of the financial sector wagging the dog of the real economy.
None of this is not true. The largest financial sectors in the world as a proportion of national income in normal countries (so ignoring tiny places such as Luxembourg) are to be found in Australia, the Netherlands and the UK (in that order) – for some reason, the OECD does not provide comparable data for Switzerland. These are three quite different countries with very different levels of inequality and rather different cultures. They are all, it should be said, decent places to live.
Even in the UK, the financial sector accounts for only 8 per cent of national income – 92 per cent of all economic activity involves producing something else other than financial services. Not only that, one-third of that output of financial services is exported to other countries to allow us to buy other things. So, only around 5 per cent of the economy of the UK is producing domestically consumed financial services.
I hear people say all the time: our economy would be better off if it was more like Germany’s. It would not. Beneficial trade relies on differences, not similarities. It is really important – for both the UK and the German economy – that both are different from each other. We often beat ourselves up about our economic performance relative to that of Germany. This is a hangover from the seventies. Our recent economic performance is almost identical to that of Germany whether you measure by national income, the proportion of people in poverty, consumption or unemployment or a whole load of other variables.
Is the financial sector not human enough?
So, let’s move on to ask whether the financial sector is insufficiently human. Would the common good be better promoted if we had more financial institutions based in the community, more mutual finance, and so on? People lament the loss of the building societies, the trustee savings banks, friendly societies, mutual insurance companies. Adair Turner called for bank managers that were more like Captain Mainwaring and less like those we have today.
This is a complicated story to unpick. There is a tendency for people to look back with rose-tinted spectacles. Yes, there may have been certain advantages of a model where the bank manager played golf and went to the Rotary Club with all the local business owners and the City was a tight-knit network. However, it was a more exclusive place. There was more what is often called “bonding social capital” but less “bridging social capital” between different groups in society.
Secondly, the very diverse range of financial institutions that existed at the beginning of the 20th century (7 million members of Friendly Societies, an incredible 645 Trustee Savings Banks rooted in the local community in 1861, dozens of mutual insurance companies, and so on) was, essentially, destroyed by government action – this was no inevitable process of market centralisation. The functions of the friendly societies were deliberately taken over by the state. Eventually, the Trustee Savings Bank was turned into a PLC by act of parliament. There is a wealth of evidence also that the hugely increased regulation of the financial sector removed the need for (that is, it removed the comparative advantage of) these community institutions.
The comparative advantage of a mutual insurer, for example, was that it prevented conflicts of interest between owners and customers. When such things became regulated, essentially from 1988 onwards, the technical inefficiency of mutuals and the fact that they had difficulties raising capital provided an overwhelming reason for them to convert.
The comparative advantage of trustee savings banks and building societies was that they were safer for depositors. The former had to invest in treasury bills or similar instruments and the latter had a trade association that required them to keep very high levels of capital. When the EU forced Britain to introduce deposit insurance in 1979 and banks had minimum capital requirements, why would anybody use a bank that did not pay the highest rate of interest?
Before the state got involved, there was a rich tapestry of institutions within the financial sector.
A den of thieves?
Finally, is finance a den of thieves? Human imperfection is a fact of life. The fast-moving activity of finance is probably going to attract a decent proportion of dodgy people – houses attract a fair proportion of burglars, but it is better to have them than not. Indeed, I believe in a market economy partly because, ultimately, a business has to serve its customers in a market economy, however nasty or incompetent those at the top are. We should not judge a market against perfection but, given the imperfectability of man, we should judge it against the alternatives that are available.
However, and this relates to my previous point, if the state bails out financial institutions, it is not going to make them any more ethical. Why does Lloyds need to promote a reputation for fair dealing when the government regulates these things? Why does Barclays – originally a Quaker institution – need to promote a reputation for prudence when the government regulates its capital and gives customers deposit insurance?
A financial institution should be a common endeavour of owners and workers serving customers and, hence, wider society. A financial institution should look outwards towards the customers and society it services and not Canary-Wharf-wards to the regulators. We have hugely increased financial regulation over the last three decades. This did not stop the crash and, I believe, it has helped to make the financial sector more self-serving.
Finance contributes to the common good, but we cannot build the common good on finance alone. Finance is more valuable than we think, but we have made it less human than it once was and should be. Government intervention is a particular problem here and, hopefully, as new forms of finance come along, they can transcend both the government regulatory model and existing financial institutions. But, let’s not compare finance against perfection. After all we don’t compare the government – or even the institutions of the Church – against that standard.