Economic Theory

It is fashionable to attack the financial sector. It is also ignorant


Attacks on the financial sector are commonplace.

The Pope, the Archbishop of Canterbury, and Jeremy Corbyn have all been critical of modern finance while demanding a financial sector that serves the “real economy”.

Of course, religion and finance have always been uncomfortable bedfellows, and the extreme left now has a clear preference for a centrally planned economy.

However, voices from the industry are also criticising the sector – the enemy within, it could be said. Former chairman of the Financial Services Authority, Adair Turner, famously described much of the financial sector as “socially useless”.

Such commentary is socially destructive. It leads to a misunderstanding about the purpose and value of finance, and creates a climate of opinion which undermines the industry.

Some would say that talking down success is a peculiarly British pre-occupation. In his 2011 budget, George Osborne called for a “march of the makers” and a rebalancing of the economy away from things the British are good at (financial services) and towards manufacturing.

Would any German want to replace the industry in which they excel with finance? No wonder we have a productivity crisis.

As we show in a new IEA paper, published this week, the productivity of the financial services industry is immense. With just three per cent of the country’s employees, it produces over seven per cent of value added.

London and the south east are not the richest regions of the country because they suck resources from elsewhere. They are the richest regions in the country because they play host to the UK’s most productive large industry. Not one person in Liverpool would be better off if Morgan Stanley stopped providing corporate finance services.

Indeed, 50 per cent – or £125bn – of the output of the financial services sector is exported. Foreign businesses and consumers are paying good money to the UK for services, and we then spend that money on imports made up largely of manufactured goods.

Are these exported financial services really socially useless? At the very worst, misguided foreigners are buying useless UK financial services so that we can buy goods and services from abroad. Not a bad deal.

Domestically consumed financial services make up about 3.5 per cent of the economy. They include insurance, banking, pension and fund management services, and a whole range of other products without which our lives would be a total misery.

In economic terms, these services exist to reduce “transactions costs”. In that sense, they are rather like the retail sector.

Imagine putting together a roast dinner without a supermarket. It would involve a visit to one farmer to buy a chicken, another to buy a cabbage, another to buy potatoes, and so on. Supermarkets draw all these things together in one place. They produce nothing tangible themselves, but they enable us to do important things at much less cost.

The financial services sector is much the same. Without it, only the very richest could protect themselves against the risk of injuring somebody in their car. It would be impossible for all but the wealthy to obtain the capital to start a business. And the idea of saving for retirement through a diversified portfolio of investments would be a pipe dream.

Financial institutions make all these things possible for the many and not just the few.

Those who attack the sector are skating on thin ice. Criticisms that speculators cause damage to the real economy are based more on hunch than theory or evidence.

Indeed, the critics are not consistent. Complaints are made about the cost of fund management – complaints that were taken so seriously that the government has introduced a damaging cap on pensions charges.

However, innovation in the sector has led to the development of exchanged traded funds which are often 80 per cent cheaper than the old managed funds of a decade ago. Such innovation then leads others to complain that company ownership is too dispersed – the sector cannot win.

This is an industry that innovates in response to problems, and that is what we should expect of a vibrant, productive, valuable part of the economy. It is, though, hamstrung by regulation. And more regulation tends to beget more complexity and hamper productivity. It possibly even increases risks.

We need to liberate the financial services industry again. And it is time for the sector to help people understand its social contribution – not in terms of higher tax revenues or jobs, but in terms of the contribution that the production of financial services makes to overall economic welfare.

 

This article was first published in City AM.

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.


4 thoughts on “It is fashionable to attack the financial sector. It is also ignorant”

  1. Posted 03/03/2018 at 16:34 | Permalink

    Excellent – I hope people share this widely.

  2. Posted 05/03/2018 at 09:40 | Permalink

    I appreciate Prof. Philip Booth. You said what I believe. Every citizen should get equal benefits from it. What is going right here is there is no one to support to the poor people to grow up. The financial services must be distributed.

  3. Posted 08/04/2018 at 11:10 | Permalink

    Great post

  4. Posted 09/01/2021 at 08:24 | Permalink

    Good post!

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