Economic Theory

The financial sector: unpopular but useful


In many ways we take the financial sector for granted. We tend to assume that we would be more prosperous without it. Commentators often lament that clever mathematicians or physicists, for example, end up in the financial sector rather than becoming engineers and building bridges.

Indeed, people down the ages have criticised the financial sector for being either useless or dangerous.

Lord Adair Turner (former head of the financial regulator) said in a report on the financial crisis that much of what goes on in the financial sector is ‘socially useless’. Around 800 years earlier, St Thomas Aquinas had said “to take usury [or interest] for money lent is unjust in itself, because this is to sell what does not exist, and this evidently leads to inequality which is contrary to justice”. President Roosevelt in his inaugural address nearly 90 years ago said: “Practices of the unscrupulous money changers stand indicted in the court of public opinion, rejected by the hearts and minds of men”.

And yet the total value added by the UK financial sector is £132 billion (2018). This represents about 7% of all output but only just over 3% of all jobs. In other words, it is a very high productivity sector – a relatively small number of people are producing a rather higher proportion of national output. That is why many clever physicists go and work for banks rather than build bridges. Jobs in the financial sector seem to be productive and pay highly. About 50% of financial sector output is exported. The UK has a huge trade surplus in financial services of £41 billion or about 3% of national income which, of course, allows us to buy imported manufacturing goods that can be made relatively cheaper elsewhere.

What is this value the financial sector adds?

The Nobel Prize winner Ronald Coase once said: “A large part of what we think of as economic activity is designed to accomplish what high transactions costs would otherwise prevent.” Transactions costs are a huge issue in economics but ignoring them often makes our models simpler. So they do not get the attention they deserve. Much of the value the financial sector adds comes from reducing the transactions costs that would otherwise make certain types of economic activity prohibitively expensive.

To improve public understanding of such counterintuitive economic issues, Buckingham University’s Vinson Centre for the Public Understanding of Economics and Entrepreneurship has now started a YouTube series “Economics explainers”. The first video in that series continues this topic and explains more about the value of the financial sector.

 

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.



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