It is more than a coincidence: the growth of finance really is holding the rest of the economy back. Even worse, according to a new paper from the Bank for International Settlements, 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.
While the study looks at data from 15 advanced economies, the US experience is a good illustration. Profits from the financial sector now run at about 20 per cent of the whole, about double the level from the Second World War 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 labour 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 centre of the problem seems to be the way in which an overdeveloped financial sector seems to distort the allocation of resources.
In part this is because finance will tend to favour 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 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.
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.
