When banking goes bad, everyone suffers: that is a lesson taxpayers up and down Britain have learned the hard way over the past seven years or so. But the latest evidence suggests that even when it’s not collapsing into the arms of the state, a large finance sector is a debilitating drain on an economy.
Catherine L Mann, twinkly-eyed chief economist for the Organisation for Economic Co-operation and Development, brought a harsh message to the heart of Europe’s great financial centre last week: too much finance is bad for you.
In 2009, Adair Turner, then chairman of the Financial Services Authority, caught the public mood in the aftermath of the crisis that had ripped through the world’s financial markets when he called much of the activity carried out in the City of London and Canary Wharf “socially useless”.
The OECD agrees. The thinktank has made a concerted effort to keep fomenting unorthodox economic debate in the wake of the crisis – despite secretary general Angel Gurría’s vocal enthusiasm for George Osborne’s very orthodox austerity programme. Sifting through 50 years of data, its experts found that, in general, the larger a country’s banking sector, the more slowly the economy grows and the worse inequality becomes.
These findings echo recent research from the International Monetary Fund, which found that enlarging the financial sector is critically important for developing countries – if businesses can’t get loans and households don’t have bank accounts, economic progress is all but impossible. But beyond a certain point, too much “financialisation”, as the economists call it, can be counterproductive.
The OECD’s work – which would have seemed deeply heretical back in the days when Alan Greenspan was still a maestro and Gordon Brown was proudly opening Lehman Brothers’ London headquarters – shows that even in the good times, finance is not just another sector of the economy, like car manufacturing or construction, whose growth should be celebrated. And neither is it just plumbing, allowing capital to flow to the most promising businesses. Large financial sectors, the OECD says, tend to create too much credit and direct too much of it to consumers, pumping up asset bubbles (in Britain’s case, housing) instead of backing businesses and nurturing growth.
So not only do its cadre of highly paid workers (who earn up to 40% more than those in comparable jobs in other sectors, the OECD found) widen inequality by their very existence, they also make investment decisions that exacerbate the imbalances that have long been a deep-seated problem for Britain’s economy.
So even when they’re not trying to rig Libor, con customers or facilitate tax avoidance, it seems finance’s finest minds are not all that great at what we might have hoped was their raison d’être – putting capital to its best use.
Mann proffered a range of specific policy solutions: tackling top pay by cracking down on bonuses; removing the tax advantages that can make risky leveraged takeovers more attractive than equity investments; and tougher measures to rein in the biggest banks, which despite regulators’ efforts still benefit, she says, from an implicit state subsidy because they are too big to fail.
But perhaps the most important insight in the OECD work is that – as Karel Williams and colleagues at Manchester’s Centre for Research on Socio-Cultural Change have long argued – the sheer size of Britain’s banking sector fundamentally distorts its economic model, stoking what is now universally known as the “housing crisis” while failing to allocate sufficient capital to productive investment.
As if on cue, the Bank of England published a mind-boggling “map” of Britain’s financial sector on Friday, pointing out that not only is the banking business extraordinarily concentrated, but “the UK financial system is bigger, relative to the size of the economy, than that of most other countries”. UK GDP was £1.8tn in 2014; the banks’ balance sheets totalled £20tn – more than 10 times as large.
Yet as the OECD concluded: “When the financial system is already well-developed, as has been the case in OECD economies for some time, further increases in its size usually slow long-term growth.”
When the Bank of England examined Britain’s lamentably weak productivity record in its May inflation report, it suggested that low interest rates, which have prevented firms going bust in the wake of the crisis, may have temporarily “impaired the reallocation of resources to new or more dynamic companies with the potential to achieve higher productivity”.
But there may be a much longer-term and more fundamental misallocation of resources going on. Osborne will make boosting productivity a centrepiece of next month’s budget, and we can expect a string of new announcements on infrastructure, skills and his cherished northern powerhouse. He’s also likely to try to make good on manifesto promises to tackle the housing crisis.
Yet these two deep-seated challenges could perhaps be traced back to the same source – the country’s unwieldy financial sector. Since Osborne’s party receives a large share of its funding from the City, however, don’t expect to hear much about the Square Mile’s baleful influence on Britain’s economic life.