Why too much banking can be a ‘finance curse’

Credit to private sector at 100% of a country’s GDP can hurt

November 10, 2018 08:52 pm | Updated 08:52 pm IST - Singapore

One of the more perverse ideas of modern economics is that an abundance of natural resources is a handicap rather than a blessing. In Africa and elsewhere, excessive mineral wealth appears to have imposed inordinate costs on regular people. Now, Nicholas Shaxson has extended the concept to finance, arguing that overdeveloped banks and markets can also prove too much of a good thing.

The “resource curse” posits that economies which depend on mineral wealth develop more slowly, with more violence, corruption and poorer governance. Even law-abiding governments grapple with exchange rates pushed up by commodity exports. Mr. Shaxson, a former journalist, chronicled the problem eloquently in “Poisoned Wells”, his 2007 book on the politics of African oil.

“The Finance Curse” applies the same argument to the business of money. Sure, economies need banks, equity and debt markets to develop, and companies cannot function without cash and financial intermediaries. Yet, beyond a certain point — roughly when credit to the private sector approaches 100% of a country’s GDP — the impact turns negative. That is when finance begins to suck up talent, concentrate wealth, hurt other sectors and absorb too much government attention.

Mr. Shaxson, whose last book was about tax havens, has been developing this idea for some time, and makes his case at a compelling pace. Certainly, the vast wealth generated by the City of London, for example, has not trickled down to the rest of Britain, which remains one of the most unequal countries in Europe.

Yet, the city is hardly unique in unequally dividing the spoils of an out-sized industry. Nobody complains about the entertainment curse in Los Angeles, though the majority of Hollywood’s earnings flows into the pockets of a handful of producers, agents and stars.

2008 crisis

One reason finance is different is because the public is ultimately on the hook. The 2008 crisis showed that when financial institutions became too large and complex, taxpayers had to step in. Too-tight links between government and finance confuse interests. Witness George Osborne, Britain’s former chancellor, turning up as an adviser to fund management giant BlackRock. This dependence has a real cost, even if the estimated expense to Britain of £4.5 trillion ($5.9 trillion) over 20 years, cited by Mr. Shaxson, is highly suspect. That astronomical figure, more than twice the country’s average annual GDP over that 1995 to 2015 period, is based on a study by the Sheffield Political Economy Research Institute. It puts the price of misallocation — the impact of resources that were sucked up by the financial sector which could have been deployed elsewhere - at £2.7 trillion.

Mr. Shaxson also sprays his criticisms widely, gaining anger but losing the clarity of his argument. He spends too much ammunition on the purported evils of privatisation, for example. Outsourced services have taken a battering in Britain due to scandals like the collapse of services firm Carillion. But State-run alternatives are hardly a panacea. And while the brain drain into finance is real, it’s laughable to claim that people who would otherwise be curing malaria are becoming hedge fund managers. All of this leaves “The Finance Curse” insufficient time to tackle potential alternatives. After all, returning to highly localised, small-time banking would involve real costs and risks, even if it was possible.

(The author is a Reuters Breakingviews columnist. The opinions expressed are her own)

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