Socially Useless? The Crucial Contribution of Finance to Economic Life

56 Pages Posted: 7 Jun 2021

See all articles by Philip Booth

Philip Booth

City University London - The Business School

Diego Zuluaga

Institute of Economic Affairs (IEA)

Date Written: February 28, 2018

Abstract

Animosity towards the business of finance is ancient and persistent. As finance creates intangible value, its contribution is invisible to many observers, but the proposed remedy – increased statutory regulation – may heighten, rather than mitigate the exposure of taxpayers and households to recessions and speculative bubbles. Financial firms serve many useful functions, which individuals and households could scarcely undertake on their own: maturity transformation, matching lenders and borrowers at low cost, facilitating the transfer of risk and consumption across time and between people, monitoring, and diversification of investments. Banks reduce the transaction costs of financial activity, enabling people to spend their time more productively. Gross value added (GVA) by the UK financial sector amounted to £124 billion in 2016. Of this, 50% is exported. Contrary to the claims of critics, the sales and trading activity, alleged to be self-serving, accounts at most for 10% to 13% of financial services business in Britain. It is often argued that private-sector finance is short-term oriented. Whilst there is evidence that shareholders may be heavily discounting distant profits, the reasons for this could be policy uncertainty, and not irrationality. Moreover, the valuations of tech firms – whose positive cash flows lie far in the future – and low yields on corporate bonds suggest that investors are patient by historical standards. Much financial regulation assumes that providers ‘dupe’ consumers. But regulatory intervention is grossly miscalculated. The Financial Conduct Authority’s recent interest cap on payday loans shrank the market by between three and five times more than the regulator expected. Markets are not perfect, but regulation is often a poor substitute. The much-cited literature linking financial growth and adverse economic outcomes is simply too crude to warrant drawing clear policy conclusions. Studies linking financialisation with inequality are similarly ambiguous: the top ten countries for their share of finance in GDP are a mixture of high-, medium- and low-inequality countries. Complex financial instruments and speculation, both unpopular in the wake of the 2008 crash, are not harmful on their own. In fact, they transfer risks to those who can best bear it, whilst giving greater income certainty to vulnerable people. Until and unless the value of finance is properly understood, public policy will fail to harness its benefits and may well endanger public welfare.

Keywords: UK, Britain, finance, financial services, banking, sales, trading, regulation, government regulation, government policy, speculation

JEL Classification: L51, G18, G28, G38, G15, G14, G21, G22, G24, G20, G34, G32, E52, E60, E62

Suggested Citation

Booth, Philip and Zuluaga, Diego, Socially Useless? The Crucial Contribution of Finance to Economic Life (February 28, 2018). Institute of Economic Affairs Discussion Paper No. 87, Available at SSRN: https://ssrn.com/abstract=3853681 or http://dx.doi.org/10.2139/ssrn.3853681

Philip Booth

City University London - The Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Diego Zuluaga (Contact Author)

Institute of Economic Affairs (IEA) ( email )

2 Lord North Street, Westminster
London, SW1P 3LB
United Kingdom

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
27
Abstract Views
259
PlumX Metrics