VoxEU has commenced a worthy debate on whether we need a financial sector in the first place. Two recent briefings in VoxEU website document the inefficiency and the economic uselessness of much of the activities in the financial sector.

Thomas Philippon shows that the introduction of information technology (IT) and productivity improvements led to a declining share of retail and wholesale trade in GDP whereas in the case of finance, the share of finance in GDP rose along with IT investment in the sector. It is not as though the sector found ways to contribute to economic activity. It was because financial market trading activity exploded. Since when? The Eighties, of course! Has increased trading led to better price-discovery or risk-sharing? The evidence – in terms of the number of bubbles and crises – provides its own conclusive evidence. The verdict is in even before the trial commences.

Andrew Haldane, in another paper, as part of the same debate, says that the value-added of the financial sector is measured through the compensation paid to the sector for financial risk-transfer activities. Second, compensation in the sector was tied to risk-taking. Risk transfer does not lead to economic growth. But, risk management does. How good a job has the financial sector done in risk management? Again, we know the evidence. Three years after the crisis caused, in large measure, due to the inability of financial institutions to understand (let alone manage) risk that they had created, UBS reported another couple of billions of dollars of loss in financial trading activity. Not only does the financial sector not add to economic activity or welfare through its risk-transfer or risk-bearing activities, but it reduces welfare and dampens activity when it imposes the losses of its risk-taking on the rest of the society.


DISCLAIMER: This is an archived post from the Indian National Interest blogroll. Views expressed are those of the blogger's and do not represent The Takshashila Institution’s view.