Finance Curse: why a ‘competitive’ financial sector means lower growth

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One of the core insights driving the Fools’ Gold project is this: national ‘competitiveness’ is a confused and dangerous term to use when talking about an economy. What people (politicians, especially) often seem to think is that if you support one economic sector, that will necessarily make your economy as a whole more competitive. The problem is: that ‘support’ generally has to come from somewhere else in your economy.

So a corporate tax cut, for instance, is paid for by others in the economy, via lower corporate tax revenues, which may mean reduced fewer universities and courts, and so on. A more deregulated (and hence supposedly ‘competitive’) financial sector will see taxpayers taking on risks and eventually being forced to pay for them, while bankers get the cream.

These kinds of internal transfer do not automatically enhance growth, productivity, or anything that one might call ‘competitiveness.’

Another example of the way financial sectors can harm other parts of the economy is provided by Anat Admati and Martin Hellwig:

“Banks in a country are not just competing with banks in other countries. They are also competing with industries in their own country. Most importantly, they are competing for people, particularly those with scarce talents, whom firms in other industries would also like to hire.”

So there’s a brain drain out of, say, manufacturing, and into Big Finance. It’s an age-old story.

These issues create the core of arguments used in a thesis called the Finance Curse, which Fools’ Gold authors have actively been involved in, in partnership with Duncan Wigan of the Copenhagen Business School. The Finance Curse thesis argues, basically, that too much finance is bad for an economy – and often for reasons that are similar to those behind the “Resource Curse” that afflicts mineral-rich economies.

There is plenty of research to back this up, and new evidence base is emerging all the time.


From Stephen Cecchetti, Enisse Kharroubi July 2015

As the abstract of a forthcoming paper states:

“The Global Financial Crisis placed the utility of financial services in question. The crash, great recession, wealth transfers from public to private, austerity and growing inequality cast doubt on the idea that finance is a boon to the host economy. This article systematizes these doubts to highlight the perils of an oversized financial sector.

States failing to harness natural resources for development, led to the concept of the Resource Curse. In many countries resource dependence generated slower growth, crowding out, reduced economic diversity, lost entrepreneurialism, unemployment, economic instability, inequality, conflict, rent-seeking and corruption.

The Finance Curse produces similarly effects, often for similar reasons. Beyond a point, a growing financial sector can do more harm than good. Unlike the Resource Curse, these harms transcend borders.”

Through a ‘competitiveness’ prism, we’d put it like this. Boosting your financial sector, willy-nilly, will not do anything to make your economy as a whole more ‘competitive,’ whatever that c-word may mean. It will merely transfer goodies from some sectors to the financial sector. And if your financial sector is already oversized, then that will create all sorts of other problems, including lower economic growth.

The Unconventional Economist now has a new post looking at the latest bit of research backing the Finance Curse thesis:

“More and more studies are coming to the conclusion that having a large financial sector is actually productivity destroying for an economy and slows its growth.”

It then goes on to list a series of mainstream studies from the IMF, the Bank for International Settlements (BIS) and the OECD, all showing variants of the same result. Most of these are already referenced in the Finance Curse literature. The new report it cites is from from economists Stephen Cecchetti and Enisse Kharroubi at the BIS. As they write at Vox:

“Financial booms are not, in general, growth-enhancing. And, the distributional nature of the impact is disturbing, as credit booms harm what we normally think of as the engines for growth – those industries that have either lower asset tangibility or high research and development intensity. This evidence, together with recent experience during the financial crisis, leads us to conclude that there is a pressing need to reassess the relationship of finance and real growth in modern economic systems.”

They have their own theories about why this might be: the Finance Curse thesis lays out a far broader range of reasons why oversized finance might be harmful. For instance, increased ‘financialisation’ shifts company directors’ attention away from what they do best — creating the best goods and services and so on at the best price — towards seeking out new ways to free-ride off society: tax subsidies, too big to fail taxpayer subsidies, and so on. And there are a raft of other reasons outlined.

Andrew Baker adds, at SPERI:

“In a previous SPERI blog post, I lamented the complete absence of a co-ordinating discourse or grand political narrative about the financial crash of 2008.  Instead, we have seen isolated and disjointed technical changes in policy thinking in relation to: global imbalances, tax and macroprudential regulation (MPR).  In this contribution I address a question raised in that previous piece: what kind of common framework of thought, explanation and narrative could effectively link these seemingly disparate areas of change?

The most plausible contender for such a new grand narrative is the concept of a ‘finance curse’.”

We think so too. More on this large subject in due course.



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