November 9, 2018 / 12:39 PM / in 8 days

Breakingviews - Review: Why too much banking can hurt

SINGAPORE (Reuters Breakingviews) - 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.

A city worker walks through the City of London with St. Andrew Undershaft church surrounded by business skyscrapers, December 16, 2014. REUTERS/Toby Melville

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. 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 percent 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.

Shaxson, whose last book was about tax havens, has been developing this idea for some time, and he 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 outsized industry. Nobody complains about the “entertainment curse” in Los Angeles, even though the majority of Hollywood’s earnings flow into the pockets of a handful of producers, agents and stars.

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 have 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 pounds ($5.9 trillion) over 20 years, cited by 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 pounds.

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. Shaxson argues against tax havens and monopolies and proposes “smart capital controls” which would control cash coming in and cut down on damaging tax loopholes.

It might have been more helpful for him to return to the original comparison with the minerals sector and spend more time examining ways to strengthen institutions. These help explain why Norway has managed to build a diversified economy on the back of oil wealth, while Angola is a poster child for the dangers of the resource curse. In finance, robust regulation can counteract financial behemoths.

A second factor is transparency. Global steps like the Extractive Industries Transparency Initiative have encouraged the oil and mining industries to provide a clearer view of the revenue they generated, taxes paid and collected, and social investments made. For countries with big banks, sunlight might also be an effective way to tackle the scourge of big finance.

Breakingviews

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