Andrew Haldane: What Is the Contribution of the Financial Sector?

While few would argue that the financial crisis has not brought the real economy down with it, there is considerably less clarity about what the positive contribution of the financial sector is during normal times. This lead commentary in the current Vox debate on the issue focuses on the value-added of risk and government subsidies in national accounting.

This article written by Andrew G Haldane – Executive Director, Financial Stability, Bank of England and Vasileios Madouro – Economist in the Financial Stability directorate of the Bank of England is well worth reading whole. Here is a short extract:

[T]his much is clear: Starved of the services of the financial sector, the real economy cannot recuperate quickly. But that does not answer the question of what positive contribution finance makes in normal, non-recessionary states. This is an altogether murkier picture. Even in concept, there is little clarity about the services that banks provide to customers, much less whether statisticians are correctly measuring those services. As currently measured, however, it seems likely that the value of financial intermediation services is significantly overstated in the national accounts…

We now know that the risk being taken by banks was not in fact borne by them, fully or potentially even partially. Instead it has been borne by society. That is why GDP today lies below its pre-crisis level. And it is why government balance sheets, relative to GDP, are set to double as a result of the crisis in many countries.

But if banking risks are not borne by banks, they will not be priced by banks, or investors in banks, either. The implicit support of the taxpayer and society will show up as an explicit profits bonus to the financial system. Lower risk means lower funding costs, which in turn means fatter banking profits. If there are expectations that the government cavalry always stands at the ready, excess returns will be harvested both pre and post-crisis.

Elsewhere, we have sought to estimate those implicit subsidies to banking arising from its too big-to-fail status. For the largest 25 or so global banks, the average annual subsidy between 2007-2010 was hundreds of billions of dollars; on some estimates it was over $1 trillion (Haldane 2011). This compares with average annual profitability of the largest global banks of about $170 billion per annum in the five years ahead of the crisis.

Government subsidies – whether implicit or explicit – cannot be said to have added to economic well-being in aggregate. At best, they are a sectoral re-distribution of resources from the general taxpayer to the banks.

If raising taxes or lowering government revenues has deadweight welfare costs, this transfer is actually welfare-reducing.

That effect, too, is completely missed by existing statistical measures of the contribution of the financial sector.

If risk-making were a value-adding activity, Russian roulette players would contribute disproportionately to global welfare. And if government subsidies were the route to improved well-being, today’s growth problems could be solved at a stroke. Typically, this is not the way societies keep score. But it was those very misconceptions which caused the measured contribution of the financial sector to be over-estimated ahead of the crisis.

Read the whole article here.