Socially Useless? The crucial contribution of finance to economic life

Introduction

Public animosity towards the financial sector is a longstanding phenomenon. Because finance involves the creation of intangible value, many observers have struggled to comprehend its social contribution. Furthermore, ignorance about fundamental features of the financial system, such as risk, uncertainty and the opportunity cost of money, led monotheistic religions to proscribe or severely constrain the charging of interest. This in turn fueled prejudice against people who, pushed out of other occupations and less constrained by their own creeds, dedicated themselves to finance.

We have advanced much since the times of Shakespeare’s Shylock, yet the suspicion of finance remains and is progressively stoked by financial crises. As we will show, there are important problems with the present system of financial regulation and risk management. But claims that financial activity is largely self-serving and, in the words of a prominent former financial regulator, “socially useless” are unfounded and dangerous.

The claims are unfounded because a closer look at the type and volume of financial activity in developed countries reveals that little of it is unrelated to customer needs, such as transfers of resources across time and space, risk diversification and insurance, hedging and the mitigation of uncertainty, and income smoothing across people’s lifetimes. They are dangerous because the doctrine that finance is useless beyond an arbitrary threshold may lead to crude policy measures that will restrict people’s ability to lend, borrow and insure themselves.

Furthermore, reliance on statutory regulation to address the perceived problems of finance may heighten not mitigate the exposure of taxpayers and households, especially poor ones, to adverse events such as recessions and speculative bubbles.

Authors

• Philip Booth
  Professor of Finance, Public Policy and Ethics, St. Mary’s University, Twickenham
• Diego Zuluaga
  Head of Financial Services and Tech Policy, Institute of Economic Affairs, London