Bankers: Who Needs Them?

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Would the world be a happier place if we just got rid of all the bankers? Well, no. The financial sector, for all of its foibles, is as necessary for the economy as blood is for our bodies: it facilitates trade, allocates capital, and takes care of all sorts of nuts-and-bolts economic activities that make it possible for economies to not only survive but grow and flourish.

The more interesting questions are: do we really need to have so many bankers, and pay them as much as we do? Do we really need to have such a massive amount of money sloshing around in our financial system? The answer to these questions is also, most likely, no.

Back in the 1950s, an era of economic growth and prosperity, the financial sector accounted for only 3 percent of our Gross Domestic Product; these days, it eats up more than 8 percent of our GDP, and as you may have noticed our economy is a mess.

As economist James Tobin once observed,

“We are throwing more and more of our resources, including the cream of our youth, into financial activities remote from the production of goods and services, into activities that generate high private rewards disproportionate to their social productivity.”

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A new working paper prepared by three economists for the International Monetary Fund asks bluntly if we’ve got  “Too Much Finance?” That is, would we do better, economically speaking, if we reduced the size of our financial sector?  According to their study, the answer is yes. While countries with relatively small financial sectors tend to do better when they put more of their resources into finance, that equation reverses once the size of the financial sector reaches a certain threshold – one that the United States has definitely passed.

As UN economist Ugo Panizza, one of the authors of the study, explains:

“Our findings show that there can be “too much” finance. While [opponents of regulation like Alan] Greenspan argued that less credit may hurt our future standard of living, our results indicate that, in countries with very large financial sectors, regulatory policies that reduce the size of the financial sector may have a positive effect on economic growth.”

But what about the question of pay? Even if we reduce the size of the financial sector, finance is complicated stuff. Don’t we need to pay a premium in order to make sure that the people running the system are smart enough to handle it?

Thomas Philippon of NYU’s Stern School of Business has looked into that question. While agreeing that better pay means smarter bankers, he notes that it’s still possible to overpay for these sorts of skills, and that’s exactly what we’re doing. As he figures it, the “compensation of employees in the financial industry appears to be too high to be consistent with a sustainable labour-market equilibrium” and that in recent years bankers have been paid anywhere from 30 to 50 percent more than they’re worth. At pay levels like this, bankers aren’t adding value to the economy; they’re extracting a “rent” paid for by the rest of us.

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Not everyone agrees with this analysis. In his book Finance and the Good Society, which came out this spring, economist Robert Shiller sets forth a defense of sorts for our much-criticized financial sector. But in his zeal to remind us all of the good and necessary functions the financial sector serves, he ends up offering an unbalanced paean to finance. As he figures it, the best way to improve our financial sector isn’t to “restrain financial innovation but instead to release it. … better financial instruments, not less activity in finance, is what we need to reduce the probability of financial crises in the future.”

Really? The financial instruments that contributed to the craziness of the past several years were designed by some very clever, and very well-compensated people. It’s hard to imagine that “unleashing” more such “innovation” is going to make the world a better or more prosperous place – except for those in our financial sector — who get paid very, very well when things go well but are almost never punished when things go very, very badly.

The genius of capitalism is that, at its best, it aligns self-interest with the interests of society large. In finance, that equation seems to have broken down. If we can’t realign these interests, our financial sector will keep costing us more than it’s worth.

11 comments
baldskits
baldskits

All the world's major economies use fiat currencies. In a fiat currency system money is created by the issuance of debt by banks. The debt is paid back with interest. Why can't banks be part of the commons and all the interest money earned be used for useful things like infrastructure and education? There is a state bank in operation in North Dakota which is owned by the people. Why can't this be a national model? We do not need Wall street banks if the banks are owned by all of the people.

Oliver Crangle
Oliver Crangle

It's really difficult to take anything David Futrelle says seriously.

If you read his own personal blog at Manboobz for any length of time and run down his character assassinations and slurs there you can quickly determine he is an agenda driven hack, and does not bind himself with the niceties of journalistic ethics or intellectual honesty.

If he is not honest at his own blog, and provably dishonest and distortive, why should we think he is better behaved or acts more ethically and honestly here? I sure don't.

When you publish articles like this from reporters like that, it's just one more straw.

Chhajuram Induscharwak
Chhajuram Induscharwak

finance and banking are as medium needs more amp; more expansion but must be proper regulated.Both the version above are not comprehensive. 

Britain Loans
Britain Loans

As  someone who used to work in banking amp; still has the odd contact there, my frustration with banks now is that they do not actually allow their staff to take responsibility for decisions (computers are so much better I hear) and so we cannot be surprised when in fact their employees do not take responsibility. The reality is that so many skills are being lost in banking because they are no longer valued.

Rick Fitzgerald
Rick Fitzgerald

What would Joe say?

The banking system has been subsidized for years and propped up when things go badly so they have little consequences for their actions. Shareholders have no power or desire to limit pay. Congress coffers are flush with millions of dollars in bank money and have no will to change anything. Yes we need bankers to fully expand economies but we don't need them dictating to us our monetary policies or how we create our own currency.

Jim Dandy
Jim Dandy

We now live in an age where the least productive (in terms of goods and services) members of society are the most highly rewarded.  The people who grow our food, manufacture and distribute goods, teach our children, police our streets, defend our freedoms, and heal the sick are the least financially rewarded members of society. We need to figure out what our priorities are.

worth_every_cent
worth_every_cent

This is an often repeated criticism, and the truth is these so called least productive members make order out of chaos. Without them, Imagine that the productive people have no monetary system and no coinage, imagine you can only barter with those you personally trust.

All the public good that society members enjoy, security, mobility, opportunity, result from the fact that commerce can be conducted in bulk, at great distance, between perfect strangers. That's why you  are paying the "bloodsuckers" for their services. You can justifiably say they are over-paid, but please don't label them least productive.

Jim Dandy
Jim Dandy

 Then why are we living in the least financially secure times? The thrust of the article was the huge number of bankers, yet the system is less stable than it's been since the second world war. That state of affairs doesn't sound to me like it meets the definition of productive.