Some economic activity makes the world better, some is a cost of making the world better, and some actually makes the world worse. Where does the business of finance – lending, borrowing and securities trading – fit in? Mark Carney, the new governor of the Bank of England, recently said: “a vibrant financial sector brings substantial benefits.” The implication is that more finance is a good thing, as long as it is safe. That is simply wrong.
True, empirical studies show that financial activity increases along with incomes in poor countries. But this correlation has little bearing on developed economies with mature financial systems. In these countries, additional financial activity unquestionably adds to GDP, but the same can be said for the substitution of expensive medical care for cheap preventative action. The question is whether additional finance promotes overall economic good.
It can do so, but not directly. Finance is a cost. It is a means not an end, an input not an output. People and companies should engage in financial activity only to help them do other things – most notably to preserve or increase wealth, to coordinate expenditure with incomes and to help organise real investments, production and distribution.
Unnecessary financial activity is a wasted expense. Even if the excess does not directly cause problems – such as housing bubbles or fiscal crises – it makes the world worse because it wastes economic resources. The right goal for the financial system is to be as small as possible without doing economic harm.
By that standard, the current system is extremely wasteful. The waste can be seen in both the quantity of financial assets and pace of the financial activity. One measure of quantity is the ratio of debt to GDP. For the United States, which probably leads the world in financial excess, the calculation is aided by the U.S. Federal Reserve, which every quarter tots up all the outstanding debts, from government borrowing to bank loans. Total debts were 144 percent of GDP in 1975. In the most recent quarter, they were 263 percent.