Howard Davies On The Banks That Ate The Economy

Tyler Durden's picture

Authored by Howard Davies, originally posted at Project Syndicate,

Bank of England Governor Mark Carney surprised his audience at a conference late last year by speculating that banking assets in London could grow to more than nine times Britain’s GDP by 2050. His forecast represented a simple extrapolation of two trends: continued financial deepening worldwide (that is, faster growth of financial assets than of the real economy), and London’s maintenance of its share of the global financial business.

These may be reasonable assumptions, but the estimate was deeply unsettling to many. Hosting a huge financial center, with outsize domestic banks, can be costly to taxpayers. In Iceland and Ireland, banks outgrew their governments’ ability to support them when needed. The result was disastrous.

Quite apart from the potential bailout costs, some argue that financial hypertrophy harms the real economy by syphoning off talent and resources that could better be deployed elsewhere. But Carney argues that, on the contrary, the rest of the British economy benefits from having a global financial center in its midst. “Being at the heart of the global financial system,” he said, “broadens the investment opportunities for the institutions that look after British savings, and reinforces the ability of UK manufacturing and creative industries to compete globally.”

That is certainly the assumption on which the London market has been built and the line that successive governments have peddled. But it is coming under fire.

Andy Haldane, one of the lieutenants Carney inherited at the BoE, has questioned the financial sector’s economic contribution, pointing to “its ability to both invigorate and incapacitate large parts of the non-financial economy.” He argues (in a speech revealingly entitled “The Contribution of the Financial Sector: Miracle or Mirage?”) that the financial sector’s reported contribution to GDP has been significantly overrated.

Two recent papers raise further doubts. In “The Growth of Modern Finance,” Robin Greenwood and David Scharfstein of Harvard Business School show that the share of finance in US GDP almost doubled between 1980 and 2006, just before the onset of the financial crisis, from 4.9% to 8.3%. The two main factors driving that increase were the expansion of credit and the rapid rise in resources devoted to asset management (associated, not coincidentally, with the exponential growth in financial-sector incomes).

Greenwood and Scharfstein argue that increased financialization was a mixed blessing. There may have been more savings opportunities for households and more diverse funding sources for firms, but the added value of asset-management activity was illusory. Much of it involved costly churning of portfolios, while increased leverage implied fragility for the financial system as a whole and imposed severe social costs as over-exposed households subsequently went bankrupt.

Stephen G. Cecchetti and Enisse Kharroubi of the Bank for International Settlements – the central banks’ central bank – go further. They argue that rapid financial-sector growth reduces productivity growth in other sectors. Using a sample of 20 developed countries, they find a negative correlation between the financial sector’s share of GDP and the health of the real economy.

The reasons for this relationship are not easy to establish definitively, and the authors’ conclusions are controversial. But it is clear that financial firms compete with others for resources, and especially for skilled labor. Physicists or engineers with doctorates can choose to develop complex mathematical models of market movements for investment banks or hedge funds, where they are known colloquially as “rocket scientists.” Or they could use their talents to design, say, real rockets.

Cecchetti and Kharroubi find evidence that it is indeed research-intensive firms that suffer most when finance is booming. These companies find it harder to recruit skilled graduates when financial firms can pay higher salaries. And we are not just talking about the so-called “quants.” In the years before the 2008 financial crisis, more than a third of Harvard MBAs, and a similar proportion of graduates of the London School of Economics, went to work for financial firms. (Some might cynically say that keeping MBAs and economists out of real businesses is a blessing, but I doubt that that is really true.)

The authors find another intriguing effect, too. Periods of rapid growth in lending are often associated with construction booms, partly because real-estate assets are relatively easy to post as collateral for loans. But the rate of productivity growth in construction is low, and the value of many credit-fueled projects subsequently turns out to be low or negative.

So, should Britons look forward with enthusiasm to the future sketched by Carney? Aspiring derivatives traders certainly will be more confident of their career prospects. And other parts of the economy that provide services to the financial sector – Porsche dealers and strip clubs, for example – will be similarly encouraged.

But if finance continues to take a disproportionate number of the best and the brightest, there could be little British manufacturing left by 2050, and even fewer hi-tech firms than today. Anyone concerned about economic imbalances, and about excessive reliance on a volatile financial sector, will certainly hope that this aspect of the BoE’s “forward guidance” proves as unreliable as its forecasts of unemployment have been.

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Flying Wombat's picture

How's this for a treasure hunter's dream and stacker's nightmare. Ha! Take care with your stash.  Something to think about when getting out of the banking system.  Pick your trees wisely! -- Eric


"Couple Discovers $10M In Gold Coins In Rusty Can"

HedgeAccordingly's picture

 CEO of Carlyle Group Rubenstein: I Didn’t Even Know What WhatsApp Is

kaiserhoff's picture

Well, all this worked out just great for Ireland, Iceland, Cyprus, Greece, Spain, Italy, Argentina, what's the problem?


HyBrasilian's picture

Oranje JUICE ratting on other Oranje JUICE [in a 'divine' effort' to bring TRUTH to the FREE WORLD]!


What a NOBLE concept [especially at THIS stage of the game]...

GOLF clap [to these HEROES][!...

RaceToTheBottom's picture

Iceland did it right.

The role of the Bankster SHOULD BE to be thrown under the bus of their own making.

In every other case in the world the Banksters threw the taxpayer under the bus.  And you can bet the Banksters are gunning for Iceland.

Banksters belong under the bus

DetectiveStern's picture

Sigh I try explaining this to people and they look at me like I have small pox.

NoDebt's picture

All you damned terrorists look the same to me.

ZH Snob's picture

yes, we just love being the bloody brains of the banking cabal.  we say jump and wall st asks, how high?

Flying Wombat's picture

Financialization and hyper-leverage of the paper pushing econony has limitations.  Most on ZeroHedge understand this.  How can people like Carney not understand this?  I guess they speak from where they sit.

BobPaulson's picture

Hate to say it, but Marx predicted this quite accurately.

Mad_max's picture

Marx predicited sh*t all. That idiot's "Labour power" theory was so retarded it hurts. Eugen Bohm Von Bawerk ripped him a new one.

As for Capitalism being a symptom of bourgeoisie dictatorship? give me a break. He confused the symptoms of human criminality and exploitation as being the symptoms of an economic system.

Socialism is bourgeoisie dictatorship. Literaly. What we have is the result of socialism, not Capitalism.

Flying Wombat's picture

It's more corpratisim, not socialism.  But in truth, the American economy for example is somewhat of a hybrid.

NoDebt's picture

"Physicists or engineers with doctorates can choose to develop complex mathematical models of market movements for investment banks or hedge funds, where they are known colloquially as “rocket scientists.” Or they could use their talents to design, say, real rockets."

OK, maybe not the best analogy to make your point around here.

akarc's picture

They also left out the number of lawyers the bankers must be hiring

Flakmeister's picture

I worked with a guy that had Dip.Eng. in nuclear engineering. Post 3 mile island there were no jobs, so he went into finance. Ended up making anywhere from 1,000,000 to 2,000,000 depending on the year hawking CDS insurance on MBS....

The guy might have been the most reptilian sociapath I have ever met. Admittedly not dishonest, but he knew how the milk the system and exacly who it was being milked for...

He has been laughing all the way to the bank....

Yeah, maybe not rockets but real infrastructure funded by the 5% of GDP that became the new vig that the financial services industry skimed....

smacker's picture

"...some argue that financial hypertrophy harms the real economy by syphoning off talent and resources that could better be deployed elsewhere."


One cannot argue with this theoretically. But in practice it's unlikely because most of the City Slickers are unemployable anywhere else. Street-market traders - selling rotten fruit and veg - might be an alternative employment option for some.

If a person's value to society is judged by the tangible output of his labour, these people produce nothing.

RaceToTheBottom's picture

Engineers build products.  Computer scientists build computer products. Project managers manage technology projects. 

While there is a difference between a bridge builder and a software engineer, there are HUGE similarities between other technology jobs.

Sucking resources from one area to another does cause an effect.  There is transference. 

But it may have even lead to more H1Bs in the US as competition for scarce engineering skills would have lead to escalating engineering salaries, thus the increases in H1Bs forcing engineering salaries down....

So FUCK yes, there is transference.

smacker's picture

Nothing is black & white and there will always be "some" transference, but equating a City Slicker skillset with (say) a computer scientist or civil engineer is being far too generous and is way off the mark IMHO.

You may find a better comparison between these groups based upon intellect and their ability to learn another profession. But that assumes City Slickers have high intellect whereas nowadays many of them are little more than Essex market-traders, ie: spivs and conmen with a sleight of hand. Not much intellect needed there.

ebworthen's picture

Going to need a lot of rope.

We've raised generations on the notion that debt is good, unsound money is sound, and that gambling at 30X leverage is good business.

It all goes back to Central Banking and "reducing volatility" and "controlling inflation" or the biggest lie "supporting employment".

Pain tells you something is wrong, scarcity says a product is needed, a glut tells you something is overproduced, and failure teaches the most valuable lessons.

In a world of no pain or signals to the brain or consequences for bad choices - failure of the system is inevitable.

It's a long slow lurch to the tar pit; let's punish the malfeasant accordingly.

Schmuck Raker's picture

Such talk...

I gather Sir Davies no longer cares to remain on The Board of Morgan Stanley?

Idleproc's picture

The capital produces value only in the production of real goods that people use.

Finance alone does not produce anything, only creates fake profits and capital.

Out of nowhere you don't create anything.


ebworthen's picture

Yes, and robs the public treasury, the labor of individuals, and the well-being of families that aren't "in the club" - and ultimately collapses the society - but the eyes can't see the tapeworm in the gut.

Oldwood's picture

And what would happen if all the talent was siphoned off to become thieves?

Miffed Microbiologist's picture

Funny thing, they walk around us with complete impunity. Their arrogance is what completely pisses me off I think my head may explode at some point. I need a microscope to diagnose a tapeworm infection. They do make an attempt to stay hidden. These fearless criminals are laughing and living like Lords. They could care less that I know this.


Oldwood's picture

Now hold on there Miffed, these are NOT criminals. They have spent a great deal of their ill-gotten gains buying politicians to have laws changed and created to make their very specific activities LEGAL. They are also making anything we could do to preserve our liberty, our freedom, our independence, illegal. We have complained about the number of people we have in prison in this country for years, and it seems they may end up being the head of the class. We will all be criminals long before the thieves you are referring to are.

Miffed Microbiologist's picture

Well put. With that I am going out to dinner, have a nice scotch and enjoy the last dwindling gasps of my freedom. I'm so tired of the futility of fighting this losing game.


RaceToTheBottom's picture

If you like a Lagavulin like smokey Scotch, I have found a nice, cheaper substitute:  Island of Geese, an Islay single malt, that really reminds me of Lagavulin....

Miffed Microbiologist's picture

I've been trying to branch out a bit. Oban and Glenlivet have been my staples. Someone recommended Laphroaig which I am itching to try. But my budget has been slashed in this area so thank you so much for a cheaper alternative!! Nothing says sensuality as a good single malt IMHO! ;-)


akarc's picture

Then maybe we should embrace the battle purely for the sake of the fight. Let those who survive say what they will:)    

Miffed Microbiologist's picture

With you all the way my friend. I am by nature a fighter though I try to remain always the lady. I am prepared to go where I need to go when necessary. Let us hope it will never come to this.


NOTaREALmerican's picture

If we didn't have the Financial Services INDUSTRREEEEE  (say that last word with a low respectful voice) how would the smart-n-savvy people screw the dumbasses? 

Oldwood's picture

There used to be a school for dumbasses. It was called life, but today they have created a faux life that has no risk, no want of money or healthcare, no risk, for if you fall, it is not your own fault but those who tripped you. We are now breeding dumbasses, lining them up like bowling pins to be knocked down on cue. And with every scraped knee is a new demand for more faux life, security enhanced, liberty. HA! We will pay anything for delusion, even giving our life to maintain it. Until we live by fool me twice, shame on me, the hucksters will be lining up behind the very people charged with "protecting" us, KY jelly in hand. They really hate the chafe.

easypoint's picture

Using a sample of 20 developed countries, they find a negative correlation between the financial sector’s share of GDP and the health of the real economy.

The reasons for this relationship are not easy to establish definitively…

A negative correlation between the amount of skimming and the health of the real economy. Imagine that.

Captain Willard's picture

The causation may run the reverse of what we all suspect.

It's quite possible that the Developed Countries turn to mass financialization after their productivity rates fall due to atrophy and excessive government and of course, loss of competitiveness in foreign trade.

AdvancingTime's picture

I have been watching with wonder as the economic news flowing from the UK has been spun to give the impression of robust growth. How do you explain the pick up in growth to a mature country that has been struggling under debt? In general the UK economy is not particularly competitive, over-weighted in the service sector and global finance it is vulnerable to problems that surface throughout the world.

As usual we must look deeper into the facts to get a clear picture of what is really happening. It now appears much of the recent strength comes from the fact that thousands of Britons are receiving compensation for Payment Protection Insurance (PPI).  Most Americans reading about the pickup in Britain's economy never even heard of the PPI. The total paid out so far, £13.3bn or about 22 billion American dollars has been a huge economic boost. Details on this massive drop of "helicopter money"in the article below,

Restcase's picture

Keiser has the best read on Carney and the financialized UK economy and its captive regulators/govt. He pounds them relentlessly on this very point. He get's a little emotional about it. "Financial terrorism," "financial holocaust," "financial genocide." Doesn't help his points but very satisfying to those who know the score.

ItsDanger's picture

Bottom line is that banks success should be relative to the base economy.  They dont produce anything but provide a service.  if they are making that much money, then they have become a total parasite and a drag to everything around them.