Tuesday, 1 October 2013

Is there a 'Finance curse' similar to the 'Resource curse'?

Yes, according to this well produced booklet which, however, signally fails to address the elephant in the room- in this context, the fact that things like petrol are nothing like financial services because
1) optimal depletion theory has no relevance to services. You can't 'just leave it in the ground'. Either you develop it or you condemn yourself to importing it or doing without it- in which case the rest of the economy suffers.
2) Commodities are not like services. The former but not the latter are inelastic in supply and demand, subject to random shocks,  and arise from natural as opposed to acquired or comparative advantage. They can't be geographically relocated. A British manufacturer can shift operations to China, Nigerian oil can only be got from Nigeria. Price volatility is going to be greater in Commodities because of random supply shocks including technological ones e.g. fracking. Demand, too, may collapse because of a change in technology.
Finance is much more plastic and sees profit volatility arising from cyclical processes which are not random- thus there should be and has been till recently 'a great moderation' in this respect- i.e. by its nature Financial volatility can be tamed whereas commodities are always going to be risky.
3) Physical control of a resource rich piece of ground permits the capture of the economic rent. True, unless the infrastructure is maintained, that economic rent diminishes, still it potentially exists and so the cost of rent contestation is going to be high. In practice this means a higher recurring cost of securing possession. In the case of Finance, the ability to implement Capital controls is crucial in order to capture Economic rent. That can't be done just by 'boots on the ground' or 'occupy Wall street'. Indeed, the rent to Finance disappears if one adopts the sort of  dirigiste regime in which Capital Controls become optimal. India and Pakistan went in for Bank nationalization. Did they capture any rents? No. The rents disappeared along with dynamism in the economy. The Seventies were a wasted decade Economically for both countries. 
The authors fail to show that the Resource Curse is a good analogy for what is wrong with Finance through no fault of their own. The thing can't be done.
Their arguments about Finance also misfire because of their reliance on arguments from crowding out and rent seeking theory.
Crowding out arguments fail because
1) Jobs in finance aren't a perfect substitute for other vocations. I want to teach kids. I can't do that in Finance. Yes, some 'rocket scientists' get jobs in Finance. They were second rate to start with. An Einstein or Von Neumann doesn't go into Finance. He may do a spot of consultancy, but that's the end of it. Finance is as boring as shit. Everybody knows this. Better a second-rater goes into Banking than the local Bureaucracy.
2) Financial services may MISALLOCATE resources, e.g. investing too little in domestic manufacturing and too much in colonial plantations- but that isn't crowding out. Competition within the Financial sector ought to redress the misallocation, if it doesn't that's MARKET FAILURE not Crowding out.
3) Financial Services have a preference for high density geographical concentration- they don't physically crowd out more productive activities e.g. manufacturing or mining or agriculture. It is ridiculous to suggest it. Wealth generated by Financial Services may lead to higher house prices, fancy restaurants etc and that can feel like crowding out, but any type of Wealth is going to do the same thing. It is isn't a Finance specific problem.

Now for the author's arguments from rent-seeking. They themselves admit that Finance prefers countries with good Law and Order and a fiscally responsible Govt. If we are likely to elect a Chavez like nut-job determined to squeeze Finance, nothing will be there for him to squeeze except his own cronies' rent.
The problem with the author's thesis is that we already have
1) an independent Judiciary perfectly willing to send not just financial criminals but also corrupt politicians to jail. 
2) a parliamentary democracy whereby we can kick out corrupt or stupid politicians
3) a regulatory mechanism which could, and in my view should, ensure that, absent quality innovation, oligopolistic Finance takes a declining share of National Income.

In conclusion, though this is a well-written booklet and my sympathies are entirely on the side of the authors, still the arguments presented are silly. As for their policy recommendations- they are a catastrophe waiting to happen- stupid stuff like Govt. intervention to equalize factor returns across industries.

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