Economics and the Banks

Abstract

My focus is on economics and the banks or, more generally, economics and the whole fi nancial system. And I want to do three things: fi rst, set out some facts about the rising importance of fi nance within the econ-omy; second, consider what orthodox economics said about the rising importance of fi nance before the crisis and how what it said turned out to be completely wrong; and third, discuss to what extent the profound mistakes of modern economics refl ected the autonomous development of an intellectual tradition and how far, instead, the explanations lie in power relationships. A. Turner () Institute for New Economic Th inking , New York , NY , USA Rising Financial Intensity Th ere have been several studies of the growth in the relative role of fi nance within modern economies. One by Andy Haldane 1 found that the size of the US fi nancial system grew from about 2.5 % of GDP in 1950 to 8 % of GDP in 2008. Finance got much bigger in our economies. Another important study by Philippon and Reshef asked how much fi nanciers are paid relative to people of an apparently similar skill level in the rest of the economy. 2 Th ey found that the 1920s, which saw very rapid growth in the relative importance of fi nance, also saw a large 'excess wage', and they found that that excess wage re-emerged on a very large scale after about the 1980s. Finance grew very much bigger and it was very well-paid. And we must ask whether that was good for the economy, because fi nance is dif-ferent from other sectors. If the restaurant business grew as a proportion of the economy, we would not even ask whether that was good or bad, we would simply say: 'Restaurants have grown in importance because people are choosing to spend an increasing percentage of their income on restau-rant meals.' But nobody gets up in the morning and says, 'What will I do today? I think I will buy some fi nancial services for a bit of fun.' Financial services are not forms of end consumption, but perform intermediate functions within the economy. More fi nance is good if it is making the economy more effi cient or more stable, and it is bad if it is making it ineffi cient and unstable. So, we have to work out what impact it has had. A key fi rst step is to identify which specifi c aspects of fi nance got big-ger. A fi ne study by Robin Greenwood and David Scharfstein of Harvard University helps answer that question. 3 General insurance has grown a little faster than GDP because people's houses are more expensive and they have more things to insure: but there is nothing about the growth of general or life insurance which raises prima facie concerns about stability or effi ciency, and insurance has not been a major driver of the dramatic increase in the relative importance of fi nance within our economies. 1 Haldane (2010). 2 Philippon and Reshef (2012). 3 Greenwood and Scharfstein (2013).