In January last year the Bank for International Settlements (BIS) published a short paper entitled “Reassessing the impact of finance on growth”. Few people noticed it, which was surprising because its conclusions, at odds with decades of mainstream thinking about finance, were remarkable. “Beyond a certain point, financial development is bad for an economy", wrote Stephen Cecchetti, a co-author. “Instead of supplying the oxygen that the real economy needs for healthy growth, it sucks the air out of the system and starts to slowly suffocate it.” Britain, the United States and many other countries, the report noted, “passed this point long ago.” A subsequent IMF report entitled “Too Much Finance?”, and several other new papers, make similar points.
Evidence is now piling up to support an idea that many people know intuitively. Your country needs finance, of course: the essential plumbing of any economy. But once that financial centre in your neighbourhood grows above a certain size, it is likely to turn bad.
I spent 14 years researching the so-called “Resource Curse” in African countries where oil windfalls didn’t seem to have contributed meaningfully to national development - and in some cases seem to have made matters worse. It’s hard to find good evidence that the hundreds of billions of dollars earned by Angola or Nigeria have benefited ordinary citizens. Life expectancy at birth, poverty rates, economic inequality, authoritarianism, conflict - not to mention long-term economic growth - seem at least as bad as with their resource-poor peers.
Later I began studying tax havens and financial centres in rich countries, and was astonished to encounter a similar phenomenon. For all the trillions sluicing into and through Wall Street and the City of London, the U.S. and Britain perform worse on major human development indicators - inequality, infant mortality, life expectancy, and more - than nearly every other OECD (Organisation for Economic Co-operation and Development) country. Each ailment has many explanations, of course, but it turns out that oversized finance is a key factor. And many of the underlying causes look alike, too.
Here are two simple examples:
First, in both oil-rich countries and in finance-rich ones, the dominant sector acts like a giant talent-sucking sponge: its super-charged salaries draw the best educated and brightest people out of the non-oil private sector, out of civil society, and out of government, wreaking incalculable damage. As the BIS study put it: “Finance literally bids rocket scientists away from the satellite industry. Erstwhile scientists, people who in another age dreamt of curing cancer or flying to Mars, today dream of becoming hedge fund managers.”
A second example where natural resource sectors resemble oversized financial industries is that their earnings come substantially in the form of what economists call unproductive economic “rents”. As the Polish writer Ryszard Kapuscinski poetically put it: “Oil is above all a great temptation. It is the temptation of ease, wealth, strength, fortune, power. It is a filthy, foul-smelling liquid that squirts obligingly into the air and falls back to earth as a rustling shower of money. Oil creates the illusion of a completely changed life, life without work, life for free. Oil is a resource that anaesthetises thought, blurs vision, corrupts. Oil is a fairy tale and, like every fairy tale, it is a bit of a lie. It does not replace thinking or wisdom.”
Wall Street and the City of London are riddled with rent extraction, from unproductive high-frequency trading, to fee extraction for “leveraged beta”, to their ability to manipulate interest rates, to the handling of capital inflows attracted by financial secrecy, to generally lax financial regulation. “The UK’s laxity, however chaotic and crude, is the way it earns its living,” writes Janan Ganesh in the Financial Times. “This is not a country able to trade on world-beating productivity or infrastructure.”
Finance-dependent economies, as with oil-rich ones, become generally more flaccid and less entrepreneurial. Policy-makers lose interest in “difficult” challenges such as encouraging local industry, as they turn their attentions to the shiny, high-tech, lucrative dominant sector. Easy tax breaks replace good industrial policies and improved education. None of this replaces thinking or wisdom.
Oversized financial sectors also “capture” the economies and the political systems of finance-dependent countries, crowding out alternative sectors. The political “capture” is particularly strong in small financial centres and tax havens, where I have seen it veer towards authoritarianism.
This is a global phenomenon that goes far beyond, and is much older than, the damage caused by the recent financial and economic crisis. In fact, the damage is so extensive, so wide-ranging, and so similar in so many finance-dependent countries, that it is time to give the phenomenon a name: The Finance Curse. This is the title of a short e-book I’ve just published, co-authored with John Christensen, who now runs the Tax Justice Network, a group that focuses on financial centres and tax havens.
British journalist and author Nicholas Shaxson has written extensively about African oil, tax havens and offshore banking. His recently published book The Finance Curse is available as a free pdf or on Kindle.