Rent-seeking in the financial sector

24 september, 2013 kl. 17:33 | Publicerat i Economics | 2 kommentarer

Are too many of our most talented people choosing careers in finance – and, more specifically, in trading, speculating, and other allegedly “unproductive” activities? …

rent3According to a study by Thomas Philippon and Ariell Reshef, much of the increase in financial activity has taken place in the more speculative fields, at the expense of traditional finance. From 1950 to 2006, credit intermediation (lending, including traditional banking) declined relative to “other finance” (including securities, commodities, venture capital, private equity, hedge funds, trusts, and other investment activities like investment banking). Moreover, wages in “other finance” skyrocketed relative to those in credit intermediation.

We surely need some people in trading and speculation. But how do we know whether we have too many?

To some people, the question is a moral one. Trading against others is regarded as an inherently selfish pursuit, even if it might have indirect societal benefits. But, as economists like to point out, traders and speculators provide a useful service. They sort through information about businesses and (at least some of the time) try to judge their real worth. They are thus helping to allocate society’s resources to the best uses – that is, to the most promising businesses.

But these people’s activities also impose costs on the rest of us. Indeed, a 2011 paper by Patrick Bolton, Tano Santos, and José Scheinkman argues that a significant amount of speculation and deal-making is pure rent-seeking. In other words, it is wasteful activity that achieves nothing more than enabling the collection of rents on items that might otherwise be free …

Those in “other finance” often engage in similar behavior. They skim the best business deals, creating a “negative externality” on those who are not party to them. If the bad assets that they reject – for example, the subprime mortgage securities that fueled the 2008 financial crisis – are created anyway and foisted on less knowledgeable investors, financiers contribute no more to society than a lord who installs a chain across a river …

Bolton and his colleagues seem to be right in many respects, though economic research has not yet permitted us to estimate the value to society of so many of our best and brightest making their careers in the currently popular kinds of “other finance.” Speculative activities have plusses and minuses, much that is good and some that is bad, and these are very difficult to quantify. We need to be very careful about regulations that impinge on such activities, but we should not shy away from making regulations once we have clarity.

Robert Shiller

2 kommentarer

  1. Pure rent-seeking seems desirable, compared with activity that makes a modest profit at the expense of creating huge risks for others.

  2. The rise of the financial sector poses the question as to why, as their claimed role in society is the efficient allocation of capital, have we not seen a proportionate rise in the overall economy? From ”Is the Financial Sector Worth What We Pay It? at
    http://somewhatlogically.com/?p=730

    ”In a 2006 speech on the growing integration of the financial sector and the broader economy, Rodrigo deRato, Managing Director of the IMF, noted its supposed general stability and growth, and that from 1990-2005 the estimated sum of equity-market capitalization, outstanding total bond issues (sovereign and corporate) and global bank assets rose from 81% to 137% of GDP, while over-the-counter derivatives markets tripled in the latter five years to $285 trillion, six times global GDP, 50 times the U.S. public debt. So if the financial sector has worked, we should see proportional acceleration of growth plus improved consequences for all society.”

    And, discussing the huge amount of offshore capital sloshing back and forth, ”Keynes may have lost the 1944 Bretton Woods battle for a solution that transcended national financial self-interest but his plans for an international clearing agency are prophetic, especially considering how the combined financial sector dominates national and international policy for its own ends “ As Keynes said, “… no country can . . . safely allow the flight of funds for political reasons or to evade domestic taxation or in anticipation of the owner turning refugee. Equally, there is no country that can safely receive fugitive funds, which constitute an unwanted import of capital, yet cannot safely be used for fixed investment.” Right again, Lord Maynard.”

    JRHulls


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