A target size for the banking sector?

John Rentoul

crafts A target size for the banking sector?Nick Crafts, Professor of Economic History at Warwick (right), is another of my heroes, and he also has an article in this month’s Parliamentary Brief. Here is the bit that caught my eye:

It is, of course, the banking crisis that has led many people to question the size of the financial sector. There clearly is a need for better regulation of financial services to curtail excessive risk-taking (moral hazard) and to restore financial stability. Accordingly, some activities may disappear or be downsized but this should be a consequence of a regulatory authority looking at a social cost-benefit analysis of regulation rather than of adopting a policy of a target size for the sector.

Seeking to reduce exposure to the costs of financial instability by policies that aim to change the sectoral composition of the economy is a very poor second best to better regulation. Having a financial crisis is very costly but having a large financial sector is not per se bad news. Indeed, in the British economy, this has been a sector that has outperformed manufacturing in terms of both the level and rate of growth of labour productivity.

Moreover, generally speaking, output in manufacturing is more volatile than in financial services and, sure enough, in the recent crisis, OECD countries (including Finland, Germany, Italy, Japan and Sweden) with much bigger manufacturing sectors and much smaller financial sectors than Britain were exposed to the side effects of the financial crisis and all had more severe downturns.

This crystallises something that has been bothering me. When people, especially in the Labour Party, say that the financial crisis exposed Britain’s or New Labour’s over-dependence on bankers, they all too often take the wrong lesson.

The point should be that tax revenues from the financial sector kept the country afloat. Surely, the lesson of the credit crunch is that of the urgency of getting the sector back up and running again, instead of trying to tax it back into the early Tudors.

Of course the City and Canary Wharf need to be better regulated, but we need to recognise that this is an industry in which Britain still leads the world, not a temple from which the money lenders must be cast out.

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  • Charles Barry

    A refreshingly different perspective. I like it.

  • JohnBloom

    “Tax revenues from the financial sector kept the country afloat.”

    How so? The cost of the bank bail out was in the order of £500 billion when short term loans and guarantees of interbank lending are included. It will take us a generation to restore the country to economic health.

    Banking is a support service and, except for speculative bubbles, can no more provide the core activity for a country of 60 million people than can hairdressing, taxi-driving or lap-dancing. All of these activities may be useful as adjuncts and so may lending people money. But that’s about it.

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