Does The Financial Sector Pollute?
I liked this point by Financial Times columnist Martin Wolf:
A market works well if, and only if, decision-makers confront the consequences of their decisions. This is not – and probably cannot be – the case in finance: certainly, people now sit on fortunes earned in activities that have led to unprecedented rescues and the worst recession since the 1930s. Given this, the industry has become too big. If implicit and explicit guarantees and externalities, including volatility, were fully charged, the sector would surely shrink.
A number of commentators with the same insight have argued that better regulation is required. That's not Wolf's solution. Rather, he argues that this problem is intrinsic to finance. It will not go away. You cannot grow regulators so wise that they scrutinize it away. You cannot craft regulations so elegant that they rule it out of existence.
The financial sector, he says, must simply be smaller. How do you manage an inherently problematic sector? he asks. "The answer is: in the same way as any polluting activity. One taxes it." This is usefully radical: The climate change activists propose to tax coal power plants, they're not doing it so coal power plants become a bit cleaner. They're doing it so we have fewer of the plants.
I'm pretty much in agreement with this point, and I'll just add a graph I rather like. This was drawn up by Adam S. Posen and Marc Hinterschweiger and it tracks the rise of derivatives against the rise in actual capital. The basic takeaway: Fake money grew a lot faster than real money.
And as Wolf says, the people who gave us that rapid rise in fake money still, in general, have their fortunes. Or at the least, they have a lot more money than the people who became teachers and didn't blow up the world economy. The problem is that if you want less "bad" finance, you can't go in after the fact and separate the good from the bad. You have to have less finance in general. You have to stop the bad before it happens.
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