Finance, technology & power

What’s special about fintech as distinct from shopping-tech or anythingelse-tech? asks Francis Diebold. I read that question as I was on the phone to my Isa provider, who told me that to contribute to my Isa, they had to post me some documents which I had to post back. How very 19^th century

Which reminded me of a paper (pdf) by Thomas Philippon who points out that decades of technological progress has not reduced costs of finance to customers:

The unit cost of [financial] intermediation is about as high today as it was at the turn of the 20th century. Improvements in information technologies do not appear to have led to a significant decrease in the unit cost of intermediation.

His work has been replicated (pdf) for Europe and the UK by Guillaume Bazot.

If you look at spreads between deposit and borrowing rates, or at fund managers’ charges, it’s clear that decades of technical progress has not led to finance giving customers better value. And this is before we consider the atrocious lack of potentially useful products; various mis-selling and market-rigging scandals; terrible management; and the enormous cost of financial crises.

From a customer’s point of view, pretty much the only useful financial innovations of recent years have been the ATM and the index tracker funds. Finance seems to be a big exception to William Nordhaus's finding that producers capture only a "minuscule fraction" of the social benefits of innovation. 

History, then, tells us that the answer to Francis’ question is in the negative. In finance, technical change does not benefit customers. In the day job, I’ve suggested reasons for this such as customer inertia, distrust and barriers to entry. Fintech might instead be just another way for casino capitalism to spin its roulette wheels even faster.

This raises the question posed by J.W.Mason. If finance is so lousy at doing what the just-so stories of capitalist apologists pretend, might it not serve another function instead? Might it be instead, as he says, “the enforcement arm of the capitalist class as a whole.”

There are several ways in which the answer could be: yes.

 - High debt as a result of student loans and high house prices compel people to work harder and longer. They’re a form of modern-day debt bondage. They help maintain a high and acquiescent labour supply.

- Leveraged private equity encourages firms to sweat their assets. Private equity seems to increase productivity (pdf), but this might simply mean increased work intensity.

 - The shareholder-owned company is an efficient way for bosses to extract rents, but not so obviously a good way of increasing investment.

 - The centrality of banks to the economy has allowed them to extract a massive “too big to fail” subsidy.

On top of all this, finance helps to strengthen capitalists’ power over governments. We all know that if a government can print its own money then the only constraint upon doing so is inflation, as Frances says. But as Michal Kalecki pointed out, the belief in the myth of bond market vigilantes is very useful to capitalists:

Under a laissez-faire system the level of employment depends to a great extent on the so-called state of confidence…This gives the capitalists a powerful indirect control over government policy: everything which may shake the state of confidence must be carefully avoided because it would cause an economic crisis. But once the government learns the trick of increasing employment by its own purchases, this powerful controlling device loses its effectiveness. Hence budget deficits necessary to carry out government intervention must be regarded as perilous. The social function of the doctrine of ‘sound finance’ is to make the level of employment dependent on the state of confidence.

I’m tempted, therefore, to agree with J.W. Mason. The question is: how did this arise? There’s a danger of this looking like a conspiracy theory. I suspect instead that it’s an emergent process – the (at least partly) unintended consequence of countless decisions.

There is, though, another point here. The fact that decades of technical progress hasn’t improved the financial “services” industry tells us that in a capitalist economy technology alone does not determine outcomes. Instead, the potential offered by new technologies can be wasted by market failures and capitalist power. As Marx said, “the barriers of capitalist production are not barriers of production generally,” Techno-optimists are apt to forget this.

Comments

[acarraro]

I don't think you can reach such a sweeping conclusion from a single paper to be honest. Spreads in all financial markets have compressed significantly. You cannot argue that index funds are a great invention and then state that intermediation costs have not gone down.

IMHO the paper conclusions are questionable since the US is a world financial center and looking at the US domestic economy in isolation will produce all kinds of distortions.

I don't really believe we had any significant technological improvement in our ability to predict the future or to judge the viability of a business (which is the only technology that could affect borrowing spreads). Maybe big data will change that, but so far I don't see anything on the horizon.

Plus for someone that claims managers don't know enough to correctly manage a business, assuming that a central state could correctly identify what goods need producing seems contradictory. Given that you argued against central planning, I am not really sure I see any concrete alternative to finance. Should we just give up on collaboration and go back to villages where we can base credit on our direct knowledge of the borrower?

[Peter K.]

Well said. You find many young people on the left coming to similar reasonable conclusions. Meanwhile as capitalism fails to deliver rising livings standards or peace and prosperity, we're seeing the rise of the nationalist right which scapegoats immigrants and foreigners.

[Blissex]

«Spreads in all financial markets have compressed significantly.»

That's a funny claim considering that the amount of GDP consumed by finance has gone from 2% to 8% in many countries over the past few decades. What has a quadrupling of the percentage cost of finance bought in those decades?

* Have GDP growth rates increased significantly? Apparently they have gone down.
* Has the amount of capital quadrupled, at the very least? Well, most capital is long term, and the number of buildings and factories and equipment has certainly not quadrupled.

What has nearly trebled is the amount of debt, but then this suggests that the cost of finance is (more than) proportional to the amount of debt, that is finance takes an increasing cut out of ballooning debt, e.g. figures 1 and 2 here:

https://www.opendemocracy.net/neweconomics/the-ten-graphs-which-show-how-britain-became-a-wholly-owned-subsiduary-of-the-city-of-london-and-what-we-can-do-about-it/

Finance in 1980 cost 2% of GDP, and private debt was 60% of GDP, that is finance's cut was 3.3% of debt annually, and now finance takes 8% of GDP and private debt is 160% of GDP, that is the cut is 5% of debt (not interest, of the principal) annually.
Note: 80% of private debt is mortgages, hardly a novelty :-).

Even hedge funds grab just 2% of the principal annually...

That sounds like finance *in the aggregate* is becoming a lot less efficient over time. How comes?

[Blissex]

For a totally funny (or rather not) graph consider "Chart 2" in this BoE report on the "contribution" of the finance sector:

www.bankofengland.co.uk/publications/Documents/quarterlybulletin/qb110304.pdf

by major country and between 1998 and 2008.

Striking that "contribution" in France and Germany has barely oscillated around 4%, while in Australia, Eire, UK, USA, it has ballooned from 6-8% to 8-10%.

As we know between 1998 and 2008 and up to this day the french and german economies have been failing, because of such a dire shortage of financial services, while the anglo-american economies have been galloping ahead thanks to the massive contribution of their financial services to productivity and production across the whole economy. We need more Wongas!
:-)

[Blissex]

«consider "Chart 2" in this BoE report on the "contribution" of the finance sector:»

Here a bit enlarged for better legibility:

https://imgur.com/a/0GkrZ

[Blissex]

«while in Australia, ... it has ballooned»

Never mind the UĶ, but how is it possible that in Australia, a small remote country with a commodity based economy, financial services ended up consuming nearly 12% of GDP, a GDP already massively increased by huge demand for those commodities?

[Luis Enrique]

anybody know what disaggregated finance data looks like? i.e. % insurance, retail banking, pension management, other asset management, corporate finance etc. etc. And how much is for domestic versus export - if for instance foreigners are making more use of UK financial services, that'll inflate any ratio of finance versus domestic indicators (and certainly shouldn't be interpreted as finance 'consuming' GDP, tsk Blissex)

Also be interested in regulatory and other compliance (i.e. AML) costs. Things like "doing less money laundering" should really count as being more productive, but data won't show it.

[Blissex]

If you don't trust the City fluffers at the BoE, you might be amused to read this piece of "blogging from a marxit economist":

https://thenextrecession.wordpress.com/2014/05/07/britain-is-booming/

especially figures 17 and 11:

https://thenextrecession.files.wordpress.com/2014/05/uk-capital-formation.png
https://thenextrecession.files.wordpress.com/2014/05/financial-services.png

They shows that 1980-2012 gross capital formation has oscillated, with a definite downward trend, in the 15-20% of GDP band, but financial services have been mostly in the 6-10% (of GVA) band in 1997-2013, that is the finance sector has consumed a chunk of GDP almost half of the level of *gross* capital formation. A truly stunning achievement.

[Mietzsche]

Since you've mentioned centrality of finance, a question presents itself: is ownership of assets at this stage concentrated enought that capitalism might plausibly be described as centrally planned?

[Blissex]

«if for instance foreigners are making more use of UK financial services, that'll inflate any ratio of finance versus domestic indicators (and certainly shouldn't be interpreted as finance 'consuming' GDP, tsk Blissex)»

The numbers are easily available, and don't show the City consuming the GDP of foreigners, but overwhelmingly consuming that of patriotic englishfolk; and the percentage of UK finance *net* consumed by foreigners has not grown a lot from the times when finance consumed only 2% of GDP.

For the extreme case consider again Australia, famous for their commodity, not finance, exports, where finance has been consuming nearly 12% of GDP (finance *gross* exports from Australia are less than 0.2% of GDP).

[Marc]

One of the key reason why costs for consumers are not coming down is that costs for banks are not coming down. And in large parts this is due to regulations. If you still need to sign pieces of paper and mail them back, it is because e-signatures are not accepted in the legal system. Besides, don’t forget that costs have recently been piling up on banks with KYC, AML, suitablitily, etc. I do work in a bank, and the costs of compliance are just staggering. Maybe it is a cost worth bearing (less money laundering, terror finance, etc) but this is not a trivial cost and in this space, governments have outsourced policing to banks but banks (and therefore the consumers) have to foot the bill.

[Blissex]

«costs for banks are not coming down. And in large parts this is due to regulations. If you still need to sign pieces of paper and mail them back, it is because e-signatures are not accepted in the legal system»

That is a rather disagreeable argument because it would be valid if the the costs of finance were related to the number of transactions rather than their total amount.

Maybe the costs *to* the finance sector of their back-offices are proportional to the number of transactions, and are falling, but the costs *of* the finance sector to the rest of the economy seems proportional the amounts handled, and are rising:

* For the very large number of personal small transactions cheques and deposit slips have been replaced by online transfers and (now contactless) credit cards, making them enormously cheaper and easier.

* For the smaller number of larger transactions the cost of finance is proportional not to the number but the amount, as it turns out that the costs of finance are more than proportional to GDP (that is, finance consumes more GDP the bigger GDP is) and in particular the costs of finance seem to be proportional to the amounts of debt and to the size of payment flows.