Tight labour laws and excessive government regulation have stifled productivity in this country. But the massive growth of the financial sector is likely a factor too.

Finance get OFF me! Picture: AP

Underpinned by valuable implicit guarantees that give banks artificially cheap access to loans, banks’ size rose to unprecedented heights, drenching the economy with loans in the process. The total value of loans in Australia, about $2.1 trillion, as a fraction of national income has risen from around 80 per cent fifteen years ago to above 140 per cent today.

Government subsidies helped too. The Productivity Commission shows the finance sector receives more federal government budgetary aid than the car industry: $615 million last year.

Banks are meant to serve commerce, not undermine it, yet growth in financial services has been elbowing the real economy out of the way relentlessly since the 1980s, cheered on by regulators and governments.

International bureaucrats are finally starting to concede this might not be a good thing.

The chief economist of the world’s pre-eminent banking body, the Bank for International Settlements, recently examined 50 advanced and developing countries, including Australia, over 30 years to 2009, and concluded that credit growth reduced income growth per worker when it passed about 100 per cent of national income - far below the level it has exceeded in Australia.

The BIS economist found also that banks had become a black hole for national productivity, sucking in the most educated and talented employees, which in turn stifled innovation in other parts of the economy, especially high-end manufacturing.

International Monetary Fund research, which reached similar conclusions, pointed out: “Almost all of the countries which have been most affected by the [global financial crisis]—Iceland, the US, Ireland, the UK, Spain and Portugal—in 2006 had credit thresholds above 110 per cent.”

Large financial sectors make economies more vulnerable to devastating financial crises and direct swathes of the labour force into jobs in which the social benefits are questionable.

For instance, only about 10 per cent of the global value of derivative contracts (more than $650 trillion in December) are with non-financial firms. Much of the rest is speculation among financial firms. One of the most popular derivatives among banks is the ‘credit default swap’ whereby banks can ‘insure’ themselves against the bankruptcy of other banks, companies and governments to which they have no exposure at all.

This is akin to you buying fire insurance for someone else’s house burning down, which you cannot do for good reason.

Where once bright graduates might have been drawn to science or engineering - even journalism! - for many years now too many of them have wanted to work for banks.

The explosion of loans in Australia has also corrupted the country’s understanding of what drives prosperity. Adam Smith said the cheapness of necessities measured a nation’s wealth. Yet today we hanker for accommodation, the second most important necessity of life, to be ever more expensive. Rising house prices impoverish renters yet leave homeowners essentially no richer than before, assuming they want to live somewhere.

The need to borrow ever larger sums for what houses, which are in effect consumption goods like bread and milk, soaks up a big chunk of available loans which would otherwise have gone to businesses to invest. A little more than 10 years ago the value of loans to businesses in Australia exceeded the value of loans to homeowner-occupiers and investors. Now business loans are close to half the value of housing loans.

In the 18th and 19th centuries, economists debated which economic activities generated real wealth: agriculture, commerce or services. That debate ended in the 20th century with the triumph of the ‘national accounts’ and the mindless obsession with GDP that accompanied it. GDP assumes all incomes and expenditures are of equal value when they are clearly not.

In the wake of the LIBOR scandal in London we are hearing yet more calls for regulation of finance, yet the world simply needs less finance. Barclays Bank and possibly other giant banks had for years been quietly rigging the interest rate that underpins a big slice of global financial contracts.

Some good will come of the scandal if it bolsters doubt about the value of a bloated financial sector. Before Australian policy makers aim to grow Australia’s financial sector beyond its already massive scale, they should look closely at what that’s done to Britain, its industrial base and cohesion of British society.

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    • J.t says:

      12:33pm | 16/07/12

      Good article.

      As a libertarian and someone who thinks Austrian economics has the right ideas, I can honestly say the only way to bring down fractional reserve banking is to end the over night loans proccess through the RBA. Yes I’m talking about ending central banking. While this won’t stop fractional reserve banking, it might stop the ease at which credit is pushed around the country and world. We should also address the concept of a limited liability company.

      Something that always struck me as wierd was that risk, in actuarial terms, is always increased when there is all upside and no downside risk. Big banks have all upside, yet its managers and, directors and shareholders share no bankruptcy risk.

      Brokerages used to all be small partnerships. Stock pickers who shared in any gains or losses from their businesses. These days the modern LTD is all upside and no much downside for investors and directors.

      Those inside banks might be much less willing to take risks or use leverage if their personal fortunes are on the line.

      not sure if more regulation is what is needed. Just an Austrian shift away from cheap credit and towards more liability.

    • AdamC says:

      12:42pm | 16/07/12

      This article is about a problem that is resolving itself. The size of the finance sector globally has peaked and it is in retreat. Meanwhile, the years of easy, property market-driven expansion for the Aussie commercial banks is over. This article would have been really prescient if it were written in 2007. It is a bad history lesson today.

      We need a finance sector to do some really important things. These are:

      1) funding business investment and asset purchases;

      2) providing a means for savers to make financial investments; and

      3) managing financial risks.

      Where a finance system has expanded to do things other than these three core functions, then it may be time for governments to consider policy responses to address any policy imbalances that are causing excessive ‘finacialisation’ of the economy. However, trying to judge (how?) which types of economic activity are beneficial is just dumb. 

      Full disclosure, I am sort of tangentially involved in the financial services sector in my work, though I am not employed by a financial institution. I also have a mortgage and a credit card, both of which are products made possible by financial intermediation.

    • TimR says:

      01:00pm | 16/07/12

      Spot on. When the best and brightest minds are going into finance instead of science, you know the world has peaked.

    • Super D says:

      05:48pm | 16/07/12

      Actually it was the fall of communism and the end of the cold war fuelled technological competition that saw physicists move into finance. The thing with science is that someone needs to pay for it.  It seems these days that outside of some medical research the big payers are banks developing largely unregulated high frequency trading strategies and governments procuring climate change propaganda.  Arguably the banks will cause less damage to the lives of ordinary people!

    • ProfoundBS says:

      01:21pm | 16/07/12

      We need capitalists/conservatives/free marketeers/right-wingers running the markets, while communists should be controlling the banks. I repeat: Keep the former group AWAY from the banks. Their self-interest factor is largely what has caused the whole catastrophe - their regime of “prvatise the profits, socialise the risk”...

    • Knemon says:

      02:51pm | 16/07/12

      Interesting comment as was the article.

    • Al B says:

      05:19pm | 16/07/12

      Are you blaming the free marketeers for the catastrophe? With central banking it is not a free market so u are confusing some labels there. Id also say true capitalist is not same as corporatist. wink

      Its socialist central banking that can take much of the heat for the last century. The hyper capitalism was fuelled by all the cheap debt and inflation. Take that away the economy would run at its own pace.

      There is no gaming or cheating the money supply in the end.

      And its populist democratic vote buying that seems to benefit, no wonder its still happening ...bust after bust…

    • ProfoundBS says:

      09:03am | 17/07/12

      @Al b: The old “take that away and the economy would run at its own pace”. Is this code for saying that regulation (those meddling governments!) is the problem? If it is you should know that not even Adam Smith - the father of the ideal itself - said the market should actually be free of regulation. Rather, they should go hand in hand

    • Al B says:

      01:30pm | 17/07/12

      Uhuh great is adam smith your god or something? My understanding is he said a bunch of things over the course of his writings. I dont read enough of him to know, too busy with ludwig von mises at the moment…

      And yes it is ‘code’ for an economic libertarian position i guess smile the extent of which u take it, well depends on the interpretation.

    • ProfoundBS says:

      04:54pm | 17/07/12

      Hey Al, Smitty ain’t no god of mine! I’m more Keynesian if anything. But when it comes to the subject of free markets, yes, Smith had some sensible things to say. Problem is now all the stuff he said about balancing the free market with regulation is being ignored by free market fundamentalists

    • Al B says:

      07:08pm | 17/07/12

      Smith is a lightweight…
      These ‘fundamentalists’ as u call them are ignoring the blend of markets and intervention as they are incompatible. Stick that in your keynesian pipe and ...
      But hey keep piling on more of the same failed approach!

    • ProfoundBS says:

      10:07am | 18/07/12

      Al B, you disappoint me. I was hoping for a more robust argument than just saying Smith is a lightweight - especially after you have said previoulsly that you “don’t read enough of him to know”. You know? The only one who’s sucking anything out of a pipe around here is you my clearly fundamentalist friend

    • Al B says:

      11:08am | 18/07/12

      I wasnt out to impress u haha ...i dont waste my time reading failed ideologies!

      Austrian is where its at, ive only read others impressions of Smith so i wont comment further. They have saved me the time of going down that winding path…

    • Tubesteak says:

      01:23pm | 16/07/12

      Lot of unsubstantiated claims here and your analogy of credit defaults swaps proves you don’t know what you’re talking about.

      The countries with 110% finance doesn’t even seem to show that you know what you’re talking about. These countries allowed their financial system to make these loans. Any prudent regulator would never have allowed it or at least let the free market do what it wanted (which would never have done so under a properly free system without all the government largesse pumped into the system to keep the economy looking good to aid re-election prospects).

      Houses are expensive due to poor government policy and planning. We all want to live within 10km of the CBD because to do so takes more than an hour to travel that distance by public transport (seriously, it used to take me 30 minutes door to desk when I lived in Redfern. That was 8 minutes walk to the station, nearly 15 minutes on a train to get off at ATown Hall and walk from TH to work). That’s not the fault of the banks. It’s the fault of governments.

      Banks merely operate in the regulatory environemnt created by government. They exist to make money. Not help people. No private business exists to help people as they all exist to make money. If you want different behaviours then you have to regulate for them.

    • Mahhrat says:

      01:49pm | 16/07/12

      I see your point Tubesteak, but if you seriously think the banks aren’t unduly influencing the very policies they’re beholden to, then you’re either in their pay or incredibly naive.

      All huge corporations put pressure on governments, and that should be the role of a regulator - to ensure the interests of private enterprise do not have any more influence on policy than any other part of society.

      As I’ve said before, capitalism is a great way to make money, except under its tenets there can be only one winner.  The natural result of capitalism is monopoly, and that’s no good for society.

    • Tubesteak says:

      04:42pm | 16/07/12

      I’ve been in “negotiations” with government over policy and legislation. I know full well how this works and how governments can influence and be influenced. Ultimately, they go with what’s popular. Banks aren’t popular. No bank could get a campaign up like the miners did because banks don’t pay bogans $300k to man a shovel. Banks are pariahs in our society so there’s little worry from government over what they wish to do. It’s the other actions of governments that are fuelling this issue. Not the banks.

      Oligopoly is the natural state of a market. Not monopoly. Check out Schumpeter’s Theory. Monopolies tend to breed prices far beyond MC which means others will enter the market destroying the monopolist’s position.

    • James says:

      03:36pm | 16/07/12

      Dr Richard Bookstaber and Dr Nassim Taleb (predicted Global Financial Crisis in his book Black Swan) spoke in 2009/10 to a panel of US Congressman after the financial crisis - 

      Dr Taleb said, “I was on Wall Street for 21 years, and a lot of (those) people I wouldn’t use for anything”...

      He explains how, on the sole principle of risk management, he wouldn’t even employ some of these people as bus drivers - because they would be unable to avoid a crash.

      Dr Bookstaber argued that “there are people who are talented in areas like medicine and physics and other fields who seem to get by on $200000, $500000, or $1m. I don’t know that the talent on Wall Street is so stellar that it is worth $50m or $100m versus these other people in other fields”

      Interesting arguments about the monetary value (represented by a pay cheque) of certain people to our economy, along the same lines as the BIS chief economist’s claim that banks have become a black hole for productivity.

    • Tubesteak says:

      04:45pm | 16/07/12

      A paycheque is not your value to society or what you represent. It is merely a representation of your contribution to the bottom line of a company. For banks their bottom lines are huge because of what they do and the deals they work on. Finance a $100m deal and you’ll get a small slice of that. A small slice of $100m can still be a few million.

    • Al B says:

      05:10pm | 16/07/12

      Thanks adam great article, the place of the finance industry and government together in monetary policy is a little troubling as well. The Austrian school have plenty to say on this.

    • Super D says:

      05:55pm | 16/07/12

      I read an article the other day saying that banks should be regulated like casinos.  In casinos if anything goes wrong the guy at the top ends up in gaol.  In banks the CEO’s claim all care but no responsibility -unless they can be proved culpable - this actually provides an incentive to not know what is really going on.  Making CEO’s ultimately accountable would result in banks becoming smaller and less complicated.  Unfortunately this would require global coordination lest banks simply move to more accomodating jurisidictions.

      Unfortunately most people are completely clueless with regard to the nature of modern banking.  If anyone wishes to educate themselves I would recommend http://www.zerohedge.com.

    • Leningen says:

      10:21pm | 16/07/12

      So I have a rock, and that is freely exchangeable for another rock. Except that I somehow convince you that my rock is worth a hundred of your rocks. I now have a hundred rocks, and I go looking for other people with more rocks than brains. Soon, I have all the rocks. I pile them up near my house, and the redistribution of mass causes the earth to fall off its axis and spiral into the sun. Before we burn to death, the government passes a law saying that I own all the rocks.
      I think that about covers how it works. There is no equitable value transfer in these transactions or the money from the share trades would go to the company whose shares were being traded, for example.  Increases in valuations of my mortgaged house should decrease my equity. I’m sorry sir, your loan no longer covers the value of your house - you’ll have to borrow some more money or fill in the swimmng pool.
      Don’t scoff - what we have now is equally surreal. And it doesn’t work.


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