Realist, not conformist analysis of the latest financial, business and political news

If Only Nick Shaxson Understood Economics – The Finance Curse

Nick Shaxson is, to put this very kindly indeed, not as versed in economics as some might think. Which is a little problemette as he wants to tell us all how things should be in this economy of ours.

He’s entirely right that there is something called the resource curse. Find vast quantities of some natural resource worth gigatonnes of money and it can actually be bad for the surrounding economy and society, not good. But then we get this:

In Angola, the cascading inflows of oil wealth raised the local price levels of goods and services, from housing to haircuts. This high-price environment caused another wave of destruction to local industry and agriculture, which found it ever harder to compete with imported goods.

That’s gibberish. Higher prices to sell goods at in the local market make it more difficult for local firms? Eh? Higher prices mean they can sell for more money, doesn’t it. Therefore they do better. Now it is true that the resource curse can lead to Dutch Disease, a slightly different concept. That’s when all that foreign money flowing in to buy the resource drives up the exchange rate thus making imports cheaper in real terms. That can and does kill local industry.

The point here being not that Shaxson is wrong with his worries about resource curses. But that he doesn’t understand the mechanism, nor the details, and thus is most unlikely to be able to tell us anything useful about any cures.

(Some mineral-rich countries, including Norway, admittedly seem to have escaped the curse.)

Well, yes, they have. Norway achieving it by not letting that oil money into the country. Actually banning it being used nationally at all. It goes into an offshore investment fund, one which can only be used to invest outside Norway. The sort of detail that is important you might think.

But then it really starts to go awry:

Back in the 1990s, John Christensen was the official economic adviser to the British tax haven of Jersey. While I was writing about the resource curse in Angola, he was reading about it, and noticing more and more parallels with what he was seeing in Jersey. A massive financial sector on the tiny island was making a visible minority filthy rich, while many Jerseyfolk were suffering extreme hardship. But he could see an even more powerful parallel: the same thing was happening in Britain. Christensen left Jersey and helped set up the Tax Justice Network, an organisation that fights against tax havens. In 2007, he contacted me, and we began to study what we called the finance curse.

It may seem bizarre to compare wartorn Angola with contemporary Britain, but it turned out that the finance curse had more parallels with the resource curse than we had first imagined. For one thing, in both cases the dominant sector sucks the best-educated people out of other economic sectors, government, civil society and the media, and into high-salaried oil or finance jobs. “Finance literally bids rocket scientists away from the satellite industry,” in the words of a landmark academic study of how finance can damage growth. “People who might have become scientists, who in another age dreamt of curing cancer or flying people to Mars, today dream of becoming hedge-fund managers.”

No, the “financial curse” is nothing at all like the resource curse. For what natural resource is being used here other than whatever skills and talents the people might have and the institutions they’ve built? Well, nowt really. There isn’t actually anything about The City other than the half million or so who work in it and the routines and laws they’ve built creating that successful finance environment. It’s not, after all, because of the weather, is it?

No, this isn’t the resource curse, this is the division and specialisation of labour plus comparative advantage – Adam Smith plus David Ricardo. And the latter of those two has been in print 201 years by now meaning that Shaxson and his like really have had time to get up to speed on this. The City is a regional specialisation – agglomeration and clustering explaining it – in the same manner that Detroit was and Silicon Valley is. The state of Detroit being a nice little warning about what happens when such specialisation and trade disappears.

Dear Lord this is so annoying. Our entire understanding of economics tells us that the division and specialisation of labour, with the resultant trade in production, driven by comparative advantage telling us who does what, is what makes us rich. The world is now richer than it ever has been. And he’s complaining about it all, the very basis, the underlying structures of the entire system?

Well, yes, apparently so, Reuters correspondents being notably badly paid (there’s a nice line about the New York one collapsing from malnutrition and his boss plaintively complaining that “We though he had friends here” – friends who would feed him as his wages never would have) and also getting to meet lots of very well paid people.

But still, to miss the entire point of economics is pretty good going when trying to describe matters economic, isn’t it.

At which point we really don’t need to know much more about Shaxson’s views on matters economic.

To argue that the City hurts Britain’s economy might seem crazy. But research increasingly shows that all the money swirling around our oversized financial sector may actually be making us collectively poorer. As Britain’s economy has steadily become re-engineered towards serving finance, other parts of the economy have struggled to survive in its shadow, like seedlings starved of light and water under the canopy of a giant, deep-rooted and invasive tree.

That’s the actual point, that we should do more of what we are more productive at and less of what we are less productive at. That’s the very method, the aim.

Yes, there’s more, sadly so:

But what exactly are these “misallocation costs?” There are many. For instance, you might expect the growth in our giant financial sector to provide a fountain of investment for other sectors in our economy, but the exact opposite has happened. A century or more ago, 80% of bank lending went to businesses for genuine investment. Now, less than 4% of financial institutions’ business lending goes to manufacturing – instead, financial institutions are lending mostly to each other, and into housing and commercial real estate.

“Anglo Saxon” economies tend to use equity more than loan finance. That’s just what is done. So, to complain about the lack of loan finance in an Anglo Saxon economy is to rather miss an important distinction, isn’t it?

Investment rates in the UK’s non-financial economy since 1997 have been the lowest in the OECD, a club that includes Mexico, Chile and Turkey.

To once again get matters the wrong way around. Capital is an input into the production process. If you use less of it – and still gain the same output of course – then you’re being more efficient in your use of the input, aren’t you. Even Shaxson would regard you as a complete nutter if you insisted that using more steel than the next guy to make a car made you a better car maker. Capital, investment, it’s just an input, just like steel, in this sense at least.

And in Britain’s supposedly “competitive” low-tax, high-finance economy, labour productivity is 20-25% lower than that of higher-tax Germany or France.

Not so. Those figures are compiled only from hours worked by those who work. Those the other economies leave entirely idle aren’t counted at all – and to miss that things change at the margin, decline here, is to rather miss the entire introduction of neoclassical economics in the 1870s, isn’t it.

Yes, sadly, there’s a whole book’s worth of this drivel. Sigh.

But there is a bigger issue than tax here. Treasury data shows that while the police training centre cost £17-18m to build, the flow of payments to the PFI consortium will add up to £112m from 2001 to 2026, well over six times as much, and vastly more than what the government would have spent if it had simply borrowed that much itself and paid Balfour Beatty directly to build it.

Seriously? He’s ignoring both the transfer of risk on the building and also the fact that PFI includes operating and maintenance costs over the 25 years? And this is what passes for analysis these days?

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2 years ago

“People who might have become scientists, who in another age dreamt of curing cancer or flying people to Mars, today dream of becoming hedge-fund managers.”

From my experience about 80% of the people working in the city came to the UK to do so. Perhaps this could be written as highly skilled people flock to the UK to work here and pay tax. Given oil is less mobile than people the analogy falls over.

Quentin Vole
Quentin Vole
2 years ago
Reply to  isp001

The skill set that would make you a good scientist is unlikely to make you a good hedge-fund manager (and vice versa). The biggest area of overlap is between quants and the mathematical sciences, but the numbers working in both areas are small compared to the number of maths and physics graduates we turn out.

2 years ago

They say Sears is selling more stores, as retailing in general is beset by Amazon. And what race of space aliens is Amazon, which is ravaging the shopping malls? No, they are fellow Americans, simply doing stuff more efficiently than the stores with a half dozen old salesmen perched on washing machines like vultures looking for fresh meat. Regarding the “resource problem,” sure, any windfall to an area (such as NAFTA) disadvantages the locals WHO ELECT NOT TO ADAPT. However, given a new economic option, we are never better off without the option.

Hallowed Be
Hallowed Be
2 years ago

“Many jersey-folk suffering extreme hardship.” Jersey peeps do OK. But to the extent “many” do not it is not because of the finance guys. And if it’s not because then there is not a problem John Christian should solve. OK its the juxtaposition of very rich and below average wealth you and he don’t like, and every instinct says take the rich guys money and redistribute it. But the finance industry was attracted by the Jersey tax regime son you could not have your cake and eat it. You were in the agonising position of a one armed man having… Read more »

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