Dani Rodrik asked a good question on twitter the other day: why has there been so much backlash against free trade but so little against finance? In the UK, it’s moot whether there has been a backlash against free trade. But there certainly hasn’t been one against finance, so Dani’s question holds. Three things make it especially puzzling. One is that the costs of the financial crisis are vastly greater than any even half-plausible estimate of the cost of being in the EU, and yet there’s much more hostility to the latter. A second is that scepticism about the financial sector is to some extent non-partisan. In his fine book Adam Smith: What He Thought and Why It Matters, Tory MP Jesse Norman accuses banks of “turbo charged” rent extraction and says: “The banking sector may be
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Dani Rodrik asked a good question on twitter the other day: why has there been so much backlash against free trade but so little against finance?
In the UK, it’s moot whether there has been a backlash against free trade. But there certainly hasn’t been one against finance, so Dani’s question holds.
Three things make it especially puzzling.
A second is that scepticism about the financial sector is to some extent non-partisan. In his fine book Adam Smith: What He Thought and Why It Matters, Tory MP Jesse Norman accuses banks of “turbo charged” rent extraction and says: “The banking sector may be generating little or no net real economic value.” And there are countless small businessmen (and ex-businessmen) whose opinion of bankers would make even the hardest line Marxist blush.
And thirdly, the financial system’s rip-off doesn’t consist merely of the “too big to fail subsidy.” It’s also because people actually choose to be ripped off for example by buying poorly performing but high-charging actively managed funds. In its report into the industry the FCA said (pdf):
On average, both actively managed and passively managed funds did not outperform their own benchmarks after fees..when choosing between active funds investors paying higher prices for funds, on average, achieve worse performance.
So, why hasn’t there been a backlash against finance? Here are five possible non-exclusive explanations.
One is plain deference. We respect scroungers and fraudsters much more if they are rich and expensively suited than if they are poor and tracksuited. As Adam Smith said:
The great mob of mankind are the admirers and worshippers, and, what may seem more extraordinary, most frequently the disinterested admirers and worshippers, of wealth and greatness.
Thirdly, we just don’t see counterfactuals. If we hadn't had the 2008 crisis we'd now have not just higher incomes but also a tolerant society without the social divisions and political crisis that Brexit has caused, But we don't see this world, We don’t therefore see so clearly the damage the financial sector has done.
This is true in another way. Even if there had been no crisis, the financial sector would still leave much to be desired. For one thing, it is exploitative and uncompetitive. As Thomas Philippon (pdf) and Guillaume Bazot (pdf) have shown, the cost of finance hasn’t changed in decades despite much technological progress. And for another, the financial sector has failed to develop useful products that might help us spread risk, such as house price futures, social care insurance or macro markets (pdf) linked to GDP, aggregate profits or occupational incomes. Because we don’t see the alternative world in which finance is competitive and offers useful innovation, we don’t realize how dysfunctional it is.
Fourthly, as David Leiser has shown, people are terrible at connecting economic facts. They just don’t link the collapse of banks with a decade of stagnant real wages. This is not helped by a media which has a bias against emergence. For example, in Jon Sopel’s interview with Gary Cohn yesterday neither party asked the extent to which the US’s economic performance might for good or ill be due to forces outside direct political control.
Which brings me to something else. For decades political debate about the economy has been framed by the presumption that capitalism is basically fundamentally healthy and that the role of the state is to provide the framework of stable policy and light regulation which frees this underlying dynamism. The question has been: how can the state serve capital? rather than: what must be done to fix or replace a rotten system? Because ideas often linger on after their factual base has withered, we are stuck in this paradigm. This is why the Tories managed to get away with describing post-crisis government deficits as the fault of Labour rather than bankers.
My point here should be a trivial one. Our perceptions of complex systems are distorted by cognitive biases. Sometimes these distortions help to legitimate inefficiency and exploitation. Behavioural economics and Marxist theories of ideology are much more compatible than is often realized.