Is a Large Finance Sector a “Curse”?

Over at Open Democracy, Nicholas Shaxson from the Tax Justice Network argues provocatively that:

Countries rich in minerals are often poverty-stricken, corrupt and violent. A relatively small rent-seeking elite captures vast wealth while the dominant sector crowds out the rest of the economy. The parallels with countries ‘blessed’ with large and powerful financial sectors are becoming too obvious to ignore.

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How do we explain this ‘curse?’ The explanations fall into three main categories. First is the so-called “Dutch Disease.” Large export revenues from oil, say, cause the real exchange rate to appreciate: that is, either the local currency gets stronger against other currencies, or local price levels rise, or both. Either way, this makes local manufactures or agriculture more expensive in foreign-currency terms, and so they lose competitiveness and wither. Much higher salaries in the dominant sector also suck the best skills and talent out of other sectors, out of government, and out of civil society, to the detriment of all. Overall, the booming natural resource sector ‘crowds out’ these other sectors, as happened when many oil producers saw devastating falls in agricultural output during the 1970s oil price booms.

Finance-dependent economies, it turns out, suffer a rather similar Dutch Disease-like phenomenon, as large financial services export revenues in places like the United Kingdom or the tax haven of Jersey raise the cost of housing, of hiring educated professionals, and the general cost of living. A Bank for International Settlements (BIS) study last year found that finance-dependent economies tend to grow more slowly over time than more balanced ones, and noted that, by way of partial explanation, ’finance literally bids rocket scientists away from the satellite industry’. My short Finance Curse e-book, co-authored with John Christensen, provides plenty of detail on this.

A second standard explanation for the Resource Curse is revenue volatility. Booms and busts in world commodity prices and revenues can destabilise the economies of countries that depend on them, further worsening the crowding-out of alternative sectors…Again, there are close parallels with the financial sector, a source of great volatility, as the latest global financial crisis shows. Britain’s industrial base, decimated by (among many other things) over-dependence on the financial sector, is proving slow to recover, post-boom.

The third category for explaining the Resource Curse – the biggest, most problematic, and the most complex – falls under the headline ‘governance’.

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When easy rents are available, rulers lose interest in the difficult challenges of state-building, or the need for a skilled, educated workforce, and instead spend their energies competing with each other for access to a slice of the mineral ‘cake’…[this]…can also lead to great corruption as each player or faction in a government knows that if it does not act fast to snaffle a particular mineral-sourced financial flow, another faction will. This is the recipe for an unseemly, corrupting scramble.

The financial sector…contains a multitude of potential sources of easy ‘rents’. A secrecy law, for instance, has long been a source of rents for Swiss bankers, who haven’t needed to do much else apart from watch the money roll in. More grandly, the network of British-linked secrecy jurisdictions scattered around the world, serving as ‘feeders’ for all kinds of questionable and dirty money into the City of London, is another big source of rents for the financial sector

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Another source of the trouble in resource-rich states is that when rulers have easy rents available, they don’t need their citizens so much to raise tax revenues. This top-down flow of money undermines the ‘no taxation without representation’ bargain that has underpinned the rise of modern, accountable states through the rise of a social contract based on bargaining around tax, and through the role that tax-gathering plays in stimulating the construction of effective state institutions. If the citizens complain, those resource rents pay for the armed force necessary to keep a lid on protests…we…see some surprisingly repressive responses to criticisms of the financial sector and the finance-dominated establishment, particularly in small tax havens like Jersey, as Mike Dun’s article in this edition – along with the main Finance Curse e-book and my book Treasure Islands – repeatedly illustrate.

All these processes – the economic crowding-out of alternative economic sectors such as agriculture or tourism, plus the ‘capture’ of rulers and government by the dominant mineral sector, who become apathetic to the challenges posed by trying to stimulate other sectors – add up to a mortal threat not just to democracy, but also to the long-term prospects for a vibrant economy.

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