I've the impression that finance is in hypertrophy. But I'm not an expert on it, so I'd like those who are more knowledgeable than I am to do a [steelman][1] of it. The things that make me thinking this are :

  • It uses many of the most talented people to lead activities that seem sometimes positive, but often neutral or negative from a global point of view (i.e either it redistributes money between ~equally rich people or it takes money from poorer people to richer ones ; the opposite seems unlikely given that financial services are more used by richer people).
  • The reasons for this (for picking among most talented people) is that finance, for whatever reasons, seems to have a rent (https://www.nber.org/system/files/working_papers/w14644/w14644.pdf), partly linked to past deregulation (http://www.parisschoolofeconomics.com/reshef-ariell/papers/BGR_finwage_RoF_final.pdf) and gives much higher salaries than other sectors, making it more attractive than other sectors for many people.

My non-expert view on different parts of finance is the following :

If we were total utilitarianists (i.e we would like to improve global welfare) and if we were social planners (i.e we could do whatever we want without cost), should we delete a part of finance for the sake of humanity ?

If there is any literature on the utility of finance, I'd appreciate to read it. And I guess that for any asset, we can find a useful goal so please, talk about the representative use of a given tool. I'd especially appreciate if you were able to grossly quantify the share of useful resources / tools and useless ones (but no problem if it's just impossible). Feel free to take any coherent definition of finance. [1]: https://en.wiktionary.org/wiki/steelman


1 Answer 1


Financial markets can look unimportant to layperson but empirical research shows that well functioning financial markets have direct impact on economic growth (have a look at Levine, 1997 and Levine 2005), which in turn benefits society greatly. For example, well functioning financial sector is crucial for economic development which helps to rise living standards of the poor (see Beck et al., 2007, Honohan, 2004). In addition, medium and small firms get large share of positive benefits brought about by financial development (see Beck and Demirguc-Kunt, 2006).

As a matter of fact non-trivial portion of development economics is dedicated to figuring out how to bring well functioning capital/financial markets you can see in the west to the poor countries (see Banerjee and Duflo Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty).

The studies above look at financial sector very broadly and consequently we can conclude that actually most of the financial sector is useful and beneficial for the society. This does not mean that every single activity that occurs on financial markets is but on the net empirical literature shows large benefits of financial markets for the economy.

For example, derivatives you mentioned in your question help price discovery and are often used for hedging (which you actually put as an example of beneficial activity).

Unfortunately, it is not easy to just list useful and harmful activities. The same activity like mortgage backed security can be excellent tool for financial development depending on the characteristics of the market and appropriate regulation, or it can be harmful to the economy if market has some serious imperfections or is improperly regulated.

In fact the same holds even about less exotic types of financial activity, such as simple insurance. For example, adverse selection (an example of market failure) can in principle lead to undesirable outcomes in the insurance market (see some examples in Freixas Microeconomics of Banking) if it is not corrected by some regulation or private mechanism.

Consequently, one can't really provide any simple list of socially 'bad' and 'good' assets. It would be possible to discuss examples when different financial activities cause problems and when they are beneficial, but providing literature review on all financial instruments would go well beyond the scope of one SE answer (heck it would likely take more than one volume as a book). If you are interested in this sort of discussion you might refer to books such as:

  • Faia & Ester, Financial Regulation: A Transatlantic Perspective
  • Armour et al. Principles of Financial Regulation

However, as noted previously if you just want big picture the literature shows that on the net financial markets are quite beneficial for the economy.


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