‘Tell your sons and daughters to cure cancer, not become hedge fund managers’

euro money banknotesToo many bankers, financial experts and insurers spoil the economic broth, writes economist Mathijs Bouman.

Imagine a country with too many plumbers. It’s not simply a question of a lot of plumbers; there’s literally one on every corner. The plumbers have united in powerful associations of plumbers. Towns and cities vie for the association of plumbers’ HQ. The expenditure of the big plumbing firms spawn thousands of small service companies. The sector creates jobs, taxable income and forms an essential link in the national economy.

Plumbing firms are a magnet for clever people who come up with ever-newer reasons for laying pipes and channelling water. Water to flush the toilet is delivered separately and shower water re-used. Drinking water comes in different flavours and compositions.

It’s not all good news, however. Optimising the pipeline network means roads are constantly closed off for building work. Nobody can find a decent carpenter as all skilled workmen are plumbers. Having a lot of plumbers is fine but too many plumbers spoil the economy.

Cecchetti

It’s the same with bankers. The effects are not immediately obvious – a surplus of bankers doesn’t impede traffic – but too many bankers are just as bad for the economy as too many plumbers. That is what economist Stephen Cecchetti found after having delved into the subject for two years.

Cecchetti is head of the economic department at the Bank for International Settlements (yes, that BIS, which a number of confused Dutch actors think is the main mover in a dastardly plot).

Financial sector growth is good for the economy in principle, Cecchetti says. Banks are excellent at bringing together savers and borrowers, separating useful investments from insane ones and financial innovations, while insurers reduce risks for citizens and companies. But there is a tipping point. Beyond that point any further financial sector growth acts as a break on economic growth.

Subprime

It is at this point that the financial sector becomes a burden to the economy. Bankers start to devise mortgages for far too ambitious would-be home owners and sell swaps to financially dyslectic entrepreneurs. Short-term profit goes up and so do salaries and bonuses. Talented people flock to the sector like flies to honey.

Cecchetti writes: ‘People who in another age might have dreamed of curing cancer or flying to Mars are now dreaming of becoming a hedge fund manager.’

Based on figures garnered from fifty countries, Cecchetti computed that the tipping point is definitely reached when 3.9% of the population works in the financial sector. But he also thinks the threshold may lie significantly lower, i.e. at 1.5%. ‘Most first world economies passed the tipping point a long time ago,’ Cecchetti writes.

His research shows that financial sector dominance underlies decisions to fund projects with pledged collateral and few risks (such as building projects) rather than higher risk projects without collateral (R&D). This lack of balance is causing a decline in productivity growth.

So what’s the situation in the Netherlands? Do we have a glut of financial experts? It is very likely. In 2012, 3% of the working population had a job in the financial sector. It’s slightly down from the 3.5% of ten years ago but up from the 2.5% of the beginning of the seventies.

Economic cake

Banks and insurers are also getting bigger portions of the economic cake. In 1969, 4.7% of gdp went to the financial sector. It is now 8.1%. Banks in particular have proliferated in the last twenty years. While the whole economy grew by two-thirds since 1988 the ‘production’ of banks shot up by 155%. Insurers only grew by a third.

The most recent CBS statistics date from 2012 and percentages may have gone down further since then. But even if they have, the Netherlands is still past the tipping point. So if you have a clever son or daughter tell them to become a rocket scientist or a cancer researcher. Or even a plumber. But whatever you do don’t tell them to become a banker.

Mathijs Bouman is an economist.

This article appeared earlier in the Financieele Dagblad