"The distinction between the creation and the appropriation of wealth – between those who add value to the cargo and those who help themselves to a fraction of it as it sails by – is vital, if not always clear. But our ability to recognise it will determine, not just the fate of individuals, but the future of modern capitalism."When Adair Turner suggested there might be good finance and pointless finance, he was probably thinking of this. Despite the City's appalled reaction, many people felt they knew exactly what he was on about.
Kay’s distinction between “brigandry and productive business” exists and has been tackled before without resorting to communism, despite the theoretical difficulties.
He mentions the gilded age when powerful industrialists transformed the US economy. Rockefeller and Vanderbilt ran monopolies that would be declared illegal and broken up today. For regulators in the 1900s, when transport and industry lifted millions out of poverty, tackling appropriation in the oil or railroad businesses probably seemed as hard as taming finance does now.
Kay says that in today's world the courts must decide who is a brigand or a criminal, as they did with Jeff Skilling and Conrad Black. He is half right; courts apply and interpret law, but most primary legislation comes from a democratic discussion of facts and evidence. If we want to tighten the rules against financial appropriation, we first have to look under the bonnet of the City and see where, exactly, it’s happening.
There have been some good initiatives. The Independent Banking Commission is looking at bank structure, and whether bank customers and clients are efficiently served, while groups such as the ABI are calling for underwriting and M&A fees to be scrutinized.
But many areas of wholesale finance have escaped a thorough check-up: high-frequency trading, cross-border transfer pricing, dividend arbitrage, leveraged recaps, commodity speculation, sell-side research, and many others. No one doubts that these are complex and well-paid activities, but does anyone know who really benefits from them and whether they are, on balance, worth their salt?
It's not a simple question. A post on Kay’s article asks whether an investor in a stock would be a creator or appropriator, if it depends on whether the company is Walmart or a small start up, on the expected risk and return or whether the investor is passive or active?
A meaningful look under the bonnet might ask who is dealing with whom, their motivation, the real costs and who bears them, the benefits and how are they distributed. Is there a risk or a cost to society, does it benefit the economic good enough, perhaps through price discovery and liquidity?
Of course it's a difficult and time-consuming analysis and is not generally done, unless there has already been a failure such as mortgage-backed CDOs. If it is done, the inevitable mix of good and bad outcomes makes a policy response difficult.
But moving to a more creative economy means facing these difficulties. It needs rules and regulators willing to tackle appropriation with tools that fit the task, such as taxes designed to limit activities to a certain size.
These are not radical suggestions, as Tony Jackson pointed out in an excellent column on commodity speculation on Monday:
“We need speculators, but only up to a point. Too much, and there may be a case for throwing some sand in the works…There are plenty such tools in financial regulation, from raising reserve requirements to banning naked shorting. And to be sure, not all of them work …But as Keynes almost put it, if feeding the world becomes the byproduct of a casino, the job is likely to be ill-done.”To avoid this gloomy picture, we need better tools for financial regulation, and to design and apply these tools we need better evidence about how and where financial appropriation occurs.
Who is going to provide it? Bankers and other market participants are generally too partial, customers too ill-informed or unsophisticated, and regulators mainly concerned with existing rules. Government might not back it, despite pre-election promises, if it saw uncomfortable conclusions ahead (what if we discovered that the City, sometimes described as the biggest offshore centre in the world, mainly benefits the UK at the expense of other countries?).
John Kay has proposed a royal commission. This would bring scrutiny into murky parts of the sector but a one-off investigation would only hold the tide for so long.
In my view, the analysis of financial activity as wealth creating or wealth appropriating, something Kay says is vital to the future of modern capitalism, should be a mainstream and continuous branch of economics.
The really interesting question is why it isn't already.