Why does Finance Benefit only the Wealthy?
The transformation of the financial sector has almost exclusively benefitted the wealthy – Why do we accept that?
David Graeber famously said that "there is an inverse relationship between the amount of money you're going to get for a job, and how much it actually helps people" (Moreau, 2019). No industry could be a better example of that than finance. While having gone through an unprecedented transformation since the late 1970s, nearly everything finance has focused on is paying elite educated workers tons of money so they can focus on enriching a tiny already wealthy minority of the population through highly complex financial instruments. The added value for the broader society has been probably even negative.
Why? Because not all of us have access to elite education and/or exorbitant wealth to join the club of modern finance beneficiaries, while all of us pay taxes that are used to bail out those same institutions that we have never benefitted from. Let's explore further what the transformation of the financial sector has looked like, why it reduces economic growth, increases risks of financial crises, and fosters economic inequality.
Back in the early 1970s, working in a bank was considered quite dull. Workers were neither more educated nor better paid than those in other sectors, which seemed reasonable because task complexity was comparably low, while routine work was almost omnipresent (Reshef & Philippon, 2009). Furthermore, finance was heavily regulated at that time – lessons learned from the Great Depression being partially caused by banks' reckless behaviour in a deregulated market – and it mostly focused on two areas: credit intermediation and insurance. With the deregulation of the financial sector – beginning in the early 1980s – another branch of finance started gaining steam – in the literature mostly called "other finance". What it entailed were derivatives, securities, venture capital, hedge funds, and so forth. According to estimates by Deutsche Bank Research, the size of the OTC (over-the-counter) derivatives market by the end of 2012 was $633 trillion, 9 to 10 times the size of the world economy at that time (Kaya et al., 2013), which signified how important the financial sector had become since the 1980s.
It also changed the requirements for workers in finance drastically. To engage with those complex financial instruments, elite levels of education were all of a sudden required, and compensation simultaneously had to go through the roof to attract that kind of talent (Figure 1).
Figure 1: Relative Wage and Education in the Financial industry compared to the non-farm private sector (Reshef & Philippon, 2009, P. 49).
But why should we care about how finance today is different from finance in the Bretton-Woods-System? Simply put, because it has influenced every aspect of our economic system – from productivity over economic growth to wages and investment behaviour of corporations. That's why economists sometimes label our current economic system finance capitalism. Finance has not only changed itself; it has changed almost everything surrounding it, and not for the better.
Let's take economic growth as an example. Proponents of modern-day finance argue tirelessly how it leads to more efficient capital allocation in the market, boosting economic growth and, consequently, everyone benefits. That broad claim is debatable at best and highly misleading at worst. A study by Law and Singh (2014, P. 36) finds that "the level of financial development is beneficial to growth only up to a certain threshold," whereas above that threshold, financialization harms economic growth. When looking at GDP per capita growth in the United States, it is not changing significantly compared to the pre-financial-transformation era (World Bank, 2020).
On the contrary, the increase of financial crises since the collapse of the Bretton-Woods-System has caused significant dips in economic growth. Ironically, Deutsche Bank Research argues that the "near exponential growth of finance and its liberalization since this point has encouraged this trend [of increased numbers of financial crises]" (Reid et al., 2017, P. 3). Too bad its mother company is not doing much to reverse that trend – to put it mildly.
Additionally, after financial crises, governments worldwide tend to impose austerity measures that hit poor and middle-class families the hardest, while the rich are either not impacted or even benefitting. While public services, such as education, public transportation, and affordable housing in the US have been cut in the aftermath of the financial crisis, 91% of all new income between 2009 and 2012 went to the top 1% of the income distribution (Carter, 2012; Saez, 2015).
So, on top of not contributing to an increase in economic growth while causing more financial crises, modern finance is also fostering income inequality – and not just because austerity widens the gap between the rich and the poor.
It is also because of the compensation structure and those who work in finance. As mentioned before, due to the increased complexity of financial products, education requirements for workers have gone through the roof. The top financial institutions hire almost exclusively from elite Ivy League Colleges (Rivera, 2016). In a world where more students from households in the top 1% of the income distribution are admitted to those universities than from the entire bottom half (Chetty et al., 2020), hiring exclusively elite educated students for extremely high paying jobs perpetuates a vicious cycle of the rich getting richer.
Furthermore, the purpose of this new financial sector is almost exclusively to enrich the wealthy. Doing high-speed trading of stocks to maximize profits is beneficial for those who have the financial resources to participate in the stock market. But, when stock ownership – like in the US – is incredibly unequally distributed, with the wealthiest 10% of households owning 84% of all stocks and the bottom 50% having none at all (Wolff, 2017), all it does is enriching an already wealthy minority, while not generating any added value for the rest of society. The same is true for derivatives trading, as it benefits only those who can afford to participate in those trillion-dollar markets, which are hardly accessible to the broader population (Turbeville, 2015).
Modern-day finance is the perfect exemplar of what David Graeber meant. Workers are paid insane amounts of money for serving a wealthy minority of the population while not generating benefits for the broader society. From being similar to any other business, finance has transformed itself into a playing field for elite educated career-driven graduates from wealthy backgrounds, who care more about their own careers and status than what their job is doing to the broader society.
Words by Torben Trapp
Illustration by Andrew Craig
Bibliography
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