Thought du Jour

Last week, Alan Greenspan described the increase in the share of the financial services sector in gross domestic product around the world. He applauded its contribution to the growth of economic activity and world trade.

But there are two ways of interpreting such data. The shares of both health expenditure and information and communications technology in GDP have also increased. But while public and politicians welcome the expansion of ICT, recognising its contribution to daily life and the efficiency of business, they fear the growth of health spending. The benefits, though real, are hard to measure, do not necessarily increase in line with the costs of provision, and threaten to squeeze other elements of spending. Are financial services like computers or like medicine?

John Kay, “The beauty is in the data“, Financial Times, 6 April 2011.

Columnist John Kay argues convincingly that financial services are like medicine, concluding with the following words.

The figures we have for the contribution of financial services to GDP are best regarded as a record of growing inputs, like the shares of health expenditures, rather than a measure of growing outputs, like ICT spending. The rise in recorded share largely replays the well-known fact about financial services – that earnings from it have risen a great deal. British statisticians are engaged in an important attempt to find measures of public service output directly. It would be useful to try to do the same for financial services.

Until that happens, it is well to recall the warning of Josiah Stamp, once both director of the Bank of England and president of the Royal Statistical Society. The statistics governments relied on were, he observed, ultimately derived from the records of the village night watchman, “who just put down whatever he damn pleased”.

The best two sentences that I read this morning.

We will succeed in managing financial risk better only when we come to recognise the limitations of formal modelling. Control of risk is almost entirely a matter of management competence, well-crafted incentives, robust structures and systems, and simplicity and transparency of design.

John Kay, “Don’t blame luck when your models misfire“, Financial Times, 2 March 2011.

[W]hen someone tells you something is too complex for you to understand, the usual reason is that they do not really understand it themselves. Sometimes they know that they do not really understand it: often they do not.

For the inquisitive intellectual, few people are as irritating as those whose combination of ignorance and arrogance is so profound that they claim to understand things they do not even know they do not know.

The world of business and finance, which values confidence and certainty, is full of such people. ….

So the blind lead the blind through the mysteries of structured financial products and the jargon-ridden thickets of corporate strategy. People sell securities whose properties they only dimly appreciate to people who do not understand them at all. Consultants describe the business world in language – and, of course, PowerPoint presentations – whose elaboration disguises the banality of the thought.

John Kay, “Those at the nucleus may not have the best view“, Financial Times, 2 February 2011.

This column is relevant to my earlier discussion of financial illiteracy as an explanation for the popularity of ‘whole life’ insurance and mutual funds with high sales commissions. If John Kay is correct, there may be ignorance on both sides of the market – salesmen may not understand the products they are selling!

John Kay believes that sales of unsafe financial products ought to be prohibited, just as sales of unsafe cars and food are prohibited.

In a world of complex products and equally complex production processes, consumers are protected from unsafe cars and toxic foods by a combination of regulatory action and supplier concern for reputation. Public agencies prohibit the sale of dangerous cars and food, and companies such as Ford Motor, Nestlé and Tesco do not want to sell them. But neither reputation nor regulation seems to achieve these results for retail financial services. ….

The [UK] regulatory agency, the Financial Services Authority, is in the grip of a theory that the right answer to the gap in information and knowledge between the investment bank’s structured products division and the person in the street is to give the person in the street more information. But the idea that small savers are equipped to assess the risk associated with these products by reading the small print is absurd; as absurd as the notion that consumers can protect their families through DIY toxicology assessments of the food they buy or that they can judge car safety by reading the technical specifications.

John Kay, “Bonds designed to leave savers bemused”, Financial Times, 17 November 2010.

At the medieval courts … the exercise of power was not a means to an end, it was itself the end. Kings and barons sought principally to extend their territory. If they occasionally claimed that the purpose was to bring the benefits of their wise rule to a wider public, the assertion was little more than a smokescreen for personal ambition. The rulers aimed to be exalted as rulers of wider domains and to levy taxes on ever more peasants. The political and economic environment has been transformed. But human nature has not, and the factors that drive powerful men today are little different from those that drove them five centuries ago.

The fine robes of Shakespeare’s princely characters were paid for by the work of the peasantry, the men and women who tilled the fields and garnered the crops. Their labours yielded revenues to support lifestyles entirely disconnected from their own experience, people who knew nothing of agriculture and cared less, and whose activities were sometimes disruptive to day-to-day economic activity but mostly irrelevant. Once there were sowers and reapers, now there are bank clients and factory workers; once there were palaces and carriages, now there are McMansions and private jets. Much has changed, yet much remains the same.

John Kay, “Wall Street play for which we pay”, Financial Times, 4 August 2010.