Dis-inflating the GVA of Finance

The conclusion of my previous post was that financial corporate business (FCB) is less than 40% as productive as nonfinancial corporate business (NCB). That conclusion, however, rests on the assumption that everything counted in Gross Value Added (GVA) is output. 

The assumption is not well-founded. Dirk Bezemer and Michael Hudson, in Finance is Not the Economy, wrote

National accounts have been recast since the 1980s to present the financial and real estate sectors as “productive” (Christophers 2011).

The calculation of GVA has been "recast": It has been changed in ways that increase what counts as output. The more the output, the more productive a business is -- or the more productive it is reported to be, depending on whether the new inclusions are output in fact, or only in the calculation.

As for myself, I like to say "nonfinancial" businesses are the ones that produce the goods and services we buy, and "financial" businesses are the ones that produce the money we use to buy those goods and services. That's a bit of a simplification, but it provides clarity. It also invokes the image of financial business as entirely non-productive. 

I have not concluded that financial business is entirely non-productive. Nor have I concluded that it isn't. Thus I asked the question in the title of the previous post: How productive is finance? But my answer depends on the size of output as given by the GVA of finance. If the output of finance has been increased by changing what's counted to make output look bigger, then GVA overstates the output of finance, and my previous post overstates the productivity of finance.

The Recasting

It seems Bezemer and Hudson's "recast since the 1980s" remark is a simplified version of the story. In Financial Output as Economic Input: Resolving the Inconsistent Treatment of Financial Services in the National Accounts, Jacob Assa provides a brief history of the changes to the accounting of finance in the System of National Accounts (SNA):

At a first stage in the history of this question (SNA 53 and before), all financial intermediation activities were excluded from calculations of national output based on the value-added approach, since they were considered to be mere transfers of funds (similar to social security payments) and hence unproductive. An intermediate approach followed with the SNA 68, where the output of the financial sector was considered to be an input to a notional (i.e. imaginary) industry which has no output....
Finally, with the 1993 SNA, financial intermediation became an explicitly productive activity, for which value added is imputed based on the net interest received by financial institutions (the FISIM approach).

Assa points out that these additions to the GVA of finance are subtracted from other components of GVA: They are treated as costs to the industries using those financial services, "thus affecting only the relative size of the financial sector rather than the total GDP".

So, if I have it right, they are not using these accounting revisions to double-count finance and boost the reported size of GDP. But they do count financial costs as part of output, by including them in the Gross Value Added of finance. In this context, it is important to remember that with "SNA 53 and before ... all financial intermediation activities were excluded ... since they were considered to be ... unproductive."

The end result of this "recasting" of the national accounts has been to include more financial cost as financial industry output and to count it as part of the Gross Value Added of finance.

The Bezemer and Hudson article and the Jacob Assa paper both reference Brett Christophers's 2011 paper Making finance productive. In the Abstract of that paper, Christophers writes:

By placing different activities on different sides of a pivotal ‘production boundary’, national income statisticians effectively dictate what counts as productive – as adding value to the economy – and what does not.

His statement clearly describes the redistricting of data that increased the output attributed to financial business. In brief, then, Bezemer and Hudson were exactly on point: the national accounts have been "recast" to present finance as productive.

Calling something productive doesn't mean it is productive. Sure, we may be able to buy more cars because of finance. And we may be able to manufacture more cars because of finance. But finance didn't make the cars. It only made the money available. 

It made the money available, and sent us the bill. And yes, that may be fair. But "fair" is not the same as "productive".

How much output does finance create, really? Not much; this is clear from the graphs of the previous post. But those graphs use the "recast" Gross Value Added as the measure of financial output. The true measure of financial output is less than the graphs show. And that means the productivity of finance is less than those graphs show.

How much output does finance create, really?

Michael Sandel teaches political philosophy at Harvard University. In an interview with Sam Harris of Making Sense, Sandel said

It's been estimated by folks who know more about it than I do, that only about 15% of financial activity consists in investment in new productive assets for the economy. 85% consists of simply bidding up the price or betting on the future prices of already existing assets or, increasingly, synthetically created derivatives and other fancy financial instruments that have precious little to do with making the economy more productive.

The productivity of finance is about fifteen percent.

In an article at LinkedIn, Rana Foroohar wrote

Market capitalism, as envisioned by Adam Smith, was supposed to funnel our collective savings into productive investment, via the banking system. But today, deep academic research shows that only around 15% of the money flowing from financial institutions actually makes its way into business investment. The rest gets moved around a closed financial loop, via the buying and selling of existing assets, like real estate, stocks, and bonds. 

The productivity of finance is about fifteen percent.

Sandel and Foroohar agree on the number. Neither one documents it: no references, no links, no quotes, no sources, not even any detail. So I cannot accept the number. Sure, it's probably right, I will say that. But as presented, it is no better than a rumor.

But how much output does finance create, really?

 

The productivity calc is one thing, the GVA calc another

Using my calculation, GVA per dollar of profit as a measure of industry productivity, corporate finance is less than 40% as productive as the standard set by nonfinancial corporate business. On average, 37.9%. But if GVA overstates the output of finance, then 37.9% overstates the productivity of finance.

I'm not the guy who can determine what is and what isn't financial output. Mine is only a hobbyist's eye. To my eye, finance produces no output, only cost. I could guess that finance is only half as productive as the "Gross Value Added" says. I think it must be much less than half, but I certainly don't know. So to be fair (yeah, that again) fifty-fifty is the only guess I can make.

If half the GVA of finance can legitimately be considered output, then, on average, half of our 37.9% number is the answer. That brings the productivity of finance down below 20%, meaning finance is less than 20% as productive as nonfinancial business, per dollar of profit. More accurately, less than 19%.

That is not far at all from the 15% number of Sandel and Foroohar.

But then, again, if "output per dollar of profit" is a valid way to figure the productivity of industry, and if it was not used in figuring the 15% number, then we should want to use it and apply the "less than 40%" rule, reducing the 15% to less than six percent. 

And if we are now saying that finance reaches less than 6 percent of the productivity achieved by nonfinancial corporate business, well, we are almost back down to zero. Nonfinancial businesses are the ones that produce the goods and services we buy, and financial businesses are the ones that produce the money we use to buy those goods and services. The narrative is clear: Finance is entirely nonproductive.