What they do with your money: Does the finance industry do its job well?

Ivaylo Iaydjiev (D.Phil. Candidate, St Antony’s College, Oxford)

Speaker: David Pitt-Watson, London Business School
Chair: David Vines, Balliol College, Oxford

What does the financial industry do with your money? That is the misleadingly simple question that motivates David Pitt-Watson’s new book (co-authored with Stephen Davis and Jon Lukomnik). Given the large amounts of fees we pay in transparent or often less so ways to financial professionals, this is a particularly pertinent question. More broadly, it invites us to step back from the complex and technical details that dominate everyday financial news and revisit how we think about the role of the financial system and its contribution to society. 

Mr. Pitt-Watson examines in his talk whether the financial industry does its job well, and his conclusions are not particularly optimistic. Intriguingly, he decides to tackle the question by first reconnecting financial activity with its initial purpose. As he aptly points out, there is a voluminous literature on what financial institutions exist, but it tends to proceed by assuming that the existence of such institutions must serve a purpose, and then deducing what that purpose might be. Instead, it is necessary to be clear on what the original purpose is and work out the institutions from there.

For Mr. Pitt-Watson finance serves four key purposes, largely in line with the academic literature. The first key function is the safekeeping of assets, especially money. In turn, this is central to the second function – transaction-processing, or reducing the costs of financial exchange. The third function is the sharing of risk through the provision of insurance, which however does not reduce the aggregate amount of risk. Finally, the financial system’s most important purpose is to intermediate funds from savings to investment. 

These four functions demonstrate that finance does indeed have a socially beneficial purpose. However, he is careful to point out that this purpose relies on technical knowledge as much as on trust in the institutions and financiers themselves. When knowledge and trust are combined with a sense of purpose, the results can be transformative. Therefore, finance is key to our economies, to opportunities for social mobility and development, and to addressing our current challenges.

Financial Reform in Turkey: Responses to Past and Current Crises

Alexandra Zeitz (St Antony’s College, University of Oxford)

Speaker: Gazi Ercel, Former Governor of the Central Bank of Turkey
Chair: Nicholas Morris, St. Antony’s College, University of Oxford

How to prevent cycles of financial crises in emerging market economies? What interventions and reforms can stabilize and strengthen these economies in the aftermath of a financial crisis? Drawing on his extensive experience in Turkey, Gazi Ercel, former Governor of the Central Bank of Turkey, shared his insights on financial crises and reform in a PEFM seminar in late April, stressing the importance of reducing political uncertainties and ensuring post-crisis reforms are carried through once economic conditions improve.

Examining the record of financial crises in Turkey in the last four decades, Ercel identified common causes. In almost all crises the country has faced in recent history, public sector deficits had expanded, which provoked investors to withdraw short-term capital and in turn plunged the economy into crisis. For instance, Ercel attributed the inflows of large volumes of short-term capital in the lead up to the 1978-1979 crisis to a positive World Bank report. When these investors abruptly and rapidly withdrew in light of worsening public sector imbalances, the country experienced its worst foreign exchange crisis in three decades.

Domestic political economy, especially the pressure for a rising public sector wage bill, is at the root of the persistent public deficits that prompt financial crises, argued Ercel. The instability of Turkish politics exacerbates this problem, disincentivizing fiscal discipline as governments seek to maintain their hold on power.

In addition to identifying these Turkish political dynamics, Ercel argued that the particular causes of financial crises in emerging economies are distinct from those in developed economies. While industrialized economies are more likely to experience crises in their capital markets, emerging economies are frequently hit by debt crises. Emerging markets are likely to have weak and unsophisticated banking sectors, which may cause fragility, while instability in developed economies stems from the complexity and lack of transparency in banking sectors.

A code of ethics for bankers – Challenges and opportunities

Alexandra Zeitz (St Antony’s College, Oxford)

Speaker: Robert Mass, Head of International Compliance, Goldman Sachs
Chair: David Vines, Balliol College, Oxford

The financial services sector continues to grapple with a string of headline-grabbing scandals. One interpretation of this has been that the industry suffers from a serious shortfall in ethical standards. Various solutions have been offered for the apparent “culture problem”. High profile commentators have argued, for instance, that managers should set a “tone from the top,” correcting for deficits in ethical standards by modelling conscientious behaviour towards clients, competitors and co-workers and expecting the same from those further down the ladder.

One popular response to the seeming problem of values has been to set out ethics codes that explicitly commit bankers to clear normative standards. Barclays, for instance, unveiled a code of conduct in 2013 as part of its efforts to address the cultural deficits that underlay the foreign exchange-fixing and personal protection insurance scandals. In 2015, the G20 released a set of Principle of Corporate Governance. What can such codes achieve, and what should they include?

In February, PEFM hosted Robert Mass, Head of International Compliance at Goldman Sachs, to discuss his proposals for a code of ethics for bankers. Mass’ engagement with codes of ethics was incredibly wide-ranging, spanning both the philosophical and pragmatic.

In order to be effective, says Mass, codes of ethics must be rooted in existing social practice, in the day-to-day lives and expectations of those they hope to influence. Drawing on moral philosophers including Hume and Smith, Mass argues that ethical standards cannot be given a priori; instead, cultural norms arise out of particular cultural milieus and conventions. The challenge of an ethics code is to set out the principles contained in existing practice, to codify them, in order to encourage socially appropriate behaviour.

The Eurozone crisis and South East Europe: Recovery or illusion?

Alexandra Zeitz (St Antony's College, Oxford)

Speakers: Adam Bennett, St. Antony’s College, Oxford; and Peter Sanfey, European Bank for Reconstruction and Development 

Chair: Jonathan Scheele, St. Antony’s College, Oxford

In late January, the PEFM seminar series was treated to a data-rich and fascinating account of the crisis experience of South East European states.  Adam Bennett of St. Antony’s College and Peter Sanfey of the European Bank for Reconstruction and Development (EBRD) presented the book they co-authored with Russell Kincaid, formerly of the IMF and the late Max Watson, also formerly of the IMF and founding director of PEFM.

Economic and Policy Foundations for Growth in South East Europe (Palgrave, 2015) reviews the experience of crisis in the ten South East European economies and argues for renewed commitment to reform to ensure sustained prosperity.

The South East European (SEE) states comprise Albania, Bulgaria, Romania and the seven successor states of former Yugoslavia. Bennett outlined three distinct phases of development in this region since the onset of “transition” in 1990. The first ten years he characterized as the “valley of tears”, as countries variously underwent the dismantlement of economic systems and then rebuilt them, or were ripped apart by conflict. The second phase comprised the boom years of the first part of this century through the onset of the global economic crisis at the end of 2008, when all countries managed to achieve remarkable (and too good to be true) growth rates—the “sunlit uplands” of peace and fruition of reform. The final phase, where SEE arguably remains today, was characterized as the “wilderness years” of post crisis recession followed by stagnation.

Though there were of course idiosyncrasies in their economic trajectories in the build up to the crisis and stagnation of 2009-2014, the trends across the region are instructive. On the basis of detailed country-level data, Bennett described the emergence of a massive savings gap in these economies during a boom period that stretched from 2000 to 2008.

Was the global financial crisis really a “debt crisis”?

Alexandra Zeitz (St Antony’s College, Oxford)

Speaker: Anatole Kaletsky, Gavekal Consultancy
Chair: Adam Bennett, St. Antony’s College, Oxford

We are accustomed to analyses of the 2008-9 financial crisis that point to and dissect particular causes of the crisis, using these to call for post-crisis reform, regulation and rethinking. In a presentation at the PEFM seminar on January 25, Anatole Kaletsky instead gave a much wider-ranging and sweeping account of the causes of global financial crisis, and outlined the fundamental shifts in the relationship between governments and markets that he believes it has unleashed.

In 2010, Kaletsky published Capitalism 4.0: The Birth of a New Economy in the Aftermath of the Financial Crisis (Bloomsbury). In his presentation in early 2016, he argued that many of the false diagnoses of the crisis that he wrote the book to challenge continue to dominate post-crisis conversations. Rather than placing blame on individual bankers or on high pre-crisis debt levels, Kaletsky sees the global financial crisis as the demise of an entire theoretical and ideological view of the economy, collapsing in on itself as economic rules came to be applied dogmatically. 

Blind faith in the efficient market hypothesis led both regulators and market participants to make bad decisions – foremost among them the Henry Paulson’s decision to allow Lehman Brothers to fail – bringing down the intellectual consensus that had supported the previous structure of capitalism.

In Kaletsky’s view, the rupture the crisis provoked in both economic theory and practice will lead to a new practice and understanding of capitalism. In fact, he argues this reinvention of capitalism is just the latest in an ongoing process of evolution and adaptation. Kaletsky’s historical narrative begins with “Capitalism 1.0,” emerging in 1776 with the independence of the United States, and coincidentally also the publication of Adam Smith’s Wealth of Nations.

The IMF in the Balkans: Recent experience

Alexandra Zeitz, St. Antony’s College, Oxford

Speakers: Adam Bennett, St. Antony’s College, Oxford and Robin McConnachie, Oxford Analytica

Chair: Stewart Fleming, St. Antony’s College, Oxford

When the IMF is called in during a time of economic crisis, the programme agreed is often politically contentious. One of the defining questions in the aftermath of the IMF’s intervention is frequently: “did it work?” In late November, PEFM heard from Adam Bennett, formerly of the IMF, about the effectiveness of IMF programmes in a region where the Fund has played a prominent role in recent decades: the Balkans. Robin McConnachie, who has acted as an advisor to governments in the region, contributed his insights into what makes for successful reform programmes. 

How does one capture the impact of an IMF programme? Bennett explained that the Fund itself has grappled with the numerous measurement challenges of evaluating effectiveness. Simple measures comparing indicators before and after an IMF programme neglect the counterfactual of how the country would be faring in the absence of an IMF programme. Comparisons between countries with and without IMF programmes cannot account for the fact that countries with IMF programmes often faced worse conditions than those that received no programme.

The Fund has responded to these measurement concerns by building complex models that attempt to capture the impact of policy interventions. These models, however, can only be as accurate as the assumptions they are built on. For his evaluation of the IMF’s programmes in the Balkans, therefore, Bennett used simple comparisons between those Balkan countries with and without IMF programmes and contrasted countries’ actual performance with the targets set in the programme.

What is needed for EU competitiveness? The view from Croatia

Alexandra Zeitz (Global Economic Governance Programme, University of Oxford)

Speaker: Boris Vujčić, Governor, Croatian National Bank

Chair: Gillian Edgeworth, Wellington Management and St. Antony’s College, Oxford 

What will it take to boost the EU’s competitiveness and firm up a shaky economic recovery? In late November, PEFM hosted Governor Boris Vujčić of the Croatian National Bank, who presented his views on the roadblocks to productivity in the EU and argued for structural reforms to encourage convergence among different European regions and increase competitiveness.

There are many explanations for Europe’s competitiveness woes, particularly for why it lags behind the United States across indicators of productivity. Indeed, Jeffrey Franks’ PEFM presentation in October outlined how the IMF accounts for Europe’s flagging competitiveness.

In his account, Governor Vujčić stressed the importance of the revolution in information and communications technology, which has made huge contributions to private sector productivity in the US, but lagged in Europe. He also highlighted the problem of financing – without well developed equity markets and venture capital funders, young European entrepreneurs often lack the investment to get their ideas off the ground. Europe has also been slow, Governor Vujčić argued, to bring research and expertise from academia into the private sector. While Europe’s universities are well represented on global league tables, transfer of knowledge into business is still lacking.