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.