Intuition for the utility of finance

There’s occasional debate among effective altruists, and among people more generally, about whether working in the financial sector does harm, and if so how much.

It’s easy to come to the conclusion that finance isn’t helpful at all, because things look zero-sum: if I sell you a share of Google, the total amount of wealth stays the same no matter what price I sold it to you at. By this logic, if I make money trading Google shares, I’m just taking it from other people who were less clever than me about trading their Google shares.

This neglects an important consideration, though, which is that different people can place different values on the same asset. As a trivial example, just after the Google IPO, Larry Page might have valued his last share of Google much less than its price in cash, because he held so many Google shares that he was highly exposed to the risk of their price falling. If Page was risk-averse, he might have strongly preferred to have cash instead of Google shares, even if their “market value” was the same.

People seem to be willing to buy this argument for physical goods like clothes; few people argue that garment-selling is zero-sum because the value of the seller’s and buyer’s assets are unchanged after the transaction. But the argument persists for financial transactions.

This may be because people underestimate the importance of liquidity—that is, ability to get your money when you want it. As Arnold Kling points out, the point of a banking financial is to turn illiquid, risky assets backed by payments from its borrowers (e.g., mortgages) into liquid, non-risky assets that its investors want (e.g., bank deposits). The financial system in the US is sufficiently well-developed that we practically take it for granted that we have as much liquidity as we need. But Poor Economics provides some excellent examples of how badly people need a banking system when it’s not there:

Obviously, this is not a justification of banking activity on the margin: the US is quite far away from any of the situations discussed above. But it suggests that simply shuffling around risk and maturity can have much more value than one might intuitively think.

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