It may be a year since the fall of Lehman Brothers, but the main questions about the future of the finance industry have yet to be settled. Perhaps the biggest of the lot is whether the industry has become too big for the good of the economy.

Adair Turner, head of Britain’s regulator, the Financial Services Authority, recently suggested another way of addressing this question by saying some banking activities were “socially useless”. The phrase rightly implies that some of its operations are “socially useful”. After all, a year ago, it was feared that if the banking system collapsed, the whole economy would break down.

Banks pool the capital of savers and lend it to companies at longer maturities, allowing them to invest in new factories and so on. They provide cash machines, debit cards and credit cards, enabling the vast majority of commercial transactions to take place. The finance industry provides liquidity to markets, thereby reducing the cost of capital. It allows companies to manage risks, such as sudden shifts in exchange rates, and thus enables more trade to take place than would otherwise occur. And the industry creates a market for corporate control, allowing capital to be moved from inefficient businesses to more efficient ones.

Most of these activities, of course, have been going on for decades, and in some cases centuries. So it seems doubtful that such activities suddenly became a lot more important in recent years. Yet between 1996 and 2007 the profits of finance companies in the S&P500 dramatically jumped from $65 billion to $232 billion, or from 19.5 per cent to 27 per cent of the total.

... contd.