Inside Money: Why technology hasn't made finance cheaper

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Following on from my moan last week about the failure of technology to reduce the cost of finance Nobel laureate Paul Krugman has had his own two-cents' worth on the subject.

I'm not implying Krugman leveraged me - perhaps he comes up with ideas off his own bat (but check the dates). Still, he brings his laureatian super powers to bear on the topic, stating that "society is devoting an ever-growing share of its resources to financial wheeling and dealing, while getting little or nothing in return".

"In short, we're giving huge sums to the financial industry while receiving little or nothing - maybe less than nothing - in return," Krugman says.

He also refers to a study by Thomas Philippon, titled 'Finance vs. WalMart: Why are Financial Services so Expensive?', that takes an interesting big picture approach to the question.

Philippon includes an historical comparison of the costs of US financial services over the last 100 years or so, concluding expenses have ratcheted up since the 1970s.

"In other words, the finance industry of 1900 was just as able as the finance industry of 2010 to produce loans, bonds and stocks, and it was certainly doing it more cheaply," Philippon says.

He also notes that while IT has driven down costs in the retail and wholesale trading sectors, the opposite has happened in the financial sector.

"Finance has obviously benefited from the IT revolution and this has certainly lowered the cost of retail finance. Yet, even accounting for all the financial assets created in the US, the cost of intermediation appears to have increased. So why is the non financial sector transferring so much income to the financial sector? ," Philippon asks.

"One simple answer is that technological improvements in finance have mostly been used to increase secondary market activities, i.e., trading."

And while he says trading is "neither good nor bad", according to Philippon, consumers appear to have benefited little from the technology-enabled financial era.

"In the absence of evidence that increased trading led to either better prices or better risk sharing, we would have to conclude that the finance industry's share of GDP is about 2 percentage points higher than it needs to be and this would represent an annual misallocation of resources of about $280 billions for the U.S. alone," the study says.