This suggests banking has undergone, at least arithmetically, a “productivity miracle” over the past few decades. Section 4 explores in greater detail some of the quantitative drivers of high aggregate returns to banking, while Section 5 explores some of banks’ business activities. Risk illusion, rather than a productivity miracle, appears to have driven high returns to finance. The recent history of banking appears to be as much mirage as miracle. Section 6 concludes with some policy implications. 2. Measuring financial sector output  (a)  Historical trends in GVA  The standard way of measuring the contribution of a sector to output in the economy is GVA. This is defined as the value of gross output that a sector or industry produces less the value of intermediate consumption (that is, goods and services used in the process of production). GVA only measures the sector’s direct contribution to the economy. The indirect contribution of finance – for example, on productivity growth through the provision of funds for start-up businesses and new investment projects – may also be important. But looking at historical trends in value added is a useful starting point. Chart 1 plots an index of real GVA of the financial intermediation sector in the UK from the middle of the 19th century, alongside an index of whole-economy output. Both series are in constant prices and indexed to 1975=100.
Many of the key planks of that debate are covered in other chapters in this volume. Some of these reform measures are extensions or elaborations of existing regulatory initiatives – for example, higher buffers of higher quality capital and liquidity. Others propose a reorientation of existing regulatory apparatus – for example, through counter-cyclical adjustments in prudential policy (Bank of England (2009b), Large (2010)). Others still suggest a root-and-branch restructuring of finance – for example, by limiting the size and/or scope of banking (Kay (2009), Kotlikoff (2010)). In evaluating these reform proposals, it is clearly important that the on-going benefits of finance are properly weighed alongside the costs of crisis. Doing so requires an understanding and measurement of the contribution made by the financial sector to economic well-being. This is important both for making sense of the past (during which time the role of finance has grown) and for shaping the future (during which it is possible the role of finance may shrink). While simple in principle, this measurement exercise is far from straightforward in practice. Recent experience makes clear the extent of the problem. In September 2008, the collapse of Lehman Brothers precipitated a chain reaction in financial markets. This brought the financial system, and many of the world’s largest institutions, close to the point of collapse. During the fourth quarter of 2008, equity prices of the major global banks fell by around 50% on average, a loss of market value of around $ billion.