As markets develop, gamblers seem to increase in numbers relative to insurers. We need to emphasise the distinction.
Three centuries ago, the modern insurance industry emerged. In Edward Lloyd’s coffee shop in London, rich and idle English gentlemen would gather to speculate on the fortunes and movements of ships. Following reports of tides and weather, they would judge which would reach port and which might founder. At the same time, Swiss farmers were meeting together in Alpine villages, pledging that if one of their cows were to die the others would help the unlucky owner to feed his family.
This caricature is due to Michel Albert, who uses it to contrast what he regards as the trading capitalism of the Anglo-American world with the cooperation and solidarity characteristic of continental European economies.
The caricature is exaggerated. Yet there is something in it. London and Switzerland developed into centres of the world insurance industry. There is still a marked contrast between the idiosyncratic individualism of the Lloyds insurance market and the powerful machines that are Munich Re and Zurich Re. But there are gamblers and insurers in every market in which risks are bought and sold.
By gamblers I mean people who know, or think they know better than other people the likelihood of uncertain events. By insurers I mean people who believe that they can reduce the costs of these uncertainties by sharing them with others. Both groups were in Lloyd’s coffee shop: merchants who were worried about the financial implications if a ship were lost and gentlemen who fancied a flutter on the successful completion of a voyage.
Both groups of people are also found in modern securities markets. Equity markets enable the costs of managing business risks to be lowered by spreading them. But they also service those who wish to back their real or imagined superior judgement of the prospect for different companies and industries.
Insurance has an important social purpose. It reduces the impact of misfortune, allowing individuals to make choices that otherwise would be too risky. Ships would not set sail on perilous ventures, new businesses would not be established.
The public value of gambling is less clear. However, the process of matching different views about risks does elicit knowledge and create expertise. The speculators in Lloyd’s coffee shop demanded information about the movements of ships and the prospects for the weather. This information was useful to mariners, and the needs of the insurance market contributed to the development of marine safety.
In a similar way gambling on horses leads to the provision of large amounts of information about the form of horses, the state of the tracks, and the abilities of riders. But this information is not of any social value at all. The only people who use it are people who gamble on horses, and if gambling on horses ceased this flow of information would dry up.
Gambling on the interest rate decisions of the Monetary Policy Committee, which sets interest rates; or what the monthly earnings index will show, is very similar. It stimulates research on the form of the members of the Monetary Policy Committee, their backgrounds and temperaments, just as punters research the qualities of horses. And City economists are employed to guess what the movement in monthly earnings is going to be, just as racing tipsters are paid to guess which horse will get home first.
But this research is as inconsequential as the contents of the Sporting Life. If City firms did not pay for it, the Economic and Social Research Council would not. If there were no gambling motive, no-one would be employed to guess future levels of economic statistics. We would simply wait a few days to see what the Monetary Policy Committee did decide, or what the level of the monthly earnings index turned out to be, and nobody would be any worse off, (except, of course, the city economists).
Equity research falls somewhere between the Sporting Life and Lloyd’s List. When analysts predict the contents of earnings announcements, or try to anticipate the next big deal, they are in the same business as racing tipsters. If they elicit new information about company strategies or company performance, they help to improve how companies function and the allocation of capital between businesses and industries.
Perhaps public policy should be directed towards encouraging the insurance element in risk markets and diminishing gambling. The issue tends to become more important as the financial system evolves. This is because, as markets develop, gamblers seem to increase in numbers relative to insurers. This is what happened at Lloyds, and nearly destroyed the market. The essence of the institution had been risk-sharing. Underwriters put their names to slips one after another. But Lloyd’s turned into a market in risks. People with different assessments of the probabilities of the same risk bought and sold them from each other. In the worst of the Lloyds excesses, they did this again and again. The result was that risks were concentrated on a few individuals with little idea of what they were doing.
Foreign exchange and derivative markets similarly began as insurance markets – for hedging and risk-sharing. Here too gamblers came to predominate. We need to emphasise the distinction between gambling and insurance. As Keynes said:
‘When the capital development of the country becomes a by-product of the activities of a casino, the job is likely to be ill-done.’