Tuesday, March 31, 2009

Is the Financial Sector Too Big?

Probably.

But a lot of the recent arguments for why the financial sector is too big don't make the case. For example, Simon Johnson cites the financial industry's share of domestic corporate profits:

From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent.
Similarly, Paul Krugman cites the growth of the financial sector as a percentage of GDP: in the 1960s, finance and insurance accounted for only 4% of GDP, whereas in 2007 finance and insurance accounted for 8% of GDP.

But these arguments don't prove that the financial sector is too big. Finance is a global industry, and the U.S. financial sector provided financial services to other countries, including emerging economies, during this period. The growth of China, India, South Korea, etc., meant that the demand for financial services was growing during this time period. Moreover, it was also during this period that competition from low-wage countries like China was slowly eroding the U.S. manufacturing base. The combination of these two trends—rising demand for financial services abroad and a shrinking U.S. manufacturing sector—absolutely contributed to the U.S. financial industry's growth relative to other domestic industries. In this story, the financial industry isn't "too big," it's just growing relative to other domestic industries.

I'm not saying that the financial sector isn't too big—in fact, I strongly suspect that it is. I'm just saying that the evidence most people use to support that argument doesn't actually prove much of anything.

15 comments:

j0hn_dee@nothotmail.fr said...

you're right, their argument is incomplete (they miss the global part), but it is still the most obvious way to see how the financial sector became a bloated cancer for the US economy. 41% !!!! The usual pro-finance argument talks about financial innovation as if it was anything comparable to technological innovation. Hilarious! The finance sector needs to come down to 10% top.

Anonymous said...

Good morning.

I am a recently retired federal prosecutor of many untold years and I have been ruminating, as I would guess most of us have, about our sick economy. One of my lines of thinking has to do with the financial sector and what if anything it adds positively to our GDP.

In Finance 101, I was taught that the purpose of finance was the astute allocation of capital. I dare say that the giant casinos of Wall Street have moved totally away from any such purpose. My over arching thinking is that the GDP should be broken down into positive sectors, neutral sectors, and negative sectors. For example, I would obviously place housing construction in the positive sector. Brick and mortar over our heads is needed. For the neutral sector, I would include the health industry. It does not positively advance our economy, but instead helps to maintain our ever aging work force. The whole criminal justice system, courts, lawyers, jails, and all would go in the negative sector.

Your blog of March 31, 2009, "Is the financial sector too big?," relates that

From 1973 to 1985, the financial sector never earned more than 16 percent of domestic corporate profits. In 1986, that figure reached 19 percent. In the 1990s, it oscillated between 21 percent and 30 percent, higher than it had ever been in the postwar period. This decade, it reached 41 percent.

If I understand the ramifications of these statistics, I don't see any way that the financial sector's 41% of domestic corporate profits adds anything positively to our GDP.

What are your thoughts?

Thanks.

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