Given everything that has happened over the past five years, no one would blame anyone else for thinking that.
But this is fundamentally about misallocation of resources. The problem is that an overly large financial sector sucks up resources better spent on more productive investments. This distortion is created by the power that any large mass of power and momentum creates both through its economic and political heft. And, as the current situation in the US and Europe demonstrates, when the threat that this imbalance may be challenged arises, those benefiting from it issue baleful warnings about the impending doom sure to follow if their advantage is curtailed.
The research from the IMF ignores the self-serving appeals to emotion and focuses on how too much emphasis on the financial sector can result in resources that might more productively be allocated to investment in new technologies, products or services be erroneously applied to pursuit of financial activity for its own sake. The problem with this is that it creates a mass that almost inevitably becomes unstable. Think, too much of a good thing...And it may exacerbate some of the negative characteristics which western society has come to associate with behavior in that sector because like any other species or force that goes unchallenged for too long, it becomes less efficient when competition diminishes.
The bitter fight against increased financial regulation is probably a doomed rear-guard action. Not so much because the forces of reason and progress will prevail, but because the markets themselves will not tolerate the diminished returns associated with inefficient enterprises so will find others venues for investment. JL
Pat Garofolo reports in Think Progress:
Over the last several decades, the financial sector has made up a larger and larger percentage of the U.S. economy, eventually accounting for 40 percent of corporate profits before the financial crisis of 2008. By the end of 2011, even as Americans on Main Street were still grappling with the effects of the Great Recession, finance made up a larger percentage of the economy than it did before the crash.
The financial sector is supposed to promote growth by allocating capital to useful parts of the economy, but is that what it’s really doing?
In a new working paper for the International Monetary Fund, Ugo Panizza, an economist with the United Nations Conference on Trade and Development, and two other economists found that a smaller financial sector can actually be good for economic growth:
In a new Working Paper titled “Too Much Finance?” and published by the International Monetary Fund, Jean Louis Arcand, Enrico Berkes, and I use various econometric techniques to test whether it is true that limiting the size of the financial sector has a negative effect on economic growth. We reproduce one standard result: at intermediate levels of financial depth, there is a positive relationship between the size of the financial system and economic growth. However, we also show that, at high levels of financial depth, a larger financial sector is associated with less growth. Our findings show that there can be “too much” finance. While Greenspan argued that less credit may hurt our future standard of living, our results indicate that, in countries with very large financial sectors, regulatory policies that reduce the size of the financial sector may have a positive effect on economic growth.
The authors add that “our analysis suggests that there are several countries for which smaller financial sectors would actually be desirable,” as a financial sector that is too large increases the odds of a crisis and increases the misallocation of capital to less useful sectors of the economy. But of course, any efforts to shrink some of the financial behemoths in the U.S. — or to separate out risky trading from more traditional lending — are met with howls from conservatives.