Back in 2011, I wrote:
In 1950, finance and insurance in the United States accounted for 2.8% of GDP…. Today, it is 8.4% of GDP…. If the US were getting good value from the extra 5.6% of GDP that it is now spending on finance and insurance--the extra $750 billion diverted annually from paying people who make directly useful goods and provide directly useful services--it would be obvious in the statistics… diverting that large a share of resources away from goods and services directly useful this year is a good bargain only if it collectively has a substantial amount of what financiers call "alpha", only if it boosts overall annual economic growth by 0.3%--or 6% per 25-year generation….
Why has the devotion of a great deal of skill and enterprise to finance and insurance sector not paid obvious economic dividends? There are two sustainable ways to make money in finance: find people with risks that need to be carried and match them with people with unused risk-bearing capacity, or find people with such risks and match them with people who are clueless but who have money…
Over the past year and a half, in the wake of Thomas Philippon and Ariel Resheff's estimate that 2% of U.S. GDP was wasted in the pointless hypertrophy of the financial sector, evidence that our modern financial system is less a device for efficiently sharing risk and more a device for separating rich people from their money--a Las Vegas without the glitz--has mounted. Bruce Bartlett points to Greenwood and Scharfstein, to Cechetti and Kharoubi's suggestion that financial deepening is only useful in early stages of economic development, to Orhangazi's evidence on a negative correlation between financial deepening and real investment, and to Lord Adair Turner's doubts that the flowering of sophisticated finance over the past generation has aided either growth or stability.
Four years ago I was largely frozen with respect to financial sophistication. It seemed to me then that 2008-9 had demonstrated that our modern sophisticated financial systems had created enormous macroeconomic risks, but it also seemed to me then that in a world short of risk-bearing capacity with an outsized equity premium virtually anything that induced people to commit their money to long-term risky investments by creating either the reality or the illusion that finance could, in John Maynard Keynes's words, "defeat the dark forces of time and ignorance which envelop our future". Most reforms that would guard against the first would also limit the ability of finance to persuade people that it performed the second, and hence further lower the supply of finance willing to take and bear risks.
But the events and economic research of the past years have demonstrated three things. First, modern finance is simply too powerful in its lobbying before legislatures and regulators for it to be possible to restrain its ability to create systemic macroeconomic risk while preserving its ability to entice customers with promises of safe, sophisticated money management. Second, the growth-financial deepening correlations on which I relied do indeed vanish when countries move beyond simple possession of a banking system, EFT, and a bond market into more sophisticated financial instruments. And, third, the social returns to the U.S.'s and the North Atlantic's investment in finance as the industry of the future over the past generation has, largely, crapped out. A back-of-the-envelope calculation I did in 2007 suggested that in mergers and acquisitions the world paid finance roughly $800 billion/year for about $170 billion/year of real economic value--a rather low benefit-cost ratio--and that appears to be not the exception but the rule.
I should, before, have read a little further in Keynes, to "when the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done". And it is time for creative and original thinking--to construct other channels and canals by which funding can reach business and bypass modern finance with its large negative alpha.
- August 2007: Fear of Finance
- April 2009: The Economist Pleads "Not Guilty" on Behalf of Finance--and Swears that Finance Will Never Ever Again Do What It Is Not Guilty of
- June 2009: The Hidden Purposes of High Finance
- April 2010: Brad DeLong : Throat-Clearing on the SEC's Goldman Sachs Case
- December 2010: Brad DeLong : Upon What Meat Hath Our Financial Sector Fed to Grow so Great?
- July 2011: Confessions of a Financial Deregulator
- October 2011: A Note: Prolegomenon to Any Useful Discussion of Modern American Finance
- January 2012: America’s Financial Leviathan
- April 2012: This Time It Is Not Different: Walter Bagehot and the Persistent Concerns of Financial Macroeconomics (DeLong: Long Form)
- John Maynard Keynes: The General Theory of Employment, Interest and Money: Chapter 12. The State of Long-Term Expectation
- Bruce Bartlett: 'Financialization' as a Cause of Economic Malaise
- Greta Krippner: The Financialization of the American Economy
- Burton Malkiel: Asset Management Fees and the Growth of Finance
- Margaret Jacobson and Filippo Occhino: Labor's Declining Share of Income and Rising Inequality
- Adair Turner: What do banks do? Why do credit booms and busts occur and what can public policy do about it?
- Thomas Philippon and Ariell Reshef: An International Look at the Growth of Modern Finance
- Thomas Philippon and Ariell Reshef: Wages and Human Capital in the U.S. Financial Industry: 1909-2006
- Ozgur Orhangazi: Financialisation and capital accumulation in the non-financial corporate sector: A theoretical and empirical investigation on the US economy: 1973–2003
- Stephen G Cecchetti and Enisse Kharroubi: Reassessing the impact of finance on growth
- Robert Waldmann: Limits to Arbitrage Bites Again
- Paul Krugman: Money for Nothing
- Alexander Hamilton to Robert Morris, April 30, 1781
- Simon Johnson: The Quiet Coup
- Robert Waldmann: Sources of Social Surplus from Finance
- Felix Salmon: US financial profits
- Robin Greenwood and David Scharfstein: The Growth of Finance