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Is the Financial Sector Too Big?

By Anonymous

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?probably 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.

Full post as published by Economics of Contempt on March 31, 2009 (boomark / email).