June 28, 2012
That’s the implication of a new study by two economists, Stephan Cecchetti and Enisse Kharroubi, at the Bank of International Settlements. This study analyzed the link between growth and the size of the financial sector across 50 wealthy and developing countries. It found that a larger financial sector seems to foster growth up to a certain point. After achieving an optimal size relative to the size of the economy, the financial sector acted as drag on growth when it grew larger.
The study looked at industry level data from a smaller sample of wealthy countries. It found that industries that were the most dependent on external financing and that were heaviest in R&D spending were the ones that were most likely to experience slower productivity growth in countries with rapidly growing financial sectors.
There is a plausible explanation for this pattern. In the first case, if a bloated financial sector is pulling away capital that could otherwise have gone to productive investment, then it makes sense that the most affected sectors would be the ones that need external financing. The companies that can generate all the money they need for investment from their own profits may not be hurt much by an over-sized financial sector.
In the case of R&D intensive industries, the financial sector should be viewed as a competitor for talent. If there are lots of high paying jobs for people with good math and technical skills in finance, then they are less likely to be working in designing software.
The Wall Street crowd will no doubt raise some issues with this study. For example, in looking at the effect of the size of financial sector on growth, it might be appropriate to have a non-linear control for starting income levels, meaning that we may expect that very wealthy countries have slower growth than other countries, but middle income countries may not. (This could distort the findings if very wealthy countries also have relatively larger financial sectors.) Also, it might useful to use 2007 as an end point in the industry regressions rather than 2008. Productivity growth in 2008 largely reflects how quickly firms could dump workers in response to the downturn.
But on the whole the basic analysis looks pretty solid. The moral of the story would seem to be that if we want more people to work developing new computer technology that people value or making advances in medicine that will extend and improve people’s lives, then we want fewer people working on Wall Street.
More Apple, Less Wall Street!
