Is Wall Street Too Big and Actually Hurting the US Economy?
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A new study by the International Monetary Fund (IMF) investigates the dangers of financial systems that have grown too big too fast. The excessive growth of the American financial system causes an enormous drag on the US economy, reducing GDP by 2 percent every year. That equates to some $320 billion lost each year.
How Did This Happen?
A new study by the International Monetary Fund (IMF) investigates the dangers of financial systems that have grown too big too fast. The excessive growth of the American financial system causes an enormous drag on the US economy, reducing GDP by 2 percent every year. That equates to some $320 billion lost each year.
How Did This Happen?
Properly scaled, a strong financial sector is a good thing for a nation’s economy. The financial sector turns products and services into financial instruments to facilitate trade that leads to capital gains for business entities. This leads to greater capacity for research, development, and production, and helps to boost the economy and GDP. The financial sector also contributes to private growth and investment through mortgages and insurance investments.
As with most things in life, though, too much of a good thing can be very bad. The financial sector becomes a problem for the economy of its host nation when it gets too big. When investors lose interest in mundane investments, and focus on short-term investments with higher risk and return, problems begin to occur. Throughout history, over developed financial systems tend to coincide with economic setbacks.
The problem stems from trying to “make money out of money.” Playing zero-sum games (or even negative-sum games) through complex transactions create situations in which excessive risk-taking takes place. This leads to improper allocations of human and financial resources and periodic financial crashes. When the focus shifts from investing in real products to making money from money, the elite gain wealth at the expense of the rest of the economy.
When is an Economy at Risk?
Another IMF study from 2012 showed that an economy becomes too large when private-sector credit reaches 80 to 100 percent of GDP. At that point, credit actually inhibits growth and increases volatility. In the United States, private-sector credit was 184 percent of GDP as of 2012.
According to the new IMF study, the cost this over-sized credit situation causes is not insubstantial. The IMF report quantified the direct cost to US economic growth at 2 percent of American GDP per year. Were the American financial sector properly sized, the US economy would be enjoying a normal economic recovery of 3-4 percent per year instead of the disappointing 1-2 percent it has experienced over the last several years.
