Wall Street Costs The Economy 2% Of GDP Each Year

Isn’t the financial industry supposed to grease the wheels of commerce, rather than apply a severe brake on economic growth? It ain’t happening in the US, where Forbes says Wall Street is hogging so much for itself that it’s slashed growth by half of what it should be:

Wall Street is back,” says the New York Times, and the economic cost is high. The excessive financialization of the US economy reduces GDP growth by 2% every year, according to a new study by International Monetary Fund. That’s a massive drag on the economy–some $320 billion per year. Wall Street has thus become, not just a moral problem with rampant illegality and outlandish compensation of executives and traders: Wall Street is a macro-economic problem of the first order.


The Financial Tail Wags The Economic Dog

How has this happened? Properly scaled, the financial sector is a good thing. The financial sector plays a healthy role in translating products and services into exchangeable financial instruments to facilitate trade in the real economy. Through deposits, banks channel citizens’ savings to businesses that can use them productively. Through mortgages, workers can trade their promise of future wages for a home. Through insurance, homeowners are able to share financial risks and avoid financial catastrophe.

Problems occur when the financial sector gets too big. When the financial sector loses interest in the “boring” returns from financing the real economy and instead devotes its efforts to activities that are more lucrative in the short-term, like playing zero-sum games, or even negative-sum games, through complex transactions aimed at making money out of money, then excessive risk-taking occurs, with mis-allocation of human and financial resources and periodic financial crashes.

Throughout history, periods of excessive financialization have coincided with periods of national economic setbacks, such as Spain in the 14th century, The Netherlands in the late 18th century, and Britain in the late 19th and early 20th centuries. The focus by elites on “making money out of money” rather than making real goods and services has led to wealth for the few, and overall national economic decline. “In a financialized economy, the financial tail is wagging the economic dog.”…