economics
Has the financial sector become a drag on the real economy?
American Compass
Oaktree Capital
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Genesis
Response
Penultimate
Finale
May 4th, 2021
How can I best respond to your sweeping criticism of the U.S. financial system? First, let's tell it like it is. It's probably true that the financial sector is bigger than is necessary for our economy to function.
But how did it get that way? Critics of the financial system give the impression that its shortcomings result from conscious decisions made by some mysterious characters intent on hijacking part of our economy. But that's not the case.
An economy -- especially a free-market economy -- isn't the result of conspiracists' manipulations, but of decisions made daily by millions of consumers, workers, and managers of businesses.
No one ever said, "let's expand the U.S. financial sector." People flock to work in finance, and they make money. Thus the sector must provide something good to someone. If not, where do financial firms' profits (and their ability to provide lofty compensation) come from?
Likewise, some manufacturers shut down in the U.S., meaning some procurement and jobs shifted overseas. But no American ever said, "let's make the U.S. a smaller factor in manufacturing." Rather, businesses found cheaper goods abroad; thus manufacturing contracted as a share of the economy.
It's true that investment banks don't provide tangible consumer products. But that's not the same as saying, as you do, that they don't "improve the typical family’s life, create better jobs, or expand productive capacity." Their ability to raise money enables U.S. businesses to start and grow and gives consumers the ability to borrow and live good lives.
You say it's the financial sector's job to make capital available, and then you criticize it by saying the cost of capital hasn't declined. First, for most suppliers of capital -- like me -- the prospective return we're receiving on our capital (i.e., the users' cost of capital) is the lowest we've ever seen. And it's easier to raise capital than ever.
Further, you overlook Wall Street's other responsibility -- to make markets function smoothly. Trading in assets, while not generating a tangible product for consumers, usually has the effect of reining in extreme over- and under-valuations. In other words, the participants' collective efforts to garner trading profits have the effect of policing the markets.
Finally, there's nothing suspect about companies' decisions to return cash to investors rather than reinvest in their businesses. Rather than some malign conspiracy, this likely results from two factors: (a) today's digital businesses -- the fastest growing part of the economy -- require less capital to expand than did the metal-benders of the past, and (b) with the economy growing slower than it did from 1950 to 2000, reinvestment opportunities aren't there to the same degree.
Churchill said, "democracy is the worst form of government, except for all the others." I'd say the same for our free-market economy. Yes, it has produced an oversized financial sector and allowed domestic manufacturing to decline. But it has also given us rapid economic growth, global preeminence, and a high standard of living. I'll take it, warts and all.
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