Has the Growth of the Financial Sector Harmed the Economy?
A new study by the Kaufmann Foundation purports that the growth of the financial sector in the United States in recent decades has signficant economic costs over and above those costs of the current recession.
The first problem, according to the study, is that the complexity of financial instruments has cannibalized employees who are otherwise the types of people who start businesses based on innovation:
The financial sector, which includes lending, stock brokerage, complex securities and insurance, among many other services, derives enormous profits from collateralized debt obligations. These new products require such sophisticated engineering that the industry now focuses its recruiting on new master’s- and doctoral-level graduates of science, engineering, math and physics, and pays them starting wages that are five times or more what they would have earned had they remained in their own fields.
“Because these new hires are often the very individuals who otherwise would have comprised the most robust pool of prospective founders of high-growth companies, the financial services industry’s steady rise has had a cannibalizing effect on entrepreneurship in the U.S. economy,” said Paul Kedrosky, Kauffman Foundation senior fellow and one of the paper’s authors. “Excessive financialization exacerbated and distorted the flow of capital in the economy, potentially suppressing entrepreneurship by drawing away entrepreneurial talent.”
The second problem, claim the authors, is that an excess of capital leads to less robust businesses getting funding, leading to a weaker economy overall:
“While the rate of entrepreneurship fell and then flattened over the past two decades, financialization also likely affected the caliber of startups,” said Dane Stangler, Kauffman research manager and co-author of the paper. “An excessively dominant financial sector may have made it easier for weaker (or potentially weaker) companies to obtain financing, thus helping to maintain that steady rate of entrepreneurship but possibly contributing to the declining quality of newly established businesses.”
On the bright side, the authors note that the financial sector is unlikely to continue its rate of growth, which could lead to overall economic benefits.
The full study can be found here.