[OPE] The role of finance in the economy...

Breakingviews.com
Less Finance May Be Just Fine
By EDWARD HADAS
Published: NYT November 2, 2008
Job cuts are the order of the day in finance - the business of money and promises. As painful as it may be, particularly in financial centers like New York and London, this shrinkage may mark a welcome reversal of a long-running trend.

 The financial expansion didn't start with the booming housing markets of the early 2000s or even with the stock market bubble of the 1990s. Finance has been a growth industry for six decades. In 1947, the sector accounted for 2.3 percent of United States gross domestic product. By 2007, it had grown to 8.1 percent, and the increase has been remarkably steady.
To listen to some politicians, finance may sound like a bad thing from top to bottom. That's wrong. Finance is tremendously helpful. Banks, brokers and their colleagues collect money from those who have it and distribute to those who need it. This industry helps manage inventories, build factories and spread economic risks around so societies can afford to take on more of them.

But finance helps the economy in much the same way the way a police force or an army helps keep the peace. Countries would be delighted to get the same order with fewer forces. They should be equally happy to get the same production and trade with less finance. Finance is a cost - not a benefit - of maintaining a complicated economy.

Some police officers and soldiers think the glamour and danger that come with their jobs make them worthwhile. Some financial types, especially those at the top of the heap, are similarly enthusiastic. But how many of them really earn that generous keep by increasing economic efficiency?

The answer probably can't be calculated precisely, but any gains have to be set against three sorts of harm.

First, a distressingly large portion of activity in the financial world is little more than gambling. When shares and bonds, or derivatives based on them, are bought and sold, the gains and losses almost cancel each other out. Such trading may be fun - portfolio management is a common hobby - but it does almost nothing for the nonfinancial economy.

As in organized gambling, the losses in financial trading are actually a bit greater than the gains because the house takes its share. In recent years, the financial house - brokers, exchanges, fund managers - has augmented its gains by playing from the inside. Until the crisis came along, such trading often paid off handsomely.

The second problem is not with the financiers but with the financial economy itself. Finance works primarily with credit rather than cash, and credit has been expanding greatly. The ratio of debt outstanding to gross domestic product in the United States has increased from 161 percent in 1974 to 354 percent in mid-2008. Half of that growth has been within the financial sector itself - from 17 percent to 114 percent of G.D.P.

Loans are promises to pay, which are much easier to make than to keep. The more credit-laden the economy, the greater the potential damage from broken promises. To see how a trickle of credit losses can turn into a cascade, just look around.

Finally, there is a psychological, even a moral, problem with finance. A country gets rich by making stuff, not by seeming to make money from money. But when people see huge financial profits - on Wall Street or just from owning a house - they tend to want more of them. The economically illusory gains of finance distract people from more valuable tasks.

So will the United States, and the world, decide that it has had too much of this not particularly good thing? Not necessarily, since a four-decade trend has the momentum of a speeding train. But the current hurricane of financial destruction might just be strong enough to derail it.

A durable reversal of finance's fortunes would be tough on Wall Street, the City of London and all whose livelihoods depend on keeping the industry running. But less finance need not cause any broader economic damage.

There's more than money involved. For at least a generation, finance has been taken up as a career by a disproportionately large proportion of the world's most talented people. If more of the best and the brightest were to take up careers in industry, education or the arts, everyone would be better off.

EDWARD HADAS

For more independent financial commentary and analysis, visit www.breakingviews.com.

http://www.nytimes.com/2008/11/03/business/03views.html

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Received on Thu Jan 29 17:12:11 2009