It’s amazing that people are talking about how excessive finance and credit money warp the economy to its detriment without ever managing to mention the vital Austrian concept of “malinvestment”. But at least they are starting to talk about it, as it will lead them there eventually.
A new study from the Bank for International Settlements (the central bankers’ central bank, as it is dubbed) shows exactly why rapid finance sector growth is bad for the rest of the economy.
The study, by Stephen Cecchetti and Enisse Kharroubi, is a follow-up to a 2012 paper which outlined the negative link between the finance sector and growth, after a certain point. When an economy is immature and the financial sector is small, then growth of the sector is helpful. Enterprising businessmen can get the capital they need to expand their companies; savers have a secure home for their money, making them more willing to provide finance to the business sector; and so on.
But you can have too much of a good thing. The 2012 paper suggests that when private sector debt passes 100% of GDP, that point is reached. Another way of looking at the same topic is the proportion of workers employed by the finance sector. Once that proportion passes 3.9%, the effect on productivity growth turns negative. Ireland and Spain are cases in point. During the five years beginning 2005, Irish and Spanish financial sector employment grew at an average annual rate of 4.1% and 1.4% respectively; output per worker fell by 2.7% and 1.4% a year over the same period.
The new paper examines why this might be. One part of the thesis is a familiar complaint, neatly summarised in the 2012 paper
people who might have become scientists, who in another age dreamt of curing cancer or flying to Mars, today dream of becoming hedge fund managers
In short, the finance sector lures away high-skilled workers from other industries. The finance sector then lends the money to businesses, but tends to favour those firms that have collateral they can pledge against the loan. This usually means builders and property developers. Businessmen are lured into this sector rather than into riskier projects that require high R&D spending and have less collateral to pledge.
I’m reading the paper now, and will review it once I’ve finished digesting it.