Simon Johnson on the Evidence for Overmighty Finance

Simon Johnson posted Tuesday on The Baseline Scenario a loose review of the economic data behind the argument that finance is simply too large. Over the past few weeks this theme has heated up; the Financial Times has columns Wednesday by Willem Buiter and John Plender wrestling with Adair Turner's comments about a new global Tobin tax and about related issues of size and financial innovation. In fact, this wandering debate (which seems to be much more active in the U.K. than the U.S.) does indicate how tightly linked matters of size, innovation, and larger macroeconomic results like stagnating wages or bank failures have become in folks' minds.

Johnson's post essentially reiterates a point I made Aug. 27 on an FT column by Harvard's Benjamin Friedman: For all its influence, economics doesn't really have much to say about something as fundamental (and yes, complex) as the relationship between the size of the financial sector and growth in the real economy. Johnson, who would clearly love to see evidence that financial size creates diseconomies, has to admit he can't find it -- at least not yet. The best he can do with a welter of conflicting observations -- including his own tortured attempt to compare finance to either electricity (good) or junk food (bad) -- is that while there is "a lot of research" that shows a relation between size and growth, the work "has a lot of limitations" and shows "correlation," not "causation." His proof that finance can get too big is poor Iceland, which is like saying the proof that government can get too big is the old Soviet Union. It might be true, but where do we go from there?

Johnson admits the work is at a very early stage. The question that recurs, as a non-economist and certainly as a non-academic, is why hasn't a topic that would seem to be so central to questions of growth and development in any era hasn't been pursued? Was it because its complexities and non-quantitative aspects did not fit into the usual narrow academic tenure-track routine? Was it because the conventional wisdom was strong that big finance produced big growth? Was it simply too big a question? At the very least, Johnson (and Friedman's) honesty about the lack of underlying proof undercuts the certainties of both camps: the big- finance-is-always-good gang and the break-em-up-boys.

I don't usually make comments about commenters, but in this case there's a relevant aspect. Johnson gets a lot of comments of an unusually high quality. In this case, it's clear that many of the commenters didn't really care what the economic evidence is; they know big finance means big trouble. Many pooh-poohed Johnson for even making the attempt to find some evidence for something that was so "intuitively" obvious. It was a matter of faith, and one that policy could and should be erected upon. So even while Johnson himself was grudgingly admitting some uncertainty, they were ready to plow ahead and shrink finance back to what they assumed was a more appropriate size, whatever that may be. Maybe they're right. But other folks out there also "assume" that supply side tax policies are intuitively right, and they're regularly accused of believing in faux economics. Both beliefs are tiny windows into how the obvious "truths" that fuel a bubble mentality, which shares a bed with an ideology, get created and diffused.

Also see:

The Nature of Modern Finance
Benjamin Friedman on overmighty finance

Robert Teitelman is the editor in chief of The Deal.

Comments

[joebhed]

I think if you take a look at the central bank research papers of the IMF, WB, BIS and, to a lesser degree, the Fed, you will find very specific criticism of this so-called financialization of the American economy, and its resulting problems of unemployment, reduced wages and a general negative effect on normal prosperity.
I think most people would agree about the general unfairness of the anti-democratic nature of the money powers.

I see little in Simon's writings on any solution to the problem.
yadda, yadda.
It is structurally deficient and it must be structurally reformed.

We don't need no regulation.
We need a legilative change to a new money system.
Interestingly, this new money system would be the old money system, just not the present money system.

In our Declaration of Independence and in our Constitution, the people reserved for themselves the right to own and control the nation's money system.

Hello, Simon.
We want it BACK.
It is OUR money system.

http://www.youtube.com/watch?v=fGV-NCmHFE8&feature=channel_page

[DiogenesOfAlaska]

Statistics is not the only method by which it can be seen that institutions too big to fail mean big trouble. For example, while it is historically true that the US introduced anti-trust laws only after bad experiences, there are perfectly valid theoretical grounds for those laws. They simply hadn't been widely known or accepted at the time.

[Aaror]

Money is a representation of the productive capacity (goods and services) of society.
Finance does not produce goods and services, rather they determine who should receive those products of industrial and commercial capacity.
In other words, the Financial sector is a tax on production in exchange for deciding who will get what. If they are making more money, we are all making less. If they are making 20% of the GDP, then our real GDP is 80% of the reported GDP, and in practice it is 60%, because the folks who make money in finance take our goods and services as payment for deciding who gets what.
A 40% tax rate, higher than any other tax rate in the US, is it too big now???