Wednesday, June 20, 2012

Why Has US Finance Grown? Because The World Is Not a Monad

. Wednesday, June 20, 2012

Guesting at Noah Smith's place, Dan Murphy seeks to explain why the financial sector grew to be such a large component of the US's economy during the 2000s. He offers three possibly explanations: finance became better at "making markets" by matching buyers and sellers, the need to manage risk became more important, and that people became convinced that employing financiars would help them boost their investment portfolios. Murphy suggests that the first two are not good explanations because they are static variables unable to explain change. He doesn't seem to think the third is as well, although it seems that way to me.

I don't think this is the right way to think about this. Instead, I'd rather embed finance into the broader US economy and then embed the broader US economy into the broader global economy. What changes have been taking place in the global economy over the past decade-plus that could help explain this? Two prominent things immediately come to mind:

1. The opening of capital accounts around the world, which began in the 1990s but accelerated dramatically during the 2000s.

2. Changes in the global trading system, particularly the expansion of the GATT -- which added many new members following the end of the Cold War -- and the transition from the GATT to the WTO.

The cumulative effect of these two factors both forced encouraged the US to pursue its comparative advantage in high-skilled service labor (e.g. finance) and increased the market into which the US could sell its comparative advantage. The result is thus entirely predictable: finance becomes a bigger size of the US's economy, while comparatively disadvantaged sectors shrank. Factor in positive feedback dynamics in global financial markets and this isn't much of a mystery at all.


joan said...

Comparative Advantage? Has the finance industry become more efficient? Bloated financial system- As Philippon comments "current financial system does not seem any better at transferring funds from savers to borrowers than the financial system of 1910." Summary at

Kindred Winecoff said...

Joan -

The US financial system is inarguably better at selling their services to the rest of the world than it was in 1910.

joan said...

Something is wrong here-why is the global market buying services that are adding very little value relative to 1910. Global market is not buying typewriters-

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Anonymous said...

Comparative advantage is about the relative advantage of one state against others - not the absolute efficiency of an industry within that state.

That voxeu article doesn't make sense, nor do the conclusions you draw from it: If the US finance industry had been MORE efficient in transferring from savers to borrowers, there would have been more people saddled with toxic assets.

Unknown said...


Why Has US Finance Grown? Because The World Is Not a Monad




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