Tuesday, April 27, 2010

How did finance swallow the economy? (George Packer)

Trying to diagnose and reform the pathologies of the financial system that brought on the financial crisis of 2008 and, by doing so, helped trigger the larger economic crash from which we're still just beginning to recover ... is a complicated business, which will require wrestling with a whole range of difficult, complex, interconnected, and in some ways dauntingly intractable issues. It's clear that the beginning of wisdom is to recognize that this is not a simple or mono-causal problem with a single magic-bullet solution.

On the other hand, it's also important not to lose the forest for the trees. As George Packer correctly pointed out last Thursday in his New Yorker blog, the most fundamental questions, which in practice are all too easily ignored or evaded even by serious proponents of financial reform, are "the ones that Paul Krugman, Simon Johnson, and others have been addressing over the past year and a half:"
[D]o we need a financial sector whose share of gross domestic product has doubled over the past several decades? Is it healthy for financial services and investment to dominate our economy as they do, and to consume the talents and advantages of astounding percentages of our élite graduates?
(My emphasis.) For some time now, John Rentoul has been running a nice series of "Questions to Which the Answer is No". It's clear that these questions belong there.

And they get to the heart of the matter. The financial system we have now is not only dysfunctional in many of the ways it operates, too open to frauds and swindles, too prone to instability and crisis, and so on. It's also just too big. It has swallowed up too much of the economy, too much talent, and (Packer could have added) too much political influence.

(For some further elaboration of what people like Paul Krugman, Simon Johnson, and Paul Volcker have been saying on this subject, see Time to restore some sanity to the financial system.)

And here are some more questions to follow those up:
Are long-term growth and shared prosperity ever to be found in an economy that depends so heavily on electronic transactions rather than production? Is social cohesion in a democracy possible when the gap in incomes between investment bankers and doctors, let alone teachers, let alone fast-food workers, is as enormously wide as it is today?
Again, no.

Effective reform of the financial system is essential (which doesn't necessarily mean it will happen). But, by itself, that won't address an even deeper and more fundamental problem--the enormously overgrown role that the financial sector has come to play in the overall economy and, by extension, in society and politics more generally. That role has metastasized over the past three decades or so, and figuring out good ways to shrink it back to reasonable proportions (without generating unpleasant side-effects in the process) is the most difficult challenge.

Of course, as Packer notes:
Investment bankers like to say that what they do makes the rest of the economy work.
And, up to a point, this is certainly true. But only up to a point. Aside from the fact that what they do can also sometimes help blow up the rest of the economy--which ought to be a sobering consideration--we need to qualify this claim in another respect, too. Some of the things that banks and investment firms do help to make the 'real' economy function effectively, and sometimes that happens through indirect mechanisms that may not be immediately obvious. (That's part of the logic of a market economy.) But it's by no means clear that everything they do benefits the larger society. For example,
the synthetic products that helped create Goldman’s record-breaking profits, drove the financial system close to collapse, cost millions of Americans their jobs and houses, and led to a civil suit against the firm have no economically redeeming aspects whatsoever. They have as little to do with productive activity as high-stakes blackjack.
Now, blackjack might be OK as long as you're gambling with your own money. But as Louis Brandeis pointed out almost a century ago, one of the central and inescapable features of the financial system is precisely that it involves some people gambling with other people's money. So all of us have an interest in making sure that this particular casino doesn't run wild--and that it doesn't dominate the rest of the economy.

(You can read the rest of George Packer's post here. Again, for some elaboration on the substantive issues, see Time to restore some sanity to the financial system. And I really do recommend reading that book by Louis Brandeis, published in 1914 but still surprisingly timely: Other People's Money--And How the Bankers Use It.)

--Jeff Weintraub