The information technology revolution of the 1980s and 1990s is justly considered one of the highest American achievements in the 20th century. Its positive impacts on the world economy, quality of life and opportunities to learn, connect and advance given to individuals around the world are universally acknowledged.
We have been far more ambivalent about another major revolution of the past quarter century, the financial revolution. Not only has it not been celebrated but, on the contrary, since the implosion of the housing bubble in the United States and the advent of the global credit crunch, it has been blamed for all our ills. Its achievements and benefits to society — which included, among other things, making the technological revolution possible — have been completely disregarded. Tighter regulation and greater restrictions on the financial services industry are looming, threatening to push it back to where it was in the 1970s.
This may end up throwing the baby out along with the bathwater. It is, in fact, very much like declaring that the use of personal computers, cell phones and the Internet should be severely restricted on the grounds that they have eliminated millions of excellent jobs for secretaries, typists and telephone operators.
It is ironic that the current financial and economic crisis is being blamed on lack of regulation and the hollowing out of U.S. regulatory structures. The truth is that resources available to the SEC were beefed up substantially at the start of this decade, following corporate malfeasance scandals involving Enron, WorldCom and other infamous cases. The U.S. regulatory environment was tightened and quite a few finance professionals complained that unnecessarily onerous restrictions cost companies millions for compliance while preventing foreign firms from listing their shares on Wall Street.
It is equally ironic that the call for new international financial regulations is being spearheaded by Gordon Brown, currently the British prime minister but over the previous decade chancellor of the exchequer. Brown oversaw the explosive growth of the City of London that took impetus from Britain’s lax, hands-off regulatory environment. The City prospered in large measure by attracting companies and financial institutions from Russia, the Middle East and other less transparent locales.
The consensus seems to be that the wrong thing was being regulated. Regulators should have kept an eye not so much on individual companies and their accounting practices but on the banking sector as a whole, making sure institutions were not taking on excessive risk, engaging in too much speculation or getting over their heads into derivatives, structured instruments, etc. Curiously, all those machinations in the banking sector are now widely seen as something that was going on outside the “real economy,” a kind of sideshow that got out of hand and scuttled our well-earned prosperity.
The reality, of course, was quite different. The explosive growth of the financial services industry and its revolutionary creativity are not only an integral part of today’s economy but the very foundation on which the prosperity of recent years was based. Many fewer of us would have had our own homes and well-paid jobs had it not been for the ingenuity of all those maligned, overpaid financial engineers.
From 1990 to 2006, the broadly defined financial services sector increased from 23 percent of U.S. GDP to 31 percent. That is a massive change, surpassing even the rise in health care expenditures over the same time period, which went from 12 percent of GDP to around 16 percent. Overall, the financial sector’s contribution to GDP increased by over $3 trillion during the past quarter of a century and accounted for one third of all growth in the U.S. economy. This has given rise to criticism that the U.S. has become mainly a manufacturer of financial derivatives and other fanciful financial products, essentially building a huge castle in the sand.
Yet, the banking sector, whose function is financial intermediation — making sure that savings are profitably invested in the form of loans so that they can earn an attractive rate of return for depositors — also grew dramatically, from around 4 percent of GDP to 8 percent. It was an era of extremely high investment and dramatic expansion of productive capacity, much of it accomplished directly or not by American companies with the assistance of U.S.-based financial institutions.
While it is true that the U.S. consumer has become overleveraged in this decade, it is also true that the rate of homeownership in the country increased, the standard of living has gone up and — perhaps most important of all — entrepreneurs, inventors and small businesses had unprecedented access to start-up capital from a variety of sources.
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