Does this statement disturb you?

In 1950, finance and insurance in the United States accounted for 2.8% of GDP, according to US Department of Commerce estimates. By 1960, that share had grown to 3.8% of GDP, and reached 6% of GDP in 1990. Today, it is 8.4% of GDP, and it is not shrinking. The Wall Street Journal’s Justin Lahart reports that the 2010 share was higher than the previous peak share in 2006.

It’s certainly not surprising is it? It makes perfect sense considering the rise of banking and Wall Street over the last generation or so. This blog has said before that this rise also lead to greater levels of compensation, and thus drew talent that may have otherwise focused on other areas (like science or education). This probably further grew the industry’s share of the economy. And when people read these kinds of comments about the rise of Wall Street it is worrisome that they always think this is a bad thing.

Consider the following. Your grandparents likely retired on a pension and collected social security and hardly ever needed to save for retirement. In 1950 the average person lived to be 68 years old. Retirement didn’t last very long, if at all. In 2009, we were living to be 78, and we all know this number is only going to rise with time. That’s an extra decade of living expenses. How is that being paid for? Pensions have had to invest considerably more money in order to deal with the burden of people living longer. Reforms here and there occasionally soften the blow for them, but the burden is still much higher than it used to be. Pensions now invest in riskier securities, and get better returns too. Wall Street’s role was to facilitate the transactions that enabled these pensions to survive just a little bit longer and pay the retirements of all these people.  And to say nothing of the rising insurance needs of the aging population.  Those premiums are invested too. When a new demand is born, an industry grows.

When you consider that baby boomers are just now retiring the rise of Wall Street makes even more sense. These were the first group of people that may have to sustain their retirement with personal savings and investments. 401(k)s became very popular in the 1980s and of course still are; IRAs too. Now people were taking their retirement into their own hands. This gave rise to the mutual fund industry and now you have a bulging population entering the prime of their careers and saving for their own retirement. Again, an industry grew to service this demand.

Just as everyone was taking responsibility for their own retirements, the internet was about to start growing too. With the internet, people were able to take their own financial management to a new level. Soon, people would be able to buy and sell stocks within a few minutes, and then seconds through online brokerages. Once again, an industry rose to meet this demand.

Further still, consider the globalization that has occurred. More so than ever before, we are engaging in huge levels of trade, moving trillions of dollars to Moscow, Beijing, Tokyo, London, Singapore, Dubai, and Rio. This movement happens at the speed of light and the infrastructure to enable it was built and managed by the finance industry.

The rise of Wall Street shouldn’t be concerning at all. Given the changing demographics and economy, it makes perfect sense. And what of the greed and the financial crisis? Unfortunately, finance is not a stable industry. The financial crisis had a lot of causes, and Wall Street was certainly part of that. Together with a poor incentive structure, they again rose to meet a demand. This is a case of the industry getting ahead of itself.

No one should be surprised nor concerned that the industry continues to be a large part of the economy. Our lives are more financially complicated. The financial crisis is a perfect example of the growing pains. It’s impossible for this industry to grow and meet demand without making mistakes. Everyone made mistakes. I’m no apologist for the criminal, greedy, and immoral acts in any industry. But the rise of finance as a share of GDP is merely a reactionary metric of the way the world has changed.

Image: Jan Tik

categories: banking, business, economics, government