Finance goes from helping to hurting the economy when debt passes 100% of GDP

A new study from the Bank for International Settlements shows exactly why rapid finance sector growth is bad for the rest of the economy.

When private sector debt passes 100% of GDP, that point is reached. Another way of looking at the same topic is the proportion of workers employed by the finance sector. Once that proportion passes 3.9%, the effect on productivity growth turns negative. Ireland and Spain are cases in point. During the five years beginning 2005, Irish and Spanish financial sector employment grew at an average annual rate of 4.1% and 1.4% respectively; output per worker fell by 2.7% and 1.4% a year over the same period.

People who might have become scientists, who in another age dreamt of curing cancer or flying to Mars, today dream of becoming hedge fund managers.

Nextbigfuture notes that the USA has at least a double problem. There are too many highly qualified people going into finance and too many becoming lawyers.

Why does financial sector growth crowd out real economic growth? (31 pages)

In this paper we examine the negative relationship between the rate of growth of the financial sector and the rate of growth of total factor productivity. We begin by showing that by disproportionately benefiting high collateral/low productivity projects, an exogenous increase in finance reduces total factor productivity growth. Then, in a model with skilled workers and endogenous financial sector growth, we establish the possibility of multiple equilibria. In the equilibrium where skilled labour works in finance, the financial sector grows more quickly at the expense of the real economy. We go on to show that consistent with this theory, financial growth disproportionately harms financially dependent and R&D-intensive industries.

The productivity of a financially dependent industry located in a country experiencing a financial boom tends to grow 2.5% a year slower than a financially independent industry not experiencing such a boom

The productivity of a financially dependent industry located in a country experiencing a financial boom tends to grow 2.5% a year slower than a financially independent industry not experiencing such a boom

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