When Wall Street Wins The Economy Loses

Mainstream political thinking holds that a nation's economic fortitude relies on an ever-expanding financial sector. But new research disputes the notion. In a new paper titled “Why does financial sector growth crowd out real economic growth?” authors Stephen Cecchetti and Enisse Kharroubi show that when banking blossoms, the “real” economy withers.

To see the way the economies of developed nations have transformed in the past few decades, look no further than the career choices of elite college students.

“When I was in school, everyone wanted to fly to Mars or invent cold fusion,” says Cecchetti, a professor of economics at Brandeis International Business School. “In the '90s, everyone wanted to become hedge fund managers.”

The shift in skilled workers toward finance plays a central role in the study. But the paper goes deeper to show how these shifts have affected real economies.

"Textbooks tell you that financial intermediation is about efficient capital allocation.” Cecchetti says. As the theory goes, society needs a sector that stokes innovation by bankrolling research and identifying promising companies. This lines up with what Cecchetti and Kharroubi have seen in smaller economies with modest financial services. “In frontier and emerging-market economies, you have to make sure that the financial infrastructure is there.”

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