Monday, February 18, 2013

Glasner on finance

In Falling Real Interest Rates, Winner-Take-All Markets, and Lance Armstrong, David Glasner writes:

... insofar as reduced marginal tax rates contributed to an expansion of the financial sector of the economy, reduced marginal tax rates may have retarded, rather than spurred, growth. The problem with the financial sector is that the resources employed in that sector, especially resources devoted to trading, are socially wasted, the profits accruing to trading reflecting not net additions to output, but losses incurred by other traders.

I wouldn't say "socially wasted", but that's just me. Glasner's important point is that an expansion of the financial sector may have retarded growth. Now, that's not something you see economists say every day!

In Of the Component Parts of the Price of Commodities Adam Smith identified three things needed to create something of value: material to work on, the working, and tools to work with -- land, labor, and capital.

He called these "the three original sources of revenue". The sources of all income.

Creating things of value was central to Smith's analysis, because the creation of things of value is the source of the wealth of nations. Work is the connection between the world of things and the world of value. If someone will pay you to do something, it is because they value whatever it is that they want done. When you do it for them, income is created. And if you add up all the income created in a year, you get GDP. (And you know how important GDP is.)

Smith pointed out that not all activities create value directly:

The interest of money is always a derivative revenue... All taxes, and all the revenue which is founded upon them, all salaries, pensions, and annuities of every kind, are ultimately derived from some one or other of those three original sources of revenue

All income arises from the three factors of production.

All income is cost. The cost is worthwhile because of the production derived from it; this is the meaning of the word "value".

But not all costs arise from the three factors of production. I recently referred to the interest of money as the factor of facilitation.

The problem with the financial sector is that the resources employed in that sector generate cost but not production. Granted, finance facilitates production. But there is no linear, one-for-one increase of output per dollar of financial cost.

Finance brings non-linearity into the picture. This is how it happens that questions of debt productivity and credit efficiency arise.

Comparable questions arise regarding the size of government, and for exactly the same reason. But everyone looks at the size of government, and no one looks at the size of finance, and therein lies the problem.

To paraphrase David Glasner, the income that accrues to finance is losses incurred by productive factors.

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