How Wall Street is crushing Main Street

The financial sector has grown faster than the rest of the economy, which cuts into long-term investment and overall growth.

By The Week Mar 28, 2014 12:20PM

Image: Bull (© Photographers Choice RF/SuperStock)By Sean McElwee and Wallace Turbeville, The Week


The conservative assertion that government spending "crowds out" private investment has been ascendant since Ronald Reagan's claim that "government is not the solution to our problem; government is the problem." The idea is that the government is so big that it discourages private investors from competing in the marketplace.

 

Today, we face the reverse condition: the casino market that dominates the finance sector is crowding out important public investments. The deregulation of the financial sector -- promoted by Republican and Democratic administrations -- has changed America from an economy focused on sustainable growth toward a free-for-all for the wealthy.

 

This change is called "financialization." The financial sector has grown to almost 8 percent of GDP, from about 4 percent in Reagan's time.


That the financial sector has grown isn't necessarily a problem; what is a problem is that it has grown faster than the rest of the economy. The purpose of the financial sector is to facilitate investment in a wide array of activities -- to grease the wheels of the economy, so to speak. If the rest of the economy doesn't grow along with the financial sector, it is not fulfilling that purpose.

 

Financialization causes many problems. First, the financial industry is a poor producer of middle-class jobs, disproportionately benefiting high-end earners (see chart).


Second, the financial industry is extremely myopic when it comes to economic trends. One study finds that the growth of the financial sector has decreased long-term investment in the real economy because financiers work in short-term gains and losses. Finally, financial "innovations" like securitization and derivatives have freed trading markets to grow unconstrained by the actual amount of stocks, bonds, and commodities in the real economy. One need only to recall the mortgage-backed market that crashed in 2008 to grasp the scope of this phenomenon. 


A consequence of the rise of the financialization machine is that there is less money available for government investment in the real economy. Direct federal investment is already constrained by fiscal dysfunction, so indirect investment is even more important. When the Federal Reserve tries to pump up the economy through easy money, that easy money flows disproportionately to the supercharged investment in the financial sector. The banks end up using it to backstop trading businesses, rather than lending it to productive enterprises that generate jobs in the real economy.

 

State and local governments, already strapped by tax bases decimated by the Great Recession, have to compete with the financial industry, since investing in Wall Street is more profitable than investing in Main Street. The financial sector's preference for the trading markets means that small businesses and households, the bulwark of state and local government tax bases, lose out in the competition for investment. As a result, critical public infrastructure investments have been ignored.


One study estimates that our infrastructure system needs a $3.6 trillion investment over the next six years. In South Dakota, Alaska, and Pennsylvania, water is still transported via century-old wooden pipes. Large portions of U.S. wastewater capacity are more than half a century old. And in Detroit, some of the sewer lines date back to the mid-19th century.

 

Government investment in research and development has plummeted, and this will not be replaced by private investment that must compete with the short-term returns from capital investment in trading. The Financial Times reports that "public investment in the U.S. has hit its lowest level since demobilization" after World War II. That's a shame, because investments in science, for example, produce huge benefits, both in terms of well-being and economic growth.


The Human Genome Project, for instance, cost 3.8 billion in public funding and has produced economic gains of $796 billion. That's a return of $140 to $1! The Internet, too, was a product of government research and has produced tens of trillions of dollars in economic output and growth.


Public spending in the U.S. is far below the international average (see chart), and the rise of finance is part of the cause. By taking up a larger and larger share of the economy's resources and using them for the economic equivalent of roulette, we've allowed important public investments to be passed up.

 

This is simply unsustainable. Rabindranath Tagore once warned of "precocious schoolboys of modern times, smart and superficially critical, worshippers of self, shrewd bargainers in the market of profit and power" who, "driven by suicidal forces of passion, set their neighbors' houses on fire and were themselves enveloped by flames." Today, these schoolboys increasingly sit on Wall Street, diverting resources from the real economy into fat paychecks. The only question is when the economy will again be enveloped by flames.

 

More from The Week

123Comments
Mar 28, 2014 12:39PM
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Total supply side economics is short term gain over long term loss and goes right along with your perception.  These greedy cats will eat their young as well as their seed corn and sit back fat and happy thinking they have actually accomplished something.  Imagine cheering the country for going into more debt to realize a profit at the expense of the other citizens futures.  This is everywhere in this country now and I suppose for some is an indication the end is near. You have to impart a value to support an economy.  We have an insidious Industry now feasting off the fatty underbelly of the American economy and they have zero regard to any harm they are doing to the total sum.  It's here's to me and the heck with you.  But when something appears free to these NEW Americans watch out.  Does anybody actually care about the country or the citizens any longer?  I'm having doubts.

Mar 28, 2014 2:40PM
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All by design! Destroy the Constitution, The Middle Class and the Dollar. This is "The New World Order". Check out the committee of 300 and connect the dots. Not one Wall Street executive or Banker has gone to jail for the Biggest Heist in US history.
Mar 28, 2014 12:55PM
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""""Public spending in the U.S. is far below the international average (see chart), and the rise of finance is part of the cause. ."""

 

there simply is no investment in public infrastructure.  there never was "investment" there.  we already pay for infrastructure, however instead of getting labor and material for our payments, our tax money now only goes to labor.  there is nothing left for material. 

 

""" When the Federal Reserve tries to pump up the economy through easy money, that easy money flows disproportionately to the supercharged investment in the financial sector. The banks end up using it to backstop trading businesses, rather than lending it to productive enterprises that generate jobs in the real economy."""

 

government money to wall street only goes to the upper crust.  this is a form of kick back from government to 1%'er private sector.  there's no doubt someone is being paid back for their influence. 

 

there government hasn't done any "investment" in USA since the moon race or space shuttle efforts.  and they likely never will again due to the extreme influence wall street has anymore in the government. 

 

 

Mar 28, 2014 2:05PM
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Wasn't this what Occupy Wallstreet was all about before it got taken over by the hippies because regular people had to go to work?
Mar 28, 2014 2:40PM
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We are now a fascist nation ran by corporations and banks.  These entities exist only to make the most amount possible in the least amount of time.  All the easy money goes into their gambling in the stock market and if they lose then we will all pay not them.  They have worked themselves into running the government as well.  Ever since Glass Stiegel was repealed and derivates and fractional reserve banking we have gone down hill.  All the problems are so plainly evident to anyone with a 6th grade education but since they have all the power and influence no one will ever change it.  America is a corporate police state and it will only get worse from here.  When they make guns illegal or unobtainable is when we really have to worry.  That is the point at which they will completely enslave all of us and start killing and ghettoizing everyone for their own gain. 
Mar 28, 2014 2:49PM
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The only people making money are the people moving it around and skimming a percentage off the top for themselves. The more money they move around the more money they make. How does this help the overall economy?  We bailed out all these guys, slapped them on the wrists, and then filled their pockets up again with even more cheaper money. When will we ever learn? The best that the little guy can hope for is invest in a good no load Mutual Fund and sleep with one eye open.    
Mar 28, 2014 3:55PM
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Wow!!!  An article that actually states the banks took the bailout money and kept it for themselves instead of loaning it out to stimulate the economy?  Anybody who didn't know this when the bailout was announced is an idiot. 
Mar 28, 2014 2:38PM
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Everything is fixed to the advantage of the rich and powerful.........but only temporarily.

Mar 28, 2014 12:38PM
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Duh... they started with all the REAL money, were given a million times that in FAKE money, bribed the governments of the world and invited all the law firms to be windfall recipient clients... what more can be said? Freedom is dead and so will the world unless we stop financial tyranny.
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Hmmm -- they tells us that government taxes are lower in Europe and yet there it is almost 40 to 50 percent of GDP as tax revenue vs 25 percent of GDP for the US

I say we increase the cap gain tax rate to 50 percent to get our tax percentage up and tax each transaction in the stock markets about 1 cent per with like billions each day that would bring in tens of millions of dollars each day and hey with APPLE and GOOGLE and others going for $500 plus a share a mere penny seems like nothing.

Mar 28, 2014 2:19PM
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It's an interesting piece in that it brings together conervative and liberal critics of Fed spending on stimulus through the banking sector.  Both agree with the author that Fed stimuls is inefficient at promoting real infrastructure investment, which our economy desperately needs, and mostly enriches the financial sector instead of making productive investments. 

 

But libs and cons diverge on the solutions:  conservatives would simply eliminate the Fed's $55 billion/month treasury purchase stimulus spending (and blow up the Fed itself). Liberals would eliminate Fed spending and replace it with direct government stimulus spending on infrastructure (much larger than the $800 billion in ARRA) until the private sector is able to sustain itself with a normal level of unemployment (below 5%).

 

Those who worry about our massive Federal debt are right to worry if it is mostly fat (i.e. unproductive investment in the finance sector).  But debt capital invested in infrastructure and productive enterprise is not scary, as long as the real economy is growing as a result and can service that debt.

Mar 28, 2014 2:36PM
Mar 28, 2014 2:49PM
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The one percenters are at it again.
Mar 28, 2014 2:49PM
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Government has always been the problem, financial and otherwise, whatever it was that some of the founding fathers had in mind surely isn't what we have today.... For the most part the people running America and holding political positions long after their ability to think or relate with the population has ended in crisis that will not be overcome my them. They are today nothing but old selfish men and women helping themselves to the cookie jar, when a newcomer arrives they beat them into submission quickly.
Mar 28, 2014 1:13PM
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"Nearly a million jars of peanut butter are being dumped at a New Mexico landfill"

 

What a waste. Think of the fun that could have been had watching nude girls doing peanut butter wrestling.  

Mar 28, 2014 2:00PM
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The reason I know absolutely that stocks and houses are way way over-priced is because the fed (the government) is propping up their prices using every stunt they can think up. In order to achieve real prices government intervention is not required!

Mar 28, 2014 3:59PM
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Maybe if GOVERNMENT would stop protecting the wealthy from market forces, this would work itself out.  But, NO ---  envious idiots will keep crying about income disparity and demanding more regulation and confiscation.   Then they will wonder why there is so much real unemployment and it is hard to run any kind of small business.

OH --- that's right --- GOVERNMENT IS THE PROBLEM.

Mar 28, 2014 1:57PM
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"NEW YORK- Investors in some of the past year's hottest U.S. stocks have been given a savage lesson in the risks of so-called "momentum trading". A group of 24 such companies compiled by Credit Suisse has lost $63 billion in market value, or almost 19 percent, so far in March. One of them, streaming video service Netflix , has declined on 15 of the last 17 trading days, while another, online travel service Priceline , is on pace to for its worst month in nearly two years, while Twitter on Wednesday sank below its November first-day closing price for the first time since December, when the company had publicly traded for less than a month.

The sell off may well have further to go, investors warn."


This says- YOU LOSE ALL YOUR MONEY STAYING IN THE MARKETS. So, why are you?

Mar 28, 2014 1:14PM
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"The whole premise of this article is flawed - private investment is crowding out gov spending?  Give me a break.  Have you seen the federal budget lately?"

Actually it's not flawed in manner you suggest and it's actually right on point. The Financialization by the FED of Corporate America is targeting massive amount of spending towards Stock Buybacks and Dividends and very little towards Capital investments in the Actual Corporation or infrastructure needs of America's future. But of course, folks like Brutus decide to mislead, again.

"I love it when progressives talk about deregulation as if there are now no laws, no SEC and no oversight anymore.  Ridiculous!  There are plenty of laws already on the books - tens of thousands of pages of them, we just have to enforce them equally.  And deregulation will work just fine if we let the free markets work. "

Deregulation led to Too Big To Fail and Too Big to Jail. Deregulation also led to the Great Recession here and a continual recession Globally. Plenty of Regulations on the Books that need to be enforced. Deregulation just leads to more Greed, Corruption, and bigger Recessions.
Mar 28, 2014 3:08PM
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Poor Mike West-he thinks that if he sniffs enough 1% rear ends he'll move up. Sorry Mike, the 1% will just have you go to work on the front when your done.
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