Tuesday, May 19, 2015

Finance Industry as a % of GDP

Time for a simple economics lesson we can all enjoy.  So gather round and listen to ole Uncle Cappie.

The finance industry, technically produces nothing of value.  Yes they provide banking services.  Yes they keep your money safe.  But in the grand scheme of things the finance industry merely supports the production of stuff.  It in it of itself produces nothing of value.

Because of this you would like to see the finance industry account for as small as a percentage of GDP as possible as it would indicate the industry is being "efficient" by supporting the "real" economy consuming as little as possible in terms of resources.  Matter of fact, you'd like to see it shrinking as this would indicate efficiency gains allowing the finance industry to support increasingly more real production while consume the same or less amount in terms of resources.

So what has happened to the US finance industry as a percentage of GDP?  Well this.

While at the end of WWII the finance industry only accounted for 2.5% of GDP, today it's now over 7%, almost reaching 8% during the height of the housing bubble.

So why is this happening and why should you care?  Because it explains a lot about the global economy and portends things for our future.

First, the US economy has gone from an industrial one to one where we are increasingly  more service based.  The decline in industry and manufacturing was caused by outsourcing our industries overseas as labor (and taxes) were typically cheaper.  This helped increase services as a percent of our GDP, partially explaining the tripling of the finance industry's size relative to GDP.

Second, manufacturing is hard and math based.  If you had the choice to work on an assembly line, doing manual labor for 8-10 hours a day, or sit in an air conditioned cubicle farm clicking a mouse, most people would prefer the air conditioned cubicle farm.  And so as economies grow they prefer to pursue these "easier" industries as they are not only likely more profitable, but just plain "easier."  Alas, this is why we have "Tina the 25 year old social worker" and "Chip the investment banker" while China has "Jing the suicidal iPhone assembler" and "Chang the coal miner dying from black lung."  Modern Americans would just prefer not to get their hands dirty, and there's really no dirty hard work in banking.

This results in a sort of "tail waging the dog" as a flood of labor into banking and finance bloats the industry's size relative to the rest of the economy, while providing less and less value to the real economy.  Alas, this is why most finance positions are sales and not providing services that help the rest of the economy grow.

Third, as the world economy becomes more integrated and globalized, different countries specialize in different things.  And so instead of merely serving and selling products within your borders, you sell your goods and services around the globe.  This results in some countries becoming the manufacturing plants of the world, while other countries (notably the UK, the US and Switzerland) become the "financial centers" of the world.  In other words the US finance industry is no longer serving the US, but the entire globe, and thus its share of the domestic economy grows.

But then there is the fourth reason.  And the fourth reason is reason enough to worry.  And the reason you should worry is because here the finance industry provides absolutely NOTHING in terms of real production or value for the rest of the economy. 

The retirement bubble.

You all know my opinion that the stock market is highly overvalued due to the trillions in retirement dollars that have flooded it.  However, do not expect people to start becoming savvy investors who start asking questions about PE ratios and contemplate how dividends ultimately drive value.  Too many commission addicted salesmen and mutual fund managers need Americans to keep buying stocks, bonds, and mutual funds.  And the "401k Clergy" in the finance industry need you guys to keep mindlessly investing in your IRA's for "retirement."  This means that instead of:

financing a new plant
raising money for a new mining company
or providing the capital to expand Stark Enterprises' robotics division

the vast majority of the finance and banking industry is focused solely on selling you assets. 

And merely selling stuff does not help contribute to GDP.

It is here I get a little chuckle because 9 out of 10 times when I run into your standard leftist they immediately point to the booming stock market as evidence that "the economy can't be doing that bad."  But of course when I cite the actual measure that measures the economy (GDP) they ignore that, preferring instead to think asset prices "are the economy."  But the divergence from economic growth and asset prices is not a good thing, because all profits (and thus all the value of all assets) ultimately has to come from economic growth.  And right now we have fantastically high prices, with slow, sluggish, lethargic economic growth.

In the end, however, the two will have to converge.  We can certainly postpone the inevitable with having a world reserve currency.  We can play currency wars and borrow till our heart's content, creating entire industries out of borrowed money to keep our precious liberal-arts majoring princesses and princes employed.  But in the end, there needs to be economic growth to warrant forever increasing asset prices.

In the meantime, keeping tabs on how big a non-producing industry like finance grows as a percent of our overall economy is a pretty good way to tell if the country and its people have any intention of growing up, putting work gloves on, and starting to produce things of genuine economic value,


if we want to continue living in Lala Land where we can all be bankers, we can all be life insurance salesmen, we can all be teachers, and we can all retire on full pensions with forever increasing asset prices at 55.

Enjoy the decline.


al said...

A couple of months ago, there was a paper that suggested that if the finance sector grows beyond 3.9% of the economy, any growth beyond that point is coming at the expense of the rest of the economy. rather than facilitating the operation of the greater economy, being rather deleterious.

more mould than yeast, if you will

Robert What? said...

Very informative, thanks.

I believe the central banksters are letting the asset bubble continue for two reasons: (a) That is where most of their their own wealth is and (b) They haven't (yet) figured out a way to offload their gambling losses onto the middle & upper-middle classes.

The bubble is so huge that there is not enough money in those classes to cover all the gambling losses of the banksters and their cronies. Not even if all their wealth was confiscated. So at some point the banksters are going to have to turn on each other.

I don't know how that might play out and what that will look like, though.

Anonymous said...

All the more reason to play in the derivatives market. I can be in and out in minutes, and stay flat in the market overnight, over the weekend, etc. No long-term worry about being caught while the market crashed, and hedging a position is easy.

Of course, all of this takes education and learning, but it's all out their folks. Pick up your own ball and run with it.

After watching money "managers" use my money to get slaughtered in the market, I decided that I could do better. I have never looked back.

You can too, it just takes time and practice. But it's certainly worth it in order to take control of your assets.

Anonymous said...

Every time I hear "Service Sector Economy", I proceed to check Manicure/Pedicure Futures. What nags the fucking shut out of me is how, exactly, do we export ManiPedis and Haircuts?

Financial disclosure: I'm long Cosmotology and Landscaping.