If the criticisms against Wall Street had been accurate, the U.S. corporate sector today would be ailing. Instead, corporate profits are at historical highs both absolutely and relative to GDP.
Lynn Stout is not the first to note that Wall Streeters and other financial types earn a lot of money. She also is not the first to struggle to determine exactly how those earnings correlate with Wall Street added value. Companies do not seem to issue large amounts of new capital relative to the amounts that are traded in the secondary market (where a lot of resources and compensation are devoted). It is not immediately clear how secondary trading leads resources to be allocated more efficiently. And, of course, Wall Street contributed to the mortgage and financial crisis.
These criticisms have been with us for a long, long time. Finance and financiers have been looked at skeptically (and scapegoated) for much of recorded history. Criticisms of finance go back at least to the Middle Ages (see D’Acunto et al.). Andrew Jackson’s skepticism of finance led to the demise of the Second Bank of the United States.
But that does not mean the criticisms are correct. Andrew Jackson’s rejection of the Second Bank led directly to the subsequent panic and depression in 1837. Both the academic evidence and a look at the world economy indicate that Professor Stout, like many of the previous skeptics, is misguided. While (God knows) Wall Street isn’t perfect, it has helped make the world a lot better off.
There is a large academic literature on the effect of financial markets. A great deal of that research finds that countries with thriving financial sectors experience greater growth in GDP. Countries that restrict their financial sectors grow less. In a survey of this research, Levine (2005) concludes that “the preponderance of evidence suggests that both financial intermediaries and markets matter for growth and that reverse causality alone is not driving this relationship. Furthermore, theory and evidence imply that better developed financial systems ease external financing constraints facing firms.”
It also is worth looking at the world economy. Most observers mark 1980 as the time when finance and shareholder value maximization became ascendant. This is also the time that Wall Street and the financial sector began to grow substantially–both in the U.S. and internationally. What has happened to the financial markets, U.S. companies, and the world economy since then?
In the early 1980s and, again, in the early 1990s, U.S. companies and, more importantly, U.S. financial markets were criticized for being too short-term oriented and for not serving U.S. companies and the U.S. economy well. See Hayes and Abernathy (1979) and Porter (1992). These authors criticized Wall Street for doing the wrong thing rather than for doing nothing.
If those criticisms had been accurate, the U.S. corporate sector today would be ailing. Instead, corporate profits are at historical highs both absolutely and relative to GDP. Private equity and activist investors–both Wall Street creations–have pushed companies to become more efficient. Venture capital funded companies, aided by capital from Wall Street and other investors, include firms like Amazon, Amgen, Apple, Facebook, Gilead Sciences, Google, Intel, Microsoft, and Starbucks that have changed the world as we know it. While it is impossible to prove causality, it seems highly likely that Wall Street has played an important role in these results.
And, as Wall Street expanded and became global, U.S. companies became more global and foreign companies obtained access to U.S. capital and knowhow. Again, while causality is hard to prove, the global outcomes have been impressive. According to the World Bank, in 1980, the number of people living in extreme poverty globally was about 2 billion, some 44 percent of the world’s population, which then numbered around 4.5 billion. By 2012, that figure had fallen to less than 900 million, or about 13 percent of the global population of 7 billion. The World Bank projected last year that for the first time, the number of people living in extreme poverty around the globe was expected to have fallen below 10 percent. While many factors have contributed to this result, Wall Street played an important role in channeling capital and corporate investment from the developed world to developing countries. And that has unequivocally left the world better off.
(Note: Steven Neil Kaplan is the Neubauer Family Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business)
Francesco D’Acunto, MarcelProkopczuk, and Michael Weber, “Distrust in Finance Lingers: Jewish Persecution and Investments,” working paper, Chicago Booth, 2015.
Robert H. Hayes and William J. Abernathy, “Managing Our Way to Economic Decline,” Harvard Business Review, 61(7): 67-77, December 1979.
Ross Levine, “Finance and growth: theory and evidence,” in Handbook of Economic Growth Vol. 1, ed. Philippe Aghion and Steven N. Durlauf (Amsterdam: Elsevier, 2005), 865-934.
Michael E. Porter, “Capital Disadvantage: America’s Failing Capital Investment System,” Harvard Business Review, 70(5): 65-82, September 1992.
Poverty statistics: http://www.worldbank.org/en/topic/poverty/overview
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