His warning against ill-considered regulation (published in Wednesday’s
Financial Times) is distorted by the pro-market ideology that blinded him to
the pre-crash excesses in financial markets. But the former chairman of the
Federal Reserve is on more solid ground when he praises finance’s
contribution to economic growth.
The statistical evidence is overwhelming. As countries get richer, their banks
and capital markets grow larger relative to gross domestic product, and more
complex. Mr Greenspan points out that the financial share of US GDP rose
from 2.4 per cent to 7.4 per cent between 1947 and 2008.
This reflects a two-way causality. More sophisticated economies need more
finance because they have more trade, capital accumulation, savings and
innovative ideas in need of investment. Conversely, more sophisticated
financial systems accelerate growth by mitigating the risks of trade and
investment and spurring on new enterprises.
Not right about regulation
But the virtues of finance do not make Mr Greenspan right about regulation.
Early emerging markets investors can testify that the money trade only works
its magic if governed by institutions that are trustworthy. It is no
accident that financial regulation and finance generally expand in tandem.
Dodd-Frank is a sort of catch-up.
Further, the benefits of adding more finance appear to decline as the sector’s
share of GDP increases. That makes sense. There is only so much capital to
be gathered, allocated and made liquid, and only so much risk to be
parcelled out. At some point, additional finance may become harmful. Think
structured derivatives or a total US debt level of 380 per cent of GDP (up
from 140 per cent in the past six decades).
If Dodd-Frank helps make finance simpler and smaller, the world should be
grateful, even if Mr Greenspan is not.
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