Actually, the U.S. Financial Sector Is Good for the Economy

On Friday, the writer Oren Cass published an essay in the New York Times claiming that the “financialization” of the American economy has ruined lives and businesses. His use of the term is at times vague, but he argues that financialization is the process of “making financial markets ends unto themselves,” with no positive impact on the “real economy.”

These arguments parrot those of decades of Marxist theorists, which have gained surprising heft and breadth in recent years. They emerge from a basic confusion about what finance does and how money circulates in an economy. At root, theories about financialization are another way to attack investors and businesses earning money—in other words, capitalism.

Finance has been around since the dawn of history. It just means providing or lending money that one expects to be paid back later, with some extra income for the trouble. Starting in the 1990s, however, Marxists such as Giovanni Arrighi claimed that under modern capitalism, traditional finance had been replaced by more esoteric and less fruitful types of financial engineering. In recent years, writers including David Graeber and Matt Stoller have claimed that the financial industry focuses on practices such as debt refinancing and stock buybacks that create no real wealth.

The economist Thomas Sowell once said that the most important question an economist could ask is, “And then what?” After a debt refinancing, does the money disappear into the ether? No: it goes back into a business that can then reinvest the money into developing new products, typically at better terms and rates. When a company buys back its stock, what happens to the money? It gets deposited in someone’s brokerage account, where it can be invested in other stocks and bonds. And then what? The money gets put into businesses that use it to develop new products. There is no separate “financial” economy that does not ultimately connect back to the so-called real one.

Critics of financialization lament that financial firms like hedge funds lend money to one another instead of to the “real” economy. But again, a thoughtful observer must ask: And then what? Those firms then lend to businesses or to consumers who buy products, as they have done from time immemorial. Banks have always borrowed money to lend money. Since the earliest days of the United States’s economy, they have also borrowed money from other banks. Financial chains involving more than one transaction are not new, and they do not destroy wealth or make it disappear.

Though debt refinancings or stock buybacks don’t destroy value, creating and maintaining financial markets does take real resources. Banks need employees, buildings, computer servers, and—even today—secure physical vaults. Opponents of financialization have no problem with these expenses in theory. Yet they claim that the modern financial sector eats up too many resources just on its own maintenance, and that this takes a toll on other sectors of the economy.

However, good evidence, going back at least to the 1990s, suggests that countries with larger financial sectors produce more growth. After all, financing something is just a slightly different way of saying investing in it. Modern investment is possible only if people with business ideas can get financing from outsiders. Some claim that the rise of American finance has led to less investment, but according to the best measures, American private companies today devote about 18 percent of the national economy to investment—around the national long-term average and higher than in the oft-celebrated boomtime of the 1960s.

The idea that financiers are defrauding real American companies is false. Of the top ten companies in the world by market capitalization, eight are American—and new giants are born all the time. The U.S. has more than 700 “unicorns” (that is, new private companies worth more than $1 billion) with a combined value of almost $3 trillion. Europe has just over a fifth as many as the U.S., and they are worth less on average. American companies are the envy of the world—and one of the reasons is our strong financial system, which invests in new ventures.

Even if newer companies are booming, financialization theorists claim that efforts to satisfy short-term stockholders have drained older companies such as General Electric. The Center for New Economic Thinking argues that “‘predatory value extraction’” through practices like stock buybacks is “central to corporate financialization.”

In fact, those companies’ stock buybacks show what’s right with the American economy. If General Electric had invested more money in its own declining businesses, it would have lost more money for its investors. By buying back stock, it returned the money to people who could shift it to Nvidia or Google or any number of booming companies.

The capaciousness of the term “financialization” becomes clear when theorists attack practices such as private equity purchases of companies. As the Hewlett Foundation writes, “private equity . . . is a paradigmatic instance of financialization,” since private equity firms treat “‘real economy’ businesses as vehicles to maximize extraction.” But there’s nothing new or innovative about one business purchasing another—that, too, has been going on for centuries. Nor is there anything new in the idea of making businesses into tools of “extraction”—or, to put it in less Marxist terms, profit.

That theorists can turn the ordinary, time-worn practices of rewarding stockholders, purchasing businesses, and earning profit into instances of “financialization” shows that the term itself has little meaning. Denuded of its more angry and hyperbolic adjectives, it’s just a rhetorical term with which to attack investors and businesses seeking to earn money for themselves without state direction. These arguments should be given no more weight than earlier Marxist contentions that have ended up in the dustbin of history.

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