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Tuesday, November 22, 2011

Finance and the Economy: Occupy Wall Street in Historical Perspective

Mark Jickling
Specialist in Financial Economics

Sean M. Hoskins
Analyst in Financial Economics

Wall Street and Main Street—the financial system and the real economy of goods and services— are bound together. If businesses large and small had to fund investment projects out of their own pockets, society would be significantly poorer. The financial system aggregates the savings of millions of households and allocates them to the most productive uses. The importance and value of this function are almost universally acknowledged and are axiomatic in market economics.

Nevertheless, the benefits of certain forms of financial intermediation to the real economy are not always apparent. American politics has a demonstrated history of attacks on Wall Street and financiers whose great personal fortunes appear disproportionate to their contribution to national prosperity. This tradition, which goes back at least to Thomas Jefferson, accuses high finance of siphoning off resources that could be better used elsewhere. A recurrent critique is that “swapping pieces of paper” is not only less useful than, but morally inferior to, actual production of goods and services, and that great concentrations of wealth represent a threat to democratic values. For all their lack of a unified, coherent program, the Occupy Wall Street protestors can be seen as the latest in a long series of anti-financial sector critiques.

This report presents examples of political statements about the fundamental costs and benefits of finance and recent economic research that points to aspects of financial activity that may not be advantageous to the real economy. The report does not attempt a comprehensive survey of either literature, but provides a reminder of the breadth of the historical debates that have shaped congressional oversight of financial institutions and markets.

Some of the political remarks excerpted here strike the theme of conflict between the real economy and the paper profits derived from financial speculation, and include claims that the temptations of the latter draw resources away from the former, or that speculators misappropriate the rewards that would otherwise accrue to hardworking businessmen, farmers, and wage earners.

Apart from the normative judgments of political and populist outcry, economists have expanded on prior research that focused on finance’s contribution to economic development to study whether an excessively large and complex financial system could be a drag on a country’s economic growth. Among the questions raised are the following:

  • When the volume of financial activity passes a certain threshold, does it have the potential to lower the rate or destabilize the pattern of growth? 
  • Do incentives to ignore long-term risks in search of short-term profits produce financial instability, leading to crises that may trigger deep recessions? 
  • Do the complex products of financial innovation yield any significant benefits to the real economy, or simply new opportunities for speculation? and 
  • Does growing income inequality, driven in part by financial sector compensation, have negative implications for the economy? 

The research summarized in this report may represent the beginning of a revaluation of the role of finance in the economy, but much difficult work remains to be done before general statements can be formulated. This report, which will not be updated, attempts to show that the basic questions raised by Occupy Wall Street about the value of certain forms of financial activity are not new.

Date of Report: November 14, 2011
Number of Pages: 14
Order Number: R42081
Price: $29.95

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