Can a Booming Financial Economy Coexist with a Lagging Real Economy?

Abstract

The U.S. today experiences an expanding financial economy. Investors benefit as common stock prices rise. Moreover, the finance industry grows relative to other industries (called “financialization”). But at the same time, the real economy lags. Workers’ pay and job opportunities stagnate as economic growth declines. How can these outcomes coexist? This article explains how and why this happened, utilizing a “forensic” approach to analyze a considerable amount of economic data. It argues that bifurcation of the economy started as far back as 1980, with new information and communications technology. Labor markets became “globalized” so that wage growth slowed, thereby reducing inflation and nominal interest rates. This boosted businesses’ profit margins, so there was less need for increased capital investment. Growth in aggregate demand fell and diminished growth in the real economy. Ironically, this helped the financial economy. Slowing demand for capital and central bank intervention led to falling real interest rates and consistently rising financial asset values. Common stocks spiked as bond rates plummeted. This helped the financial industry expand revenues through financial market activities, as opposed to traditional financial intermediation. Expanded securities trading brought increased brokerage fees. Moreover, loans were made and then sold them to open market investors, thereby moving finance into the capital markets (“securitization”). There is discussion of whether the financial sector really did add value, particularly given the financial crisis. The paper ends noting that the bifurcated economy embodies the principal elements of secular stagnation -- persistently slow growth, falling real interest rates, flat real wages, and increasing income inequality. Unfortunately, U.S. economic policy seems unprepared to offer remedy.