Finance as Dutch Disease

In and out of the car this morning, I listened to patches of a discussion of skilled labor (and the lack thereof) in the Silicon Valley. The story was disjointed, as was I, but the gist seemed to be that foreign engineers aren't coming here any more and that we aren't training enough of our own.

Oooh, is this one more story about the declining quality of California schools? Not exactly. The point was (once again) that too many of the best and the brightest get sucked off into finance.

Well, sure enough. Thomas Philippon over at Stern on Finance has the goods as finance as a share of GDP and it ain't a pretty sight. One thing I hadn't focused on before was that the share was high (though not 2007-high) in the boom years of the 20s--topped out at around six percent, then fell precipitously and remained moderate through the early postwar period (now memorialized as "the good old days"). From a glance at Philippon's chart I'd say we didn't reach the Depression-era level until around 1980; growth continued to a whopping eight percent (we may prayerfully expect that it has fallen somewhat since then).

Philippon shows his true believer stripes here: he declares flat-out that "The financial sector's share of aggregate income reveals the value that the rest of the economy attaches to these services." Uh huh. Well, he makes a manful effort to link the fortunes of the financial sector with more general trends in entrepreneurship and innovation: big gains coincide, for example, with the growth of electricity and later of IT. But then he backs off a bit:

From 2002 to 2006, I am not quite sure what the financiers were doing. Or rather, I am not sure that the services provided by insane trading volumes and real estate derivatives were worth the price tag.

Copy that, big guy, and pin a rose on you for restraint. More unbuttoned commentators--many of them skilled and informed veterans of finance itself--would say rather that the lunatics took over the asylum. Riffing Marx, men make their economy, but they do not always make it as they choose. Some of the most important shifts take place against their will and the dead hand of the past comes to lie like an incubus on the backs of the living.

That's bad enough as it is: a financial sector that has lost its reason for being and become a parasite or a cancer on the organism in which it lives.

But most of that is old news. What is new (to me, at least (update: but cf links infra)) is to consider this bloated and distorted financial incubus as a kind of Dutch disease--an enterprise which, whatever its own merits, comes to weaken the economy that surrounds it. Classically, Dutch disease is an increase in the exploitation of natural resources at the expense of manufacturing. I don't know the model can't be applied usefully to an increase in financial manipulation at the expense of everything else. One difference: in an attack of Dutch disease, at least somebody gets the oil. In the late financial bacchanal, it is not clear that anybody got anything worth having at all.

Update: An informed source points me to a piece by Steve Randy Waldman, link; and another by Steve Sailer, link. My informant adds: "I've seen others use the metaphor since, and I think most derivations have been independent. Apparently the parallels are strong between the '00s financial sector and the mild form of oil curse rich countries come down with."