Is financial industry big, costly, and inefficient?

That’s the conclusion of a new paper from Thomas Philippon. He measures the cost of the financial industry’s activities and compares it to the sector’s actual production of assets and liquidity, concluding that the financial industry provides fewer products of social value than its actual share of GDP. James Kwak of The Baseline Scenario summarizes:
(Richard Drew - AP)

The conclusion is that the per-unit cost of financial intermediation has been going up for the past few decades: that is, the financial sector is becoming less efficient rather than more, and that accounts for two percentage points of finance’s share of the economy....

The main reason why finance’s share of GDP has outstripped its production of intermediation services, according to Philippon, is a huge increase in trading volumes in recent years. Trading, of course, generates fees for financial institutions, with limited marginal social benefits. Yes, we need some trading to have price discovery. But if I sell you a share of Apple on top of the other 33 million shares that were traded today, is that really helping determine what the price of Apple should be? The more that financial institutions can convince us to trade securities, the larger their share of the economy, whether or not that activity improves financial intermediation.

Kwak believes such findings give us reason to worry about the financial industry’s still-whopping share of business profits. It also gives more weight to those who argue we should focus on reviving manufacturing and returning to an era where the US “makes stuff” with more tangible social benefits.