Finance: Function Matters, Not Size by John Cochrane

I read this ages ago but thought I’d blog about it again.

“Finance: Function Matters, Not Size” is a really interesting look at the size of finance as a share of the economy.

He points out that trying to determine the optimal percentage of GDP dedicated to a specific sector is a fool’s errand. It flies completely against Hayek’s work on central planning defects.

He points out that the finance industry expanded enormously over the past few decades but prices didn’t really fall. Think of the “2 and 20” hedge fund fee structure. That implies that there has been a shift to the right of the financial services demand curve.

Also, because many fees in finance are based on assets under management, as wealth has grown in the economy, fixed costs per fund manager have increased a bit but because AuM has increased even more that’s why you see multi-million dollar compensation packages. A handle of people can manage an enormous amount of assets.

An interesting read and well worth your time if you’re sick of the bagging of the finance industry. Here in New Zealand, the reluctance to discuss the collapse of the second tier lending industry as a key supply side shock making housing affordability harder to achieve is disappointing.