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Finance: Function Matters, Not Size
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DOI：10.1257/jep.27.2.29.png)
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Abstract
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It's fun to pass judgment on waste, size, usefulness, complexity, and excessive compensation. But as economists, we have an analytical structure for thinking about these questions. I dona(TM)epsilon t understand it doesn't mean it's bad, or regulation will improve it. That attitude pervades policy analysis in general and financial regulation in particular, and economists do the world a disservice if we echo it. I will not offer a competing black box [to explain the size of the finance industry]. I dona(TM)epsilon t claim to estimate the socially optimal size of finance at, say, 8.267 percent of GDP. It's just the wrong question. Hayek and the failure of planning should teach us a little modesty: Pronouncing on socially optimal industry size is a waste of time. Is the finance industry functioning well? Are there identifiable market or government distortions? Will proposed regulations help or make matters worse? These are useful questions.
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