For most of the media, Wall Street is the economy. The papers and pundits track its ups and downs as obsessively as they track Madonna’s love life. And Wall Street, like Madonna’s marriage, lies in ruin.
But Wall Street is in not, in fact, the heart of the economy. The implosion of financial markets, and the gut‐wrenching drop in stock values creates an illusion of total economic crisis for folks watching from the couch at home. But far from lower Manhattan, the real engine of the American economy continues to chug along.
According to University of Chicago economist Casey Mulligan, the performance of the non‐financial economy — the part that actually makes the stuff that improves our standards of living over time — is strikingly independent of the performance of financial markets.
What matters most for prosperity is the effectiveness of the non‐financial sector in delivering bang for each buck of capital that goes into it. Mulligan says that the crucial “marginal productivity of capital” over 2007 and the first half of this year was higher than the average since World War II.
The role of financial markets is to allocate capital to its most productive uses. When they get gummed up, the economy suffers. But the basis of our prosperity is the entrepreneurial energy and innovation that improves our efficiency over time. That foundation remains firmly in place.
We’re going to get out of this downturn, but that will happen sooner if the government stops trying to prop up already failed financial giants. We’ll best ensure continued investment in our still‐vital economy if we let new financial players rise from Wall Street’s ruins.
Will Wilkinson Will Wilkinson says the only thing czars are good at is looking busy on Marketplace (November 19, 2008) [MP3]