Relationship between the Finance Sector and Other Components of FIRE

In the U.S. economic accounts, there are two primary ways of measuring the role of finance in the economy—through the Flow of Funds Accounts (FFA) and the National Income and Product Accounts (NIPA).

The FFA documents activity in the financial sector through the balance sheets of financial institutions. In Chapter 4 of this study on “Structure of the Financial Sector by Form of Organization,” we provide basic data on the balance sheets of all 22 sets of institutions constituting the finance sector by the FFA as of 2012. In Chapter 9, on “Sources of Funds,” we present the relative changes in the institutions supplying credit within the U.S. economy. These figures are derived from the flow accounts within the FFA.

In this chapter, we draw upon the NIPA data to present figures on the value added generated by what is termed the FIRE industry of the U.S. economy—finance, insurance, real estate, rental and leasing. More specifically, within NIPA, the FIRE industry includes six sectors:

1. Federal reserve banks, credit intermediation, and related activities 2. Securities, commodity contracts, and investments

3. Insurance carriers and related activities 4. Funds, trusts and other financial vehicles 5. Real Estate

6. Rental and leasing services and lessors of intangible assets.

Given the way the NIPA sectors are organized, it is not as straightforward to observe, for example, the shadow banking sector relative to the traditional banking, insurance, and pension fund sectors, as we did with the FFA data. Nevertheless, we are able to observe useful patterns on the relationship between the finance sector and other components of FIRE through the NIPA figures.

The first key observation is that the FIRE industry as a whole has risen substantially as a share of GDP over the past 50 years. We can see this in Figure 5.1. As Figure 5.1 shows, the FIRE industry accounted for just over 14 percent of GDP in 1960. That proportion then rises steadily, through about 1980, at which point the FIRE/GDP ratio is at 16 percent of GDP. The rate of increase in the ratio then accelerates, peaking at 20.9 percent by 2001. By 2011, the ratio had declined modestly, to 20.3 percent of GDP.

This increase of FIRE as a share of U.S. GDP by roughly six percentage points is quite substantial. Within the context of U.S. GDP in 2011 at about $15 trillion total, six percentage points of that $15 trillion total amounts to $900 billion. That is, overall value added from FIRE activity as of 2011 is nearly $1 trillion more than it would have been had the share of FIRE remained at its 1960s level.

Components of FIRE

Within the overall FIRE industry, the relative shares of the sector have changed over time, though not dramatically. Because of data limitations within the GDP

13 14 15 16 17 18 19 20 21 22 60 65 70 75 80 85 90 95 00 05 10 Figure 5.1

U.S. FIRE Industry as Share of GDP

F IR E a s p c t o f G D P

accounts, we are not able to observe the subsectors within FIRE prior to 1977. The reason why the sectoral figures are not broken down more finely prior to 1977 is that, in the pre-1980 era, many of the subsectors of FIRE were not sufficiently large or active to warrant their own statistical category.

In Figure 5.2, we thus show the four main sectors within FIRE each as a share of U.S. GDP from 1980 to 2011. These main sectors are real estate and leasing, combined as one; banks and intermediaries; insurance companies, and security/investment firms. The main conclusion that emerges from Figure 5.2 is that these four main FIRE sectors have grown at somewhat varying rates since 1980, though without any strong patterns of change having developed. Real estate and leasing, combined, were the largest sector within FIRE as of 1980, at 11.1 percent of GDP. They remained the largest sector within FIRE as of 2011, at just below 13 percent of GDP. Banks and intermediaries rose more rapidly on a proportional basis, from 2.6 to 3.6 percent of GDP between 1980 and 2011, but nevertheless remained much smaller as a sector than real estate/leasing. The increases of insurance and security investment firms as a share of GDP were more modest but still substantial, with insurance rising from 1.9 to 2.6 percent of GDP between 1980 and 2011, while security firms rose from 0.3 to 1.2 percent of GDP over these years.

Overall, the conclusion that emerges from these figures are: 1) The value added by FIRE to U.S. GDP has risen substantially over time; and 2) The rates of expansion within the various FIRE sectors have differed, but not by large enough since 1980 amounts to constitute a meaningful pattern.

Because of the ways that the GDP accounts divide the full FIRE industry into sectors, it is difficult to see from these accounts the growing role of the shadow banking system within FIRE. That is, under the sectoral divisions of FIRE that have operated since 1977, different components of the shadow banking system are incorporated, respectively, into the banking, insurance and securities sectors. As such, the figures presented here are still fully consistent with the idea of a major structural shift occurring within FIRE, away from the less traditional institutions in favor of the shadow banking system.

0 2 4 6 8 10 12 14 1980 1985 1990 1995 2000 2005 2010 Real estate/leasing

Banks and intermediaries

Security/investment firms Insurance

Figure 5.2

Main Components of FIRE as Shares of U.S. GDP

Source: U.S. National Income and Product Accounts

P c t. o f G D P

Chapter 6. Nature and Degree of Competition between Financial