Financial innovation and growth

Economist.com debate topic - financial innovation boosts economic growth.

Sadly I am not surprised by the current voting. Click above, review the debate and vote.

The attention getter in the current Economist online debate is-

Paul Volcker put the matter clearly when he said, "I wish that somebody would give me some shred of neutral evidence about the relationship between financial innovation recently and the growth of the economy."

This is actually sad, reflecting a basic misunderstanding of the emergent and evolutionary nature of innovation and the impact of innovation on economic change. A view of economic history confirms this evolution and, like other innovations, the impact of financial innovation may take decades to emerge. Volcker is impatient and distrustful of systemic processes beyond the control of the state.

Ross Levine takes the longer view

Even the most conventional components of modern finance, such as debt contracts and liquid securities markets, were themselves once financial innovations that circumvented former barriers to investment and growth. Consider an oceanic expedition or trading voyage in the 17th or 18th century. Such an endeavour required a large injection of capital and did not produce profits for a long time. Investors were reluctant to commit savings to such a long-term, albeit profitable, project because they valued having ready access to their wealth to cushion bad times or switch into other investments. Liquid securities markets eased this problem, allowing investors to sell their financial securities, which are claims on the future profitability of the project, if they wanted access to their wealth. With liquid markets, investors fund the oceanic voyage, but without those markets, economic progress slows.

Financial innovation, like all innovation, has risks, which have been unmistakably demonstrated by the current crisis.

My reading of this interesting debate - Ross Levine of Brown argues pro and our friend Joseph Stiglitz argues con - is informed by my reading of Thomas Sowell's Intellectuals and Society. In that book, Sowell contrasts the tragic or constrained vision with the anointed or unconstrained vision.

As one of the anointed, Stiglitz exemplifies the characteristics enumerated by Sowell - the identification of a big solution for a big problem, elite decision making and an emotional argument for centralization, in this case and increase in regulation.