Jonathan B. Wight

Via John Davis comes a link to Dan Berrett's recent article in The Chronicle about Robert Shiller's new book, Finance and the Good Society (Princeton University Press, 2012). The book seeks to resurrect the field of finance from the ashes of the great collapse of 2008—and the strong perception that the field is guided solely by greedy ones who have brought the rest of us down.

Shiller argues in his new book that financial innovation is a leading force for economic growth and should be encouraged. Moreover, he argues that young people should not be discouraged from entering the field by the Occupy Wall Street protestors. Instead, Shiller says that finance offers a world-improving career for idealist.

Resurrecting the moral image of the people in finance may be a very good thing, but real moral improvement is unlikely to happen: there is probably too much of a self-selection bias. And, there appears to be a huge culture of entitlement, as evidenced by the vicious attacks that ensued when a tax increase on the wealthiest was proposed that would raise the marginal tax rate by only about 3%. If internal self-controls are lacking, then external ones are needed, such as we had in place with Glass-Steagall Act and other restraints that limited excessive risk-taking. Incidentally, this was exactly the kind of excessive risk-taking that Adam Smith opposed in The Wealth of Nations.

Here is the U.S. growth rate by decade. It should be abundantly clear that we did not need fancy financial instruments to grow rapidly in the 1950s and 1960s. All the BRICK countries today (Brazil, Russia, India, China, and South Korea) are booming and none of these is known for financial innovation. U.S. growth rates actually slowed down after financial market liberalization began in the early 1980. Of course there are lots of confounding events.

When I think of the best financial innovation of the last half-century it is micro-lending, which was not invented by Wall Street but an entrepreneur in Bangladesh. When I think of the U.S.'s innovation lead over many other countries it is because of the venture capital in Silicon Valley, not so much the investment banking of Wall Street. Of course there are interconnections and synergies to consider. But on the face of it, I am not convinced that the financial innovation Shiller touts is necessary for economic growth. However, having a well-working financial system is necessary—but I mean a plain vanilla variety that works consistently well, costs a whole lot less, and is less likely to break down than the one Shiller extols.

Here's an analogy: is a Ferrari 458 that gets a top speed of 201 mph needed to commute from home to work? Or, would a Ford Focus get you there with greater fuel economy and safety? If society is expected always to "pick up the pieces" after fabulous wrecks, I know how I want my tax dollars to work—I'll help build the roads for Fords, but not racetracks for Ferraris. The same goes for the financial system.

Note to readers: Berrett's article also quotes our own Mark White, who advises graduates to enter the field and change it from within.