A critical rethinking of finance has been prompted by the present crisis. It is also implicating the very notion of the market economy and the globalised form that it has taken in recent years. Finance, the market and globalisation are at risk of being jointly demonised, including by normally moderate observers of economic affairs. Recollecting a few basic arguments in favour of the trio may not be useless at this juncture.
Finance: instrumentum diaboli
At its core, finance is first and foremost a mechanism for shifting purchasing power over time.
Lending is an ancient human activity. Embedded in it is the suspicion of immoral conduct on the part of the lender, seen as the one who, for personal profit, either encourages the borrower’s spendthrift ways or exploits the borrower’s genuine needs. Which is why in some human communities, at certain times in the past but also today (for example in the Islamic world), charging interest on money loaned was/is forbidden by either law or religion.
The very concept of money was probably devised at the dawn of humanity along with that of credit, and perhaps even at its service, as a means of transferring spending power over time by detaching it from any specific physical good. Money flanked and possibly surpassed credit as a source of negative symbols in the popular imagination.
Yet money and credit are part of what has enabled human beings to free themselves from the barbarism of immanence, from the savagery of a life ruled by the consumption for survival, which is spent in an instant. They teach man to think about the unfolding of time and they do so by appealing to the most powerful of all psychological levers, that of desire and need. Learning how to project a desire into the future or to predict a need is a fundamental step in evolution. It pushes people to design a method for satisfying future desires or needs, and that method is saving. If everyone’s savings is lent to someone else, both the personal (if the loan is interest-bearing) and the social utility are augmented, because two ends are simultaneously met: that of investors who have in mind their future consumption (needs-desires) and that of those who instead require additional immediate purchasing power, motivated by the mere urge to consume, but possibly – and this is the most socially interesting case – by the desire to increase their own productive capacity, and therefore by a plan that is equally far-sighted and future-oriented.
In a monetary economy, finance – consisting of markets and intermediaries whose job is to assure the optimal allocation of resources and risks – is what makes the saving-credit-investment gears turn. It is one of humanity’s great intellectual achievements. Yet it does not enjoy the universal admiration accorded to such other intellectual watersheds as the wheel or the number zero. The problem is that everybody can use the wheel and the number zero profitably, easily and naturally, while by definition finance creates a conflict of interest between two major, and equally deserving, categories: lenders and borrowers. The first group will want to see high interest rates and broad guarantees, be they real collateral or based on reputation. The second group will want low interest rates and the possibility of providing the minimum possible guarantees.
The unalterable fact that the objectives of these two groups are, at least in part, conflicting leads to tensions being inevitably offloaded onto professional intermediaries. They always run the risk of being seen as parasites who are happy to sit back and let others toil – the people who produce tangible goods and save up to ensure that they can retire in peace – before fleecing them mercilessly. It must be acknowledged that the victims of this prejudice often do practically nothing to dispel it; indeed, at times their conduct seems designed to lend it credence. Evident examples of this are to be found in the current global financial crisis.
Yet, the pivotal role of finance in our lives has never been apparent as in the present turbulent days.
Market: did it fail?
In this crisis, who has failed, State or Market? I argue that it is more a State failure, but by virtue of a paradox. One firmly established conclusion of centuries of economic science is that the market must be “regulated” or it is no market. If the government practices absolute laissez-faire, the free competitive market cannot last; it is strangled by the monopolistic spirit of operators. This is a law of nature, a sort of economic entropy. The pure competitive market is the optimal regime from the standpoint of “buyers,” i.e. the community as a whole, but the worst possible for the “sellers,” a powerful minority constantly trying hard to oppose it. Such a market is a limiting condition that the public authorities may seek to approximate only by virtue of unflagging effort. Clear, comprehensive, specific rules are essential; and farsighted, attentive regulators and supervisors who cannot be captured by the “sellers” are indispensable. They must obviously be efficient: the burden of the regulatory apparatus that inevitably weighs on private agents ought to be non-distorting, light and non-bureaucratic. But we cannot do without it.
This forms the essence of what to my mind is the most advanced contribution of liberalism to economic thought. Nobody should confuse the great principles of liberty with the arbitrariness of complete laissez-faire. Eighty years ago, an Italian champion of liberalism in politics and a neatly pro-free-market economist, Luigi Einaudi, wrote:
The maxim of economic liberalism (is) taking on a third – I would call it a religious – meaning. In this interpretation, “economic liberals” are those who accept the maxim of laissez-faire, laissez-passer almost as if it were a universal principle. (…) The whole subsequent history of the doctrine demonstrates that economic science (…) has nothing to do with the religious conception of economic liberalism.1
The “religious” notion that Einaudi stigmatised so scathingly was resuscitated in the second half of last century, as the consequence of a debate on the foundations of public economy. The standard theory of regulation as fundamental to the public interest came under increasing criticism in the 60s, and gave way to an alternative view, according to which markets themselves, or at the most civil courts, can remedy virtually all market failures, whereby government is necessarily incompetent, possibly corrupt, and “captured” by the very interests it is supposed to regulate, so it can only make things worse.2
The schools of thought backing this view are unquestionably among the high points of twentieth-century economics.3 Unfortunately, in the last twenty years, especially in Britain and America, that view has been used to forge a properly religious dogma, as Einaudi understood it, and the policies today under indictment were born of that religion. The global financial crisis of these past two years turns the empirical evidence overwhelmingly against it. The fundamental problem underlying the crisis has been one of rules and their effective application. The laissez-faire fundamentalists may be seen paradoxically as State interventionists, in that they wanted the government, allying with vested interests, to purposely deprive the competitive market of the air it breathes, namely rules and supervision. If this view is correct, by a twist of language we can call it a State failure: a failure by inaction, not excessive action, due to the refusal to see, to counter or to correct an evident series of market failures.
Globalisation: the accomplice?
In the frenzied hunt for a scapegoat during this delicate conjuncture, there has been no lack of anathemas proclaimed against globalisation. In past years detractors and enthusiasts of globalisation have squared off for some time, but the former are rapidly gaining ground since the outbreak of the financial crisis.
The complaints have tended to be mixed up: the Chinese are waging unfair competition against me, the price of petrol has doubled, I find a toxic asset in my securities portfolio that I didn’t even know I had, my banks is making trouble about giving me more credit since it is unable to procure liquidity in a global market paralysed by mutual distrust. All this, most people have been thinking, should have something to do with globalisation.
The problems are serious and concrete, but the target is too generic to be useful. Globalisation involves various aspects: production, trade, finance, migrations, the diffusion of ideas and knowledge. These aspects all have one characteristic in common: the heightened mobility made possible by the ICT revolution. Technology, then, is the prime mover, even if the trade and financial liberalisation policies adopted in many countries in the 1990s assisted the process.
In effect, globalisation and innovative finance are two sides of the same coin minted by technological innovation. Because of that deep nature, they are neither good nor bad, they just represent an opportunity for individuals, for societies, for economies; they must be understood and governed, and cannot be stopped, except at the cost of accepting backwardness and marginality.
Disclaimer: The opinions here expressed are only the author’s and do not involve, in particular, the Bank of Italy. An extended version, in Italian, of this note is forthcoming in: Il Mulino, 6, 2008.
1 L. Einaudi (1931), “Dei diversi significati del concetto di liberismo economico e dei suoi rapporti con quello del liberalismo” in B. Croce and L. Einaudi, Liberismo e liberalismo (Ricciardi: Milan and Naples, 1988). English translation in Luigi Einaudi, Selected Economic Essays (Palgrave Macmillan: Basingstoke and New York, 2006), pp. 75-76.
2 This critique is ordinarily associated with the Chicago School of Law and Economics and with such economists as Ronald Coase, George Stigler and Michael Posner.
3 However, the critique has in turn been criticized both in theory and empirically. On the empirical side, in particular, it has been noted the strident contrast between the doctrine’s precepts and the reality of a world at once far wealthier and far more extensively regulated than a hundred years back. See A. Shleifer (2005), “Understanding Regulation,” European Financial Management, 11, 4, pp. 439-451.