Finance and Innovation

Assessing the impact of a modern financial sector on an economy’s capacity for innovation is tricky. We’re working on the problem.

Appeared in: Volume 10, Number 1 | Published on: August 22, 2014
Hester Peirce is a senior research fellow at the Mercatus Center at George Mason University.
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  • Anthony

    In sum, “a healthy financial sector clearly can play an important role in fostering innovation” – conclusion not exactly innovative vis-a-vis U.S. financialization function and innovation.

  • FriendlyGoat

    I wonder if this author has any idea how many people are working in collections, credit-bureau reporting, payday lending and high-frequency trading. I wish she had researched what the entire “financial sector” actually consists of and reported that to us instead of 40+ paragraphs to reach a right-winger’s conclusion that we “don’t yet know enough” to rein anything in.

    America is positively AWASH in cash. Any viable commercial idea that needs capital has people standing in line to provide it. We are short of viable commercial ideas and execution, not short of financing. We are also woefully behind the curve in regulating the “financial sector” we already have. Except for the Federal Reserve printing trillions of dollars out of thin air and robbing savers for a generation, our “financial sector” is still suitable mostly for blowing up society, vaporizing jobs, milking money upwards and widening the wealth divide.

  • rheddles

    The financial sector is not the major problem, government is. Sarbanes-Oxley and Dodd-Frank have had the effect of reducing access to capital for new companies and choking their opportunity for reward in IPOs. The ZIRP has flooded Wall Street and Sand Hill Road with so much money that investment in new ideas is far less remunerative than speculation in assets. And the same irrationality that created .com has brought the domination of social software. Further, misallocation of capital is abetted by the government takeover of housing finance by Fannie and Freddie. That is what is choking innovation. The JOBS act was a nice idea but the SEC implementation (not unreasonably) has strangled whatever innovation might have occurred. All the government mandated changes to the financial system for the last 15 years starting with the repeal of Glass-Steagall have had net negative effects on the financial sector. They have concentrated assets and power. They have created TBTF. They have increased cronyism. Is it surprising that financiers are acting irresponsibly when the rules of the game are being constantly changed to socialize risk and reward political favoritism?

  • Curious Mayhem

    No one knows what an optimally sized financial sector would look like, but it would surely be smaller than what we have today. Beyond a certain size, the financial sector can only grow through the growth of leverage; i.e., debt, which on its balance sheet is counted as an asset (at least until the next crisis), but which on the real economy’s side counts as a liability.

    It’s a strange world indeed when, for example, so much media attention and magazine covers are taken up by financial moguls and financial issues and crises. When that attention is mainly on the “real” economy and, say, people who make real goods and services, you’ll know that we’ve moved into a better world.

    To blame this on “greed,” however, is ignorant. It’s the fusion of government, pushing bad policies that temporarily benefit the financial sector and other targeted classes, and Wall Street, ever more leaving behind prudent practices of the generations that came of age during and right after the Depression, that has led us here. In its advanced form, this fusion goes under the name of “cronyism,” and it is epitomized by tight relationships of the Fed, the major money center banks and primary dealers (of government and government-backed bonds), the Treasury Department, Congressional staffers, and quasi-public entities like Fannie Mae and Freddie Mac. They all clamor for artificially low interest rates: government lowers its borrowing costs, large corporations finance themselves and buy back their shares (elevating the stock market), and speculators can borrow cheaply as well.

    But a cost is extracted: scarce capital is made to look as if it’s infinitely abundant and can be squandered on share buybacks and M&A. Productive use of capital, leading to physical investment and hiring, is neglected. Financialization looks like magic wealth creation out of nothing, but its cost is real. It’s just that Washington, New York, and a few other favored places don’t directly feel this cost. All they see are the symptoms, which puzzle and baffle our cloud-minder elite.

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