Essential Technology for Society’s Growth – Wisdom of Robert Shiller

The last three centuries have been owned by England and America. No other country or continent in the world has been able to compete first with England and now with America. There were several reasons for this dominance, industrial innovation and naval supremacy being two often cited. But underlying these was the foundation that allowed old England and today’s America to grow industrially and militarily.

That foundation is the critical technology of finance. Today the U.S. Dollar is the unquestioned reserve currency of the world. In the 19th century, it was the British Pound. England established the modern foundations of central banking and its financial innovations allowed England to grow strong in a way France and Prussia could not match. Today, America is unmatched in the scope and farsightedness of its financial innovations.

This progress has been ignored or misunderstood by traditional philosophers, historians and thinkers. Very few think of finance as a technology, a critically needed technology that can help create and maintain what is termed as a “Good Society”. Instead, as a result of the 2008 credit bust, finance is treated with derision if not outright vilification. As Professor Robert Shiller of Yale writes:

  • “Hostility runs
    high towards societal institutions that are even tangentially associated
    in people’s minds with finance. This hostility is reminiscent of the
    public state of mind during the last major world financial crisis – the
    Great Depression after 1929 – which led ultimately to a degree of unrest
    that shut down much of the world economy and contributed to the
    tensions that led to World War II.”

This makes his new book Finance and the Good Society timely and important. Just a quick look at contents of Part Two of this book would make you look differently at Finance. For example, Professor Shiller discusses “Finance, Mathematics and Beauty” and takes a look at “Financiers among Artists and Other Idealists“. Part One of the book takes into account today’s public hostility and examines the various organs of the body of financial capitalism.

If you wish to understand the beauty of financial theory that has inspired great minds and its application to economical development of modern society, read Finance and the Good Society by Professor Shiller. Below we review a few sections.

Why is Finance Critical?

Professor Shiller has argued often that the growth of a country is dependent on the growth of its financial system. We recall him warning in 2009 that efforts to reduce the size of the American financial system would result in slowing the pace of American recovery. This view was prescient. This has been the weakest economy recovery ever.

Professor Shiller points out:

  • “The gross value added by the financial corporate business was 9.1% of U.S. GDP in 2010. … By comparison, it was only 2.3% of GDP in 1948”.

To those who are troubled by this, Shiller says:

  • “…19.7% of the U.S. labor force in 2012 – supervisors, security personnel, members of the military, was involved in guarding in some form. The high percentage of our citizens paid to guard us and our installations and possessions is at its essence surely more troubling than the percentage engaged in the substantially productive activities of finance. Yet relatively few of us seem bothered by this statistic.”

So again, why is Finance critical?

  • “In fact, finance has been central to the rise of prosperous market economies in the modern age – indeed this rise would be unimaginable without it.” 

What is Finance?

  • “The  word finance
    is commonly thought of as the science and practice of wealth management
    – of enhancing portfolios, managing their risks and tax liabilities,
    ensuring the rich get richer.”

The above is just one aspect of finance.

  • “At its broadest level, finance is the science of goal architecture – of the structuring of the economic arrangements necessary to achieve a set of goals and of the stewardship of the assets needed for that development.”

Professor Shiller tells us that the word finance actually derives from the classical Latin term for “goal” – the Latin word finis, which is usually translated as end or completion. He explains further:

  • “Finance does not embody a goal. Finance is not about “making money” per se. It is a “functional” science in that it exists to support other goals – those of society.”

Financial Innovations and Financial Capitalism

Professor Shiller writes:

  • “Financial capitalism is an invention, and the process of inventing it is hardly over. … It will mean designing new financial inventions that take account of the most up-to-date financial theory, as well as the research revolution in behavioral economics and behavioral finance that has explored the real human limitations that inhibit rational and humane decision making.”

In his section “The Inexorable Spread of Financial Capitalism”, Professor Shiller describes how financial innovations emanating from Amsterdam, London, and New York are developing further in Buenos Aires, Dubai, and Tokyo. Specifically, he writes:

  • “But China, India, and Russia have seen a flourishing of financial sophistication and amazingly high economic growth rates.”

Professor Shiller also strikes a note of worry:

  • “To be sure, financial innovation is still percolating, at a slow and conservative level, but major new financial inventions cannot be launched now because of fear.”

This would be sad because,

  • “Creating and implementing such inventions will be the best tactic to deal with economic inequality.”

This is perhaps the central message of Finance and the Good Society.

Finance, Aggression in Society, Global Conflict Management

Dennis Gartman, author of the globally distributed The Gartman Letter, likes to point out that historically societies with large numbers of unemployed young men have sent them to the border. The tactic is to let these young men vent their aggression externally rather than internally.

Professor Shiller devotes sections to discuss the concept of aggression in human beings. He brings up the ideas of Albert Hirchman (author of The Passions and the Interests) that man “as he really is” is driven by passions that often create conflict. Then Professor Shiller writes:

  • “A financially sophisticated economy provides an outlet for aggression that is substantially constructive and does not result in loss of human life.”

Any one who has traded financial instruments or worked on a trading floor can easily see how human aggression can be channeled into trading, a much safer channel than was available to our ancestors.

Professor Shiller also discusses the work of Bruce Russett and John Oneal in their book Triangulating Peace.

  • “They conclude that three variables, measured for any given pair of countries, help explain the likelihood that these countries will be at war….Among these factors, Russett and Oneal found economic interconnectedness to be the most important…measured by volume of trade flows relative to GDP.”

Professor Shiller links this to the 1773 work of Charles de Montesquieu:

  • “Montesquieu argued centuries ago that “movable wealth” prevents wars by creating a sudden and intense consequence for any military action. If countries are financially free to invest in each other, and have done so but have the freedom to withdraw these investments, then the situation creates an incentive for owners of that capital to use their influence to prevent war.”

Finally Professor Shiller brings this all together:

  • “Financial interconnectedness may help prevent war for deeper reasons than those associated with the perceived risk to capital movements. Financial interconnectedness provides another outlet for aggressions, a civilized stage for the playing out of aggressive impulses and an environment in which exposure to risk is carefully chosen by each player, not determined arbitrarily by a military commander.”

His message:

  • “Thus financial development may lead to a kinder and gentler – if not altogether kind and gentle – society.”

Aristocracy, High Society, Caste Systems & Financial Democratization

Today, we see a “financial aristocracy” of sorts in American society. A few, only a few, can aspire to reach the levels of high finance that offer rich rewards, rewards far beyond those available to the majority of American workers. This may be one reason American society now views financial firms as intrinsically unfair and even detrimental to society at large.

Professor Shiller takes an opposite view. He
argues that the concept of “aristocracy” or “high society” is fading around the world. He is right. For example, the New York Times reported recently that access to jobs and financial support is creating upward social mobility for Indian people from “lower castes”, to use a British-Portuguese word. Shiller himself gives the example of Yale, the university where he has taught for some thirty years:

  • “Even my own university has seen a gradual transformation over the centuries from a training center for elite American families to an educational institution serving the people of the world. It has also become a financially sophisticated institution, given its success in investing its endowment….[its] goals are substantially social and benevolent, and reflexive of the views of a unique intellectual community.”

This financial sophistication is unique to American Universities. Their counterparts in the rest of the world do not manage their own finances and rely instead on funding from their Governments. This may be the best illustration of how financial sophistication facilitates excellence in other fields, even in the unrelated ivory tower arena of University Education.

This brings Professor Shiller to his cherished goal – democratization of finance:

  • The democratization of finance as spelled out in this book calls for an improvement in the nature and extent of participation in the financial system, including awareness of the fundamental information about the workings of the system.
  • The democratization of finance works hand in hand with the humanization of finance….The rise of behavioral economics and neuroeconomics in recent decades provides a foundation for such an approach, for understanding how people really think and act.

Professor Shiller concludes his book with:

  • The key to achieving our goals and enhancing human values is to maintain and continually improve a democratic financial system that takes into account of the diversity of human motives and drives.

Read this book.

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