Finance and the Good Society

Goodness and finance are not words one usually sees sitting alongside each other in the same sentence.

There was a sensible idea -- doux commerce -- at the time of the European Enlightenment that a common interest in commerce would tame the barbaric passions and civilize and soften societies. Alas, that’s not a viewpoint often heard since 2007.

Robert J. Shiller’s new book Finance and the Good Society came out last week. I do not have a copy (my personal ethic here is full disclosure each and every time). However, by keywording the text at the publisher’s webpage and reading the interest-provoking review by the US economics editor of the Financial Times, Robin Harding, you get an idea of the content; enough certainly to stimulate thinking on general issues of economic governance.

In particular I was intrigued by a paragraph in Harding’s review:

Mr Shiller tends to assume that innovations in finance automatically make society better. But if collateralised debt obligations and subprime mortgages prove anything, it is surely the reverse: the natural tendency of financial innovation is towards complexity, exploitation and crisis. Finance can serve the “good society”, but Mr Shiller is curiously reluctant to demand that governments, regulators and financiers make it do so…

The review concludes, by way of summary:

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Mr Shiller reminds us of the profound importance of finance to making our society work. But a good society rests always on the good people who struggle to make it so.

In this book Shiller *does* appear to rely on morality-cum-ethics as a foundation stone for creating and sustaining a capitalist world in which any poor person could start a business by “getting credit from a bank or capital from wealthy investors”. This, in essence, is the “democratization of capitalism, the opening of financial opportunities to everyone”.


The financial crisis reminds us that innovation has to be accomplished in a way that supports the stewardship of society’s assets. And the best way to do this is to build good moral behavior into the culture of Wall Street through the creation and observance of best practices in its various professions -- CEOs, traders, accountants, investment bankers, lawyers, philanthropists...

Shiller emphasizes a formal education in the ethics:

… democratizing and humanizing and expanding the scope of financial capitalism… is a social dilemma that can be addressed by changes in our educational system...

If there is going to be criticism of this book it may be that it is short on concrete remedies. However, Shiller has already written several important books replete with policy suggestions. The remedies that interest me most -- putting on my sociologist cap -- relate to insurance against financial risk. If you hear anyone complaining that there aren’t enough safe assets out there, and asking how we can solve that problem, tell them go read Shiller. There are structural bottlenecks in the supply of livelihood insurance on all rungs of the socioeconomic mobility ladder. 

True, hazards (moral and otherwise) exist in risk insurance itself. See 2005 and yesterday. Nevertheless, risk insurance may be the most important area of crisis-destruction-avoidance research. In Finance and the Good Society, Shiller has this to say:

Innovations could include the implementation of new and better safeguards against economic depression, including the proliferation of new kinds of insurance contracts to allow people to be more adventuresome in their lives without fear of economic catastrophe...

OK, back to the question of goodness.

The proliferation of Business Ethics courses at the universities long predates the present financial crisis. If only for that reason we should be cautious about relying too heavily on education to clean up griminess in finance. It did not prevent the crisis. Might we in any case hope nay expect that fair-dealing principles such as *honesty is the best policy* (Max Weber’s expression) would be taught at home from-cradle-to-skateboard, and only thereafter for the exam board? It’s not rocket science.

What are the first principles here?

There is the juxtaposition of being ‘good’, which is personal, and financial markets, which are impersonal. Both personal and impersonal social actions are components of good society. While keeping an eye on new books like Shiller’s I continue to rely on Max Weber’s conception of ideal capitalism and its impersonally regulated relationships.

In one of the remoter caverns of Economy and Society Weber -- my 'personal' hero -- I stumbled across this about impersonality:

The domination of capital is the only one which cannot be ethically regulated, because of its impersonal character… Decisive are the need for competitive survival and the conditions of the labour, money, and commodity markets; hence matter-of-fact considerations that are simply non-ethical determine individual behaviour and interpose impersonal forces between the persons involved… The penalty for non-compliance is extinction...

No, Weber was not referring here to automated trading. Neither is it dehumanization in a literal sense. Nor is it a question of whether something being impersonal is good or bad; it’s just a statement of fact that the market becomes:

the most impersonal relationship of practical life into which humans can enter...

I’ll try to sum up what he is saying that remains relevant. It has to do with simple laws or constitutions to enforce failure and protect success. Goodwill, being good, good faith, dealing well and fairly, are usually the lubricants of a healthy sustainable business relationship. But ethics and morality (which precede law in evolutionary terms), the consciousness of doing good, good faith, etc. only work for repeated and arms length transactions in complex modern society when all parties are confident of law and its credible enforcement as the ultimate backstop for deserved success, and when all parties are certain that extinction will be the ultimate penalty for deserved failure.

This is a point forgotten in a world where bailouts in one or another form are all the rage.

It would be difficult for Prof Shiller to demand that regulators *make* finance serve the good society. Regulators typically fail and may even make things worse when they attempt to regulate personal conduct. Of course there are many structural impersonal things regulators can and should do.

Ultimately the best form of regulation in financial markets is competition. That means the best form of regulation is one that removes the obstacles to competition.

Every now and then, and regularly enough for the problem not to grow so big that it becomes systemically catastrophic, the risk takers will fail massively and they will pay for their mistakes (if government and the ideologues bravely let them pay without fear or favour).

As I say, I have yet to read the book. I find myself in complete agreement with Shiller’s emphasis on the virtues and indispensability of competitive finance. I just get a wee bit uneasy about any apparent reliance on goodness, professional ethics, and other personal dynamics; even if this is only a reliance that comes from reaching a midway point on the road to more elaborate statements of desirable institutional and financial innovations-as-solutions.

Remember that Joseph Schumpeter said: “Capitalism is that form of private property economy in which innovations are carried out by means of borrowed money, which… implies credit creation”, but goes on to say that “like most other definitions of capitalism, ours is institutional”.

Perhaps economic sociology comes into its own at moments like this. There is a useful classical view on the transition from regulation by personal ethics to something ‘safer’. The beauty of law in respect of barriers to competition, the imperative of full disclosure, and the punishment of fraud is that it assumes a permanent existence of bad people, or inefficient, ignorant, and greedy people.

In varying degrees -- on a fair continuum from soft to hard landings -- we let them fail. Is that not the other side of the coin in the democratization of finance?;
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