Rethinking Finance Through Law: A Theoretical Perspective
Columbia University - Center for Law and Economic Studies
November 21, 2011
Columbia Law and Economics Working Paper No. 412
Finance is traditionally studied by lawyers as well as by economists on the basis of the premise that a market economy has, at its core, a single natural and necessary institutional form, expressed, for example, in the basic rules and doctrines of contract and property. The literature about "varieties of capitalism" has proved insufficient to challenge this assumption. A corollary of this premise is the view that, barring particular market defects, a market economy can be counted on to channel the savings of society to its most efficient possible uses. The first task of regulation is supposedly to redress such localized flaws in competitive resource allocation.
This brief text outlines the rudiments of another way of thinking about finance. It does by advancing a series of connected propositions. Under prevailing institutions, finance has become evermore decoupled from the real economy. The production system remains largely self-financed on the basis of the retained and reinvested earnings of private firms. Financial intermediation is substantially self-directed, oriented to asset trading and position taking by highly leveraged financial institutions, supported by accommodating monetary and regulatory policies.
It need not be this way. A series of innovations in our present institutions and practices can greatly enhance the usefulness of finance and mitigate its dangers. Regulation, as conventionally understood and practiced, is not enough. Regulation, better oriented, can represent a first step toward institutional reorganization.
The reorganization of finance should in turn be judged by the standard of its service to broader aims. The most important proximate aim is to increase the likelihood that finance will serve the productive agenda of society rather than serving only itself. One ulterior purpose is to enhance the contribution of finance to socially inclusive economic growth: the most widely professed political-economic objective in the world today. Another is to organize finance in ways that favor active rather than passive globalization: the engagement of a national economy with the world economy without abandonment of its capacity to implement a distinctive strategy of national development and to establish the institutional arrangements that the strategy may require. Such arrangements are likely to contradict the institutional formulas preferred by the interests and ideas prevailing in the great powers of the day.
A crucial test of every program of reform is success in establishing the institutional vehicles that the program needs. This imperative gives reason to re-invent comparative law as a handmaiden of institutional innovation. Institutional details matter. They exist only as law.
Number of Pages in PDF File: 25
Date posted: November 22, 2011 ; Last revised: January 7, 2013