What Kind of Finance Should There Be?

Abstract

In recent decades, most developed economies around the world have been increasingly exhibiting a structural trend popularly labeled “financialization.” The systemically destabilizing potential of this trend came into a particularly sharp relief during the global financial crisis of 2008. Not surprisingly, the crisis has revived a long-standing academic debate on the causal link between growth of the financial system, on the one hand, and broader economic growth, on the other.

This article takes the economic literature on the relationship between the size of the financial sector and economic growth as a starting point for broadening and deepening the inquiry into the qualitative aspects of their relationship. It shifts the discussion beyond the economists’ question “Can there be too much finance?” to the bigger and more complicated question, “What kind of finance should there be?” The article outlines an effective macro-systemic approach to financial markets and regulation, which explicitly ties together the traditionally technical issues of financial stability and innovation and the broader issues of sustainable and structurally-balanced socio-economic development.

To concretize this interdependence, the article (1) offers a novel conceptual framework for understanding financial innovation, and (2) lays out a proposal for reforming public infrastructure finance.

Keywords: financialization, financial crisis, economic growth, development, financial stability, financial innovation, capital markets, fintech, infrastructure finance, industrial policy, financial system, structural reform, financial regulation