Finance: Past, Present and Future

Click here to read Chris Colvin's excellent post on NEP-HIS Blog, where he reviews Richard Easterlin's paper ' Cross-Sections Are History '. Here is a flavour of what Chris writes in his post: Easterlin’s particular beef is with purveyors of cross-country growth regressions. He notes that studies of actual historical experience of individual countries frequently disprove expectations about causation based on cross-sectional relationships. The fact that a certain group of countries enjoys high levels of per-capita GDP and high life expectancies does not mean the former causes the latter. Indeed, the fact even that these countries were the first to enjoy both high GDP and high life expectancies still does not prove causality. Easterlin, famous for his  Easterlin Hypothesis , instead argues that there could be unrelated factors causing GDP and life expectancy that cannot be picked up in a cross-sectional regression. The reason: cross sections register the results...

Click here to read an interesting piece by Robert Shiller , where he wrestles with the meaning of the term 'bubble', and he suggests that we maybe use the term too carelessly. Some economists, such as Eugene Fama , even deny their existence - click here .

The video below is an interesting BBC report into the Royal Mint and the cashless society. Prof. Bernardo Batiz-Lazo , formerly of Queen's and an expert on the cashless society, is interviewed by Jon Sopel in this report (hat tip - Chris Colvin).

The Archbishop of Canterbury has recently attacked payday lenders, such as Wonga. He also has stated that the Church of England will support the English credit union movement and compete head-on with payday lenders (see FT video below). Just go to the Wonga  website to see the extortionate interest rates that they charge - 365% pa!

Perhaps the main challenge to the legal-origin or law and finance hypothesis comes from history. Aldo Musacchio  (Harvard Business School) and I have co-edited a special issue of Business History which examines the law and finance hypothesis from an historical perspective.  We have also written an article which argues that the law and finance does not pass the test of history - click here . The article's abstract is: For the body of work known as the law and finance literature, the development of financial markets and the concentration of ownership across countries is to a large extent the consequence of the legal system nations created or inherited decades or hundreds of years ago. Despite the seemingly historical nature of this explanation, most of the body of work supporting the law and finance hypothesis has been ahistorical. This paper summarises the business history literature and provides evidence on investor protection and financial development over the long run t...

The work of the law and finance school has generated a lot of criticism. The criticisms can be categorized under three headings. 1. Empirical problems  For example, Holger Spamann , using primary legal documents, re-codes the investor protection measures of La Porta, Lopez-de-Silanes, Shleifer and Vishny and finds that none of their results hold with his more accurate measure ( click here ).  See also work by Dam  and  Graff . 2. Legal origin is a proxy Legal origin may simply be a proxy for culture , initial colonization conditions , political instability , electoral systems , society's historical decision about the role of the State , or the way in which laws were transplanted . 3. Historical evidence See the next post for more on this. Click here to read the response of La Porta, Lopez-de-Silanes and Shleifer to their critics.

In yesterday's post , I outlined the legal-origin or law-and-finance hypothesis, which argues that economies with a common-law legal origin have better financial development, investor protection laws, etc.. But w hy is common law better than civil law?  According  to the  legal-o rigin school, Civil law is viewed as inferior to common law because it is devised by academics and legal philosophers,  whereas  common law emerges from the process of judges resolving specific and real business disputes in a pragmatic manner.  The infrequent revisions of civil-law codes means that they can quickly go out of date, whereas the common law can easily respond to new business environments and practices.   Civil law is also subject to greater interference from politicians than common law.      But why did differences emerge between English common law and French civil law?  According to the legal-origin school, there are two possible explan...

One of my research interests is the relationship between law and finance. This area has been a huge growth area in economics since Rafael La Porta , Florencio Lopez-de-Silanes , Andrei Shleifer and Robert Vishny published their path-breaking ' Law and Finance ' in 1998. In this paper, they examined the legal protections afforded to shareholders and creditors in 49 economies. Their results were startling: investor protection was best in common-law countries (i.e., the UK and her former colonies) and worst in French-civil-law countries (i.e., France and her former colonies). German-civil-law and Scandinavian-civil-law countries were somewhere in between. Legal origin (i.e., how a country's legal system was developed centuries ago whether within a country or transplanted via colonisation) seems to matter for present-day legal protection of investors. In other words, the legacy of the past very much matters for the present.  Subsequent work on this topic found that legal...

Ziggurats were massive temple structures built by the Sumerians, Babylonians, and Assyrians. The Tower of Babel  mentioned in the Old Testament may have been one of the first ziggurats. Click here to read an article about In Tempo , a massive unfinished ziggurat-like residential property in Benidorm (see picture below). This property stands as a testament to the extent and sheer madness of Spain's bank-fueled property boom.   

Click here for a post by J. Bradford DeLong , where he argues that too much finance can be bad for economic growth. Although I might have a vested interest in making a counter argument, I actually believe that Brad DeLong might be correct. For sure, financial deepening has been an important driver of economic growth over the past two centuries (see here and here ), but maybe the relationship between financial development and economic growth is an inverted U shaped and we are now on a downwards slope!

The Institute of Economic Affairs is sponsoring a Brexit  competition where individuals or teams have to tackle the following scenario: A referendum has resulted in an “Out” vote and Her Majesty’s Government has triggered Article 50 of the Lisbon Treaty. What measures does the UK need to take in the following two years, domestically (within the UK), vis-a-vis the remaining EU and internationally, in order to promote a free and prosperous economy? The great irony for me is that the prize money being put up by the IEA, which has a long tradition of being anti-European, is 100,000 euros for the winner!!   

Some economists like to think of economics as a physical or hard science, with immutable laws. Indeed, there is such a thing as econophysics , which applies the methods and theories of physics to economics! However, unlike hard sciences, economic theories are not subject to rigorous testing in controlled lab experiments. Even though some economists have developed the field of experimental economics , it cannot come close to the experiments in hard science. Economics is really a social science , and we should therefore be very careful in drawing parallels between the physical sciences and economics. Click here to read an article which highlights the dangers associated with the myth that economics is a science with fixed and accepted axioms (hat tip - Chris Colvin).       

Socialists advocate public ownership of the means of production, whereas capitalism is simply where capitalists own the means of production. But who controls the means of production in a capitalist economy? I am currently working on a project with co-authors which looks at corporate ownership and control, and we are trying to answer the following question: are firms controlled by their owners or by managers? According to a recent post by Mark Roe , the United States is more a managerial economy than a capitalist one. A small cadre of managers and CEOs controls the means of production rather than capitalists. This gives these managers lots of influence on the economy and one has to ask whether they control the means of production in the interests of the capitalists (the owners of the means of production), never mind wider society. Increasingly, there is doubt as to whether they do either.

Following on from Monday's post , here is a post on the Irish Economy blog by Oxford's Kevin O'Rourke , which looks at the importance of economic and financial history to economic theory and economic policy-making (hat tip - Christopher Coyle).

Congratulations to Christopher Coyle who graduated on Friday with a PhD from Queen's. Christopher is a product of the Queen's system, having studied Economics and Finance at BSc, MSc and PhD levels. He has also just joined the faculty at QUMS and QUCEH . Christopher's PhD looks at financial development and stability over the long run. He and I have a paper forthcoming in the Journal of Economic History , which looks at the role played by law and  politics in the evolution of the UK corporate bond market from 1860 until 2000. 

MIT has produced some influential economic historians over the years, e.g.s.  Walt Rostow , Charles Kindleberger , and Peter Temin . However, after Temin's retirement and Dora Costa's move to California, there are no economic historians at MIT and graduate students no longer receive instruction in economic history. Click here to read Peter Temin's view of the rise and fall of economic history at MIT (hat tip - Graham Brownlow). Notably, this story has parallels in the wider economics profession.  As the ongoing crisis demonstrates, the fall of economic history has been detrimental to economics and economic policy. Why did economic history fall? One possibility is that economic history stopped doing what economic historians are good at - explaining for us the long-run patterns and trends in the economy. Another possibility is that economic history did not fit neatly into the mathematical and 'scientific' turn which economics took in the 1940s. Yet another possi...

My 2013 Corporate Finance class graduate this afternoon. I really enjoyed teaching this class so it will be great to see them do the graduation walk!  I am delighted that many of them have done well in the job market. Ligia   Mladin  is to be congratulated for graduating top of her year group and Liam  Trainor  is to be congratulated for being the top student in my Corporate Finance class. Both  Ligia  and Liam received  prizes  at the School  prize -giving ceremony this morning.      

Because large financial institutions are bailed out by governments when they fail, they receive a subsidy from taxpayers. How valuable is this too-big-to-fail subsidy to large financial institutions? Click here for an IMF study which suggests that it is substantial. Mark Roe has an opinion piece at Project Syndicate which also suggests that big banks enjoy a large subsidy from the taxpayer.   

What effect does bank distress have on innovation? This is an important question for economies which are still suffering the effects of the 2008 banking crash. At last week's QUCEH workshop , Tom Nicholas of Harvard Business School presented a paper which examined the effect of bank failures during the Great Depression on innovation. Using firm-level patent records, he and his co-author find that bank distress had a significant negative impact on the level, quality and trajectory of firm-level innovation. Tom's paper is available here .