Hero or villain? The financial system in the 21st century

Abstract

The paper reviews the literature and data on the role of finance in socioeconomic development. The evidence suggests that a well-developed financial system can certainly enhance people's prosperity, but an excessively large and poorly regulated financial system can do more harm than good. We start by making the important distinction between traditional finance (retail banking, insurance, etc.) and modern finance (financial "innovation" and asset trading). We then document that the financialization trend of the past four decades has largely transformed modern finance from "hero" into "villain." We discuss the driving forces behind this, as well as some policy reform proposals that could in principle make modern finance a hero once again.

The evolving financial landscape: analyzing uncertainty, risks, and growth in G7 economies of the 21st century

“…However, the negative correlation between stock price volatility (SPV) and economic growth (r=-0.30) offers a counterpoint, emphasizing the potential adverse consequences of excessive market risk and instability. Libich's (2022) warnings about poorly regulated financial systems and their potential to cause financial crises become more salient in the context of this negative correlation.…”

“…According to Libich (2022), the evidence presented in his study suggests that a developed financial system can certainly contribute to increasing the prosperity of individuals and societies as a whole (Libich & Lenten, 2022). This type of system, consisting of traditional financial institutions such as banks and insurance, play a key role in supporting economic activity and investment in infrastructure, manufacturing, and other important sectors.…”

The Growth of Finance is Not Remarkable

“…Our work shows that the growth of finance was not unusual, which directly challenges the "financial exceptionalism" narrative that exists in much of the literature. But it is beyond the scope of this article to address whether the growth of finance has been, on net, good or bad for society (e.g., Philippon and Reshef (2013), Philippon (2015), and Libich and Lenten (2022)). In particular, even if the evolution of finance is part of a much broader expansion of skill-intensive servicesas it appears to bethe resulting size and scale of the financial sector may be concerning.…”

“…As such, our work does not dispute the findings in other studies linking the timing of changes in the finance wage or income share with particular policies and regulations. 5 Second, although our work provides context for policymakers and researchers trying to understand the growth of finance and to evaluate the relative costs and benefits of this growth (e.g., Cochrane (2013), Greenwood andScharfstein (2013), andGennaioli et al (2014)), our analysis has nothing to say about the optimal size of finance or whether the growth of finance has been good or bad (e.g., Philippon and Reshef (2013), Philippon (2015), and Libich and Lenten (2022)).…”