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Dirk Bezemer
Metaphors are appealing in their simplicity, but can mislead if they are framed inaccurately. Before 2007, there was a ruling metaphor for finance and the economy. The economy was viewed as an engine humming along; credit was the oil lubricating its many moving parts. This seemed to be the case in the NICE decade (non-inflationary, consistent expansion). It was only afterwards that we learned that too much oil can also flood an engine, leading to seizure and long term damage. The metaphor had proven inadequate.
So how should we now think of credit? A good place to start is history. Schumpeter’s ‘Theory of Economic Development’ (1912) described economic development as a combination of credit and entrepreneurship. Development was not GDP growth – it was the spread of innovations.
These qualitative distinctions receded into the background with Shaw’s 1973 ‘Financial Deepening in Economic Development’ which used a quantitative metaphor, since deeper simply meant more. Levine and King’s 1993 article, ‘Finance and Growth: Schumpeter Might be Right’ also transformed Schumpeter’s qualitative concern with development into the quantitative analysis of income growth. Schumpeter had not treated credit as a vague mass measured by credit/GDP ratios. Some finance supports innovation, but Schumpeter recognized that not all of it does.
These distinctions initially found no place in the new empirical research program on the relationship between credit and growth. Over the next decade, dozens of papers confirmed and detailed the finding that ‘finance is good for growth’ – which soon acquired the simplistic status of stylized fact: more credit was better.
Some economists held different views. For example, the Austrian School worried that excessive credit creation would lead to a mal-investment boom-and-bust sequence. Marxists and Post-Keynesians warned of the consequences of financialization (i.e. rent-seeking by financial-sector actors). Sociologists like Krippner (2005) warned how rent-seeking behaviour can ‘crowd-out’ productive investment, raising debt burdens and leading to inequalities in wealth and income.
But in the expansion of the 1990s and 2000s, the concepts of financialization, credit cycles, and credit creation were scarcely featured in ‘core’ macroeconomic models. There were notable exceptions, such as Kiyotaki & Moore (1997) and Bernanke & Gertler (1996), but these ideas were rarely integrated into core mainstream macroeconomic models. As a result, the problematic sides of credit growth (rising private sector debt and financial fragility) remained largely undiscussed.
In the aftermath of the global financial crisis, the scope of questions we ask about finance has widened again. The flagship economic journals have published papers such as ‘Too much finance?’ (Arcand et al., 2015). Philippon & Resheff (2013) argue the need to “evaluate in a more rigorous way, whether finance is too big, or too expensive, from a social point of view.” This suggests a broader line of enquiry on how does finance affect the economy beyond investment and income.
The financial crisis has encouraged an intellectual space to discuss wider concerns through other scholarly lenses. Political scientists and sociologists have studied the intersection of financial system development with political economy issues and social dynamics. This connects finance with stratification, inequality, power relations, and social system resilience.
At the same time, the analysis of these issues can build on the sophisticated methods that were developed in the finance-and-growth tradition. This also gave a tremendous push to so-called heterodox research programs. Microdata, even on the level of loan transactions, have shed new light on the impact of debt and credit on consumption and investment decisions. Finance and inequality have been connected in new data sets, and network analysis has been brought to bear on questions of stability.
A striking example is the rediscovery of the financial cycle (beyond the exceptions above). This used to be the province of thinkers like Veblen, Hilferding, Schumpeter, Keynes, and of course, Minsky. Financial-cycle analysis is now a research focus in academia and in institutions like the Bank of England and the Bank for International Settlements. New models of the financial cycle have been developed, for example, Aikman et al. (2013), ‘Curbing the Credit Cycle.’
There are now also many empirical studies on financial cycles, such as Borio & Drehmann’s (2012) ‘The financial cycle and macroeconomics: What have we learnt?’ This implies recognition that finance does not always and everywhere support growth, but comes with growth spurts and growth contractions, and waves of financial distress. We need to understand the drivers and consequences of these waves.
Another approach is to ask what structure of the financial system would offer the best outcome for citizens. If finance is so important for the efficient allocation of resources, what is the best design of the system? It is perhaps a paradox that a discipline based on optimisation has such a wide disparity of structures across countries around the world. Not since Allen and Gale’s (1999) ‘Comparative Financial Systems’ has this obvious but profoundly important question been addressed in a comprehensive way.
In the aftermath of the Great Depression, legislators had a clear vision of what ‘fit for purpose’ meant. They introduced interstate banking, deposit insurance, separation of retail and investment banking and even the creation of long term fixed rate mortgage markets. They recognised who finance was supposed to serve. Economists and social scientists need to have a new conversation if we are to choose our best financial engine and how much oil is needed.