Professor Robert Schiller from Yale University spoke at the RSA in London tonight on the roles and responsibilities of the financial sector and built an argument that finance can be a root to addressing some of the toughest economic and social challenges of the age. Here are some brief notes from his talk.
Financial innovation has got a bad name recently - creativity in financial markets gave us Enron, sub-prime mortgages, credit default swaps and a myriad of other incredibly complex new financial instruments deeply connected to the global financial crisis. But despite this, “financial capitalism” is taking hold all over the world, for example futures and stock markets are setting up in many fast-growing emerging countries. But how strong is public support for and tolerance of financial institutions? Are financial businesses taking too many of our most talented students? In 2006 - 46% of Princeton students went into financial businesses - are they draining the real economy of too many talented people? How do we distinguishh between good and bad financial innovations? What does the Good Society actually mean?
Robert Schiller argues that we cannot go back in time - “practically everything that is good or important in society will at some point have to go through financial systems to grow and be sustained” - we need think of finance as something that manages and maintains our goals - be they individual, corporate or social. He argues that we need stronger knowledge of finance (an important message here for exam boards as they condiers re-calibrating the A level syllabus). The logical next step from the worldwide Occupy movement protests is structural changes to financial institutions but first we need to understand them more and reform on that basis.
Recent innovations in finance
Consider the last two years only ......
1/ The Benefit Corporation
Companies in US are constrained by law to maximise profits - they are fearful of a shareholder law suit if they dont do this - the Benefit Corporation creates a stated purpose of making profits and allocating some for a social purpose and the communities that surround businesses. Benefit corporations in the United States are spreading quite widely but they are still very small. An example is Blessed Coffee
2/ Social Impact Bonds
This is a bond that pays to investors if some goal to society is met e.g. social impact bond whose goal is to reduce re-offending rates at Peterborough prison - the bond pays to investors only if there is a 7.5% reduction in re-offending rates - social impact bonds focuses entrepreneural attention on solving social problems. More details on social impact bonds can be found here BBC News - August 2011 - Social impact bonds launched by government to help poor
3/ Crowd Funding
Web sites such as KickStarter that allow people to invest small amounts of money in start up businesses many of which are social enterprises.
These are a few examples of the penetration of finance to a broader group of people and they reflect the increasing emphasis given to allocating finance to social projects. Schiller regards this as financial innovation to help grow and deepen the spread of social enterprises - profits for a purpose.
Future innovations in finance
Schiller claims that “We need to democratise and humanise finance, we should strive to make it work better for real people and communities
a) A new kind of participatory philantrophy - a participation non-profit - e.g. a school or a hospital that takes donations by selling shares from people (perhaps tax deductible), shares receive dividends which go into a special closed account in your name that then allows you to make donations to charities and causes of your choice. People would be motivated to watch their account grow and then take active decisions about how to allocate their dividends.
b) A new form of government debt - shares in the nation’s economy - the convention is that governments issue straight debt but little else. The government might start selling shares (Schiller talks about trills - a “trillionth” of a share of GDP) or GDP-linked bonds - the UK should sell £1 trillion worth of shares in the economy, the shares would pay a dividend (variable) and would be traded on the stock market. Issuing shares would curb the sovereign debt crisis and there would be a pent up demand from overseas investors and domestic investors would drive up the price.
Trills would have a coupon (interest payment) tied to a country’s growth prospects. The security would have a long-term maturity (say 20-30 years) that pays out an annual coupon worth a fraction of that year’s nominal GDP.
An interesting idea - but how would GDP/GNP be calculated? Would there be share buy-backs? And annual country AGMs? The sandwiches would have to be pretty good.
“If the Greek economy was diversified around the world with shares held by many investors globally, then the systemic risk of debt default from a tiny economy relative to the rest of the world would be much lower”
c) Mortgage reforms - at the moment they are simple debt contracts and people get into trouble as hosue prices fall and mortgage arrears build up - a huge problem for highly leveraged young families who have put virtually everything into getting onto the property ladder. Schiller proposes that mortgages have compulsory “work-out” elements - when house prices fall, the outstanding mortgage would fall too.
Schiller proposes inequality indexation of taxes - this means that the tax system becomes more progressive automatically in the future if inequality (relative poverty) exceeds some agreed threshold. Inequality is trending higher in many advanced countries, some limit on the extent of inequality has to be decided on now rather than waits until it happens. A really interesting pyschological viewpoint lies behind this approach - this would be an insurance policy against future inequality.
Financial innovation provides a clear path for dealing with many concerns - not the innovation that one would normally think about - e.g. sub-prime - this is convention-challenging stuff! Schiller is trying to formulate ideas that reform our financial system in ways that moderate and manage risk for the social good rather than simply maximising returns to private sector financial organisations.
For more background on Schiller’s ideas in “Finance and the Good Society”