Practical analysis for investment professionals
30 July 2012

Robert Shiller: In Praise of Financial Innovation

Support for capitalism is falling all over the world. Recently, former U.S. Federal Reserve chairman Paul Volcker gained some notoriety by claiming that all the financial innovation in the past 30 years has had no value whatsoever. But as Yale University economics professor Robert Shiller reminded delegates at the CFA Institute Financial Analysts Seminar last week, cynicism about finance is in fact misplaced frustration with today’s crises.

“Financial innovation is everything,” said Shiller, who argues in his forthcoming book, Finance and the Good Society, that finance needs to be reclaimed for the greater good. “Our civilization is built on it. And criticism of capitalism is really criticism of innovation itself.”

On the heels of the 2008 crisis, many people have focused their ire on Wall Street for its role in creating the housing and real estate bubble. But as Shiller pointed out, history is replete with “speculative bubbles [that] have occurred in a wide range of human endeavors, not just in markets.” Between 1929 and 1933, he noted, millions of people were swayed by a “bubble” of enthusiasm for collectivism, which failed miserably and killed millions of people in Soviet Russia. Later, from 1958-1961, Mao Zedong generated a lot of enthusiasm in China for a collectivist food program — and 30 million people died of starvation. Speculative bubbles reflect the human condition, not capitalism per se.

Shiller contended that capitalism is a complex invention that is changing all the time. Because the world is dynamic, he emphasized that society needs financial innovation to solve new problems. One example: the recent breakthroughs in neuroeconomics, which give us totally new insights into how people make choices. These innovations promise to change everything we know about people in general, and economics in particular. Other recent innovations include crowdfunding and benefit corporations. Albeit a nascent effort, crowdfunding uses the Internet to break down some of the traditional barriers that prevent entrepreneurs from obtaining capital to fund new business ideas. Shiller also highlighted the recent emergence of benefit corporations, which focus explicitly on creating a societal benefit as part of their mission. He cited the example of a fertilizer company called Grower’s Seeker whose mission includes the reduction of levels of NPK (nitrogen, phosphorus, and potassium) from fertilizer run-off that ends up in the world’s oceans.

Shiller also explained a financial innovative of his own. Given the over-indebtedness of many sovereign nations today, he suggests that their governments sell “trills” that would pay a dividend based on achieved levels of gross domestic product (GDP), akin to a corporation issuing equity. In doing so, a nation could reduce its debt-service costs and strengthen its national balance sheet without having to go through a painful rebalancing. Shiller said that he has had many discussions with the Bank of England about his idea, but that it has yet to spark any enthusiasm.

The true test for any innovation is that it endures. Unfortunately, many recent innovations over the past 25 years or so have failed to meet that test. The key point is not that some will fail — as some most surely will. Rather, the virtue is that some will succeed and ultimately improve all of our lives. If we kill capitalism, we also kill innovation. As both investors and citizens, we all benefit from the creative destruction that is implicit in capitalism.

If we don’t defend capitalism and free markets, who will?


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
Ron Rimkus, CFA

Ron Rimkus, CFA, was Director of Economics & Alternative Assets at CFA Institute, where he wrote about economics, monetary policy, currencies, global macro, behavioral finance, fixed income and alternative investments, such as gold and bitcoin (among other things). Previously, he served as SVP and Director of Large-cap Equity Products for BB&T Asset Management, where he led a team of research analysts, 300 regional portfolio managers, client service specialists, and marketing staff. He also served as a Senior Vice President and Lead Portfolio Manager of large-cap equity products at Mesirow Financial. Rimkus earned a BA degree in economics from Brown University and his MBA from the Anderson School of Management at UCLA. Topical Expertise: Alternative Investments · Economics

2 thoughts on “Robert Shiller: In Praise of Financial Innovation”

  1. Trish Coy says:

    I am not impressed by the logic here. The issue is not whether financial innovation is good or bad. The issue is that financial innovation must be subject to careful scrutiny and regulation not unlike how the FDA scrutinizes and regulates drugs. I want to know what Schiller has to say on this.

  2. Adil Zaid says:

    The logic here is misplaced. Capitalism is good, when it operates in free markets. The reason why those who were supporters of capitalism are cynical about it today is because free markets are being disrupted by government interruption and bail-outs of failed financial innovations.
    If the market place is free where bad decisions face bad results, we would have a more responsible and more robust capitalist society. But because governments are bailing out bad investments and creating a cushion for bad financial innovations, we are witnessing how big institutions are mishandling the nation’s money and getting away with both a government bailout and hefty bonuses. Recent events are again testimony to that.
    Innovation and capitalism are good. Subject to the condition that they operate in a free market and not in a distorted one.

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