Does financial innovation contribute to economic growth?

[Uncle Max]

A few years ago I happened to be at a conference of business people, not financial people, and I was making a presentation. The conference was being addressed by a very vigorous young investment banker from London who was explaining to all these older executives how their companies would be dust if they did not realize the joys of financial innovation and financial engineering, and that they had better get with it.

I was listening to this, and I found myself sitting next to one of the inventors of financial engineering. I didn't know him, but I knew who he was and that he had won a Nobel Prize, and I nudged him and asked what all the financial engineering does for the economy and what it does for productivity.

Much to my surprise, he leaned over and whispered in my ear that it does nothingand this was from a leader in the world of financial engineering. I asked him what it did do, and he said that it moves around the rents in the financial systemand besides, it's a lot of intellectual fun.

Paul Volcker: Think More Boldly

 

[GoIllini]

In a perfectly efficient economy, further financial innovation doesn't buy you anything besides maybe a shift towards more risk and more reward. In a barter economy, the "financial innovation" from developing a currency buys you a lot.

My view is that there is sort of this production possibilities curve between risk and economic growth. "Financial Innovation" allows us to get closer to the curve, but it clearly has its limits. Financial innovation simply helps the economy keep growing at the optimal rate for the risk the market participants are willing to assume.

As the economy grows, financial innovation is required to keep us close to the PPC. The economy of the 18th century may have needed currency, trade and stock markets to function properly, but it didn't require an options and futures market. By the late 19th century, the economy- the grain market being the biggest part- had grown to the point that we needed grain futures to keep it efficient. By the mid-to-late 20th century, we needed equities options. And here in the 21st century, we need to be able to fractionate more components of risk in assets besides just declines below a certain level in stocks and commodities. Coming up with greyhound default swaps doesn't help the economy grow faster right now, but if the dog-race betting market gets to the point where it's worth trillions of dollars, it might be required to help the economy operate efficiently and keep growing at 2-3% with lower risk.

Just the opinion of an IT guy who works on some of these products (Not Greyhound Default Swaps yet, though I'm sure I just gave someone an idea.)

 

[xoxqun]

Contrarian view of how innovation and economic growth happen

Ten Companies That All of Us Know That Almost Weren’t (Minyanville)

As the cases of innovative companies discussed in the above article indicate probably most innovation and economic growth has nothing to do with stereotypical and often academic / "armchair philosophy" ways of linear thinking. Probably what most of the world does is much ado about nothing, while both innovation and growth continue to happen often in unforeseen and unpredictable ways. Or do the above cases represent exceptions that prove the rule? When we start observing many such exceptions, however, is it time to think if the exceptions represent the new rule?

Much to my surprise, he leaned over and whispered in my ear that it does nothing.
Paul Volcker: Think More Boldly

 

[NeedOPT]

Agreed with GoIllini on the benefits and the limitations of financial innovation. Emphasis must be placed on the playoff between diminishing returns and the secular growth of specialization/complexity/scale/integration of the global economy.