Posted by: Dirk | May 11, 2009

On the Efficiency of the Financial System

James Tobin wrote an article of this title in 1984. After 25 years, it must be admitted that James Tobin had been smart and courageous:

I have decided … to voice some sceptical views of the efficiency of our vast system of financial markets and institutions. These views run against current tides – not only the general enthusiasm for deregulation and unfettered competition but my profession’s intellectual admiration for the efficiency of financial markets.

In his paper, Tobin attacks the financial system as being too big and too inefficient. There are costs for making markets, and it would not be clear how some of the markets created would help to increase efficiency. By 1984, financial marktes were still small compared to what they look like today. Finance and Insurance provided only 7,5 percent of after-tax profits, compared to a number of 30-80 percent recently.

It seems to me that we have to review the whole financial system and decide which parts are efficient, which are necessary and what we expect of the financial system. If we pay smart people to fool the other people which then bear the cost is not a way of running an economy. The distribution of income should be skewed in favor of those who are more efficient than average in creating value, not those that are more efficient than average in destroying value.

I think even Alan Greenspan would agree with that, based on Ayn Rand’s ideas as developed in Atlas Shrugged. Firms should not go into debt deeply, they should invest by using retained earnings. That way, only productive firms that are financially healthy get to expand. But somehow Alan Greenspan did not agree with Tobin, and since he was chairman of the Fed he got his way.



  1. I would be a bit more careful in claiming that Greenspan agrees with Ayn Rand’s ideas. In his recent book, he states he has drifted away from her political beliefs. And considering what Rand has said about the role of government in economic issues, I cannot imagine how she would have supported Greenspan in his role as chairman of the fed. Without sounding too presumptuous, I believe she would have condemned his acceptance of that job.

    As for the rest of your post, there seems to be an underlying assumption that the markets work “inefficently” (by whose standard) and that the government must fix it. Unfortunately, the facts do not bare this out.

  2. Das ist eine sehr interessante Thematik, die Sie da anschneiden.
    Bei der Lektüre einiger Reden von Ben Bernanke fiel mir auf, dass er früher (vielleicht auch heute noch) das amerikanische Finanzsystem als deep, sophisticated und well regulated lobt(e). (Vgl. meinen Blog-Eintrag “Aufräumarbeiten enthüllen Ben Bernanke’s Perspective of the American Financial System as SOWERED” –

    Ich frage mich nur, wie man diese Begriffe ex post, also nach dem Ausbruch der Finanzkrise, verstehen darf/muss.

    Sie zitieren einen relativ alten Aufsatz. Ich habe zwar nicht systematisch gesucht, aber bei meinen zahlreichen Lektürestreifzügen zur Finanzkrise zwar einige Kritik am Finanzsystem gefunden, aber eigentlich keine wissenschaftlichen, anspruchsvollen Arbeiten, die den angeblichen Wert von Tiefe, Innovationen und Raffiniertheit (wenn man “sophistication” mal – etwas polemisch – so übersetzen will) infrage stellen.

    Obwohl es doch nahe gelegen hätte, Fragen wie etwa jene, die ich in meinem Blog-Eintrag formuliert habe, im Zusammenhang zu analysieren, sozusagen aus der Zentralperspektive der (Dys-?)Funktionalität des Finanzsystems.

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