“We know that markets can do harm, but even under these most adverse circumstances, is there a way to fix the markets in order to promote social good?” This is the opening question posed by Professor Emilios Avgouleas in the penultimate lecture of Murray Edwards’ two-year programme, Capitalism on the Edge.
The inaugural holder of the Chair in International Banking, Law and Finance at the University of Edinburgh is an acknowledged expert in financial regulation. Avgouleas is also acutely aware of the social functions that financial markets should perform.
Firing off more questions, he asks: “If there is a way, do I have an idea how that can be done? Is it all doom and gloom? Is our fate to be hostages to the forces of speculation or to the anti-capitalist forces?” His answer to that last one: “As a liberal, not a neo-liberal, I regard both sides of that argument as catastrophic.”
What are markets for?
In Avgouleas’s opinion, the fundamental role of a financial system should be:
- Mobilisation and pooling of savings
- Information pooling to reduce the costs of forecasts which guide possible investments
- Competitive pricing
- Competitive monitoring of the impact and quality of investments
- Diversification and management of risk.
The list itself doesn’t tell us to what end the financial system is mobilising resources. However, Avgouleas suggests that evidence from the past 10-15 years shows that availability of finance through a developed financial sector can help society to become wealthier, and to develop socially and culturally. “This is strong empirical research and not just a wish of the capitalist.” he says.
If we look deeper, he suggests, there is probably a virtuous connection between financial development and liberal democracy. “When the financial system works well, and distributes wealth on merit, the result - at least in Britain - has been political development as well.” he says.
Learning from History
Avgouleas turns briefly to 19th century British history in support of this hypothesis. The Electoral Reform Acts of 1832, 1867 and 1884 extended voting rights to previously disenfranchised citizens, People who didn’t have land, but had income, could now vote.
It was access to finance, says Avgouleas, mostly through joint-stock companies (JSC) and the Stock Exchange, which distributed the resources to those who could further technology, and drive the Industrial Revolution.
This accelerated the impact of that technology on social and economic welfare, and those who benefitted asked for the right to vote, to influence the fate of the country they lived in.
Interestingly, this happened despite the fact that the British banking system in the 19th century experienced major crashes and bank failures. Yet the stock exchange worked well, democratising access to finance (that’s what the stock exchange is) and underwriting the British economic prosperity that led to political enfranchisement.
Two faced finance
So, yes the financial system can certainly do good. However, like the two-faced Roman god Janus, it can also bring grief. The two main reasons for this, says Avgouleas, are excessive leverage and speculation.
Repeated cycles of over-confidence followed by pessimism in the markets make the financial sys- tem prone to instability. When excessive leverage is built in, financial crisis is inevitable, and the worst result of a financial crash is that it can push the real economy into deep recession.
This happens because the financial system, unlike other parts of the economy, has the peculiarity of handling other peoples’ money.
Financial crises are not new, but the results can be dire, and what interests Avgouleas is how we respond. In the aftermath of the catastrophic 1929 financial crash there was a rise of populism, of extremism and of intolerance; a story which is perhaps repeating itself in our times, suggests Avgouleas.