Innovations, good and bad

As he analyzed the financial crisis for Newsweek, Johns Hopkins professor Francis Fukuyama contrasted Silicon-Valley-style technological innovation and financial innovation. Supporters of financial regulation, Fukuyama wrote, had

argued that long-standing regulations like the Depression-era Glass-Steagall Act (which split up commercial and investment banking) were stifling innovation and undermining the competitiveness of U.S. financial institutions. They were right”only, deregulation produced a flood of innovative new products like collateralized debt obligations, which are at the core of the current crisis….The problem is that Wall Street is very different from, say, Silicon Valley, where a light regulatory hand is genuinely beneficial. Financial institutions are based on trust, which can only flourish if governments ensure they are transparent and constrained in the risks they can take with other people’s money.

Columbia Business School Professor Amar Bhidé, in an essay posted on his website, also contrasts the impact of innovation in the financial sector and in other sectors. According to Bhidé, a contraction of the financial sector could have long-run positive effects on prosperity (see the end of his essay). His reasoning? An overly large financial sector may crowd out innovation in other sectors — by competing for talent and capital with what Bhidé calls “the real economy.”