Four decades-worth of extraordinary financial innovation were, until recently, regarded as cause for congratulation among Anglophone policymakers and bankers. The events of the past two years have put an end to that. Among those now highlighting the dangers of financial innovation is Lord Turner, head of Britain's Financial Services Authority. As well as stirring up controversy over the bloated size of the financial sector in the latest issue of Prospect magazine, he argued that much financial innovation was socially useless. Is it time, then, for regulators to incorporate a bias against such activity?
Clearly, some innovation is beneficial. But there are not many innovations in finance that do not have malign as well as benign effects. One of the few I can pinpoint without clear drawbacks is the discovery by Fibonacci of Pisa in the late 12th century of the use of discounting to establish present values for different cash flows. This vastly improved the efficiency of capital allocation without adverse unintended consequences.
Other great basic innovations have been double-edged. Interest, allowing the transfer of value through time, was miraculous. Yet it gave rise to the problem of usury. Paper money is a boon, but when unsupported by bullion is all too easily devalued. Insurance is essential to modern life, but involves moral hazard whereby a safety net encourages people to indulge in more risky behaviour.