Did Financial Innovation Cause Deng Xiaoping’s Economic Reforms?

Eugene Fama makes a curious claim on behalf of financial innovation since 1980:

But suppose we buy into the more common negative current view of finance. There is still a big open question. Beginning in the early 1980s, the developed world and some big players in the developing world experienced a period of extraordinary growth. It’s reasonable to argue that in facilitating the flow of world savings to productive uses around the world, financial markets and financial institutions played a big role in this growth. Despite any role of finance in the current recession, are the market naysayers really ready to argue that worldwide wealth would be higher today if financial markets and financial institutions didn’t develop as they did?

A banker in Frankfurt put this same point to me, apparently believing it’s a brilliant argumentative trump card. In reality, it’s a bit nuts—it’s relying on a post-1980 boom that didn’t happen. The United States didn’t start growing faster in 1980:


The claim you’re supposed to make on behalf of the post-1980 US economy isn’t that it’s grown faster (it hasn’t!) but that it’s been less variable than was growth in the early postwar decades. That’s why the term “Great Moderation” was termed. Except in the wake of the current bust, it’s clear that no such decrease in variation was actually achieved. Growth has been the same as it was before, and yet median income growth has been substantially slower. In Europe and Japan growth post-1980 has been much worse than growth was in the previous decades.


The place where growth really has been much better since 1980 than it was before is China. This is not a fact to be neglected. Chinese growth has been very rapid, and very consistently maintained. And a very large number of people live in China, people who started this process being very poor. The past 30 years’ worth of economic growth in China have done an enormous amount to improve human welfare.

But the cause of this turnaround pretty clearly wasn’t financial deregulation in the developed world. It was policy shifts in China—the process, commenced by Deng Xiaoping, of moving away from central planning and joining the global economy. This doesn’t strike me as even remotely debatable. When we look at impressive growth over the past 30 years were looking at policy shifts in China, the success of container shipping, and to an extent shifts in developed world trade policy.


Paul Krugman brings a better chart “From Angus Maddison’s dataset”:


Finance doesn’t deserve the credit for the post-1980 growth acceleration in the developed world because no such acceleration happened.

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