The Value of Financial Engineering

Paul Volcker offers an anecdote in which he asks “one of the inventors of financial engineering” what his opinion is on “what all the financial engineering does for the economy and what it does for productivity.”

Much to my surprise, he leaned over and whispered in my ear that it does nothing — and this was from a leader in the world of financial engineering. I asked him what it did do, and he said that it moves around the rents in the financial system — and besides, it’s a lot of intellectual fun.

This leads Kevin Drum to wonder if anyone even bothers to mount an argument as to the value of modern financial engineering. In my experience, people who tackle this issue normally join Eugene Fama in attributing the world’s rapid post-1980 growth in part to financial innovation. The problem is that in the developed world, this rapid growth didn’t happen. Growth slowed down:


The impressive thing about the past 30 years in the world economy has been rapid growth in the Asian “tiger” economies more recently joined by China and India. And it’s very impressive. But the policy factors that led to this growth takeoff are not that mysterious and don’t have anything to do with financial innovation.