Destructive Creation: The Unintended Consequences of the Rise of Finance

Abstract

The intent of this dissertation is to determine how financial liberalization – specifically, the withdrawal of the state from credit allocation decisions, the removal of restrictions on financial firms' activities, and the introduction of greater competition into financial markets – has affected capital allocations in developed countries.

It follows the cases of Britain and France between 1979 and the present day. It finds that, at first, the two countries followed remarkably similar trajectories: (1) liberalization heightened the competitive pressures facing financial firms, reducing the profitability of traditional financial activities; (2) financial firms adapted by consolidating, expanding, and innovating; (3) these adaptations resulted in a "backwards" allocation of resources, with nonproductive sectors (the household and the financial sectors) borrowing more than the productive (non-financial) sector; (4) the growth which resulted was predicated on consumer spending and asset price appreciation rather than investment; and (5) such growth was unstable, generating both inequality and large macroeconomic imbalances.

After both countries' 1980s-era credit booms gave way to recessions in the early 1990s, the British and French narratives diverged. While Britain restarted the boom-bust progression at the end of the 1990s, the French government took steps to prevent the cycle from repeating. It discouraged household indebtedness and incentivized household savings, aiming to liberalize the country's financial sector without completely deregulating households' financial activities. As a result, France avoided a return to the "backwards" resource allocations and unstable growth of the 1980s; Britain did not.

Extending this analysis to the developed world reveals a highly generalizable story. The trend toward increased competition, financial adaptation, unproductive resource allocations, and ultimately toward instability, inequality, and external imbalances is evident across a broad cross-section of countries. Even so, these problems are less evident in countries – like France – where increases in household borrowing have been mitigated.