The New Financial Order: Risk in the 21st Century.

• Author: Dowd, Kevin
• Position: Book Review

Robert J. Shiller Princeton and Oxford: Princeton University Press, 2003, 366 pp.

The New Financial Order presents a vision of a radically new world of greatly enhanced risk sharing and much greater economic security for us all. It confronts the problem of how to deal with the risks we face, or how to reduce economic insecurity. These risks, large and small, are the downside of capitalism's ongoing process of "creative destruction." They have hampered economic progress throughout history, and have been the source of countless foregone opportunities and untold misery. This book proposes a new framework to handle these risks, and so protect people against them. As such, it will encourage more positive risk-taking behavior, better development and use of individual skills, and greater personal fulfillment. As Shiller notes, he wishes to "democratize" finance and "'bring the [risk-management] advantages enjoyed by the clients of Wall Street to the customers of Wal-Mart" (p. 1). Implementing this vision involves a huge extension of risk-trading activity, and the establishment of a global infrastructure to measure and manage the risks involved.

The New Financial Order provides an insightful, and in many ways appealing, perspective on the process of economic development, with discussions on a great range of diverse topics. The book is divided into five parts. Part 1 looks at the many different types of risks we face, the factors that give rise to them, and the damage they can do. Part 2 examines how science and technology create new economic opportunities and new risks. It also looks at the psychology of risk perception (focusing especially on risk-framing issues and the work of Daniel Kahneman and Amos Tversky) and the nature of invention. Part 3 outlines Shiller's six core proposals (of which more below), and part 4 looks at "deploying" the new financial order: the use of new units of measurement, the problems involved in establishing international data-base systems to underpin risk-trading activity, the difficulties faced by financial and political reformers, and research into, and advocacy of, the new financial order itself. Finally, part 5 looks at the new financial order as the continuation of an ongoing historical process, and looks at the lessons to be drawn from the major financial and social insurance innovations of the past.

The essence of the new financial order is to be found in Shiller's six core proposals. The first of these is to extend the purview of insurance to cover long-term economic risks, leading to livelihood insurance to protect income and to a more radical form of home insurance to protect the economic value of the home (and not just to protect against specific risks such as fire risk). The second is to establish macromarkets: large international markets trading long-term claims on national income or gross domestic product, occupational income, real estate prices, and various other risky variables, including world GDP. (One could 'also envisage other macromarkets that Shiller does not explicitly discuss: for example, insurance companies and pension funds could share mortality risk by means of mortality swaps.) The scale of these macromarkets would be massive and dwarf anything yet seen. The third is for banks and other financial institutions to offer income-linked loans to enable people to sell shares in their future incomes and hedge income-related risk, and so avoid the hardship and other problems that many borrowers currently face. The fourth idea is inequality insurance, which is designed to ensure that income inequality within a nation does not increase. This proposal involves reframing the...