Presidential Address: Does Finance Benefit Society?

• Published date: 01 August 2015
• DOI: http://doi.org/10.1111/jofi.12295
• Author: LUIGI ZINGALES
• Date: 01 August 2015

The Journal of Finance R

Luigi Zingales

President of the American Finance Association 2014

THE JOURNAL OF FINANCE •VOL. LXX, NO. 4 •AUGUST 2015

Presidential Address: Does Finance Benefit

Society?

LUIGI ZINGALES∗

ABSTRACT

Academics’ view of the benefits of finance vastly exceeds societal perception. This

dissonance is at least partly explained by an underappreciation by academia of how,

without proper rules, finance can easily degenerate into a rent-seeking activity. I

outline what finance academics can do, from a research point of view and from an

educational point of view, to promote good finance and minimize the bad.

FOR MOST ACADEMIC ECONOMISTS the answer to the question raised in the title

seems obvious. After all, there are plenty of theories that explain the crucial

role played by the financial sector: from managing risk (Froot, Scharfstein, and

Stein (1993)) to providing valuable price signals (Hayek (1945); Holmstrom and

Tirole (1993)), from monitoring (Diamond (1984)) to designing securities that

alleviate informational asymmetries (Myers and Majluf (1984)). Furthermore,

there appears to be plenty of evidence that finance is positively associated

with growth (e.g., Levine (2005)) and entrepreneurship (Guiso, Sapienza, and

Zingales (2004), Mollica and Zingales (2008)), and even with better education

(Flug, Spilimbergo, and Wachtenheim (1998), Levine and Rubinstein (2014)),

and less inequality (Beck, Demirg ¨

uc¸-Kunt, and Levine (2007)).

Yet, this feeling is not shared by society at large. Fifty-seven percent of

readers of The Economist (not a particularly unsympathetic crowd) disagree

with the statement that “financial innovation boosts economic growth.” When

asked “Overall, how much, if at all, do you think the U.S. financial system

benefits or hurts the U.S. economy?,” 48% of a representative sample of adult

Americans respond that finance hurts the U.S. economy, while only 34% say

that it benefits it.1

This sentiment is not just the result of the crisis: throughout history, finance

has been perceived as a rent-seeking activity.Prohibitions against finance date

∗Luigi Zingales is at University of Chicago Booth School of Business, NBER, and CEPR. Pre-

pared for the 2015 AFA Presidential Address. While a consultant to the PCAOB, the opinions

expressed in this paper are my own and do not necessarily reflect those of the Board or the PCAOB

as a whole. I wish to thank Sarah Niemann for research assistantship and Nava Ashraf, Bruno

Biais (the editor), Luigi Guiso, Oliver Hart, Adair Morse, Donatella Picarelli, Raghu Rajan, Guy

Rolnick, Paola Sapienza, Amit Seru, Andrei Shleifer, Amir Sufi, and Paul Tuckerfor very valuable

comments.

1Chicago Booth-Kellogg School Financial Trust Index survey December 2014. The survey, con-

ducted by Social Science Research Solutions, collects information on a representative sample of

roughly 1,000 American households.

DOI: 10.1111/jofi.12295

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1328 The Journal of Finance R

as far back as the Old Testament.2The aftermath of the 2007 to 2008 finan-

cial crisis has only worsened this view. From Libor fixing to exchange rate

manipulation, from gold price rigging to outright financial fraud in subprime

mortgages, not a day passes without news of a fresh financial scandal. After

the financial crisis, Americans’ trust towards bankers dropped tremendously

(Sapienza and Zingales (2012)) and has not yet fully recovered.

It is very tempting for us academics to dismiss such distrust as the expression

of ignorant populism (Sapienza and Zingales (2013)). After all, we are the

priests of an esoteric religion, only we understand the academic scriptures and

can appreciate the truths therein revealed. For this reason, we almost wallow

in public disdain and refuse to engage, rather than wonder whether there is

any reason for these feelings.

This is a huge mistake. As finance academics, we should care deeply about

the way the financial industry is perceived by society.Not so much because this

affects our own reputation, but because there might be some truth in all these

criticisms, truths we cannot see because we are too embedded in our own world.

And even if we thought there were no truth, we should care about the effects

that this reputation has in shaping regulation and government intervention in

the financial industry. Last but not least, we should care because the positive

role that finance can play in society depends on the public’s perception of our

industry.

When the antifinance sentiment becomes rage, it is difficult to maintain

a prompt and unbiased enforcement of contracts, a necessary condition for

competitive arm’s length financing. Without public support, financiers need

political protection to operate, but only those financiers who enjoy rents can

afford to pay for heavy lobbying. Thus, in the face of public resentment only the

noncompetitive and clubbish type of finance can survive. The more prevalent

this bad type of finance is, the stronger the antifinance sentiment will become.

Hence, a deterioration the public perception of finance risks triggering a vicious

circle, all too common around the world (Zingales (2012)). The United States

experienced such a vicious circle after the 1929 stock market crash and it faces

this risk again today.

What can we do as a profession? First of all, we should acknowledge that

our view of the benefits of finance is inflated. While there is no doubt that a

developed economy needs a sophisticated financial sector, at the current state

of knowledge there is no theoretical reason or empirical evidence to support the

notion that all growth in the financial sector over the last 40 years has been

beneficial to society. In fact, we have both theoretical reasons and empirical

evidence to claim that a component has been pure rent seeking. By defending

all forms of finance, by being unwilling to separate the wheat from the chaff,

we have lost credibility in defending the real contribution of finance.

Our second task is to use our research and our teaching to curb the rent-

seeking dimension of finance. We should use our research to challenge existing

2“If you lend money to any of my people with you who is poor, you shall not be to him as a

creditor, and you shall not exact interest from him.” Exodus 22:24 (22:25 in English trans).