Financial History 25th Anniversary Special Edition (104, Fall 2012) | Page 29
Museum of American Finance
Check for $642,600,000 issued to the Ford Foundation after investment bankers sold a
large block of the Foundation’s stock in the Ford Motor Company to the public, 1956.
World War II, Japan became the first nonwestern country to equal the developed
western nations in virtually every respect.
From Whence the
Power of Finance?
Despite the work of economists and economic historians, to most people the power
of finance is hardly self-evident. Even people working on Wall Street can miss it. A
foreign currency trader there once told
me he could not understand why he was
earning 10 times as much as his mother, a
teacher, when in his view his mother was
doing far more important work. What can
explain the power of finance?
A century ago, the noted Austrian (later
American) economist Joseph Schumpeter
(1883–1950) provided the best short analysis. In his Theory of Economic Development,
Schumpeter identified the entrepreneur,
the innovator of new products, markets,
processes, sources of supply, etc., as a driving force in economic progress. Thanks to
Schumpeter, we cherish entrepreneurship.
and this is often forgotten in accounts of Schumpeter’s analysis — besides the entrepreneur, there is
an equally important driving force, the
banker. The banker is important because
the entrepreneur cannot implement his
innovative ideas without credit and capital,
which is what the banker can supply. There
are many would-be entrepreneurs, but far
fewer good ones. A part of the banker’s
job is to identify and back the good ones;
one will recognize modern venture capital activities as an example of this. When
bankers do their work successfully, good
ideas get implemented, economies grow
and the world has more goods and services.
There are, of course, some losers in
the development process. Those who do
things the old way and fail to innovate are
driven to the wall. Schumpeter called it
“creative destruction.” Think, for example,
of what Jeff Bezos and Amazon have done
to traditional booksellers and other traditional retailers.
More generally, Schumpeter’s concept
of the banker can be regarded as the entire
financial system, which is a vast network
of governments financing themselves;
banks lending and facilitating payments;
financial markets making assets liquid
and tradable; and a variety of financial
and non-financial corporations that issue
stocks and bonds, lend and borrow and
provide most of our goods and services.
This vast financial network, working
properly, allocates scarce capital to its best
uses. It also provides ways of managing
risks by offering insurance, diversification
and hedging. The network has what economists call network externalities. When
they are positive, the whole is greater
than the sum of the parts, and we experience prosperity and economic growth.
When something goes wrong in a part of
the network, the externalities can become
negative. The result is a financial crisis
in which financing is crippled or dries
up, economic growth slows or stops and
Economic and business historians at
NYU’s Stern School of Business, where
I teach, have created what is in essence a
more historically-attuned model of development than Schumpeter’s simple one of
entrepreneur and banker. We call it “the
diamond of sustainable growth,” which
like a baseball diamond has four corners or