Law and Finance: A Theoretical Perspective

Abstract

Finance is traditionally studied by lawyers as well as by economists from the vantage point of the premise that a market economy has, at its core, a single natural and necessary institutional form, expressed, for example, in the basic rules and doctrines of contract and property. The literature about varieties of capitalism has proved insufficient to challenge this assumption. A corollary of this view is the idea that, barring particular market defects, a market economy will channel the savings of society to its most efficient possible uses. The first task of regulation is supposedly to redress such localized flaws in the competitive allocation of resources.This brief text outlines the rudiments of another way of thinking about finance. It does so in the form of a list of connected propositions. Under prevailing arrangements, finance has become increasingly decoupled from the real economy. The production system is largely self-financed on the basis of the retained and reinvested earnings of private firms. Financial intermediation is largely self-directed, oriented to asset trading and position taking by highly leveraged financial institutions, supported in good times and bad by favorable monetary and regulatory policies. It need not be this way. A series of innovations in our present institutions and practices could greatly enhance the usefulness of finance and mitigate its dangers. Regulation, as conventionally understood and practiced, is not enough. Regulation better understood and directed is the first step toward institutional reorganization. The reorganization of finance should in turn be judged by the standard of its service to broader aims. One aim is the organization of socially inclusive economic growth. Another is the power of a national economy to participate actively in the global economy without accepting an unfavorable niche in the international division of labor or abdicating its potential for strategies of development that go against the institutional formulas favored in the world today.A crucial test of every program of reform is success in forming the appropriate institutional vehicles for carrying its agenda forward. From this imperative arises the need to re-invent comparative law as a handmaiden of institutional innovation. The institutional details matter, and they exist only as law.