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Whither Capitalism? Financial Externalities and Crisis

Author

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  • Miller, Marcus

    (University of Warwick)

  • Zhang, Lei

    (University of Warwick)

Abstract

As with global warming, so with financial crises – externalities have a lot to answer for. We look at three of them. First the financial accelerator due to ‘fire sales’ of collateral assets -- a form of pecuniary externality that leads to liquidity being undervalued. Second the ‘risk- shifting’ behaviour of highly-levered financial institutions who keep the upside of risky investment while passing the downside to others thanks to limited liability. Finally, the network externality where the structure of the financial industry helps propagate shocks around the system unless this is checked by some form of circuit breaker, or ‘ring-fence’. The contrast between crisis-induced Great Recession and its aftermath of slow growth in the West and the rapid - and (so far) sustained - growth in the East suggests that successful economic progress may depend on how well these externalities are managed.

Suggested Citation

  • Miller, Marcus & Zhang, Lei, 2012. "Whither Capitalism? Financial Externalities and Crisis," CAGE Online Working Paper Series 79, Competitive Advantage in the Global Economy (CAGE).
    • Handle: RePEc:cge:wacage:79
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    File URL: http://www2.warwick.ac.uk/fac/soc/economics/research/centres/cage/manage/publications/79.2012_miller.pdf
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    References listed on IDEAS

    as
    1. Marcus Miller & Joseph Stiglitz, 2010. "Leverage and Asset Bubbles: Averting Armageddon with Chapter 11?," Economic Journal, Royal Economic Society, vol. 120(544), pages 500-518, May.
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