23 Things they don't tell you about Capitalism

According to free-market economists, fully opening and deregulating financial markets allows for the most efficient and responsive allocation of resources. In this view, the 2008 financial crisis was a one-time, unpredictable blip that need not lead to new regulations.

Chang suggests that the efficiency of financial markets is part of the problem: Although they effectively generate quick profits, they have only increased economic instability. He presents the case of Iceland, which, following the lead of the US and the United Kingdom, privatized and deregulated its financial sector in the late 1990s. For a while, growth accelerated at an incredible rate. However, during the 2008 financial crisis, Iceland’s three largest banks became insolvent, and the country’s economy shrunk more than the economies of other rich countries impacted by the crisis. Other countries that followed similar investment strategies, such as Ireland and Latvia, were likewise more heavily impacted.

The problem with this approach is that they facilitate making profits through financial activities than through real market sectors such as manufacturing. In fact, several manufacturing firms in the US, including General Electric, GM, and Ford, expanded their financial agencies to the point that they became their main source of profit. As the financial sector outpaced real economic activities, the type and number of financial assets expanded. In the housing market, mortgages were packaged into increasingly layered and complex financial assets. Despite the increase in financial assets, the number of real mortgages and economic activity remained unchanged, creating a precarious system whose collapse set off the 2008 financial crisis.

Chang explains that the liquidity of financial assets is both their greatest strength and a major drawback. They allow flexibility of investment, but they are so easily transferable that those who own them are tempted to follow short-term gains. To mitigate this effect, Chang suggests taxes or other regulations to help slow down the flow of financial assets and encourage longer-term investment.