Restoring trust in finance and the market system requires requires adopting a relational perspective, so economist Lans Bovenberg (University of Tilburg) argues in this talk. What is needed is a change in culture and identity, something that we should be working on at various levels. Not only the finance sector should work on these changes, but also high schools educating tomorrow's business professionals and citizens. A relational perspective is the basis for a new educational method on economics that prof. Bovenberg is currently developing for high school students.

1. Finance:
a
relational
perspective
Lans Bovenberg
January 27, 2017

2. J.M. Keynes
“The ideas of economists and political
philosophers, both when they are right and when
they are wrong, are more powerful than is
commonly understood. Indeed the world is ruled
by little else.”
2

3. 3
Out of balance
Hawk
Dove

4. 4
Governance out of balance
o Regulation and control
o Competition and liquidity
o Intrinsic motivation
• Reciprocity
• Identity

5. More relational view of men
5
Limited
rationality
Preferences are
shaped by
others
Social preferences
(intrinsic value of
relationships)

6. 6
Economics in three steps
Win-win
Bounded rationality and
bounded morality
Hierarchy,
Interchangeability,
Voluntary commitment
3. Better balance
1. Balance
(of goals and interests)
2. Imbalance

7. Step 1:
goals and interests in balance
7

8. 8
The miracle of Economics
Diversity
generates value
Sharing gains
creates trust
Together
you can do more
1+1=3

9. Finance as relational infrastructure:
trust in win-win
• Solidarity
trade systematic risks and pool idiosyncratic risks
intertemporal trade
• Innovation
Develop ideas and talents
 Intertemporal trade
 Pool and shift risks

10. 10
Step 2: out of balance

11. 11
Limited human capabilities
Limited
morality
Limited
rationality

12. 12
“Nobody ever saw a dog make a fair
and deliberate exchange of one bone
for another with another dog.”
Adam Smith
fair
deliberate

13. Finance as a curse:
multiplier on imbalance due to human biases
• Limited rationality
People feature biases in trading time and risks: myopic loss aversion
Herding behavior (‘group think’) causes macroeconomic instability
• Limited morality
Moral hazard: People exploit complexities to deceive
 Finance as den of robbers: sharks phishing for phools
 Unintended consequences: Asymmetric contracts and guarantees increase fragility
• Limited rationality and limited morality
Large, complex groups with many linkages
Unintended consequences, fragility and lack empathy for anonymous victims

14. 14
Step 3: More balance

15. 15
Economics in three steps
Win-win
Bounded rationality and
bounded morality
Hierarchy,
Interchangeability,
Voluntary commitment
3. Better balance
1. Balance
(of goals and interests)
2. Imbalance

16. 16
Governance out of balance
o Control and regulation
o Liquidity and competition
o Intrinsic motivation
• Reciprocity
• Identity

17. Complete contracts (debt) = control
• Less discretion disciplines debtor
More trust in win-win: less fear of vulnerable creditor for greedy debtor
• Problematic aspects
Inefficient risk sharing
 Debtor bears risks that he cannot affect
Inefficient, inequitable and unstable
Bad incentives
 Asymmetric contracts: debtor can steal by taking excessive risks
Fragility: debt overhang in bad times
Guarantees extended by third parties: even more risk taking in good times
 Control crowds out intrinsic motivation
Lack of trust and discretion dehumanizes and is self-fulfilling

18. Liquidity: trade relationships
• Flexibility creditor disciplines debtor
More trust in win-win: less fear of vulnerable creditor for greedy debtor
• Problematic aspects
Lack of information and herding behavior
 Reputation mechanism fails: animal spirits lead to fragility
Discourages specific investments in knowing, trusting and appreciating others
 Illiquidity (‘relationship’) premium is high
Liquidity crowds out intrinsic motivation
 Lack of trust dehumanizes and is self-fulfilling

19. 19
Governance: unity in diversity
Reciprocity
(friendship)
A lot of stakeholders
A limited number of stakeholders
Complex interactionsSimple interactions
Hierarchy Identity
(norms and values)
Competition
(free exchangeability;
contracts)

20. Equity: creditors share risk with debtor
• More simplicity and less stakeholders
More equity in firms and banks
 Debt becomes a less complicated (more symmetric) and less interconnected contract
• Durable, illiquid face-to-face relationships (rather than transactions/contracts)
More specific investments in getting to know, trust and appreciate stakeholders
 Better risk sharing and more stability
Better incentives for win-win in complex, dynamic relationships
 Commitment gift exchange (instead of liquidity) humanizes: preciousness and purpose
 More trust: develop a sacred “we” identity
• Less tax advantages debt
Negative externalities
 SME depend more on equity: focus on transactions yields less competition
 macroeconomic fragility and implicit subsidies on debt on account of implicit guarantees
Negative internalities: myopia and myopic loss aversion

21. Relational culture:
Less control and less autonomy yields more life
• Safety and liquidity trap: fear is self-fulfilling
Safety paradox: For whoever wants to save their life will lose it, but whoever loses
their life for me will find it. (Matthew 16:25)
• Perceived costs creditors: more vulnerability
Less liquidity: less control
Less diversification (scale economies): more credit risk
• Perceived costs debtor: less autonomy and less privacy
Voice instead of exit: decisions are taken together

22. Changing culture and identity
• Takes time to transform fear, skepticism, selfishness into faith, hope, love
Ex ante: Courage to trust and value people (‘faith’ and ‘love’)
Ex post: Develop resilience to deal with failures (‘hope’)
• Education: develop virtues and inclusive ‘we’ identity
• Aristotle: Not only good hard institutions but also good, virtuous people
• Does it take a generation to restore balance between hawks and doves?
• Creating strong professional identities and cultures
Leaders (’elite’) with integrity to protect ‘sacred’ values
Develop narratives to create human dimension

23. Other measures
• Less implicit subsidies in banks
Less liquidity (transformation)
• More diversity in financing
Investing illiquid retirement saving in SME and housing
Less diversification: voice rather than exit
• Bankruptcy law; bail in (especially in EMU)
• Reduce debt overhang: debt-equity swaps
• Better rent market in housing