A Conversation on Financial Exclusion and Inclusion

On this episode of the Authors Corner, Ethan Yang interviews AIER Senior Fellow Robert Wright on his book Financial Exclusion: How Competition can Fix a Broken System. A written summary of the book can be found here. During the interview, Robert discusses major themes in his book, which touch on the importance of the financial system and the damage exclusion has brought on marginalized communities. Robert demonstrated an impressive breadth of knowledge on the history of finance in the United States and the discrimination faced by various groups from women to African-Americans. His ultimate conclusion was that although many of the economic disparities experienced by different minority groups can be attributed to financial exclusion, entrepreneurship and private action can be a powerful remedy. The government, which has repeatedly tried to address these issues with unilateral public policy, has often made things worse and should do its best to stay out of the way. 

The first portion of the interview touched on how essential a financial system is to a sophisticated society. Today we have a massive network of multibillion-dollar banks, hedge funds, insurance companies, and other investment vehicles. As complicated and confusing as the modern world of finance may seem today, it all goes back to a set of core necessities. One of those is the ability to acquire and store capital. Without the ability to safely store assets and take loans, forward-looking projects are nearly impossible. Such projects could encompass anything from expanding a multibillion-dollar company to opening up a small corner store.

Another critical function of the financial system is managing risk. Insurance companies make it possible for people to confidently purchase more expensive assets such as houses and cars. Without car insurance, driving anything worth more than a couple thousand dollars, if that, would be putting your entire future at risk. Stock exchanges, although today may seem like a complicated game of numbers, have a base function of allowing companies to raise capital to operate and also be assured that they have capacity stretching into the future. With this in mind, access to such a system would be a key component for economic prosperity, while being excluded will have dire consequences. 

After outlining the importance of financial inclusion, Robert then moves on to discuss the historic exclusion of minorities from the system for a variety of reasons. At first, this was due to outright prejudice, whether it be for non-white individuals, women, or low-class white people. Right from the start, this could explain disparities in living standards and achievement amongst included and excluded groups. Eventually, as overt discrimination fell out of practice, minorities faced stereotyping that could be justified to exclude them on technical grounds. Banks could say that they don’t lend to black people or women, not because of overt racism, but because these groups of people are simply not fit to handle money and pose a financial risk. Such practices continued for over a hundred years and are likely still lingering around. Robert explains how these assumptions were patently false and gave abundant examples of how all these groups had proud histories of financial achievement. 

However, the main issue today is not necessarily stereotyping or racism but the legacy of such practices. Many members of excluded groups such as racial minorities simply don’t have the qualifications or the knowledge to access the financial system, likely due to many years of exclusion. This creates a dilemma in which even if banks would like to do business with historically excluded groups, they can’t. This led to some short-sighted government policies aimed at expanding access via unilateral policy, such as loosening lending standards and arbitrarily expanding access to credit. This among many things contributed to the 2008 Recession. 

This brings us to Robert’s conclusion, which is that many years of financial marginalization cannot be solved overnight with the signing of a bill. Such an issue can only be solved with a gradual and community-focused approach, which is only possible through private action. Looking to history, members of groups that were excluded from the financial system still managed to create their own networks and institutions, which allowed for some limited engagement. Today a similar strategy is necessary, except now society would embrace inclusion and not resist it. The government ought to reduce barriers to entry by getting rid of onerous regulations and red tape that are preventing entrepreneurial activity from blooming in underserved communities. Such a solution will unleash a bottom-up movement of resilient and sustainable economic activity. That is because there is nothing inherently wrong with historically excluded communities; they are more than capable of succeeding when they are given the freedom and the knowledge to do so. Society just needs to take its boot off their backs.

Related Articles – Books, Financial Markets, Video