How We Create the Wealth of Nations
Chapter 13: High Frequency Trading
Originally, I resolved not to include any material on financial innovation in this book. Why? Although I can claim some expertise in industrial innovation, I do not have equivalent expertise in financial innovation. However, I later decided that there simply must be a chapter on the destructive side of financial innovation, for one reason, if no other. It appears that financial innovation is one of the more destructive innovations, in terms of its effects on the real economy.1 In Greek mythology, Pandora had a beautiful box, which she had been told not to open under any circumstances. But curiosity got the better of her, and she opened the box, allowing all the contents to escape and do untold harm. Only hope remained inside the box.2 It is tempting to use the tale of Pandora’s box as a metaphor for what happened in Britain after ‘Big Bang’ – the dramatic deregulation of financial markets in October 1986, endorsed by Prime Minister Margaret Thatcher and managed by Chancellor Nigel Lawson. True, the opening of Pandora’s box at the time of deregulation did not bring immediate crisis, but many believe that deregulation was ultimately responsible for many of the most dysfunctional activities of the City of London in recent years.3 This chapter concerns the destructive effects of high frequency trading. This is but one example of the increasingly dysfunctional innovations emanating from the financial sector. But it is one of the easiest cases in which to perceive the destructive side of innovation.
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