It may not be obvious to many (and in fact may actively be denied by some!) that the great prosperity enjoyed by enormous masses of people in the world today has come about thanks to some ingenious inventions in the area of finance as much as in the areas of science and technology. What Science discovers and Technology invents, Business produces for the mass market, and Finance funds that production. The Industrial Revolution could not have had the impact it did without a corresponding Financial/Legal Revolution.
My personal choice for the most important financial/legal innovation of the past five hundred years would be the joint stock company with the added clause of limited liability.
This is the innovation which allowed the mass of humankind to participate in and guide the exploitation of ideas, not only directly (by funding them), but also indirectly (by favouring some over others). By limiting the liability (the risk) of investors to the amount they invest (and preventing creditors from pursuing them for the debts of the corporation), the limited liability company encouraged shareholding on a scale never seen before.
This set in motion a virtuous circle of truly gargantuan proportions. A large mass of investors funded the practical applications of theoretical innovation. In turn, the corporate vehicles that converted ideas into tangible goods and services made their investors richer. Wealth began to flow to society on a scale unparalleled in history, and the mill has never stopped churning since.
In terms of an actual date in history, perhaps 1855 could be considered the official turning point. This was when the Limited Liability Company finally became the accepted norm in Britain thanks to an act of parliament.
The LLC has served the world well, but the world may be discovering the limitations to its usefulness. The world economy today is dominated by limited liability companies, but what use is a system that suffers major upheavals every few years? Capitalism may have created enormous wealth over the past two centuries, but all that seems to register nowadays is the wealth that is wiped out in a single day of a stock market crash.
I have written in the past (1, 2, 3, 4, 5) about my economic philosophy of Liquidism, and how a liquid market can be relatively immune to systemic collapse even if individual players in the market fail.
The problem with ensuring liquidity is that enforcing it is hard in practice. Ensuring liquidity goes against the grain of the capitalist system as it is currently structured. Calls for the break-up of monopolies and oligopolies are wrongly depicted as "leftist", whereas a high level of competition is in fact the capitalist ideal. This inherent contradiction is summed up in the book "Saving Capitalism from the Capitalists". I've elaborated on this earlier.
Today's firms are geared for individual growth, whether organic or through mergers and acquisitions. Firms are not at all well suited for divestiture or corporate break-ups, which can facilitate market growth with its associated liquidity advantages. We need both types of growth, going hand in hand, to achieve wealth creation without the dangerous instability that seems to accompany the concentration of wealth among a few very large firms.
Are there any mechanisms available to achieve that?
In today's world, a new kind of company is becoming common - the company designed not for independent existence, but purely as a takeover target. Venture capitalists often fund startups whose sole business plan is to be taken over by a larger company at an attractive price. This is the way the startup repays its investors.
Why can we not consider the opposite (the business division that is designed to be spun off as an independent company)? Shareholders in the original company are automatically offered a stock split, with ownership in the newly formed company. As more and more units are spun off, the original shareholders' holdings become more diversified. And as the child entities begin to thrive and grow in their respective niches, the wealth of the shareholders begins to grow as well.
The constant creation of new companies increases the liquidity of the markets in which they operate, reducing systemic risk. From time to time, a governmental competition watchdog (suitably renamed to reflect its systemic risk mitigation role) provides a friendly nudge to encourage some divestitures (if antitrust is an ugly word to some), but in general, the spin-offs are internally driven.
In this newer world, continuous amoeba-like phases of organic growth and splitting are seen as the best way to grow shareholders' wealth.
What we need, therefore, is the next major financial innovation. We need a built-in mechanism within a corporation that will propel it to seek out wealth through a combination of growth and divestiture, rather than through growth and merger.
Arguments based on economies of scale have often been made in favour of mergers, but having worked in small companies as well as large ones, I can testify (anecdotally) to the extreme diseconomies of scale that are exhibited by large companies as well. Large companies in an oligopolistic market charge their customers more than they should and pay their shareholders less than they should. The difference is lost through sheer inefficiency. On balance, I think shareholders are served better by smaller and more diversified players.
I wrote before about injecting "amoeba DNA" into the modern corporation, so that it naturally supports market liquidity instead of opposing it. I believe that is the next financial innovation that needs to happen, perhaps with some legislative support to push the world in that direction.
In sum, capitalism has served us well so far, but we have lately stumbled upon some of the limits to its wealth-creating potential. The reasons have to do with market liquidity as a whole, which individual firms are not designed to address. Newer firms must be built in smaller and more agile units that can be readily started, shut down, combined or (more importantly) spun off from larger ones. That will take the capitalist system to the next higher plane of its existence.