Todai Finance Innovation Program Lecture 2 Report

The second lecture of the Todai Finance Innovation Program was held on May 9th, at theDaiwa Ubiquitous Computing Research Building located within Hongo Campus of the University ofTokyo. The lecture on the topic of “Capitalism and the Economy” was lead by Yosuke Yasuda,currently an Associate Professor at the Faculty of Economics at Osaka University.

Professor Yasuda graduated from the Faculty of Economics at the University of Tokyo in
2002, receiving the highly prestigious Ouchi Hyoue Prize for best graduation thesis, before obtaining
his PhD in Economics at Princeton University in the United States. Before taking up his current roleat Osaka University, he taught as an Assistant Professor at the National Graduate Institute for Policy
Studies (GRIPS). Professor Yasuda specializes in game theory and the analysis of strategic
situations, with his main research field being market and institution design. In addition to hisresearch, he is also active in information dissemination for the general public through mass media,and government committee activities.

The lecture on “Capitalism and the Economy” focused on three main questions:ØWhy are talks of money and interest seen in a negative light?

ØWhy does money hold value?

ØDo markets increase inequality?

Why is money and interest seen in negative light?
Famous authors stretching long into the past have painted money and interest in anegative light. For example, in The Merchant of Venice by William Shakespeare, Antonio in Act I
states that “If thou wilt lend this money...lend it rather to thine enemy, who, if he break, thou mayst
with better face exact the penalty." In modern English this translates to;“If you’re going to lend us this money, don’t lend it to us as if we were yourfriends. When did friends charge interest? Instead, lend it to me as your enemy. If
your enemy goes bankrupt, it’s easier for you to take your penalty from him.”

However, the development of money has also had some positive influences on society. It
has greatly expanded the possibility of trading compared to the old barter system, and has given us
new freedoms. Furthermore, it has also worked to bring about equality beyond status. The example
given in the lecture was that of the children’s story “Buying mittens” by Nankichi Niimi. What we
saw was that as long as the storeowner was able to receive legitimate money in return for the mittens,
he or she was willing to sell to anyone regardless of whether the customer was a human or a fox. In
such a way money can have a positive effect on working against discrimination.

Digging a little deeper into the issue, it can be seen that money can be seen in a negativeor positive light depending on the circumstance. Exactly under what circumstances does money
function positively and when does it function negatively? According to Professor Yasuda’s
hypothesis, in a competitive market where there is anonymity and symmetry of information, such as
in the story of “Buying mittens”, the positive aspects of money become prominent. However, thereality in most markets is that there exists an asymmetry of information, leading to the increased
importance of the matching mechanism in the market. This in turn can lead to mismatching and thenegative aspects of money becoming apparent.

Why does money hold value?
There are two types of money: commodity money and fiat money. To explain its origin,commodity money theory states that the value is intrinsic, in other words the value lies in the productitself. This can be seen in products such as metals and food. On the other hand, fiat money theory statesthat any product can be utilized as money (for example paper notes) if it has been given official approvaland backing by an authority such as the king or central bank. (Katsuhito Iwai, Kaheiron)Currently, for the majority of people money takes the form of bank bills and notes approvedby the central bank of a country. It has allowed for a significant increase in opportunities for economic
activities and trade. This can be seen by the comparison of the search cost of barter K(K-1) and money
K+K = 2K. As these approximations show, as K gets large (where K represents the total number ofdifferent products available to be traded which is considerably large in the real world) the search cost for
trade using money becomes considerably smaller than that of barter. But why does a flimsy piece of paper
hold value?

The reason why money holds value was explained using the figure below. In the model
represented in the figure, each generation only lives for two periods. In the first period of your life you
produce output y, while in the second period you do not produce anything (concept of retirement). If there
were no trade, in an extreme case where the good was perishable such as food, you would be able toconsume lots when young, but nothing when you are old. Obviously the problem arises that you would
like to spread your consumption over your whole lifetime and save some of the production from the first
period of your life for the second period.
One possible solution would be toproperly distribute from young to old people.
Although theoretically this is a good solution,in reality it is very hard to enforce, as there
are people who do not obey the rules. An
example of this can be seen in the case of thePanama Papers.

Taken from lecture slides Pg. 19
What if we introduce money? Firstly, it should be noted that barter is not possible in this case as there isnever an overlap of wants. Each generation only wants food for when they are in the (generation +1)
period. If we introduce money this enables trade between generations. This is based on the belief that themoney will have value in the future and will be able to be traded in exchange for the desired product.
Thus, money functions on the basis that it will have value going into the infinite future.

What if the world is to end? As soon as we find out that the world will end in a particular year, people
living in the year before the world end will no longer accept money. Money has no value when there is nofuture. From backward induction, if the generation before the world ends refuses to accept money thenthe generation before them should also refuse to accept money. Therefore, shouldn’t money lose all of its
value given the fact we are fairly certain that the human population will die out sometime in the future?
However, the reality is that money still holds value today. The key lies in the fact that there is uncertainty
as to when exactly we will die out. Our backward induction reasoning depends critically on thepresumption that the world will end at some specific time period for sure. If there is uncertainty and theprobability of the world continuing next year is expressed by p, then such uncertainty is taken into
account in the value of money through the concept of discounting. That is, the evaluation of the future (ayear ahead) can be represented by p multiplied by delta (standard discount factor), and hence it becomes
possible to draw value from the infinite future to the present.

Changing Population? What happens if the population increases / decreases while the amount of output
for each individual remains constant? When there is an increasing population, subsequent generations canhave access to an increasing amount of output per person. In this way, we have been able to reap therewards of considerable population growth. However, we are now experiencing a slowdown in global
population growth and the issue has already been well highlighted in countries such as Japan. This meansthat each elderly person is receiving an increasingly small proportion of the total output, or each young
person is giving an increasingly large proportion compared to previous generations, or both. A typicalexample of this can be seen in the pension system. Hence, such changing demographics may call for newchanges to be made to the current system or the development of an entirely new system altogether.

Does the market increase inequality?

Taken from English lecture slides Pg. 9, 15
The standard measure of the benefit of a trade is to look at the surplus produced, and theaim has been to try to maximize this pie. Although the market system leads to the maximization of
the surplus, it does not account for the problem of the left over agents. In this particular example, thevalues attributed by 4 buyers and the costs of production for 4 sellers in a particular market areoutlined (previous page left). If allocation occurs according to CE (competitive equilibrium), 4 outof the 8 trading agents are left out. It is these left over trading agents who are suffering greatly.

So is it possible to come up with another system that includes everyone? We have two cases Xand Y (previous page right), where in X there are 6 trading agents and in Y everyone is involved.
But as you can see the total surplus produced is smaller than that achieved by the market atcompetitive equilibrium. The market maximizes surplus, but the number of people who receive thebenefits is minimized.
One method that can rectify this issue isredistribution. As shown in the figure to theleft, if proper redistribution takes place thesurplus can be maximized while alsomaximizing

thenumberofpeople

receiving the surplus. However, as seen in
the case with the Panama scandal such
Taken from English lecture slides Pg. 19

redistribution is very difficult to enforce.

What we can take from this is that redistribution is very important. At the same time
redistribution can be very difficult to enforce. If there is a good matching system we can perhaps
realize allocation X or Y without the need for the help of redistribution. Such matching agencies andmechanism may well exist in society today. For example, a typical matching agency has strong
incentive to maximize the number of pairings to gain maximum income from the agent fee.
Preventing market going to equilibrium in such a manner had been seen in a bad light as it preventsthe maximization of the surplus, but it may actually be creating a different system altogether.

While there is the potential for the matching system to have a positive influence onsociety, we must be weary due to the fact that as discussed in the first part of the lecture money tends
to function negatively under conditions of a matching market. The issue is largely attributed to theappraisal process, with sellers posing different prices for different buyers. Going into the future, theuse of new technologies could be used to try to solve such problems and prevent such negative
aspects of money becoming apparent in matching markets.