CONCLUSION
By the late twentieth century, finance was perceived as being much more productive than before. Finance, too, became increasingly valuable to policymakers, in order to maintain economic growth and manage inequality of wealth and income. The cost was mounting household debt and increasing government dependence on tax revenues from the financial sector.
To ignore the question of value in relation to finance is, then, highly irresponsible. But in the end, the real challenge is not to label finance as value-creating or value-extracting, but to fundamentally transform it so that it is genuinely value-creating. This requires paying attention to characteristics such as timeframe. Impatient finance – the quest for short-term returns – can hurt the productive capacity of the economy and its potential for innovation.
Indeed, the crash of 2008 vindicated the warnings of Keynes, Minsky and others about the dangers of excessive financialization. Yet while the crash and the ensuing crisis weakened banks, it still left them in a dominant position in the economy, sparing the embarrassment of those who had extolled the value of financial services in the years before they imploded into bankruptcy and fraud.
In the intervening years, there has, unsurprisingly, been a regulatory reversal – or at least a partial one. Under political pressure, and recognizing that they may have gone too far in allowing commercial and investment banks to share the same roof, regulators in the US and Europe have since 2008 sought to distance one from the other. Reforms such as the US Dodd–Frank Act of 2010 attempt to prevent investment banks from using the deposits of their commercial-bank parents (which are ultimately backed by government under deposit insurance schemes) to finance their riskier income-generating activities. New rules have tried, at least partly, to steer investment banks back to their original function of using borrowed money raised in wholesale markets to finance risky transactions – which even mainstream economists sometimes liken to a casino.
Yet today financialization appears to be thriving again despite its questionable productivity. Financialization remains a powerful force and its capacity for value extraction is scarcely diminished. Attempts to end excessively dangerous and socially useless financial processes, or at least shine a light on them, have merely displaced them into darker corners. Tighter regulation of the activities that caused the last crash has encouraged banks to seek ways around the new curbs, while still lobbying to relax them (except where they conveniently keep out new competitors). It has led less regulated ‘non-bank financial institutions’ or ‘shadow banks’ to expand where banks were forced to contract. What we must now look at is the wider web of different financial intermediaries that have cropped up, with their desire to make a quick, high return and their effect on company organization and the evolution of industry.
5
The Rise of Casino Capitalism
Rather than the financial conservatism that pension funds, mutual funds and insurance companies were supposed to bring, money manager capitalism has ushered in a new era of pervasive casino capitalism.
Hyman Minsky, 19921
When we talk about finance, we should bear in mind its many different forms. While traditional activities like bank lending remain important, they have been eclipsed by others. One is ‘shadow banking’, a term coined in 2007 to describe diverse financial intermediaries that carry out bank-like activities but are not regulated as banks.2 These include pawnbrokers, payday lenders, peer-to-peer lenders, mortgage lenders, investment banks, mobile payment systems and bond-trading platforms established by tech firms and money market funds. Between 2004 and 2014, the value of assets serviced by the ‘informal lending sector’ globally rose from $26 trillion to $80 trillion and may account for as much as a quarter of the global financial system. Shadow-banking activities – borrowing, lending and asset-trading by firms that are not banks and escape their more onerous regulation – all have one thing in common: they funnel finance to finance, making money from moving existing money around. Another significant boost to finance has been the rise of the asset management industry and its different components, from widely marketed retail investment funds to hedge funds and private equity. While average incomes have grown, enabling a build-up of savings especially by the better-off, rising longevity and governments’ reduced appetite for social insurance and pension provision have put pressure on households around the world to make their savings work harder. Those who ‘manage’ investments on their behalf can often claim a fee – often a percentage of the funds under management – whether or not their stock-picks and strategies have demonstrably added value. Taken together with traditional banking, and released from the regulations that previously kept financial firms’ size and risk appetite in check, these forces caused the sector to grow disproportionately large.
There are two key aspects to the long-term growth of the financial sector and its effect on the real economy. These two aspects of financialization are covered in this and the next chapter. I will focus on the UK and the US, where both forms of financialization have been developing most. The first, covered in this chapter, is its expansion in absolute terms and as a share of total economic activity. Today, the sector has sprawled way beyond the limits of traditional finance, mainly banking, to cover an immense array of financial instruments and has created a new force in modern capitalism: asset management. The financial sector now accounts for a significant and growing share of the economy’s value added and profits. But only 15 per cent of the funds generated go to businesses in non-financial industries.3 The rest is traded between financial institutions, making money simply from money changing hands, a phenomenon that has developed hugely, giving rise to what Hyman Minsky called ‘money manager capitalism’.4 Or, put another way: when finance makes money by serving not the ‘real’ economy, but itself.
The second aspect, covered in the next chapter, is the effect of financial motives on non-financial sectors, e.g. industries such as energy, pharmaceuticals and IT. Such financialization can include the provision of financial instruments for customers – for example, car manufacturers offering finance to their customers – and, more importantly, the use of profits to boost share prices rather than reinvest in actual production.
Both these aspects of financialization show how, in the growth of the financial sector, value creation has been confused with value extraction, with serious economic and social consequences. Finance has both benefited from and partly caused widening inequality of income and wealth, initially in the main ‘Anglo-Saxon’ countries, but spreading since the 1990s to previously less financialized European and Asian economies. Rising inequality might be ‘justified’ by economic gains if it promotes faster growth that raises basic or average incomes, for example by giving richer entrepreneurs the means and incentive to invest more. But recent increases in inequality have been associated with slower growth,5 linked to its social impact as well as the deflationary effect of reducing already-low incomes. The key issue is: what role does finance, in all its complexity, play in the economy? Does it justify its size and pervasiveness? Are the sometimes huge rewards that can be earned from financial activities such as hedge funds (an investment fund that speculates using borrowed capital or credit) or private equity proportional to the actual risks taken?
PROMETHEUS (WITH A PILOT’S LICENCE) UNBOUND
Such questions are not new. Back in 1925, Winston Churchill, then Chancellor of the Exchequer, had begun to get itchy about the way in which finance was changing. He famously claimed that he would ‘rather see finance less proud and industry more content’.6 The suspicion troubling policymakers (and their newly emerging economic advisers) was that financiers were positioned in relation to industrial producers in the same way as pre-industrial landowners related to agricultural producers – extracting a significant share of the revenue, without playing any active part in the process of production. Investors who passively collected interest on loans and dividends from shares were ‘rentiers’ in the classic sense, exploiting their (often inherite
d) control over large sums of money to generate unearned income, which – if not used for conspicuous consumption – added to their wealth, especially in an age of low taxation.
The profits extracted by lenders and stock market investors could not be used for investment in industrial expansion and modernization. This was a growing concern, especially in the UK, whose inexorable fall behind the industrial power of Germany and America (especially in industries that could convert to military use) had been the subject of increasingly anxious parliamentary enquiries since the late nineteenth century. The inclination of British-based banking families and trusts to channel funds abroad in search of higher returns, while foreign-based investors brought British assets through its stock market, amplified these concerns as more of the country’s colonies began to agitate for independence, and the storm clouds that had heralded the First World War began to gather again. Churchill’s Chancellorship had also alerted him to rent-seeking behaviour – lobbying government for rules and entry barriers that would enhance financial profit, and making loans to investors who expected to repay out of share price gains – which was soon to rebound internationally in the Wall Street Crash of 1929.
Yet at the time he wrote, the financial sector in the UK was only 6.4 per cent of the entire economy.7 Finance trundled along at the same pace in the first thirty years after the Second World War. Then, after a process of deregulation begun during the 1970s, and the shifts in the production boundary reviewed in the previous chapter, it powered ahead of the real economy – manufacturing and the non-financial services provided by private-sector companies, voluntary organizations and the state. By reclassifying them from collectors of rent to creators of financial ‘value added’, the newly ignited bundle of finance, insurance and real estate (FIRE) was transformed into a productive sector at which economists of the eighteenth, nineteenth and even the first half of the twentieth century would have marvelled.
In the US, from 1960 to 2014, finance’s share of gross value added more than doubled, from 3.7 to 8.4 per cent; over the same period, manufacturing’s share of output fell by more than half, from 25 per cent to 12 per cent. The same happened in the UK: manufacturing’s share fell from over 30 per cent of total value added in 1970 to 10 per cent in 2014, while that of finance and insurance rose from less than 5 per cent to a peak of over 9 per cent in 2009, dropping slightly to 8 per cent in 2014.8 So in the three decades following deregulation, the financial sector comprehensively outpaced the ‘real’ economy. This can be seen clearly for the UK in Figure 14.
As regulations started to be lifted in the early 1980s, US private-sector financial corporations’ profits as a share of total corporate profits – stable at around 10–15 per cent in the first forty years after the Second World War – rose to over 20 per cent, peaking at 40 per cent at the beginning of the twenty-first century (Figure 15).
Figure 14. Gross value added, UK 1945–2013 (1975 = 100)9
Figure 15. US financial corporate profits as share of domestic total profits10
The proportion of wages that goes to financial-sector workers also illustrates the sector’s growth. Until 1980, finance’s share of employment and income was almost identical (the ratio is 1). After that, the ratio spiked: by 2009 it had almost doubled to 1.7 (Figure 16).11
The financial sector’s profits were fabulous, especially in the UK and US with their global financial hubs in London and New York City, and were contributing an increasing share of GDP. It was hardly surprising that the public went along with ‘financial innovation’. People spent. From London to Hong Kong the retail and leisure sectors of the world’s financial centres were doing a roaring trade.
Figure 16. Finance employee compensation share of national employment share12
From the 1980s onwards the financial sector was on a mission to convince governments that it was productive. In the minds of policymakers, finance had become an increasingly productive industry, an idea they were keen to convey to the public.
Strange as it might seem now, policymakers largely ignored the danger of financial turmoil. Only a few years after his 2004 Mansion House speech, in which he paid fulsome tribute to the productivity of the City of London’s financial and business elite, then Labour Chancellor of the Exchequer Gordon Brown voiced the hubris which financiers, regulators, politicians and many economists shared when the economy was still apparently robust. In his 2007 Budget Statement, months before the first signs of the coming crash appeared on the horizon, Brown solemnly declared (not for the first time): ‘We will not return to the old boom and bust.’
How could Brown – and so many others – have got it so horribly wrong? The key to this catastrophic misjudgement lies in their losing sight of one crucial factor: the distinction between ‘price’ and ‘value’, which over the previous decades had been lost from sight. The marginalist revolution that had changed the centuries-old theory of value to one of price had exposed marginalism’s ultimate tautology: finance is valuable because it is valued, and its extraordinary profits are proof of that value.
So when the global financial crisis arrived in 2007 it blew apart the ideology that had promoted financialization above all else. Yet the crisis did not fundamentally change how the sector is valued: two years later the head of Goldman Sachs could still keep a straight face when arguing that his bankers were the most productive in the world. And the fact that ex-Goldman Sachs employees were abundant in both the Obama and Trump administrations shows the power of the ‘story’ of the value created by Goldman Sachs across political parties.
In modern capitalism, the financial sector has greatly diversified as well as grown in overall size. Asset management in particular is a sector which has risen rapidly and secured influence and prominence; it comprises the banks which have traditionally been at the centre of the value debate but also, now, a broad range of actors. Hyman Minsky argued it was reshaping the economy into what he called ‘money manager capitalism’. But how much value does it actually create?
During the three decades after the Second World War, Western economies grew robustly, in the process accumulating massive savings. These ‘thirty golden years’, better known by their French name of the trente glorieuses, also saw a huge rise in pension commitments as people lived longer and were able to save more. The wealth built up in savings and pensions had to be managed. Investment management developed to meet the demand and gave an enormous fillip to the size and profits of the financial sector as a whole. Individual investors, who had made up a significant part of stock market activity, gave way to massive institutions run by professional fund managers, many of whom shared the attitudes and remuneration of the executives running the companies in which the fund managers invested their clients’ money.
The financial system evolved to meet savers’ needs in an uncertain future several decades away. Investment had to be long-term, reasonably liquid and yield an attractive return, particularly to counter inflation’s inevitable corrosion of savings. Pensions are central to such investments, especially in the Anglo-Saxon countries, where they make up about half of wage earners’ retirement funds. Today, it is hard to overstate the importance of pensions for individual beneficiaries and the economy: pensions sustain aggregate demand by enabling the elderly to consume after they retire. But they are also crucial for the whole financial system, partly by virtue of size – the volume of assets held in pension funds – and, even more significantly, because the private pensions industry is driven by profit and returns to shareholders. The number of mutual pension providers – companies owned by their members – has steadily declined as they convert to shareholder-owned companies or consolidate in order to compete with them.
Although the pensions industry existed in the early twentieth century, it came of age in the post-war years with the rise of the welfare state. In an era of full employment, often in large enterprises, compulsory pension schemes to which employers and employees contributed piled up enormous assets. Voluntary pension savings were common too. L
ife insurance has also been an important savings vehicle, but payments into life insurance policies have not generally been compulsory. In the UK and the US, governments have long given pension savings significant tax advantages, partly to encourage private savings and reduce the burden on state pension provision.
Here, I look at how the investment industry and investment banks, despite seeming to be highly competitive, often behave more like monopolies protected from competition. They extract rent for the benefit of managers and shareholders while the ultimate clients – ordinary customers and investors in shares, pensions and insurance policies – frequently pay fees for mediocre returns that do not pass on the benefits of fund management’s expansion and profitability.
NEW ACTORS IN THE ECONOMY
The post-war accumulation of savings placed asset managers centre-stage. They were not completely new on the scene. Mutual funds, called unit trusts in the UK, had existed before the war, and in the UK investment trusts were a popular form of middle-class saving. But the sheer scale of the investment required – and the social responsibilities that went with it – turned asset managers into a new set of actors in the economy. Their job was not to invest in productive assets like entrepreneurs, but to be the temporary stewards of savings which they invested in liquid and, generally, financial assets (as opposed to, say, property). In the US, assets under management (AUM) grew dramatically from $3.1 billion in 1951 to some $17 trillion in 2015.13 In the UK, the asset management industry accounted for £5.7 trillion by the end of 2015, more than three times the size of GDP in the same year.14
The Value of Everything (UK) Page 17