Wednesday, 20 April 2016

The government isn’t to blame for the rise of Wall Street

Costas Lapavitsas is professor of economics at the School of Oriental and African Studies, University of London, and author of “Profiting Without Producing: How Finance Exploits Us All.” During 2015, he was a member of the Greek Parliament collaborating with the governing Syriza party.

A trader works at the New York Stock Exchange on Feb. 9. (AP Photo/Mark Lennihan)

Financialization is an awkward word, but it captures a prominent aspect of contemporary capitalism: During the last several decades, the financial sector has grown in extraordinary ways, even to the point of dominating economies.

Some consider the ascendancy of finance to be the result of government policy. There is no doubt that in the U.S., the country that best exemplifies financialization, deregulation by the government has benefitted Wall Street. However, the phenomenon of financialization is so widely observed across the world that it calls for a fuller explanation. Indeed, it is more plausible that government policy has favored finance because deeper trends in economy and society have already made financialization an underlying reality.

Financialization is best understood as a great historical shift in the development of capitalism that began in the 1970s and has been unfolding for four decades. Its roots lie in profound changes in technology and the conditions of labor. Specifically, there has been a revolution in telecommunications and informatics, which has however failed to create sustained productivity growth, for reasons that are not yet clearly understood. At the same time, labor has become more intensified and insecure, while income inequality has exploded. In this context, the sphere of production in developed economies has performed sluggishly, while the sphere of finance has ballooned. This imbalance marks contemporary capitalism.

These underlying changes have led to three characteristic trends which mark a financialized landscape, all of which are apparent in the United States. First, large non-financial enterprises, for instance, large oil and car companies have become “financialized”; that is, they draw substantial profits from financial operations while becoming relatively more independent of banks, since they usually have ample resources to finance their investment. Contrary to what is often imagined, financialization does not imply that big banks are able to dictate terms to big business. What it does show is that big banks and big business engage more intensely in financial activities but without one dominating the other.

Because of this, big banks have shifted some of their profit-making away from lending money and providing financial services to non-financial corporations. Instead, they favor transacting in financial markets and dealing with individuals and households.

Finally, individual households have become “financialized,” as exposure to formal financial institutions – banks, insurance companies, other finance companies – for borrowing, saving, pensions, insurance, and so on, has grown in unprecedented ways. Personal income is now a significant source of profit for banks.

The historic nature of this transformation is exemplified by the remarkable growth of financial profit over the past few decades. The figure below shows profits made by formal financial institutions as a percentage of the total domestic profit in the U.S. between 1955 and 2015, which basically comprises the total corporate profits of domestic industries. This measure is actually an underestimate, since it leaves out bonuses paid to financial executives, financial profits made by non-financial corporations, and so on. But it is revealing nonetheless.

From the early 1960s to the early 1980s, financial profits were a fairly stable proportion of total profits. The shift to financialization began in the 1970s, and its high period occurred from the early 1980s to the early 2000s. During those two decades financial profit exploded as a proportion of total profit. These years were riven with financial bubbles, each typically ending with a financial crisis marked by falling financial profits, such as the Savings and Loans crisis in the late 1980s and early 1990s. The upward trend resumed soon afterwards.

There should be no surprise at the pronounced instability of financialization. Finance is relatively detached from production, and when it is given sufficient scope, tends to create towers of loans and debts, or obligations and counter-obligations, that have only the most tenuous connection with value-creating processes. Collapse is the frequent end result.

By far the most pronounced crisis occurred in 2007-‘09 following the real estate bubble of the 2000s that brought a tremendous expansion of indebtedness to households. The crisis featured a catastrophic fall in financial profits. Recovery was sharp, but since 2009, the proportion of financial profits has been gently declining. The vast debt overhang of the previous bubble appears to have put a break on financialization, while the U.S. economy seems stuck in “the new normal” of stagnation.

The path that the U.S. takes now will help determine the direction of other countries. The U.S. has a historic opportunity to hack a way out of the dead-end by beginning “definancialization” – the process of rebalancing the economy in favor of the sphere of production relative to the sphere of finance.

For that to happen, it is not enough merely to regulate Wall Street. Coordinated public policy will be needed to confront the fundamental trends of financialization, to encourage non-financial corporations to increase their investment in productive activities and move away from financial activities, to redirect the banks toward supporting the productive sector of the economy, and to reduce the reliance of households on complex and intangible financial instruments. None of these steps is easy and all will entail deep changes in how people live, work and study. But the challenge is worthwhile.

First published in The Washington Post, 19 April 2016