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In essence, we behave as economic actors according to the vision of the world of those who devise the accounting conventions. The marginalist theory of value underlying contemporary national accounting systems leads to an indiscriminate attribution of productivity to anyone grabbing a large income, and downplays the productivity of the less fortunate. In so doing, it justifies excessive inequalities of income and wealth and turns value extraction into value creation.
Underpinning this expansion is the belief that a country benefits from an ever-growing financial sector, in terms of its growing contribution to GDP and exports, and as total financial-sector assets (bank loans, equities, bonds and derivatives) become an ever-larger multiple of GDP.
for much of recent human history, in stark contrast to the current enthusiasm for financial-sector growth as a sign of (and spur to) prosperity, banks and financial markets were long regarded as a cost of doing business. Their profits reflected added value only to the extent that they improved the allocation of a country’s resources, and cross-subsidized a reliable payments system.
Finance also diverted many highly trained scientists and engineers away from work in direct production, by offering them on average 70 per
cent more pay than other sectors could afford.
having redesignated finance as productive, to strip away the regulations that had previously kept its charging and risk-taking under control.
So in 2015, the IMF concluded an exhaustive study ‘rethinking’ financial deepening by concluding that while the positive effects of the sector’s expansion might weaken at high levels of per-capita GDP, and/or if it grew too fast, ‘there is very little or no conflict between promoting financial stability and financial development’, and ‘most emerging markets are still in the relatively safe and growth-enhancing region of financial development’.
an equally serious problem arises when prices are charged for (and profits made from) a product or service that doesn’t obviously confer any value.
this is classified and condemned as monopoly rent-extraction.
Mainstream opinion, meanwhile, continued to view banks as intermediaries which, in charging to connect buyers and sellers (or borrowers and savers), made their income by capturing value from others rather than creating it themselves.
if we use the value-added formula (wages plus profits), we find that the financial sector, far from contributing 7.2 per cent of GDP to the UK economy and 7.3 per cent to the US (as the 2016 national accounts showed), in fact makes a contribution to output that is zero, or even negative. By this yardstick it is profoundly, fundamentally unproductive to society.
The persistence of this interest differential is, according to the economists who invented FISIM, a sign that banks are doing a useful job. If the gap between their lending rates and borrowing rates goes up, they must be getting better at that job. That’s especially true given that, since the late 1990s, major banks have succeeded in imposing more direct charges for their services as well as maintaining their ‘indirect’ charge through the interest-rate gap.
Banking services are of course necessary to keep the economy’s wheels turning. But it does not follow that interest and other charges on the users of financial services are a productive ‘output’. If all firms could finance their business investments through retained earnings (the profits they don’t distribute to shareholders), and all households could pay for theirs through savings, the private sector would not need to borrow, no interest would be paid and bank loans would be redundant.
Society at large then bears the costs of the speculative mania: unemployment rises and wages are held down, especially for those left behind during the previous economic expansion. In other words, value is extracted from labour’s share of earnings in order to restore corporate profits.
It is, then, difficult to think about the financial sector as anything but a rentier: a value extractor.
Bretton Woods Agreement of 1944. In line with the so-called ‘Keynes Plan’, the Bretton Woods system imposed tight curbs on international capital movements in order to preserve a system of fixed exchange rates–thereby ruling out most of the cross-border investments and currency trades which had previously been major sources of instability and speculative profits. The Bretton Woods Agreement also required governments to maintain tight restrictions on their domestic financial sectors–including high minimum ratios of capital to assets and liquid reserves to total bank assets, interest rate caps
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banks never ceased to lobby against the regulations that deprived them of significant markets, and others (like the Glass–Steagall Act) which restricted their scope to combine operations in different markets. As well as pushing for an end to regulations, banks proved adept at persuading politicians that restrictive regulations were unworkable, by finding ways to work around them.
As non-US companies, mainly in Europe, accumulated dollars from exports to the US and from oil sales, financiers realized they could borrow and lend in these dollars, which would be outside the control of European governments because they had not issued the currency. UK banks were keen as early as 1957 to mobilize their dollar-denominated deposits, as the chronic balance-of-payments deficit forced the government to impose controls on their use of sterling for foreign transactions.
Banks are not only empowered to create money as well as channel it from one part of the economy to another; they also do remarkably little to turn households’ savings into business investment. In fact, in the US case, when the flow of funds is analysed in detail, households ‘invest’ their savings entirely in the consumption of durable goods while large businesses finance their investment through their own retained profits.
Writing in the 1930s, one of the most influential critics of finance, John Maynard Keynes, was upfront about what financial speculation entailed. In his lifetime he observed how
financial markets and public attitudes to financial trading were changing, becoming ends in themselves rather than facilitators of growth in the real economy.
Keynes also thought that the proceeds from such betting and speculating should go to the state to remove the incentive–a better word might be temptation–to reap private gains from it.
He went on to stress the difference between this kind of speculation (value extraction) and finance for actual productive investment (value creation), which he saw as crucial for growth and which was only possible without the speculative apparatus around it. If ‘the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done’.
responsible for all financial instability) by Milton Friedman (1912–2006; Nobel Prize 1976) and the ‘monetarists’ propelled to prominence by 1970s stagnation, central banks such as the US Federal Reserve can only indirectly and weakly control the private-sector banks and their money creation, by setting the base interest rate. Minsky charted the way in which the banking system would eventually end up moving to ‘speculative finance’, pursuing returns that depended on the appreciation of asset values rather than the generation of income from productive activity.
Financial bubbles can be seen as the result of value being extracted; during financial crises value is actually destroyed.
When the financial sector is so interconnected, it is very possible for one bank’s failure to become contagious, leading to the bankruptcy of banks all over the world. In order to avoid this ‘butterfly effect’ (as chaos theory calls it), Minsky favoured strong regulation of financial intermediaries. In this he followed Keynes,
Back in the eighteenth century, Adam Smith’s belief that a free market was one free from rent implied government action to eliminate rent. Modern-day free marketeers, who have gagged Smith while claiming his mantle, would not agree with him.
Financial regulators have focused on introducing more competition–through the break-up
up of large banks and the entry of new ‘challenger banks’–as an essential step towards preventing another financial crisis. But this ‘quantity theory of competition’–the assumption that the problem is just size and numbers, and not fundamental behaviour–avoids the uncomfortable reality...
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That’s why the Glass–Steagall Act and its counterparts elsewhere, forcing banks to choose between taking customer deposits or playing the markets, was so unpopular in banking circles, and why they celebrated its repeal at the turn of the twenty-first century.
Two classes of financial instrument in particular were made available to investors by deregulation from the 1970s onwards, and were central to the subsequent massive growth in financial transactions and profitability. These were derivatives, contracts on the future delivery of a financial instrument or commodity which allowed investors to make bets on their price movement; and securitizations, bundles of income-yielding instruments that turned these into tradable securities (and enabled their inclusion in derivative contracts).
The subtle yet fundamental change in the way that the banking sector’s productivity has been redefined over the last two decades or so has corresponded with its increasing capture of the economy’s surplus.
Banks also believed that they had become much better at handling risk:
Investment banks lent to hedge funds and private equity firms and developed and traded exotic instruments based on assets like subprime mortgages, because the returns were higher than lending to industry or government.
In 2006 Alan Greenspan, then Chairman of the US Federal Reserve, and Tim Geithner, the former President of the Federal Reserve Bank of New York, claimed that derivatives were a stabilizing factor because they spread the risk among the financial institutions best equipped to deal with it.
The growth of finance has also fed the growth of inequality, not least by adding to the influence and lobbying power of financiers who tend to favour reduction of taxes and social expenditures, and promoting the financial-market volatility that boosts the fortunes of those who serially buy low and sell high.
Commercial banks profited from direct loans for anything from cars to homes to holidays, and from credit cards.
As previously prudent banks bombarded customers with offers of credit–the age of tempting credit card promotions dropping almost daily through millions of letter boxes had arrived–household borrowing began to rise inexorably.
the relaxation of controls on mortgage lending became another source of profit and also fuelled the increased household borrowing.
Governments rejoiced when banks offered mortgages to low-paid, marginally employed home buyers on the assumption that their debt could be ‘securitized’ and quickly resold to other investors. It seemed less a reckless gamble and more a social innovation, helping to broaden property ownership and boosting the ‘property-owning democracy’, while increasing the flow of income to an already buoyant investor class.
As soon as people begin to have doubts about the assets’ value, however, the cracks appear.
The rise in private debt in the US and UK has resulted in household savings falling as a percentage of disposable income–income minus taxes–especially in periods of sustained economic growth (during the 1980s, the late 1990s and the beginning of the 2000s). Simultaneously, household consumption expenditure has been buoyant. It has outpaced any rise in disposable income, and its contribution to GDP has grown.
First, real wages have fallen or stagnated for many low- and middle-income households.
wage shares have declined by several percentage points in favour of rising profit shares, even when real employee compensation has gone up.
personal distribution of income and wealth has become more and more unequal.
those with the highest incomes have enjoyed an increasing share of total national income ever since the 1970s,
A 2017 Oxfam report, An Economy for the 99%, found that in 2016 eight men own the same wealth as the poorest half of the world’s population.
The wealth of the sixty-two very richest individuals increased by 45 per cent in the five years to 2015, a jump of more than half a trillion dollars in total. Over the same period, the wealth of the bottom half fell by just over a trillion dollars–a drop of 38 per cent.48
to maintain the living standards they had enjoyed from the Second World War to the 1980s, workers had to shoulder an increasing debt burden from the 1980s onwards.
In the US, mortgage loans were a principal cause of rising household indebtedness (Figure 12), partially a reflection of households’ propensity to extract equity from the rising value of their houses.
