The Value of Everything: Making and Taking in the Global Economy

by Mariana Mazzucato

But despite all the effort that has gone into developing it, the SNA lacks a coherent and rigorous underlying value theory.

The way we define and measure growth is of course affected by our theory of value. And the resulting growth figures may guide the activities that are deemed important. And in the process possibly distort the economy.

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.

The celebration of finance by political leaders and expert bankers is, however, not universally shared among economists. It clashes with the common experience of business investors and households, for whom financial institutions’ control of the flow of money seems to guarantee the institutions’ own prosperity far more readily than that of their customers.

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.

The current chapter looks at the expansion of banking, and the way in which political decisions to recognize its value in national accounts (although based on economically contentious assumptions) helped to drive a deregulation which fuelled its ultimately over-reaching growth. In the next two chapters I explore the relationship between this growth and the financialization of the rest of the economy.

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’.

If financial intermediaries promote economic growth by mobilizing capital and giving it better uses, national output (GDP) could be expected to grow faster than financial-sector output, thus diminishing its share of GDP.

If banks and financial markets become more efficient, firms should make increased use of their services over time, losing their early preference for internal financing of investment out of retained profit. In practice, numerous studies find that firms continue to finance most of their investment (in production and new product development) internally through retentions, because external financers know less about their activities and offset their greater risk by demanding a higher return.

National accounts conventionally ascribe a value to these, notwithstanding the free-market critics’ objection that non-marketed goods and services are cross-subsidized by (and constitute a drain on) the marketed-sector producers, thus subtracting from national productivity.4

But 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.

Investment banks’ importance in channelling professional investors’ funds into productive industry rose up the political agenda because early savings banks, which took deposits from households, often lost them to fraudulent or excessively risky money-making schemes and so were steered by regulation into buying mainly government bonds.

Indeed today, 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.

Borrowers might lose it on a failed business venture, or simply steal it and refuse to repay. Far from being ‘usurious’, therefore, the payment of interest can be interpreted as the lender’s reward for running the risk of never seeing their money again. The greater this risk, the higher the interest they are justified in charging.

The cost of ‘financial intermediation services, indirectly measured’ (FISIM) is calculated by the extent to which banks can mark up their customers’ borrowing rates over the lowest available interest rate.

The 1993 SNA revision, however, began the process of counting FISIM as value added, so that it contributed to GDP.

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. National accounting conventions recognize this incongruity by treating the cost of financial services (FISIM plus direct fees and charges) as a cost of production for firms or governments.

It is only the flow of goods and services from non-financial firms (and government) that counts as final production. But exceptions are made for financial services provided to a country’s households and non-resident businesses; these services, as well as direct fees and charges imposed by financial institutions, are treated as a final output, counting towards GDP alongside everything else that households and non-residents consume.

The increasingly hazardous nature of lending to subprime and already indebted households further boosted this measured contribution, since it resulted in a higher premium of borrowers’ rates over the reference rate with inadequate adjustment for the increased risks.

money is made by shorting property-related investments before a slump, as investors such as the hedge fund manager John Paulson famously did before the 2008 crash, the profit increases GDP.

According to theories that view the financial sector as productive, ever-expanding finance does not harm the economy; indeed, it actually facilitates the circulation of goods and services.

It is, then, difficult to think about the financial sector as anything but a rentier: a value extractor. This, indeed, was the economic verdict on finance before the 1970s, incorporated into national accounts, until a decision was taken to ascribe ‘value added’ to banks and their financial-market activities.

The redrawing of the production boundary to include finance was in part a response to banks’ lobbying, which was itself a feature of their market power and influence.

Financial sectors were heavily regulated in the early 1970s, even in countries with large international financial centres such as the US and UK. Governments viewed regulation as essential, because a long international history of bank crashes and failed or fraudulent investment schemes showed how, left to themselves, financial firms could easily lose depositors’ money and, in so doing, disrupt real economic activity and even cause social unrest.

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.

Rather than being reinvested in the US economy to build new factories or research laboratories, Eurodollars were siphoned off to developing countries in search of a higher yield than was available in developed economies at the time.

The deregulation and transformation of finance was both a response to, and a cause of, huge social and economic changes which began in the 1970s.

Large financial firms were, however, careful to secure a lightening of regulation, rather than the complete deregulation advocated by free-marketeers such as the Nobel Prize-winning economist Friedrich Hayek. Their reasoning was as follows. To maintain their high profits, the big commercial and investment banks still needed regulators who would keep potential competitors out of the market.

In issuing licences sparingly, governments and central banks were quietly admitting something they were still reluctant to announce publicly: the extraordinary power of private-sector bank lending to determine the pace of money creation, and therefore economic growth.

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.17

Money creation also occurs when you pay for dinner with a credit or debit card. As a matter of fact, only about 3 per cent of the money in the UK economy is cash (or what is sometimes called fiat money, i.e. any legal tender backed by government).

Banks create all the rest. It wasn’t until after the 2008 crisis that the Bank of England admitted that ‘loans create deposits’, and not vice versa.18

For example, it took an investigation by the UK’s Competition Commission in 2000 to establish that the country’s Big Four banks had been operating a complex monopoly on services for small businesses, using their 90 per cent market share to extract £2 billion in annual profit and push their average return on equity up to 36 per cent, by mutually agreeing not to compete.19 If banks’ gambles ever endangered their solvency, the government would have to rescue them with public money.

Taking (not uncommonly) reassurance about capitalism from its arch-opponent, twentieth-century economists assumed that financial profits would always be limited by (and total less than) the sum of productive firms’ profits, and might even move up and down to even out the flow of profits in the ‘real’ economy.

Crashes reveal the investment banks’ ‘risk-taking’ service–which justified their inclusion in GDP accounting–to be a hollow boast. It is the taxpayer who is called on to take the real risk, bailing out the banks.

By this yardstick, Keynes commented, Wall Street could not ‘be claimed as one of the outstanding triumphs of laissez-faire capitalism–which is not surprising, if I am right in thinking that the best brains of Wall Street have been in fact directed towards a different object’.22 That ‘different object’, in Keynes’s view, was not a form of production, but ‘betting’–and the profits of the bookmaker were ‘a mere transfer’,23 a transfer which should be limited lest individuals ruin themselves and harm others in the process.

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.

In his work on financial instability26 he nested Keynes’s critique within an alternative theory of money. This theory, which began far from the mainstream but forced its way in when a bubble-bursting ‘Minsky moment’ broke the long boom in 2008, holds that the quantity of money in an economy is created by the interplay of economic forces rather than by an outside agency such as a central bank.

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.

As long as financial assets can be bought and sold in a reasonable amount of time without incurring losses, and debt can be rolled over to pay previous loans, markets are liquid and the economy runs smoothly. But once investors realize that borrowers are not earning enough to pay interest and principal (on which the interest is based), creditors stop financing them and try to sell their assets as soon as possible. Financial bubbles can be seen as the result of value being extracted; during financial crises value is actually destroyed. The fallout can be measured not only in output and job losses but also by the amount of money that governments had to pour into private banks because they were ‘too big to fail’: the quantitative easing (QE) schemes that followed the crisis might have been used to help sustain the economy, but ended up further propping up the banks.

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.

Lord Adair Turner, who took over as Chair of the UK financial regulator (then called the Financial Services Authority) in 2008, just as the system was crashing around it, reflected when the dust settled that: ‘financial services (particularly wholesale trading activities) include a large share of highly remunerated activities that are purely distributive in their indirect effects… the ability of national income accounts to distinguish between activities that are meaningfully value-creative and activities that are essentially distributive rent extraction is far from perfect’.30

Over the past decades, Keynes’s and Minsky’s insights and warnings about the potentially destructive nature of an unbridled financial sector have been totally ignored. Today, the economic mainstream continues to argue that the bigger (measured by the number of actors) or ‘deeper’ financial markets are, the more likely they are to be efficient, revealing the ‘true’ price and therefore value of an asset in the sense defined by the Nobel Prize-winning US economist Eugene Fama.

Commercial banks seem literally to have been given a licence to print money, through their ability to create money in the process of lending it, and to lend it at higher interest rates than they borrow. But such lending remains a risky source of profit, if those they lend to don’t pay back. And because they can only lend if a household or business wants to borrow, it’s a highly cyclical source of profit, rising and falling with the scale of investment activity.

The massive and disproportionate growth of the financial sector (and with it the origins of the global financial crisis) can be traced back to the early 2000s, when banks began increasingly to lend to other financial institutions via wholesale markets, making loans not matched by deposits.

In the UK the ‘customer funding gap’ between loans advanced and deposits from households (traditionally viewed as the most stable form of bank financing) widened from zero in 2001 to more than £900 billion ($1,300 billion) in 2008, before the crisis cut it to less than £300 billion in 2011.

These lenders benefited from a seemingly virtuous circle in which additional lending raised financial asset prices, which strengthened their balance sheets, giving them the scope to borrow and lend more within existing minimum capital ratios, the amount of capital banks had to retain relative to their lending.

Greenspan had, a decade before the crisis struck, vetoed a proposal to regulate over-the-counter (OTC) derivatives, claiming that on the contrary ‘the fact that OTC markets function so effectively without the benefits of the Commodity Exchange Act [CEA] provides a strong argument for development of a less burdensome regulatory regime for financial derivatives traded on futures exchanges

Following deregulation, the enormous increase in finance available to households was the main reason for the rise in banks’ profits.