Financialization as symptom

“To understand the person you have to know what was happening in the world when they were twenty.” I was reminded of this (correct) line from Napoleon Bonaparte by reading Grace Blakeley’s Stolen.

To an intelligent person of Grace’s generation, the defining event of one’s formative years was the financial crisis of 2007-09, which highlighted the fact that capitalism had indeed become financialized, in the sense that financial institutions play a much bigger role in driving booms and slumps than they did previously. One indicator of this process is the growth in profits of financial companies, from less 1% of GDP in the 50s and 60s to over 3% in the mid-00s*.

My generation of leftists, by contrast, was shaped by a crisis of non-financial capitalism – that of the 70s and early 80s. I therefore enjoyed Michael Roberts’ review of Stolen.

What I want to do here, though, is consider the links between these two crises. I agree with Grace that financialization “has been driven by the logic of capitalism itself”. But I’m not sure she draws out the mechanisms here.

To see them, let’s start with the crisis of the 70s. Profits were then being squeezed by wage militancy. Thatcher’s response to this was to weaken labour’s bargaining power by (inadvertently!) creating mass unemployment, and reasserting “management’s right to manage” (a popular Tory slogan in the 80s).

But how does this restore profits? To see the possible mechanisms, let’s use a national accounts identity. GDP is equal to the sum of wages (W), profits (P) and taxes on production (T). It’s also equal to the sum of consumption (C), capital spending (I), government spending (G) and net exports (NX). Rearranging these gives us an identity for profits:

P = (C – W) + I + (G – T) + NX.

Profits can rise if and only if the right-hand terms rise. But how can this happen? One possibility is that more quiescent workers improve capitalists’ animal spirits and so raise I. Another is that lower wage growth and greater efficiency improve competitiveness and so raise NX. Both, though, are weak.

Leaving aside fiscal policy, this means that C – W is doing the work. Which highlights the problem. Bashing workers – by raising unemployment and cutting labour’s share of GDP – does not, in itself, raise profits if workers cut their spending. As Michal Kalecki said, “a reduction of wages does not constitute a way out of depression”.

Which is where financialization comes in. The defining event on the road to financialization in the 80s was not big bang: at the time, this was seen as merely the ending of a restrictive practice rather than the start of the creation of global investment banks. Instead, it was the credit liberalization of the early 80s, which made mortgages and consumer credit much easier to get.

This did not merely increase the activity and hence profits of lenders: note the big rise in financial profits in the mid-80s. It did something even better for capitalism. In allowing workers to borrow more it raised C – W and thus boosted profits: the household savings ratio slumped in the 80s.

In this sense, financialization was a solution to a crisis in the real capitalist economy – albeit one discovered by accident.

But it was only a temporary solution. Even with the most liberal credit conditions, there is a limit to how much people can borrow and how far C – W can rise. Worse still, the inequality unleashed by Thatcher in the 80s had a detrimental effect upon productivity and investment. (Grace says that inequality depressed growth by transferring income to people with a low propensity to consume, but I fear this understates the many other mechanisms whereby inequality harms output). Alongside other factors depressing capital spending – such as the fact that capitalists had learned that investment doesn’t pay – the result was that by 2005 Fed chairman Ben Bernanke was complaining about a “dearth of domestic investment opportunities” in the west.

This gave another spur to financialization. It meant that the Asian savings glut was invested not into productive real projects in the west but instead into Treasury bonds, which reduced their yields and hence facilitated the creation of mortgage derivatives. As Adam Tooze wrote:

Emerging market investors bought first Treasuries and then GSE-issued agency debt. This left other institutional investors looking for alternatives. What filled the gap was financial engineering. If pension funds, life insurers and the managers of the gigantic cash pools accumulated by profitable corporations and the ultrawealthy needed safe assets, AAA-rated securities were a product America’s mortgage machine knew how to synthesize. (Crashed, p59)

In this sense as well, financialization is the result of a crisis in the real capitalist economy; the lack of real investment opportunities meant that cheap money flowed into the financial sector instead. As Ravi Jagannathan has said (pdf), the crisis was a symptom.  

Financialization, then, is not a Bad Thing done by Bad People. It is instead an endogenous response to a longstanding crisis of real capitalism.

* My chart uses ONS code identifiers NHCZ and YBHA. This measures the profits generated in the UK by financial companies, so excludes the foreign profits of UK-based banks.

Comments

[qwertboi]

So we are really talking about two distinct things when we use the word ”crisis” -
i) crises as cyclical, almost routine oscillations between boom and slump, between inflation and recession, the cycles which are systemic and take approximately a decade to run,; and
ii) the tendency, played out over decades and centuries, for life under capitalism to become more and more untenable and for the economic model itself to become unsustainable for ecological and economic reasons?

Yes, Ravi Jagannathan could well be right: some crises of the ‘real’ economy are actually symptoms of the economic model's inability to deal with them, and therefore its terminal decline.

The inevitability of the economy’s need to develop alternatives that do not require, or which do not produce, the ‘contradictions’ of capitalism (i.e. the features of it which cause it to be non-sustainable and untenable to its 'stakeholders (i.e. customers and workers))is, hopefully, progressing nicely and is developing new robust models and viable alternatives.

[Ralph Musgrave]

If Grace Blakeley is so keen to cut banks and financialisation down to size, it's a bit odd that she makes no mention of one of the biggest privileges enjoyed by banks, namely their right to print / create money out of thin air and lend it out at interest.

[Davy Jones]

"Bashing workers – by raising unemployment and cutting labour’s share of GDP – does not, in itself, raise profits if workers cut their spending. As Michal Kalecki said, “a reduction of wages does not constitute a way out of depression”."

But according to Marx, it might, if by reducing wages, all other things being equal, aggregate profits increase. There's no reason in principle that profits have to be realised through consumption goods.

[Darren]

This makes me think of Andrew Kliman’s point that capitalist production has never really overcome the crisis of “real” production in Chris’ (and my) Napoleonic youth. I agree too that it’s plausible that “financialisation” via credit to the working class and low interest rates generally is a stop gap that’s now run out out of room.

I guess we will see what’s next. With growth in China slowing, perhaps the “savings glut” will dry up. What then for the “mortgage machine”.