GRACE BLAKELEY. The Latest Incarnation of Capitalism (Jacobin, September 2018)Jan 18, 2019
Financialization isn’t a perversion of an otherwise well-functioning system. It’s just capitalism’s latest survival mechanism.
Philosophers and economists have decried the parasitical effect of finance on productive economic activity. Plato opens his Republic with an exchange challenging the idea that one should always repay one’s debts. Adam Smith argued for attacks on landlords’ entrenched privileges, while Keynes called for the “euthanasia of the rentier.” This narrative is still prominent today. Indeed, many modern economists argue that we are entering an era of “rentier capitalism,” in which financial capitalists thrive at the expense of good, productive industrialists.
And they have a point. There is mounting evidence that an ever-increasing portion of economic output is accruing to those who gain their money from unproductive economic rents — that is, from monopolizing inputs to production and charging above-market rates for their use. The “rentier share” increased from 4 percent to 14 percent of total income between 1970 and 2000. Financial profits increased by a similar magnitude over the same period. These trends are linked: much of finance’s modern activity is little more than rentierism.
But any analysis that sees financialization as a “perversion” of a purer, more productive form of capitalism fails to grasp the real context. What has emerged in the global economy in recent decades is a new model of capitalism, one that is far more integrated than simple dichotomies suggest. As we pass the tenth anniversary of the 2008 financial crisis, developing conceptual tools to understand financialized capitalism is vital to building strategies to overcome it.
The Rise and Fall of Global Finance
Financialization — “the increasing importance of financial markets, financial motives, financial institutions, and financial elites in the operation of the economy” — is a process that began in the 1980s with the removal of barriers to capital mobility. Global capital flows rose from about 5 percent of world GDP in the mid-1990s to about 20 percent in 2007. This is about three times faster than world trade flows.
Increases in capital mobility helped facilitate the emergence of large imbalances between creditor countries with large current account surpluses and debtors with large current account deficits. According to textbook economic theory, these imbalances should be self-correcting. When a country runs a deficit, currency is flowing out of the country. If this currency does not return in the form of capital inflows, the resulting increase in supply will exert downward pressure on the currency. A less valuable currency makes your exports cheaper to international consumers and should therefore increase demand for those exports. Played out over the scale of the global economy, this should lead to equilibrium.
In the lead-up to the crisis, the fact that this equilibrium was not forthcoming puzzled some economists. Deficit countries should have been experiencing large currency depreciations, given the size of their current account deficits. These depreciations should, in turn, then have increased the competitiveness of their goods. Ben Bernanke, then chairman of the Fed, accused a number of emerging economies of “hoarding” savings to protect themselves from future crises, preventing the global economy from reaching equilibrium.
In fact, deficit countries were able to maintain strong currencies because, even though there was relatively little demand for their goods, there was strong demand for their assets — particularly financial assets. The main reason for the high demand for UK and US assets was the financial deregulation undertaken by neoliberal governments in these states in the 1980s, which facilitated a dramatic expansion in the provision of private credit to individuals, businesses, and financial institutions.
In the UK, consumer debt — primarily composed of mortgage lending — reached 148 percent of household disposable incomes in 2008, the highest it has ever been. While UK banks’ lending to the non-financial economy rose 50 percent between 2005-8, their lending to other financial institutions rose by 260 percet. Capital from the rest of the world flowed into banks in the UK and the US, which were generating significant returns from this lending.
High levels of bank lending dramatically increased the broad money supply. All this new money led to sharp increases in asset prices. In the fourth quarter of 2017, UK house prices were almost ten times what they had been in fourth quarter of 1979, while consumer prices increased just five times over the same period. The FTSE index increased from under 100 points pre-1980 to almost 3,500 in 2007. New financial securities were also created during this era: the mortgage-backed securities (MBSs) and collateralized debt obligations (CDOs) that will be familiar to those who have seen The Big Short. Rising asset prices attracted yet more international capital, creating a self-reinforcing cycle that led many to believe the party would continue forever.
But ultimately this model, like any model premised on the continuous expansion of private credit, proved unsustainable. The combination of capital mobility and financial deregulation led to the emergence of a huge speculative bubble that eventually popped, resulting in the crisis of 2007-8.
After the Crash
Mainstream economists failed to see the crash coming. Rather than looking back through history and observing that in finance a period of calm always precedes a storm, they saw booming asset prices as a vindication of their management of the economy. Some even went so far as to declare the “end of boom and bust.” Financial crises like that which occurred in 2008 simply didn’t fit their theoretical models.
Some economists, however, did see it coming. Nouriel Roubini was referred to as Dr. Doom before the 2008 crisis finally hit. Ann Pettifor’s book The Coming First World Debt Crisis was largely ignored by the economics profession. Steve Keen was ridiculed for teaching his students about the “global debt bubble.” These economists had one thing in common: they had read Hyman Minsky.
According to Minsky’s “two price theory,” the rules governing asset prices are different than those governing goods and services. In essence, during good times investors become overly optimistic based on their recent experience of high and increasing returns, so they borrow to invest more in assets that are increasing in price. Higher levels of investment increase the prices of those assets even more, creating a self-reinforcing cycle of optimism-driven asset price inflation.
As their optimism grows after several periods of strong returns, investors will borrow more and more to invest in riskier projects because they anticipate that their returns will continue to grow. Eventually, the financial cycle enters a phase of “Ponzi finance,” with investors piling into assets one after another based purely on the speculation-driven price rises of the recent past. This creates further asset price inflation, driving a positive feedback loop that leads to bubbles which eventually burst, creating a “Minsky moment.”
The reason the financial cycle matters is that, when the Minsky moment occurs, it can lead to an extended period of debt deflation, in which asset prices start falling and panic selling begins, catalyzing a chain reaction throughout the financial system. This causes deflation in the real economy, leading to falls in profitability, and therefore the need to liquidate even more assets to pay down debts.
As business and consumer confidence is shattered, this feeds through into employment, output, and financial stability in a debt-deflation spiral that mirrors the upswing of the financial cycle in both size and severity. Unrestricted lending exacerbates these dynamics by prolonging the upswing and exacerbating the downturn. In this sense, the prolonged period of financial stability before 2008 should have been a warning sign to economists, not a source of comfort.
The deficit countries experienced their Minsky moment in 2008 when lending slowed, house prices fell, and financial assets such as mortgage-backed securities and credit-default swaps effectively became worthless. Mass panic ensued when the banks suddenly found that many of the assets on their balance sheets were not really assets at all. This drove some of the world’s largest banks into insolvency — a situation from which they were quickly rescued by frightened governments.
But saving the banks couldn’t save the economy. In the UK today, we are in the longest period of wage stagnation since the 1860s. Households’ outgoings exceeded their incomings in 2017 for the first time since 1988. Productivity has stalled since 2008, and the UK now produces 13 percent less output per hour worked than the G7 average. All in all, the recovery from 2008 has been the weakest since World War II.
Rather than dealing with the underlying issues that led to the crisis, policymakers have attempted to engineer a return to the pre-crisis world. The Bank of England, the Fed, and the ECB pumped huge sums into the financial system by printing money to buy government debt, creating a new round of asset-price inflation that allowed bank profits to recover fairly quickly. But as much as central banks might want to, there is no going back to before 2008.
Rather than dealing with the underlying issues that led to the crisis, policymakers have attempted to engineer a return to the pre-crisis world.
Since then, global cross-border capital flows have declined by 65 percent. Globalization, many believe, is now “in retreat” owing to the collapse of its financial wing. UK corporations have become net savers rather than borrowers. Investment flows between banks have contracted as they have become much more risk averse. While household debt is rising again, it is doing so more slowly than once anticipated. We’re still securitizing much of this debt – though today CDOs and ABSs are much more likely to be based on car loans and student debt, which are much smaller than mortgages.
It is clear that the debt-boom of the pre-2008 period is over, at least in the UK and the US. But the debt overhang remains. We are entering a period of zombie capitalism, in which little new debt can be created to drive growth, but there is not enough productive economic activity to pay the old debt off. In this situation, only an extended period of extremely low interest rates can keep the economy ticking over.
The Financialization of (Nearly) Everything
One of the most common narratives about the rise of financialization sees this development as a product of the victory of financial over industrial capital. According to this perspective, industrial capital in the Global North experienced a profit squeeze in the 1970s amid rising input costs and increasing competition from the Global South. Weakened industrial capital found many traditional avenues of accumulation closed off, and financial speculation emerged as the most profitable alternative.
However, as Costas Lapavitsas has argued, that narrative overstates the division between financial and industrial capital. Finance should not be “treated as surface phenomena sitting atop the ‘real’ economic activities of production and exchange,” but as an essential system to support capitalist accumulation. Financialization does not represent a perversion of an otherwise well-functioning capitalism; instead it is the adaption of the capitalist class to the escalating contradictions evident in capitalist political economy.
We aren’t witnessing the “rise of the rentiers” in this era; rather, all capitalists — industrial and not — have turned into rentiers.
The modern manifestation of this phenomenon is the ideology of shareholder value maximization. Since the 1980s, share ownership has become increasingly concentrated in the hands of of financial intermediaries like hedge funds and pension funds. As this process has intensified, incentives have been created for corporate executives to distribute money to shareholders today, rather than investing in ways to boost the profitability of the enterprise tomorrow.
We aren’t witnessing the ‘rise of the rentiers’ in this era; rather, all capitalists have turned into rentiers.
In fact, nonfinancial corporations are increasingly engaging in financial activities themselves in order to secure the highest possible returns. The fact that this model is unsustainable — resting as it does on rising leverage and increasing profit distribution over investment in future production — is beside the point. Production was never the point of the capitalist enterprise — profit was. And the financialization of nonfinancial corporation has been an excellent way to maximize profit.
Certain households have also been able to extract peculiar benefits from the financialization of the economy. Globalization was a convenient excuse for wage repression in many parts of the Global North. The problem of overaccumulation this created — that is, when workers aren’t paid enough to buy what capitalists produce — was solved by the proliferation of debt. The dramatic increases in consumer lending between 1979 and 2007 improved people’s subjective sense of prosperity and allowed them to purchase luxuries like cars, iPhones, and laptops produced by hyper-exploited labor in the Global South.
Some of this debt was used to purchase assets like housing, which increased in value as more people were able to purchase them. Large sections of society, and a majority of the electorate, were therefore able to materially benefit from the new economic model through capital gains.
This class of “mini-capitalists” had a material interest in the continuation of the model of debt-driven asset price inflation. The privatization of pensions was another critical extension of this model. Together, “property owning democracy” and “pension fund capitalism” sustained a bargain between financial capital and the middle classes that lasted all the way up to 2008.
Government itself was also financialized. Under the UK’s private financing initiatives (PFIs) of the 1990s, for instance, when the government wanted to build something it would outsource the job to a private firm, which also came up with the capital to fund the project, with the government paying them back over several decades.
PFI was just one way of replacing public money with private: the privatization of pensions schemes, the marketization of higher education, and the privatization of our health services have all taken liabilities off the public books and placed them with individuals and investors. Austerity can also be seen as an extension of this model.
States have used private financing to demonstrate their fiscal rectitude. Part of the reason governments consider such a demonstration necessary is that they need private investors to believe that they will honor their debts. Demand for government debt is inversely correlated with yield: the higher the demand, the lower the interest payments. This gives the markets a huge amount of power to discipline states that fail to demonstrate a commitment to creditworthiness.
States that fail to implement neoliberal policies can be punished through bond sell-offs (and through runs on their currencies), giving international investors the power to determine the policies of democratic states. It doesn’t matter that forcing states to implement neoliberal economic policy actually reduces their creditworthiness over the long term; the time horizons of financial capitalism are shorter than at any other period in history.
All these processes of financialization in the Global North rest on hyper-exploitation in the Global South. Facing rising input costs and increasingly militant workers in the Global North, capitalists took advantage of falling transport costs in the 1970s and ’80s to offshore production to places less integrated in the global economy.
In some places, such as China, this offshoring has led to the development of a domestic capitalist class and a fundamental transformation in economic relations. In others, the process merely entailed greater levels of extraction by capitalists in the Global North. Newly independent states in the Global South didn’t have the power to boost domestic industry as the Chinese state did, so foreign direct investment was focused on multinationals extracting commodities from these countries, and surplus value from their workers, while reshoring the profits to the Global North, paying off domestic capitalists and functionaries for the privilege.
The glory days of financial globalization are now over.
The processes of capital extraction visible at an international level are also visible at the sub-national level within financialized economies. Capital inflows have allowed deficit countries to maintain strong currencies, eviscerating exporting industries and leading to ever greater concentrations of power and wealth within the finance sector, concentrated geographically in one space.
An economy that is overheating in one area and stagnating in another is an inevitable outcome of this process of asymmetric integration. Huge financial entrepôts sit atop domestic economies with little interest in what goes on in the nation-states below. Financialized governments are quite happy to allow this to continue: London’s imperial role in the global economy is not only a source of tax revenues, but of national pride.
As Marx argued, each adaptation of capitalism merely kicks the can down the road. The crash of 2008 was a structural crisis of the financial capitalist model. And the malaise into which the global economy, and particularly the economies of the Global North, has sunk since then is a result of the failure to paper over the contradictions of the old model or move onto something new. The glory days of financial globalization are now over.
But moments of crisis are also moments of opportunity. Sustaining late-capitalist political economy in the Global North requires the continuous expansion of middle class home ownership and constant house price inflation. In the post-crash world, it is no longer possible to rely on continuous expansions of debt, partly because of changes to banking regulation. This has created serious political problems, due to the role once played by asset price inflation in sustaining neoliberalism politically. You can’t create mini-capitalists without providing them with increasingly valuable capital.
And it isn’t just housing; contradictions abound. Households have become so indebted that permanently low interest rates are required to avoid another crisis, yet permanently low interest rates only lead to higher levels of indebtedness. When the next crisis comes, central banks won’t be able to loosen monetary policy much more and the resulting shock to the economy will be much worse.
Aware that the current model is unsustainable, businesses aren’t investing or increasing wages. Instead they are using the profits they gain from the debt-driven spending of consumers to increase payouts to shareholders and engaging in financial activities, whether hedging, real estate investment, or even, in the case of Google and Amazon, buying up the debt of other corporations — in essence, acting like banks. This failure to invest in production, in turn, acts as a further brake on current and future economic growth.
The rising indebtedness of the state adds to these problems. Traditional Keynesian economists would argue that getting out of this mess simply requires using fiscal policy to manage demand, solving the problem of overaccumulation. But government debt doubled practically overnight during the financial crisis, primarily due to the bailout of the banks. This isn’t an economic problem, but a political one.
Selling ever greater amounts of public debt to private investors involves giving more and more power to creditors, who are able to discipline governments into adopting their favored economic policies. Greece is only the most extreme example of this trend. A mass sell-off of UK government debt would create a huge crisis for the British economy, which is the logic that underlies austerity. But austerity only increases the debt burden by shrinking economic growth and impoverishing large swathes of the population, exacerbating the crisis of overaccumulation.
The question that remains is, can the Left provide us with a way out? For the first time in many decades, we have the opportunity to build a coalition for socialism based on the material interests of non-capitalist classes in the Global North. Low levels of investment mean declining productivity and stagnating wages — both of which feed into the consumer debt problem outlined above.
Anyone who does not own capital — i.e. most of the population — will, under our current economic model, become worse off for the foreseeable future. And most of them know it. Even those who do own capital are increasingly squeezed. The inability of the system to sustain increases in wealth based on debt-backed capital gains was made painfully obvious in 2008. Late capitalism after the debt bubble has burst means falling living standards, rising inequality, and increasing political turmoil as a result.
These are the changes that underlie the rise of left-wing alternatives like Jeremy Corbyn and Bernie Sanders. But the Left needs to do more to highlight them. Most people know capitalism is broken, but few people can tell you how. Our economic narrative has yet to move beyond “austerity is bad” to a wider diagnosis of the structural conditions that led the economy to collapse in 2008, and which have kept it on life support ever since.
Labour’s 2017 manifesto was excellent given the constraints under which it was drafted, but it merely represents an extension of a social democratic settlement that is already creaking under the strains of financialization all over the Global North. Recently, John McDonnell addressed a group of bankers saying, “When we go into government, you come into government with us.”
In the coming years the Left must refocus on the central economic questions of our time, showing that the suffering most people have endured since 2007 can be traced back to the financialization of our economy. We must show that previous governments have been too busy protecting the interests of finance to support the needs of ordinary people. And we must adopt a policy agenda that challenges the hegemony of financial capital, revoking its privileges and placing the powers of investment back under democratic control. In doing so, we might just be able to move beyond capitalism altogether.