Secular stagnation and the financial sector (updated)

by John Quiggin on November 29, 2015

In my last post on private infrastructure finance and secular stagnation, I suggested a bigger argument that

The financialization of the global economy has produced a hugely costly financial sector, extracting returns that must, in the end, be taken out of the returns to investment of all kinds. The costs were hidden during the pre-crisis bubble era, but are now evident to everyone, including potential investors. So, even massively expansionary monetary policy doesn’t produce much in the way of new private investment.
This isn’t an original idea. The Bank of International Settlements put out a paper earlier this year arguing that financial sector growth crowds out real growth. But how does this work and what can be done about it?

The financial sector is an intermediary between savers and borrowers (for investment or consumption). So, the costs of running the financial sector and the profits generated in that sector must be included in the margin between the rates of return by savers and those paid by borrowers, or else they must be shifted on to society at large (for example, through bailouts or tax subsidies).

I’m still organizing my thoughts on this, so what I have are some ideas rather than a fully formed argument.

First, if the financial sector is unproductive, how can it be so large and profitable in a market economy?

There are a few possible explanations
(a) As in the official theory of efficient markets, the financial sector is actually earning its keep by allocating capital to the most productive investments, and by spreading and managing risk. I don’t see how anyone can argue this with a straight face in the light of the last 20 years of bubbles and busts.
(b) Tax evasion: the global financial sector allows corporations to greatly reduce their tax liabilities. Most of the savings in tax is captured in the financial sector itself, but the amount flowing to corporations is sufficient to offset the high costs of the modern financial sector, relative to (for example) old-style bank finance and simple corporate structures financed by debt and equity
(c) Volatility: the financialisation of the economy has produced greatly increased volatility (in exchange rates, asset prices and so on). The financial sector amplifies and profits from this volatility, partly through regulatory arbitrage, and partly through entrenched and systematic fraud as in the LIBOR and Forex scandals.
(d) Political capture: The financial sector controls political outcomes in both traditional ways (political donations, highly revolving door jobs for future and former politicians) and through the ideology of market liberalism, which is perfectly designed to support policies supporting the financial sector, while discrediting policies traditionally sought by other parts of the corporate sector, such as protection for manufacturing industry. The shift to private finance for infrastructure, discussed in the previous post is part of this. The construction part of the infrastructure sector (which was always private) has suffered from the reduced flow of projects, but the finance part (previously managed through government bonds) has benefited massively.

The result of all this is that the financial sector benefits from an evolutionary strategy similar to that of an Australian eucalypt forest. Eucalypts are both highly flammable (they generate lots of combustible oil) and highly fire resistant. So eucalypt forests are subject to frequent fires which kill competing species, and allow the eucalypts to extend their range.

{ 157 comments }

1

dsquared 11.29.15 at 1:24 pm

Surely the answer is “risk transfer”. The biggest economic policy decision of the last thirty years has been the decision to de-socialise a lot of previously socially insured risks and transfer them back to the household sector (in their various capacities as workers, homeowners and consumers of healthcare). The financial sector was obviously the conduit for this policy decision. Their role is to provide insurance to the rest of society and this is what they did – in fact, they provided too much of it, with too little capital which is why they went bust, and why their bankruptcy was so disastrous (there’s nothing worse than an insurer bankruptcy, because it hits you with a big loss at exactly the worst time). I think c) above is particularly unconvincing, as the biggest stylised feature of the period of financialisation was the Great Moderation – in fact, the financial sector stored up volatility that would otherwise have been experienced by other people, including the intermediation of some genuinely historically massive imbalances associated with the industrialisation of China, and stored it up until it couldn’t hold any more and exploded.

I also don’t think LIBOR and FX fit into that pattern at all very well either. Financial systems have two kinds of problem, which is why they often have two kinds of regulators. They have prudential problems and conduct problems. Both LIBOR and FX were old-fashioned profiteering and cartel arrangements, which could happen in any industry (hey let’s talk about drug pricing and indeed university tuition some time). In actual fact, as I wrote a while ago, it’s only LIBOR that can really be considered a scandal – FX was very much more a case of customers who wanted the benefits of tight regulation but didn’t want to pay for them, and were lucky enough to find a political moment in which the time was right for an otherwise very unpromising case.

In other words, the answer to all your questions is “leverage”. That’s why financial systems grew so fast, that’s why they’re associated with poor economic performance, and that’s why they tend to show up in periods of secular stagnation – a secular stagnation is almost defined as a period during which people try to maintain their standard of living by borrowing. Of course, if the financial sector had been required to hold enough equity capital in the first place, it would never have grown so big in the first place, and we could all be enjoying the thirteenth year of the post-dot-com bust[1] in relative contentment.

[1] I am never going to shut up about this. The real estate bubble was a policy-created bubble. It was blown up in real time and intentionally, by a Federal Reserve which wanted to cushion the blow of the tech bust. If the financial sector had refused to finance it, the financial sector would have been trying to run a monetary policy directly opposed to that of the central bank.

2

John Quiggin 11.29.15 at 1:55 pm

I agree that risk transfer is a big deal. On the other hand, it’s not obvious that the financial sector did a lot to insure households against most of the additional risk, or that the Great Moderation corresponded to a reduction in the volatility faced by households. On the first point, despite massive financial innovation since 1980, the set of financial instruments easily available to households hasn’t changed all that much. Most obviously, there’s no insurance against bad employment and wage outcomes and home equity insurance hasn’t really happened either.

Is what you’re saying here is that, by extending a lot of credit, the financial sector allowed households to maintain consumption in the face of a permanent decline in income (at least relative to expectation)? That’s an important part of the story, I agree.

The secular stagnation framing of the question leads me to think more about why investment hasn’t responded to monetary policy rather than directly about households.

3

Eggplant 11.29.15 at 2:04 pm

(e) Principle-agent problem.
(f) Implicit government backing allowing the underpricing of risk.

4

dsquared 11.29.15 at 2:32 pm

Yeah, that’s my point – the massive extension of credit to households was the financial sector’s role in the big policy shift. At the end of the day, although we might with the benefit of hindsight agree that “subprime mortgages with no income verification at teaser rates” were a pretty stupid product that should never have been offered, they were a brand new financial product that had never been offered to households before! Even the example you mention – “insurance against bad employment and wage outcomes” – was sort of sold, albeit that what I’m referring to here is Payment Protection Insurance in the UK, which sort of underlines that it wasn’t done well or responsibly.

I guess my argument here is that it’s the combination of deregulation and stagnation that was necessary to create the 2000s policy disaster. But if we hadn’t had the bad products we got, we’d have had something else go wrong, probably outside the regulated sector. Because the high debt levels were a policy goal (or at least, were the inevitable and forseeable consequence of trying to do demand management without fiscal policy), and as I keep saying in different contexts, you can’t get to a stupid debt ratio by only doing sensible things.

The secular stagnation framing of the question leads me to think more about why investment hasn’t responded to monetary policy rather than directly about households.

Isn’t the answer to this just the definition of a Keynesian recession? Investment hasn’t responded to monetary policy because there’s no interest rate at which it makes sense to produce goods that can’t be sold.

5

DrDick 11.29.15 at 2:32 pm

Capital generally, and the FIRE sector in particular, are parasitic on the economy. They provide some minimal benefits if kept strongly in check, but quickly become destructive if allowed to grow unchecked, as they have now.

6

Eggplant 11.29.15 at 2:37 pm

(g) Rising inequality leading to an ever increasing savings glut, providing the financial industry with a target-rich environment.

7

yastreblyansky 11.29.15 at 3:22 pm

Dumb outsider thought, turning Eggplant @6 upside down: What about r > g? Perhaps financialization isn’t so much a thing-in-itself as the mechanism through which wealth concentrates in periods of slow growth?

8

T 11.29.15 at 3:31 pm

“But if we hadn’t had the bad products we got, we’d have had something else go wrong, probably outside the regulated sector.”

A more sophisticated version of the widely debunked theory that Fannie and Freddie blew up the housing sector by giving loans to poor people. Rule 1: It’s never ever the bankers’ fault. Rule 2: see Rule 1. At least d-squared has been consistent…

Or maybe there has been a systematic continuous effort to use political influence to garner rents by gutting both the regulatory and judicial constraints on their behavior. http://www.nytimes.com/2015/11/30/us/politics/illinois-campaign-money-bruce-rauner.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=first-column-region&region=top-news&WT.nav=top-news

9

yastreblyansky 11.29.15 at 3:35 pm

Or rather through which rent-claimers concentrate wealth (@t) bringing long-term low growth.

10

bjk 11.29.15 at 3:43 pm

Which direction is financialization heading? It looks to be decreasing. The mutual fund industry is in terminal decline, losing market share to ETFs. There are fewer financial advisors today than in 2008, yet the number of millionaires has increased. Stock trading has broken a 40 year trend of increasing volumes. Electronic and exchange trading of bonds and derivatives is increasing, driving down margins. Bots have driven human traders out of jobs (Dark Pools has a good account of this). Banks are earnings low single digit returns in their trading divisions, which suggests they will be shut down if things don’t improve. It looks like finance is doing a good job of shrinking itself, with a little help from Elizabeth Warren.

11

dsquared 11.29.15 at 3:43 pm

A more sophisticated version of the widely debunked theory

when you find yourself writing something like this, it’s often a good opportunity to check yourself and ask “do I really understand what I’m going on about? Might I be on the verge of writing something daft?”. I mean basically no it isn’t, it’s got nothing to do with that theory.

12

yastreblyansky 11.29.15 at 3:52 pm

bjk @10 is that decreasing the proportion of the economy devoted to finance, or merely decreasing the number of people that profit from it? Especially the automation of trading doesn’t mean the sector as a whole is getting smaller, just that it benefits fewer humans.

13

T 11.29.15 at 4:03 pm

@11 Guess you missed the point. Of course it has nothing to do with your theory. But everything to do with your conclusion — it’s never the bankers’ fault. (However, you shouldn’t be surprised that the Fannie crowd might read your fn. 1 and think they found a friend.)

There are 150+ families responsible for funding half the Republican party. They’re primarily from 3 sectors — finance, pharma and energy. Notice a pattern?

14

Anarcissie 11.29.15 at 4:12 pm

bjk 11.29.15 at 3:43 pm @ 10 —
How long has that been going on? I have been watching for the beginning of the Collapse, but I am not sure at what point on the horizon the cloud no bigger than a man’s hand will appear.

T 11.29.15 at 3:31 pm @ 8: ‘… Or maybe there has been a systematic continuous effort to use political influence to garner rents by gutting both the regulatory and judicial constraints on their behavior.’ And garnering these rents would lead to greater political power in both the governmental and corporate worlds, leading to an increased power to garner rents. Financialization, like war, may be globally inefficient, but it does some people good. Or what they see as good.

15

Lee A. Arnold 11.29.15 at 4:28 pm

But long term rates have fallen too. Do you think that a central bank can affect long-term rates? It goes against pretty much everything in economics, doesn’t it? (not that this is a resounding indicator, these days)

16

T 11.29.15 at 4:50 pm

There were several issues and arguments posed in the OP. I’m addressing this:

“First, if the financial sector is unproductive, how can it be so large and profitable in a market economy?
There are a few possible explanations
(a) As in the official theory of efficient markets, the financial sector is actually earning its keep by allocating capital to the most productive investments, and by spreading and managing risk. I don’t see how anyone can argue this with a straight face in the light of the last 20 years of bubbles and busts.”

D-squared response is of course it’s the risk transfer. That flat out contradicts JQ, but d-squared is a master of the straight face. And then he proceeds — “there has been a decision to desocilaize”; “the financial sector was obviously the conduit for this policy decision”; and “the real estate bubble was a policy-created bubble.”

So JQ, here’s your answer of FIRE’s ascendancy from an insider: You know me and my friends were standing around just doing nothin’ and then these policy guys come around. Next thing ya know, we’ve doubled our share of GDP and put our bosses in the top 0.01%. Who woulda known? Crazy shit, huh? Hey and if anyone asks, tell ‘um “risk transfer.” And if they press, tell ‘um “secular stagnation.” In fact, tell ‘um frickin’ anything. It just wasn’t our fault.

17

Rakesh Bhandari 11.29.15 at 4:51 pm

I know that I shall have to read John Kay’s Other People’s Money at some point.
I am wondering what people make of the old the then Marxist Hilferding’s concept of promoters’ profit as a way to understand some financial sector activity. I posted this here a few years back.

Here’s his example, and I am trying to figure out to the extent that it throws light on the recent activity of Wall Street.

Start with an industrial firm with a capital of 1,000,000 marks that makes a profit of 150,000 marks with the average profit of 15 percent.

With an interest rate of 5% straight capitalization of income of 150,000 marks will have an estimated price of 3,000,000 marks (150,000/.05=3,000,000 marks)

A deduction of 20,000 marks for the various administration costs and directors fees would make the actual payment to shareholders 130,000 rather 150,000 marks

A risk premium of, say, 2% would be added to a fixed safe rate of interest of 5% in estimating the actual stock price

So what, then, is the stock price (130,000/.07)? 1,857,143 or roughly 1,900.000 marks

This 900,000 is free after deducting the initial investment of 1,000,000 marks

The balance of 900, 000 marks appears as promoters’ profit which arises from the conversion of profit-bearing capital into interest bearing capital.

In 1910, Hilferding called this promoters profit, an economic category sui generis; it is earned by the promoter by selling of stocks or the securitizing of income on the capital market.

For Hilferding the investment bank, which promotes the conversion of profit-bearing to interest-bearing capital, claims the promoters profit.

The analysis seems pertinent to the securitization process today, and I would love to hear Henwood’s and others’ thoughts about this.

As Roubini and Mihm have pointed out, we have seen the securitization of mortgages, consumer loans, student loans, auto loans, airplane leases, revenues from forests and mines, delinquent tax liens, radio tower loans, boat loans, state revenues, the royalties of rock bands!

We have seen, in their words, an explosion in the selling of future income of dependable projected revenue streams such as rents or interest payments on mortgage payments as securities.

That securitization been driven by investors’ quest for yield lift given the low rate of interest, itself the result of the global savings glut and Fed policy.

And it seems that Wall Street, with the connivance of the credit agencies, was able to appropriate value from the purchasers of securities by understating the risk premia.

The risk premium and promoters’ profit are inversely correlated so there is a strong incentive to understate the former. This is what Hilferding did not say, but seems worth emphasizing today.

18

Aaron Brown 11.29.15 at 5:43 pm

I sincerely do not understand your point here. I’m not arguing, just asking for clarification:

(a) As in the official theory of efficient markets, the financial sector is actually earning its keep by allocating capital to the most productive investments, and by spreading and managing risk. I don’t see how anyone can argue this with a straight face in the light of the last 20 years of bubbles and busts.

For one thing, I don’t see that the two bubbles and one bust of 1996 – 2015 are self-evidently worse than the more numerous bubbles and busts of 1976 – 1995. You might say the 2008 brush with Great Depression outweighs the hyperinflation and multiple deep recessions of the earlier era, but certainly the Internet and housing bubbles were more productive and less threatening than the commodity, Japan, emerging debt and other bubbles. Anyway, it’s a close enough comparison that someone could certainly keep a straight face while saying that in the last 20 years financial volatility inflicted less real economic damage than in the preceding 20 years.

But the bigger issue is no one claims the financial system encourages steady growth. Creative (bubble) destruction (bust) is the rule. It is command economies that outlaw bubbles and busts–and inflation and unemployment–at the cost of unproductive employment, empty shelves, stifled innovation, loss of freedom and other consequences.

If you want to argue that the financial system did not earn its profits in the last 20 years, it seems to me you have to argue that economic growth was slow, or that more people in the world are in poverty today, or that there was not enough innovation; not that the ride was too volatile. Did Cuba, Venezuela, Argentina and North Korea do better than the financialized economies of the world? Did the hand of the State in Russia, China and other countries secure better outcomes than the global financial sector in countries that allowed it to operate (albeit with heavy regulation)?

It is certainly possible to argue that we could have had more growth and innovation and poverty reduction; and less volatility; with some third way that’s better than both our current financial system and the alternatives practiced in the world today. But that point is not so obvious that any defender of the global financial system must be joking.

Why do you think the booms and busts of the last 20 years are such a clear and damning indictment of the financial system that the point needs no further elaboration?

19

Bruce Wilder 11.29.15 at 6:11 pm

The financial system can engage in usury, lending money with no connection to productive investment, by simply creating a parasitic claim on income. There are straightforward ways of doing this: credit cards with high rates of interest or payday lending. There are slightly more complicated approaches: insurance that by design doesn’t pay off for the nominal beneficiary.

There are really complicated ways of doing this: derivatives, for example, which blow up (and as an added bonus, undermine the informational efficiency of financial markets).

I keep thinking of Piketty’s r > g: the ever-accumulating pile of money rising like a slow, but unstoppable tide. It has to be invested or “invested” — that is, it can buy the assembly of resources into productive capital assets that represent financial claims on the additional income generated by business innovation and expansion . . . OR . . . it can be used to finance the parasitic and predatory manipulations of an emergent neo-feudalism.

Where the secular stagnation thesis is not pure apologetic fraud, I would interpret it as saying, there are currently few opportunities to invest in additional productive “real” capital stock. For technological reasons, the new systems require much less capital than the old systems, so when an old telephone company replaces its expensive copper wire with fiber optics and cellphone towers, it may be able to fund a large part of the transition out of current cash-flow, even while maintaining the value of the bonds that once represented investment in a mountain of copper, but are now just rentier claims on an obsolete world.

In the brave new world, a handful of companies, who have lucked into commercial positions with high rents, throw off a lot of cash. So, the Apples and Intels do not need to be allocated new capital, but their distribution of cash to people who don’t need it, is generating a lot of demand for “financial product”. The rest of the business world is just trying to manage a slow decline, able to throw off modest amounts of cash, desperate to find sources of political power that might yield reliable rents, but without opportunities to innovate that would actually require net investment in excess of current cashflows from operations.

So, the financial system is just responding to this enlarged demand for non-productive investment in financial products that generate return from parasitic extraction.

In the interest of parasitic extraction, the financial system pursues the politics of neoliberal privatization as a means of generating financial products to satisfy demand.

Does that sound like a plausible narrative?

20

Dipper 11.29.15 at 6:30 pm

re volatility, the thing you really want to worry about is liquidity. Pre-crash banks could warehouse risk and so provide liquidity. One consequence was volatility was recorded because liquid markets allowed prices to be observed.

Regulators have observed the conflict of interest caused by banks providing a financial service but also participating in the markets with their own money, and have acted to restrict banks from holding risk for proprietary trading (the Volcker rule). This is fine, but there has been a noticeable decrease in liquidity in what were once deep markets. The EURCHF un-pegging in Jan this year is a good example of reduced liquidity resulting in a massive move. There may well be more of this to come.

21

Sebastian H 11.29.15 at 6:34 pm

“The biggest economic policy decision of the last thirty years has been the decision to de-socialise a lot of previously socially insured risks and transfer them back to the household sector (in their various capacities as workers, homeowners and consumers of healthcare). The financial sector was obviously the conduit for this policy decision.”

I can’t tell if you are arguing with John or agreeing with him. Is this agreement with his d) [the political capture explanation]? I don’t know very much about the deep history of financial regulation, but I’m fairly certain that most voters have never put desocialization of risk in their top 5 concerns. Is it possible that the financial sector was the obvious conduit because they were among the important authors of the ideas?

22

MisterMr 11.29.15 at 6:50 pm

Previously commented here as Random Lurker.

In my opinion, finance had a passive role in the build up of the crisis.
Others have said similar things uptread, however this is my opinion:

1) the wage share of GDP depends largely on political choices; since the late seventies there has been a trend of a falling wage share more or less everywhere, as countries with a lower wage share are more competitive on the world market.
2) a falling wage share means a rising profit share, and “capitalists” tend to reinvest part of their profits, so a falling wage share caused a worldwide saving glut.
3) this worldwide saving glut caused an increased financialisation and a bubbling up of the price of some assets, particularly those assets whose supply is inelastic (for example, the value of distribution chains or of famous consumer brands).
4) this in turn causes an increased volatility of financial markets, and worse financial crises.

This situation is what we perceive as a secular stagnation, and IMHO depends mostly on a low worldwide wage share.
Unfortunately, I have no idea of how to reach an higher wage share, and I don’t think “the market” has any mechanism to push up said wage share.

23

Rakesh Bhandari 11.29.15 at 7:08 pm

Bruce,
What you are saying makes sense to me. Steven Pressman has also raised the question of how r is to be maintained with “an abundance of capital and its need for high rates of return.” (Understanding Piketty’s Capital in the Twenty First Century).
It’s almost as if Piketty in his criticism of the rentier has a rentier’s disregard for how the returns are actually to be made. To the extent that he considers production it is through marginal productivity theory. Piketty claims that marginal rate of substitution of capital for labor will remain above unity (and too bad Piketty dismissed the Cambridge Capital critique because Ian Steedman has used Sraffian theory to show the possibilities of high profits in even a fully automated economy).
Of course as Pressman implies, this “technical” view may blind us to the higher exploitation that may be necessary for returns to continue to remain high as capital becomes more abundant. Pressman also implies that Piketty also does not consider how finance can make higher rates of return by making higher-interest loans to weaker parties while having them absorb most of the risk (this would be your second kind of investment).
Search for the several paragraphs on the rentier in this section. It is remarkable that no one has yet compared Piketty’s criticism of the rentier to this.
https://www.marxists.org/archive/bukharin/works/1927/leisure-economics/introduction.htm

24

felwith 11.29.15 at 8:31 pm

” I don’t know very much about the deep history of financial regulation, but I’m fairly certain that most voters have never put desocialization of risk in their top 5 concerns.”

Of course not, but there are actors here other than “the public” and “the banks”. In this case, I’m pretty sure Daniel is referring to the destruction of unionized middle class jobs with pensions and cheap-to-the-worker health insurance, which was carried out by their employers. While I doubt I could pick a bank owner out of a lineup filled out with captains of industry, they aren’t actually interchangeable.

25

Peter K. 11.29.15 at 9:43 pm

@1 Dsquared:

“Of course, if the financial sector had been required to hold enough equity capital in the first place, it would never have grown so big in the first place, and we could all be enjoying the thirteenth year of the post-dot-com bust[1] in relative contentment.”

Secular stagnation to me just means not enough macro (monetary/fiscal) policy to keep up aggregate demand for full employment and target inflation.

Monetary and fiscal policy is being blocked by politics partly because filthy rich financiers are buying their way into politics:

http://www.nytimes.com/2015/11/30/us/politics/illinois-campaign-money-bruce-rauner.html

The question about Dsquare’s alternate history I would have is: what is the response of fiscal and monetary policy to the “domestication” of the financial sector via higher capital requirements and leverage regulations, etc.?

If fiscal and monetary policy keeps the economy at a high-pressure level with full employment and rising wages, I don’t see why secular stagnation is a problem.

But politics is blocking fiscal and monetary policy. Professor Quiggin talks of “massive” monetary policy, but it wasn’t massive given the need. (It was massive compared to past recoveries.) It was big enough to avoid deflation despite unprecedented fiscal austerity. It wasn’t big enough to hit their inflation target in a timely matter.

26

Eggplant 11.29.15 at 9:46 pm

Monetary policy can never fail, it can only be failed.

27

Ze K 11.29.15 at 9:53 pm

My feeling (based on nothing but intuition) is that the answer is (d). The government is a tool of moneyed interests. I know, it sounds awfully libertarian, but it is what it is. And I can’t foresee any non-catastrophic end to it.

28

Peter Dorman 11.29.15 at 10:22 pm

My view is rather different from the others I’ve read here. It begins with the observation that the financial sector is fundamentally different from all the others, in that it overlaps with them. Finance is always about other people’s money, through equity, deposit, credit and securitization channels. It’s not like finance is over here and households and other business sectors are over there.

Moreover, financialization is not just about the increasing size of financial institutions. Nonfinancial firms have also become financialized as they organize and manage themselves as essentially financial entities (read Managed by the Markets by Davis for a nice summary), even to the point that cash and near-cash play an important role in their investment portfolios. Meanwhile, people who work in finance are being paid in part for their role in managing an increasing share of the affairs of formally external nonfinancial entities.

I really think the statistics, with their well-defined boundaries between finance and the rest of the economy, obscure more than reveal.

29

T 11.29.15 at 10:41 pm

Anarcissie @14 –

Point well taken. When d-squared talks about the Keynesian recession (liquidity trap and the need for expansionary fiscal policy) it’s as if the austerity policies were independent of the financial sector; the financial deregulation of the 90s was independent of the financial sector; the massive push for free flow goods and capital were independent of the financial sector and on and on. Now of course it’s all about secular stagnation (with Larry Summers at the point) and the mysterious productivity decline. So the new villains are the (de)regulators and the spooky decline in productivity. It should come as no surprise that the reasons why finance gets rich and everyone else gets poor are always ex post and typically put forward by the miscreants.

This type of reasoning reminds me of the education/technology explanation for the stagnation in US wages and the explicit dismissal of the trade effects. Ex post, of course, Autor and the gang are finding large effects from the increase in Chinese imports both on US wages and the import-competing communities (like it was some huge surprise that US wages continued to stagnate after hundreds of millions of workers were added to the world labor force many manufacturing goods for export.)

At what point do you acknowledge that policy is endogenous and that the winners of the rent-seeking pigfest might have had a hand in setting the policies? How long did the Gilded Age last?

So yeah JQ, in the short run, per d-squared, the lack of private investment from the massive increase in the money supply is likely much more of a liquidity-trap issue brought about by insufficient demand rather than the financial sector crowding out other real investment. But in general rent seeking behavior including in the financial sector seems to be affecting the real economy bigtime. In the US, we have the lowest rate of new business startups, increased concentration in key industries due to lack of anti-trust enforcement, huge rent-seeking in the IP space (with a push to expand this world-wide through new trade agreements), and finance pushing back hard on the regulatory regime. I go with reason 4 from the OP.

30

John Quiggin 11.29.15 at 10:52 pm

Did the hand of the State in Russia, China and other countries secure better outcomes than the global financial sector in countries that allowed it to operate (albeit with heavy regulation)?

Certainly, outcomes in China have been much better than in most other places. Indeed, I’m used to seeing China quoted in the opposite way, as a counterweight to the poor economic outcomes of most households in developed countries in the era of financialisation. In response, I routinely make the point that China has far more intervention than the developed countries have now and at least as much as they during the Bretton Woods era.

Coming to your main point, I’d shift the dates back a bit, but I’d still agree that the performance of the economy under financialisation (roughly mid-80s to now) is pretty comparable to that of the period from the collapse of Bretton Woods (1971-3) to the emergence of financialisation. But that is setting the bar very low. You’re comparing the entire experience of one system with the crisis and collapse of the one it replaced. What about the previous thirty years of growth and widely shared prosperity?

31

John Quiggin 11.29.15 at 10:53 pm

Peter Dorman @28 I wanted to make a similar point, but it got lost in writing the post.

32

Marshall Peace 11.29.15 at 11:33 pm

It seems to this amateur that capture would apply in the other direction, towards the means of production, including everything that actually does productive work, ie supervisory management and labor, all of which are regarded as fodder for profits. Easy to see a successful evolutionary strategy at work, yes. Compete or die.

Besides return on investment, short-term profits are also available by liquidating capital; which, I would argue, is what is happening to the labor segment. And therefore new plant and infrastructure investment isn’t attractive.

33

Sebastian H 11.30.15 at 12:33 am

Maybe secular stagnation is an incentive story: if finance has set itself up to capture nearly all the rewards the other sectors no longer have the proper incentives to innovate.

34

ZM 11.30.15 at 12:35 am

John Quiggin: “Is what you’re saying here is that, by extending a lot of credit, the financial sector allowed households to maintain consumption in the face of a permanent decline in income (at least relative to expectation)? That’s an important part of the story, I agree.”

dsquared: “Yeah, that’s my point – the massive extension of credit to households was the financial sector’s role in the big policy shift.”

It seems like the extension of credit really created a “lag” where stabilisation or declines in income were cushioned so consumption — which is an economic driver so more valued — did not evince a similar stabilisation or decline. That would not be a sustainable trend in the long term though.

I don’t think that stabilisation and decline of consumption in advanced economies is a bad thing really, it should be encouraged since at a physical level the consumption is too high.

Obviously then you have sort of a problem where the physical solution is at odds with the (social) structural solution — as economics generally is not in favour of an economic structure with decreasing physical consumption, and where economists have suggested this (eg. de-growth etc) it remains on the periphery of the profession and also there is not any evidence about how this could work in practice, and in practice what we have seen is that in the post-war era strategy of growth has been used to level out income inequality.

So while decreasing incomes and consumption are a good thing for advanced economies, if this trend continued until consumption was sustainable, there would need to be other policies to counter increases in income inequality that result from no growth or de-growth.

But just because growth in incomes and consumption has in the past been used as a policy goal and lever for a range of different ends and means (wellbeing, equality, national presence, etc), that doesn’t mean you can’t use other levers and recognise the positives of lowering consumption.

The role of finance would necessarily change as well in this sort of economic transition, and to a small extent I think this is already becoming visible in that there is more of a role of partnering with the community as well as finance to deliver projects.

I think this is still small scale — but for instance there is the role of participatory-public-private-partnerships in the pacification of the favelas, or councils partnering with community groups to maintain things like pools and parks or urban greening.

35

SamChevre 11.30.15 at 2:18 am

Thinking about the de-socialisation of risk I know best (the near-disappearance of private pensions), I tend to agree with dsquared (as usual).

Pre-ERISA (1974), there was no Pension Benefit Guarantee Corporation, and no requirement that pension obligations be funded. This worked sort-of OK, in a world with large stable businesses that stayed in business–but it was risky to everyone, as if your employer went out of business (and that happened more as the 60’s went on), you lost your pension with no recourse.

The PBGC and ERISA funding rules were the response. But that led to a huge need for finance, as all the obligations that previously were backed with future earnings from a particular business now needed to be backed with market securities.

After the dust settled (30 years in), private pensions had almost disappeared, in favor of 401(k)’s and the like.

I think the absolute key thing to remember, about modern finance, is that the dominant class of beneficiaries is current or future pensioners. Running pension obligations beyond the government benefit (US Social Security) through the financial markets is one choice–it would be possible to run them through private non-financial property or through family obligations or through employer-specific obligations. All those choices have downsides.

(The story of mortgages moving from owned by a local bank, which is bankrupt if the local mill goes out of business, to securitized mortgages, is a similar story.)

36

Peter K. 11.30.15 at 2:31 am

@ 26

“Monetary policy can never fail, it can only be failed.”

If it’s failed then why are they raising rates next month?

37

T 11.30.15 at 2:32 am

dsquared @1 was linked by Tyler Cowen at MR. Cowen didn’t even bother linking to the OP, just directly to @1. Enough said.

38

mpowell 11.30.15 at 2:54 am

SamChevre @35: Were people really losing their pensions in the 60s due to companies going out of business? That’s seems like it would really cast the allegedly golden 50s and 60s in a different light, with un-insured pensions basically lurking as an unaccounted for cost in the economy.

I’ve long thought that maybe SS coverage should increase, but for anybody earning over the 0.1$ owed / 1$ payed line (which is probably half of contributors), the only way this would offer them value is to effectively make the system look less progressive. As a result, nobody is interested in expanding the system this way and if you want more retirement income, it’s 401(k) or nothing.

39

Bernard Yomtov 11.30.15 at 3:48 am

Mpowell,

Yes. lots of people lost pensions for various reasons, including employer bankruptcy. Some of the other reasons were job changes prior to meeting vesting requirements, mergers that altered pension commitments, and probably some others.

Indeed, problems with company-run DB plans contributed to the rise of IRA’s and the like. Remember that the next time you hear someone wax nostalgic for the good old days of widespread DB plans.

40

JJ 11.30.15 at 3:58 am

“What about the previous thirty years of growth and widely shared prosperity?”

Wasn’t that period largely a period of catchup back to long-term trend GDP growth which had been severely interrupted by the great depression and WW2? When you’ve just had a near-global war of that destructive scale there’s a lot of low-hanging fruit to pick until you return back to trend. I don’t think that sui generis period of history should be something that policy makers believe we can return to in a realistic way.

41

JimV 11.30.15 at 5:43 am

I don’t know about the 1950’s, but I was working at the end of the 1960’s, and it seems to me that the reason a lot of people had DB pensions then was that large companies employed a large percentage of the population and most of those employees had strong unions (and the white-collar workers like myself were given all the benefits of the union contracts to keep us from forming unions). Old technologies died out, new technologies “outsourced” (Orwell should have written a book about the language of company managers), the unions faded away, and DB pension plans went with them.

GE went through several mergers and divestitures in the 35 years I was there, but I don’t recall anyone losing a pension benefit without some sort of compensation which was acceptable to the unions. The unions could and did shut down a plant for months over contract disputes.

42

Eggplant 11.30.15 at 5:50 am

36: That was a response to 25 and quantitative easing. I do believe the Fed can constrain certain financial strategies by raising their overnight rates, though I’m not certain of the exact mechanics and its effect on the economy. Why do you ask?

43

Sebastian H 11.30.15 at 6:16 am

“but I was working at the end of the 1960’s, and it seems to me that the reason a lot of people had DB pensions then was that large companies employed a large percentage of the population and most of those employees had strong unions (and the white-collar workers like myself were given all the benefits of the union contracts to keep us from forming unions).”

That was never true in the US. Even at the height of unionization in the US it never was more than about 1/3 of the workers. And that was when women were mostly not in the workforce. Even in Michigan it was never as high as 50%.

44

dsquared 11.30.15 at 8:21 am

I can’t tell if you are arguing with John or agreeing with him. Is this agreement with his d) [the political capture explanation]?

Well, it is and it isn’t. I think we’re in violent agreement about what actually happened, but my view would be that it’s a real misreading of history to tell a story about the financial sector having all the class consciousness and political agency and everyone else being bent to their whims.

Margaret Thatcher wasn’t a banker. Nor was Ronald Reagan. The Clinton White House did have a lot of people in it who had come through the financial sector revolving door, but it also had Brad DeLong, and it really wasn’t because of bankers that NAFTA got passed. In general, the debt bubble had two component causes – a) stagnant real wages and b) borrowing to maintain consumption. My argument would be that a) was a general policy goal of more or less the whole political system, including a lot of nominally social-democratic parties, and b) is just the logical consequence of a) in a world in which fiscal policy isn’t used and the balanced budget multiplier isn’t a tool of policy – the demonisation of state spending and taxation also having been a consensus policy during the period.

So it was a consequence of the ideology of the times – if you have policies of reduced government investment, combined with low real wage growth, then you have, de facto, a policy either of falling living standards or one of increasing debt levels and therefore a growing financial sector. But it’s a real stretch (albeit one that some people on this thread, in my opinion unconvincingly, are prepared to make) to claim that the whole growth of “neoliberalism”, “economic rationalism”, “Thatcherism” and all the other names for this policy mix, was foisted on the population even by the industrial sector as a whole, let alone by a particular industry with in it. This revolution was brought to you by ideologues and economists.

45

dsquared 11.30.15 at 8:24 am

(and further to 43, these policies won elections. If the median of public opinion wanted to have a set of policies which didn’t result in financial sector growth, they could have voted for Michael Foot or Walter Mondale. After about 1990 I agree it became more difficult to find candidates who didn’t support this consensus, but that’s because it was a consensus. Again, you can tell stories about Clinton and Blair being corrupted by finance capital but IMO it’s a lot more plausible to believe what they themselves kept saying – that they were tired of losing elections and were compromising with public opinion on this low wage, low tax, high debt policy mix in order to get some of their other agenda through.)

46

HoosierPoli 11.30.15 at 8:51 am

I side with Eggplant here. Supply-side orthodoxy has led us to create massive amounts of savings in the hands of just a few people, who invest almost all of their income and consume surprisingly little. You have too much investment chasing too little consumption, which is great for the financial sector because they can keep collecting their management fees, but it also compulsively blows up bubbles that then collapse.

The way to kill the financial sector is to kill its customers: wealth taxes, high progressive income taxes on all sources of income, etc. Get the money out of the hands of the idle investor class and give it to the people who will spend it on things that people actually need, and you’ll find the market providing things that are actually useful instead of building and burning paper castles over and over.

47

James Wimberley 11.30.15 at 9:13 am

I’d like to see some thinking on the extraordinary bloat of the financial sector compared to the non-financial (“real”) economy”, documented in the Vickers report. Banks lend to other banks and non-bank financial entities, several times more than they lend to real firms. This certainly helps explain the ineffectiveness of monetary policy: the monetary expansion is trapped in the financial circuit. I’m not sure how it shifts relative returns.

48

PaulB 11.30.15 at 9:36 am

(e) the financial sector increases the velocity of circulation of money, particularly through securitization. (You might see this as simply increasing the money supply, depending on your definition of money.)

This isn’t exactly a useful thing to be doing – if the demand for money exists, governments can achieve the same effect just by issuing the stuff. But politics.

49

reason 11.30.15 at 9:40 am

dsquared @1
I mostly agree with this. All that is missing is a discussion of the US trade deficit as the heart of the problem. The Fed wasn’t being unaccountably irresponsible, it was following it’s mandate. Because a large persistent trade deficit is a drain of wealth (and spending power) out of the country.

50

reason 11.30.15 at 9:52 am

Hoosier Poli @45
I don’t think this is entirely wrong – but it is not obvious that taxing the rich achieves the object of “give it to the people who will spend it”. You need to spell out exactly how you intend to do this.

51

Z 11.30.15 at 11:29 am

it’s a real misreading of history to tell a story about the financial sector having all the class consciousness and political agency and everyone else being bent to their whims.

I think this is an important point, and one that has prima facie high plausibility as the growth and change in the nature of the financial system have been very different among different western advanced economies (pointing to a possible insufficiency of the “economy only” explanation, as well as the clear insufficiency of a US/UK only discussion).

If I had to suggest the ultimate causal change, I would look for the the sudden halt (and in fact sharp reversal) of the main tendency in educationally change of the past three centuries. During this period, the rise of first mass literacy then universal primary and secondary education have had powerful equalitarian consequences. Starting in the 1970s, a substantial minority of the population reached higher education and the productivity attached to it whereas the rest stagnated, creating a large and powerful (but still minority) class which stood to benefit from (and thus was willing to implement) much more unequal social arrangements, in particular the low-wages policies and reduced public spending for the rest that came to characterize the 1980/2015 period.

The parasitic growth of the financial system seems to me to be (merely?) a disastrous epiphenomenon.

52

Layman 11.30.15 at 12:22 pm

Pity the poor banksters, forced to become fabulously rich at the expense of everyone else, by policy changes with which they had nothing to do! Forced, perhaps at gunpoint, to merge investment banking with consumer banking when, though a series of wild, random events, Glass-Steagall was repealed. Victims of their own employees, who for reasons impossible to imagine, felt compelled, or perhaps incentivized (by what? The Fates? The Furies?) to package shitty mortgages – mortgages they were forced to buy! – into shittier securities in order to transfer them, at a profit, to the unsuspecting public. What could the poor banksters have done? They were screwed from the start. All they really wanted, really, was to give their money to the poor. Why won’t someone let them?

53

Zamfir 11.30.15 at 12:23 pm

@dsquared, I would expect a responsible financial sector to oppose that consensus, not to benefit from it. Saying, no, we can’t extend credit under these terms. Instead of finding elaborate ways to hide the risk and do it anyway.

As an analogy: suppose there’s a widely supported public demand for lots of bridges without much budget. Then I expect engineers to say, safe bridges cost much more than that, we can’t do it. Not to repackage unsafe bridges as revolutionary new bridges based on opaque math and stuff, charge a lot of money for that revolution, then retire comfortably when the bridges eventually collapse.

They are the experts, after all.

54

dsquared 11.30.15 at 1:04 pm

I would expect a responsible financial sector to oppose that consensus, not to benefit from it. Saying, no, we can’t extend credit under these terms.

This is certainly a plausible criticism to make, but think about what you’re saying here. The official policy of the central banks which were given the task of demand management by the deomcratically elected government, was to expand credit. This superficially plausible critique would have the implication that the banking sector should systematically second-guess the authorities, and work to undermine an expansionary public policy, creating a recession in the process.

What would that kind of a world look like? Well, it would look like Europe between 2008 and the present day. That’s exactly what the banks have been doing – they’ve been saying “no, we feel like it wouldn’t be prudent, we need to build up capital levels and resolve bad debts before we are comfortable with extending credit”. And the ECB has been left trying to adopt increasingly desperate policy measures to get its desired monetary policy implemented. It seems to me that the US system, in which banks are responsible for managing their own idiosyncratic credit risks and the Federal Reserve is responsible for managing the business cycle as a whole, works better.

55

dsquared 11.30.15 at 1:07 pm

by the way, I was never really in the market for “engineers would be sooo much more ethical” rhetoric even in the old days – there are any number of horrible residential developments put up cheap, after all. But post Volkswagen – a fraud which actually killed thousands of people by the way – I’m not in the market for it at all.

56

Layman 11.30.15 at 1:34 pm

dsquared @ 54: “The official policy of the central banks which were given the task of demand management by the deomcratically elected government, was to expand credit.”

The banksters, of course, had nothing to do with this policy, nor with the election of that government; to say nothing of the laws passed by that government. It was a cosmic accident. What else could they do but go along?

57

T 11.30.15 at 1:48 pm

@44 and @45
” Again, you can tell stories about Clinton and Blair being corrupted by finance capital but IMO it’s a lot more plausible to believe what they themselves kept saying – that they were tired of losing elections and were compromising with public opinion on this low wage, low tax, high debt policy mix in order to get some of their other agenda through.)” — dsquared

Huh? The first thing Clinton did was raise taxes in the 1993. The deficit shrank. It was a period of rising real wages.

” The Clinton White House did have a lot of people in it who had come through the financial sector revolving door, but it also had Brad DeLong,” — dquared

Do you really think this? Brad DeLong? Could you have found a person with less power and influence? A deputy assistant secretary at Treasury? Five levels down from the Secretary? Try the bosses — Bob Rubin and Roger Altman. And Greenspan and Summers.

I wrote this above a bit tongue in check but after @44 and @45 it seems that it’s dsquared position: “So JQ, here’s your answer of FIRE’s ascendancy from an insider: You know me and my friends were standing around just doing nothin’ and then these policy guys come around. Next thing ya know, we’ve doubled our share of GDP and put our bosses in the top 0.01%. Who woulda known? Crazy shit, huh? Hey and if anyone asks, tell ‘um “risk transfer.” And if they press, tell ‘um “secular stagnation.” In fact, tell ‘um frickin’ anything. It just wasn’t our fault.”

Maybe “policy guys” needs to be replaced with “ideologues and economists per @44.

58

John Quiggin 11.30.15 at 2:02 pm

Whatever terms you want to use, Blair and Clinton were closer to the financial sector than to the business class in general. Blair went on to an apparent sinecure with JP Morgan, and this path has been followed by lots of former politicians in Australia (notably former PM Keating and NSW Premier Greiner). Currently, the PMs in Australia and New Zealand, as well as the Premier of New South Wales, are all former investment bankers.

I don’t want to rest the case primarily on personal links like this (other avenues of influence are probably more important) but they do illustrate the outsized influence of the financial sector.

59

SamChevre 11.30.15 at 2:02 pm

mpowell @ 38

People definitely lost pensions. Probably the largest single failure, and the one that got the issue into national prominence, was the Studebaker bankruptcy.

60

Trader Joe 11.30.15 at 2:03 pm

I hope this ‘all powerful financial’ sector holds up at least through bonus season…. contrary to most of the comments above, I think the financial sector has been in significant decline for the better part of 10 years and maybe as long as 15. Glass-Steagall, as someone noted above, created a huge opening that the financial sector filled with lots of products both good and bad. Since that moment however, its been a bull market for re-regulation.

Perhaps its fair to observe that where there is regulation, there is decline.

Dodd-Frank was the greatest legislation ever passed if you want JP Morgan, Citi and B of A to eventually crush or consume the thousands of smaller community banks that can’t afford the compliance costs. Proponents saw it as “reigning in” the banks, those who actually understood it saw it as ‘destroying their competition.’ Step 1 is revise (not repeal) D-F.

The financial industry is not by any means unproductive. It is actually incredibly efficient at doing one thing – toll taking. As economies grow, their tolls rise and the number of financial bridges on which it can erect toll booths increases. It has always been and remains a truism now and corresponds with the point above (BW I think) that as more wealth is generated from financial products, there is a need for more financial products to generate wealth is spot on.

61

mdc 11.30.15 at 2:21 pm

re: pensions-

I think new, legally mandated accounting standards required employers to calculate and carry the liability of a defined benefit plan. In some cases, this meant that small year-to-year costs were suddenly eclipsed by an astronomically high accounting fiction (the total cost of the benefit for all eligible employees in perpetuity). It became imperative to “fund” the latter (to avoid the horror of an “unfunded mandate”), which is virtually impossible.

62

dsquared 11.30.15 at 2:22 pm

I am not sure I really agree – if you look at someone like Blair, Cameron or indeed Turnbull, then their actual career has been “lifelong political influence peddler”. This sometimes takes them through banks, but only because at various points, banks have been better payers than other professional services firms – when you see a politician like Hillary Clinton who spent her Arkansas career as a lawyer and a consigliere to the Walton family, you don’t conclude that this shows the outsized influence of either the legal profession or big box retail over the government.

In fact, Blair at least was not particularly close to the financial sector in the 1990s when it might have made a difference. Notoriously, New Labour was very heavily staffed up and co-opted by consultancies (particularly PA Associates) and Big Four accountancy firms (particularly PWC). These guys got their payback in very large amounts. Later towards the end of the boom, everyone wanted to be friends with the financial sector, but why wouldn’t they? The sector looked like it was a massive success story, and its continued growth was essential to the policy model.

I think you’re hugely underestimating the extent to which the Washington Consensus was a consensus. It really was. And it was a consensus around a set of policies which (as nobody except Wynne Godley seemed to realise) implied a structurally growing financing sector and structurally increasing leverage. The banks were obviously very keen on this, because it was good for them, and so they assuredly invested money and influence in promoting it. But this is like a theory of why we have so many wars which blames them on arms manufacturers – they’re part of the story but if that’s your whole explanation you’re missing the big picture.

63

Zamfir 11.30.15 at 2:27 pm

The VW comparison looks reasonable to me. Deliberate fraud at some places, not enough critical questions from the people nearby, revolving doors to regulators, governments (especially in Germany) that put the welfare of the car industry over the general welfare. Partially for honest if ideological reasons, partially because money.

And we do expect them to second-guess policy. The policy wants clean cars at low prices. If the engineers can’t deliver, they should say so. Not make pretend-clean cars. Then the ball is back at the policy-makers, who have to make harder choices. Just as governments have to make new choices when they are the end of the possibilities of monetary policy. Like fiscal policy, or less ambitious goals.

64

Chris E 11.30.15 at 2:44 pm

“The banks were obviously very keen on this, because it was good for them, and so they assuredly invested money and influence in promoting it. “

and by extension so were the senior managers at various industries once they spotted that financialisation of their own firms offered a means of cashing out.

65

T 11.30.15 at 3:10 pm

Rubin walked away from the Clinton administration in ’97 with $126M from Citibank.

As for the Clintons in Arkansas, think Stephens, the investment bankers, not Walton. http://www.nytimes.com/1992/02/05/us/1992-campaign-personal-finances-wealthy-investment-family-big-help-clinton.html Walton was not a huge Clinton guy although he liked him for a dem and did make small contributions.

Glad to see that dsquared now thinks the finance industry was at least part of the story.

I don’t get the feeling that the commentators from Australia and the UK fully grasp the role of finance industry money in US politics. The average congressman spends between 1/2 and 3/4s of their time fundraising. Fundraising has been off the charts for presidential elections for quite a while.

And has Peter Dorman has so rightly observed, non-banking corporate money is often just finance money by another name.

66

John Quiggin 11.30.15 at 4:22 pm

I think you’re hugely underestimating the extent to which the Washington Consensus was a consensus.

Certainly, a consensus of the political class. But if you take an issue like privatisation, it hardly ever commanded majority support anywhere. Here’s UK opinion versus that of the parties (I can find data going back to the 90s on this)
http://weownit.org.uk/privatisation-people-vs-politicians

Australia is the same, and there were a string of electoral defeats for parties advocating privatisation from the 1990s onwards. It didn’t stop the privatisations happening – the bankers kept coming back until they pushed it through one way or another.

Even in the US social security privatisation was so toxic that Cato and the Repubs changed the name to “choice”, not that this was sufficient.

67

Peter K. 11.30.15 at 4:27 pm

“So it was a consequence of the ideology of the times – if you have policies of reduced government investment, combined with low real wage growth, then you have, de facto, a policy either of falling living standards or one of increasing debt levels and therefore a growing financial sector.”

Or a growing financial sector means reduced government investment and low real wage growth. The causation could go the other way. Bill Clinton dropped his campaign pledge of a middle class spending bill under pressure from Rubin and Greenspan. And there was a lot of fraud and bad regulation. Deregulation was pushed by the financial sector. So, derivatives aren’t regulated. The shadow banking system is unregulated.

Government regulation stifles growth, they argue. So does popped bubbles and insufficient macro policy.

Dsqaured assumes the only alternative to debt-fueled growth and a metastasizing financial sector is secular stagnation. That’s what they would have you believe.

But in the post-World War II years, we had high-pressure macro policy with full employment, growing wages and rising living standards. But adequate monetary and fiscal policy is being blocked by politicians funded by the rich who are mostly financiers. And there has been a decades-long attack on unions, campaign finance reform, regulations, social insurance, etc. Inequality begets inequality and stagnation.

68

Eggplant 11.30.15 at 4:34 pm

A bit off topic, but someone linked to a Krugman review of Reich’s latest somewhere upthread (I can’t for the life of me find it now), that is really interesting and mostly convincing except for the part where Krugman accepts the dismissal of global competition as a force for suppressing domestic wages. Perhaps somewhere it’s spelled out more convincingly, but this belief that because relatively few jobs were physically relocated the effects on the prevailing wage have to be proportionally small is incredibly unconvincing, as the threat of offshoring can be used to suppress wages often more easily than following through, and good evidence that economists, even the good ones like Krugman, have unexamined, labor market specific biases. On seeing the price of widgets in Springfield plunge towards that in Shelbyville, I doubt you would see many economists dismissing competition as a cause because relatively few widgets make the intertown journey.
D2 is right when he points to the Washington consensus, and the theoretical justifications provided by neoliberal economists, as a causal factor.

69

dsquared 11.30.15 at 4:44 pm

Dsqaured assumes the only alternative to debt-fueled growth and a metastasizing financial sector is secular stagnation. That’s what they would have you believe.

No that’s not true. Every single time I explained this I was very careful to point out that debt-financed demand management was made necessary by the lack of willingness to carry out government investment. It kind of irritates me when people ignore important points like this.

70

john 11.30.15 at 4:48 pm

For the record, in both 1983 and 1987, the median UK voter backed the SDP-Liberal alliance. (In fact, the total of Labour plus SDP-Liberal popular vote share barely shifted at all, going from 53% to 53.4%).

The Tories got a plurality of the popular vote and a stonking majority of the House of Commons, of course, but that is very much not the same as “the median voter supported Tory policies”.

71

dsquared 11.30.15 at 4:51 pm

#66 I don’t think you can break off single issues from a policy consensus like this though. People didn’t like privatisation per se – who doesn’t want to keep assets? But they preferred it to the alternatives, which would have involved higher taxes. Pro-privatisation parties consistently won elections.

And I think that bringing up the issue of social security privatisation kind of supports my point. This is the ultimate financial sector lobbying issue, with a very obvious massive windfall attached to it and which has almost certainly had more financial services industry time and money spent on it than any other (any other general policy issue that is, probably not counting the lobbying budget with respect to industry specific regulation). And it didn’t happen. In fact, privatisation of state pension schemes has been very much uncorrelated with any of the other indicators of “financialisation” as far as I can see. This still looks, to me at least, much more like an ideological movement which tended to favour an industry, not an industrial lobby which generated an ideology.

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Eggplant 11.30.15 at 4:54 pm

Obviously most social phenomena are multicausal, and feedback effects like those between wealth and political influence abound, but I really the structural, rising inequality and capitol wage share explanation. It offers an easy explanation for both the growing size of the financial industry, and possibly its continued massive profits: as the savings continue to accrue and concentrate, new entrants into the market for extremely expensive assets supply steady profits for existing stakeholders in a sort of Ponzi scheme. There are necessarily very few participants, so cultural norms like the standard 2 and 20 fee structures can be maintained.

73

Layman 11.30.15 at 5:20 pm

Yes, with respect to Social Security, the banksters found that they could get away with killing grandma, but not get away with cooking and eating her. So, really, they had no power. Pfui.

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John Quiggin 11.30.15 at 5:29 pm

“Pro-privatisation parties consistently won elections.”

As I said, not in Australia or (AFAICT) most places where the voters faced a choice rather than a united political class, and where the outcome of the election reflected majority views rather than the vagaries of FPP voting.

Similarly, there’s never been anything like a public consensus in favor of deregulation, particularly financial deregulation. It was, and remains, much more a case of “There Is No Alternative” than “this is going to be good for people like me”.

75

Sebastian H 11.30.15 at 5:33 pm

“And it was a consensus around a set of policies which (as nobody except Wynne Godley seemed to realise) implied a structurally growing financing sector and structurally increasing leverage.”

I guess I do not understand the “implied”. Why should privatization lead to increased capture of nearly all growth in the finance sector? Why didn’t the growth go to the host of other productive areas of the economy like it had in a host of previous rounds of expansion–some government driven and some not. Why did so much of the “great moderation” growth go there AND so much of the post great crash growth go there? I would expect one or the other but not both. The stylized fact is that we have somehow gone from Titans of business to Titans of finance. The VW experience is instructive–they lost CEOs over it. Jamie Dimon still sits atop JPMorgan.

I feel like I’m missing a key link.

76

T 11.30.15 at 6:09 pm

@71 point well taken. by dsquared’s reckoning, it seems finance would have had to have every major initiative passed to prove they had undue influence. Well they didn’t get that. But they got free flow of international capital; they got deregulation; they blocked incipient regulation (the famous CFTC Rubin/Summers/Greenspan intervention is but one example); and more. The regulatory agencies have been gutted — mass exodus from the SEC of career civil servants, budgets cut, etc.

Finance is the leading contributor to both parties (although the Republicans seem to be doing much better this cycle.) Finance is a common landing spot for senior gov’t officials from administration to administration. The finance sector also doubled its share of gdp and became the nations most lucrative employer. But dsq got a story and he’s sticking to it. See, the finance bros were just lucky enough to be around to pick up the lose change when the “revolution was brought to you by ideologues and economists.” Right place, right time.

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dsquared 11.30.15 at 6:28 pm

Why should privatization lead to increased capture of nearly all growth in the finance sector?

Because this wasn’t your normal expansion. The only source of demand was increasing personal sector debt.

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SamChevre 11.30.15 at 6:45 pm

Why didn’t the growth go to the host of other productive areas of the economy like it had in a host of previous rounds of expansion.

My opinion, not dsquared’s–but the issue is that there weren’t any “other productive areas of the economy” in the needed sense. Real investments in productive capacity that need large amounts of funding have been very scarce. The whole computer/technology industry is growing, but it didn’t take investments on anything like the scale that an industrial boom does; finance is growing, but it is only in a very limited sense productive capacity.

You can blame women working, or Japan/Taiwan/China, or environmental regulations, or rising energy costs, or consumer saturation, or a very long list of other things–but the return on building new industrial complexes in the last 40 years has been low throughout the developed countries.

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Bruce Wilder 11.30.15 at 6:45 pm

JQ: a consensus of the political class. But if you take an issue like privatisation, it hardly ever commanded majority support anywhere.

dsquared: People didn’t like privatisation per se – who doesn’t want to keep assets? But they preferred it to the alternatives, which would have involved higher taxes. Pro-privatisation parties consistently won elections.

The dog that didn’t bark plays a big part in the political dynamics. Neoliberalism, as an ideology or rhetorical engine of the political class is an epiphenomenon of the collapse or corruption of institutions and organizations, representing and mobilizing mass interests. http://www.washingtonmonthly.com/features/1983/8305_Neoliberalism.pdf
Charles Peter’s Neoliberalism: A Manifesto is a root document of an important thread in American neoliberalism, and it is also a pretty clear statement of the desire to abandon what seemed in 1983 to be a tired stalemate of politics cleaved across class lines. The economic reforms of the late 1970s and 1980s — deregulation and trade liberalization were possible because the liberal professional classes were ready to abandon labor unions as racists and Reagan Republicans, but also because those organizations were in manifest decline as the general decline in social affiliation in American society and culture took hold. A vicious cycle took hold: deregulation and trade liberalization, along with a general decline in mainstream religious and other social affiliations destroyed the institutions that gave the liberal classes an economic base, as Chris Hedges lamented in The Death of the Liberal Class.

The expansion of the financial sector, at least in the U.S., was accompanied by a deeply corrupting homogenization, as giant bank holding companies assembled themselves and subsectors, which had previously pursued conflicting political agendas in Washington and State Capitals, as well as competing economic strategies in the marketplace, were subsumed. That’s a huge and underappreciated fact: both politically and economically, neoliberal policy permitted a loss of diversity that undermined the politics and economics both.

Projecting that “they” (voters) didn’t “like” some (proffered?) alternative of public ownership and finance, supported by sufficient and effective taxation, slides over the problem of political organization and mobilization. There is No Alternative (TINA) is the central challenge presented by neoliberalism, as political parties of the Left have repeatedly failed to find ways to mobilize mass support to sustain any alternative vital critique and program.

It does seem to me that attributing too much to the overawing strength or evil of the Finance Sector misses the abject weakness of any potential political mass movement, whether of the populist or neo fascist Right or liberal or socialist Left.

Even comparatively feeble efforts show how little it takes, I think. The successes of Elizabeth Warren are a remarkable demonstration, in a way, of how little it takes to push back. (That’s not a criticism of Warren, who does her homework and is amazingly professional and incisive — I’m just saying, she’s not atop a well-disciplined mass movement with real political muscle; she’s just good at the job she’s taken on, and that’s enough sometimes to have effect. Because the corruption she goes after has a guilty conscience and is not atop a mass movement either, and fears any potential mass movement for good reason will eventually want heads on pikes.)

There is No Alternative is a racket and a ratchet downward, ever downward. But, it isn’t backed with great political power, so much as it is backed by the absence of political power among the mass of people, who are no longer readily mobilized or even informed. And, also it represents a narrow homogenization of interests, so not much political conflict surfaces for politicians to manage: a politician cannot make himself independent without conflict — the only job available in this environment is spokesmodel. Most people are not well-informed politically — even the news junkies, who might seem superficially well-informed about politics have little capacity to think critically. They just react like Pavlov’s dogs and, for all practical purposes, if they vote at all, they might as well be voting at random. (A friend in China explained to me recently, that China tells itself that it is a democracy, and the voters are presented with a ballot in municipal elections, but no one knows even half the names on the ballot. I told him it sounds like voting in Los Angeles. I wasn’t joking.)

It takes a lot of political organization and mobilization, including education and some careful thinking about programs and policies, before a polity can make genuinely “hard” choices (to use ironically, the fatuous neoliberal rhetoric for doing something stupid, cruel and corrupt). I mean to accept short-term pain for long-term gain, but also to accept the short-term pain necessary to impose costs and accountability on elites and to dismantle existing systems.

Genuinely reforming the financial sector would be an act of altruistic punishment. It would be costly in the short-term even for those wielding the knives and tying the hanging rope. In the U.S., it would mean shrinking substantially employment in some of the highest income sectors of the economy — not just in finance, itself, but in the corporate C-suites and big sectors of the economy, like health care, where insurance has jacked up prices and incomes, drawing in excess resources.

Absent a partial collapse of society, directly affecting elites, it is hard to imagine organizing or motivating a politics of altruistic punishment. The U.S. can just barely manage to mobilize some outrage, by invoking the hot button of race, but that’s wearing thin surprisingly fast, I think and easily side-tracked into purely symbolic b.s., at least among the youngest political activists.

I don’t object to pointing out that the Clintons are political opportunists, or that Tony Blair was a political opportunist for that matter. That their moral sense is deranged seems like a valid point. But, the thing about opportunists is that they are not handicapped by convictions; if there were a reliable and loyal political movement available to lead, they would happily lead it, I think. It would have to be a remarkably resilient movement, before any sane politician would tackle shrinking the UK financial sector, because the immediate economic feedback is likely to be severely negative for any effective measures taken in advance of some self-created crisis or collapse. Ditto in the U.S.

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Map Maker 11.30.15 at 7:11 pm

Look at Japan as an alternative, with the caveat that their real estate bubble took a long time to work through, BUT …

no big growth in banking or insurance sectors, no debt/default cycle, etc.
yet poor economic growth, and as Sam Chevre points out, a slow steady weakening of capital investment in “productive” sectors of the economy. There has been only one new auto plant in Japan in 20 years, and at least the auto engineer I spoke thought it would be the last one. No sign that a lack of a large financial sector crowded out other investment opportunities…

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Aaron Brown 11.30.15 at 7:23 pm

Coming to your main point, I’d shift the dates back a bit, but I’d still agree that the performance of the economy under financialisation (roughly mid-80s to now) is pretty comparable to that of the period from the collapse of Bretton Woods (1971-3) to the emergence of financialisation. But that is setting the bar very low. You’re comparing the entire experience of one system with the crisis and collapse of the one it replaced. What about the previous thirty years of growth and widely shared prosperity?

Okay, so you think overall economic performance from 1946 – 71 was better than 1973 – 2015. Personally I think it’s too broad a question to answer one way or the other, but I’ll stipulate it. Since the importance and profits of the financial sector increased enormously during the latter period, that’s one piece of evidence that financialization has become excessive.

However in the original post, you specifically singled out the booms and busts of our financialized economy as self-evident rebuttals of the claim that the financial system creates value greater than its cost. If you had written, “I don’t see how anyone can argue this with a straight face in the light of the last 20 years of slow economic growth and concentrated rewards,” I would have countered that global economic growth has been pretty good in the last 20 years (and even better in the longer period you prefer since the mid-80s), and that the global benefits have been shared more widely than any period in history–although of course there are some groups worse off than they were in 1995.

As I said, I’m not trying to argue here, I just want to understand your point. I thought you were saying that the volatility of the last 20 years makes a joke out of any defense of finance. Now I think your point is that the slow growth and failure to lift people out of poverty of the 1973 – 2015 era compared to 1946 – 1971 proves without further comment that financial profits are excessive. I wouldn’t agree with that, but I do understand the claim.

Have I got it right?

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ZedBlank 11.30.15 at 7:58 pm

It seems to me that dsquared is playing some kind of chicken-or-egg game. My Q is then: if it wasn’t the influence of the financiers, whence the ideology?

They key trend is upward redistribution of wealth. The rich elites were scared shitless after the 60s, and their solemn vow of “never again” has been their battle cry ever since, as they’ve siphoned more and more of the economy’s wealth from the actual workers. dsqaured might be right that it began before the financialization of the economy, but it has hardly abated since then – if anything, it’s accelerated. So if the bankers didn’t invent the scam, they certainly jumped on board with both feet, and they never looked back. A useful distinction when it comes to history, but they are still fighting for the armies of Sauron.

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geo 11.30.15 at 8:12 pm

Jim V@41: Orwell should have written a book about the language of company managers

See The Baffler, issues 1-29.

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dsquared 11.30.15 at 8:27 pm

A useful distinction when it comes to history

No, I think it’s an important distinction right now. If we think this is all about the financial sector, then Euroland (for example) is doing the right thing, and in general (since there has been a massive step shift in financial regulation) we could expect things to get better in the medium term. If this is a more general problem of stagnation and bad policy choices, particularly with respect to government spending, then we’re just making avoidable problems for ourselves by throwing sand in the monetary policy transition mechanism.

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T 11.30.15 at 8:33 pm

Once again, it seems that events in the UK are being incorrectly generalized. In fact, there was very little privatization in the US under Reagan. http://reason.org/news/show/ronald-reagan-and-the-privatiz (The author, a Reagan adviser, laments the near complete lack of US privatization compared to the UK.) Further, Reagan’s fiscal policy, rather than rhetoric, was Keynesian. He increased military spending significantly and instituted large block grants to the states such that, unlike the current austerity, total fed + state + local spending increased absolutely and as a share of gdp. He raised taxes a bunch of times including on both SS and Medicare.

The real killers were the Reagan regulatory changes.

A group of people with considerable power changed the rules to benefit themselves. The best you can say is that some of them thought what was good for them was good for the country as a whole. But most of them didn’t get passed thinking about what was good for them.

The skewing of the rules dramatically shifted the share of gdp away from wage income and towards profits with the concomitant effects of increased inequality and enormous transfers to the very top. The interaction between the increased inequality and lowered productivity/growth are just beginning to be studied. But the idea that finance is earning some kind of normal return is, er, daft. And the idea that finance didn’t successfully go rent seeking is also daft. dsquared has been making his argument for years. He can count Tyler Cowen as a fan. Congratulations.

We are turning into a rentier society. The smart kids go into finance, tech, and consulting –. finance rents, IP and network rents, and information arbitrage. The most benign story of the recent past is that of Robert Gordon — we’ve invented all the easy stuff so productivity has declined a lot causing all these problems. Tyler likes that one too. He likes any story that doesn’t point the finger at his benefactors.

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geo 11.30.15 at 8:56 pm

dsquared @44, 45, et seq: I think you seriously underestimate the degree to which US financial and corporate elites coordinate their lobbying efforts (through the Business Roundtable, the US Chamber of Commerce, Grover Norquist’s breakfast group, industry associations, and myriad other K-Street and country-club venues; as well as the degree to which the .1 percent’s efforts to influence both public opinion and legislative and regulatory outcomes are successful.

As everyone at CT doubtless knows by now, I’m not really a facts man — rhetoric and logic-chopping are my milieus. But I believe there’s good polling data showing that Americans have by and large not supported the actual policies of the Republican Party since 1980, having instead been sold various bills of cultural and patriotic goods; as well as a large body of both academic and journalistic commentary tending to confirm the existence and describe the activities of the plutocracy in America.

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ZedBlank 11.30.15 at 9:03 pm

If we think this is all about the financial sector, then Euroland (for example) is doing the right thing, and in general (since there has been a massive step shift in financial regulation) we could expect things to get better in the medium term

To each his own conclusions. I certainly don’t think that Euroland is doing the right thing, and as far as the massive step shift in regulation, I will await the proof that it is doing any good. Which might be your point, I’m not sure; are you saying that this increase in regulation is so much “throwing sand in the… mechanism?” If it isn’t helping people now, perhaps it is helping to prevent or at least forestall the next meltdown. One could take your statement to imply that there is a need for more regulation, different, or less.

The last time I checked, Goldman Sachs still wanted to collect on the usurious credit it extended to Greece, along with everybody else who would rather stomp on Greek pensioners than take a modest hit in their bottom line (if any.) Perhaps when we start seeing certain CEOs in shackles and orange jumpsuits, it might be time to take a more favorable view of how effective current regulation is.

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dsquared 11.30.15 at 9:39 pm

US financial and corporate elites

whoa whoa. I thought the whole point here was that there was something particular about the financial services industry, distinct from other professional services businesses, which were in turn distinct from other kinds of corporation which in turn have interests not entirely co-extensive with the wealthy as a class. This post is about a specific theory of a single sector having a disproportionate influence in political economy, not about generic facts about the political economy of the USA.

The last time I checked, Goldman Sachs still wanted to collect on the usurious credit it extended to Greece

Well, that would mean that the last time you checked couldn’t have been more recent than early 2012, when private sector holdings of Greek sovereign debt were written down to the equivalent of less than third of face value.

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Bruce Wilder 11.30.15 at 9:55 pm

dsquared: If we think this is all about the financial sector, then Euroland (for example) is doing the right thing, and in general (since there has been a massive step shift in financial regulation) we could expect things to get better in the medium term. If this is a more general problem of stagnation and bad policy choices, particularly with respect to government spending, then we’re just making avoidable problems for ourselves by throwing sand in the monetary policy transition mechanism.

I will admit it. I have no idea what you are saying.

Why cannot the “massive step shift in financial regulation” and the “more general problem of stagnation and bad policy choices” be of a piece: the left and right hand of the same corrupt elite?

That Larry Summers, author of some of the most corruptly misguided American de-regulation in the late 1990s, as well the force behind limiting the fiscal and regulatory response to the crisis of 2008, is the self-appointed worrywort over secular stagnation ought to be some clue that this is all being cooked in the same tainted kitchen.

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Bruce Wilder 11.30.15 at 10:05 pm

dsquared: I thought the whole point here was that there was something particular about the financial services industry, distinct from other professional services businesses, which were in turn distinct from other kinds of corporation which in turn have interests not entirely co-extensive with the wealthy as a class.

Those are not distinctions I would concede to you: one of the important mechanisms driving the dynamics of the U.S. economy under financialization has been the erasing of the boundaries and political conflicts between what were once separate sectors.

This is really fundamental to what went wrong in the U.S. financial services sector and more broadly in the economy over the last generation, as institutions that depend on those conflicts and boundaries to function properly have been subverted and the diversity of interests represented in politics has narrowed sharply.

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Rakesh Bhandari 11.30.15 at 10:11 pm

A couple of questions:
dsquared writes: “If this is a more general problem of stagnation and bad policy choices, particularly with respect to government spending, then we’re just making avoidable problems for ourselves by throwing sand in the monetary policy transition mechanism.”

First, could it be that given a more general problem of stagnation (few new profitable investment opportunities, global savings glut), financial capital is likely to become primus inter pares among capitals and thus get its way with policy?

Second, does financialization refer only to the rise of the financial sector; or does it include the shareholder revolution as it affects all big firms as well as developments such as the rise of GMAC, the emergence of USX, hostile take overs financed by junk bonds?

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ZedBlank 11.30.15 at 10:22 pm

Well, that would mean that the last time you checked couldn’t have been more recent than early 2012, when private sector holdings of Greek sovereign debt were written down to the equivalent of less than third of face value.

Ah, the write-down, purchased with the suffering of the Greek citizenry, who got round upon round of austerity for their trouble, while Goldman (a small fish in the overall picture) still got to keep the enormous fees they collected for helping to hide Greek debt, and thus abet the growing crisis. Goldman made out handsomely (despite their criminal behavior) and the Greek population got disciplined, with no end in sight.

But sure, there was a write-down (not a write-off.) I’m simply awed at the benevolence of the bigwigs at Goldman, or, if that isn’t convincing, at the iron collar of regulation on international finance.

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geo 11.30.15 at 10:28 pm

dsquared@88: As Peter Dorman argued @28, and Bruce and Rakesh suggest @90 and 91, you may be construing the issue of financial sector influence too narrowly.

Just noticed your comment @71 that the defeat of Social Security privatization tells strongly against the notion of Wall Street dominance. Again, I think that is a misunderstanding of American politics. Social Security is much the most popular government program in existence. No politician dares breathe a word against it, including Bush during his reelection campaign — it was the equivalent of impugning motherhood or Jesus. The timing — early 2005 — was chosen so that popular political anger at the Republican Party would have maximum time to dissipate. The fact that Bush chose even to attempt this colossal giveaway to Wall Street is a testimony to its political power.

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John Quiggin 11.30.15 at 10:34 pm

@81 My original point was much more specific to financial sector bubbles and busts. In the US case, the most notable were the dotcom bubble leading to the 2000 bust and the real estate/derivatives bubble leading to the GFC.

Unless you reduce it to a tautology (as many supporters do when pressed), I don’t see how anyone could reconcile these and similar episodes with the claim that financial markets are doing a greatly improved job of allocating resources and managing risk.

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Akshay 11.30.15 at 10:53 pm

But Bruce Wilder @ 90, surely this is dsquared’s point, that the problems are caused by anti-Keynesianism in a broad sense, in trade and fiscal policy, and that bad behaviour and bad incentives in the financial sector are an inevitable result/symptom of this broader set of policies? (Wynne Godley’s article on “seven unsustainable processes” points out that the trade/monetary/outsourcing policies which led to a massive US current account deficit and policies leading to the Clinton budget surplus can only be sustained if you engineer a private debt bubble along side them, as can be intuited from accounting identity)

If so, better incentives in the financial sector are not going to do much, without a broader return to Keynesianism. This faces not just elite resistance, but popular resistance: Broad swathes of public opinion in Europe favour Swabian housewife economics. (dsquared can correct me if I am misrepresenting him)

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Russell L. Carter 11.30.15 at 11:18 pm

“Wynne Godley’s article on “seven unsustainable processes” points out that the trade/monetary/outsourcing policies which led to a massive US current account deficit and policies leading to the Clinton budget surplus can only be sustained if you engineer a private debt bubble along side them, as can be intuited from accounting identity”

Reading that article, now I begin to understand why Dean Baker’s always going on about the trade deficit.

The part about D^2’s claims about the finance industry that doesn’t seem well founded is the supposed agnosticism of the professionals toward the policies (he says) were prescribed for them. I just keep returning to thinking about Tanta (of CR) laying out the machinery in real time as the whole colossal edifice erupted, burned and crashed. Those guys knew exactly what they were doing. Who runs GS and MS these days, I wonder.

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Watson Ladd 11.30.15 at 11:18 pm

The story of the financial industry over the past 30 years is one of falling margins due to increased competition in asset management and market making. To the extent that the finance sector continues to have outsize profits, it’s probably due to the banking side of things. I don’t see how finance as a whole profits from increased volatility: volatility doesn’t change the return of the underlying, but does make people with risk preferences not prefer it, thus enabling those with more risk to buy more of it. I doubt this explains the profits of investment banks.

However, I have to push back against the idea that there was no popular constituency for neoliberal deregulation. Deregulation in the transport sector massively reduced prices: it would be very difficult to reestablish ICC regulations today. I doubt that there was much public discussion about the ICC during the election of Jimmy Carter, but particularly in the US there is a grassroots antipathy towards meddling bureaucrats.

Globally this stagnation isn’t apparent. What happened is a global convergence of living standards as manufacturing became globalized, and the impact on those who were working in manufacturing industries was large. But countries with safety nets focused on redistribution did not experience the increase in post-transfer inequality, such as the Nordic countries and the Netherlands.

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greg 11.30.15 at 11:58 pm

The financial sector allocates money according to what is most profitable, not according to what is most productive. The financial circle jerk in imaginary assets that passes for resource allocation is far more profitable for its players than any real production could ever be. Real production is difficult and risky to capitalize. Financial profits, especially with complicit government officials happy with the bone that’s thrown them, is easy and certain. And the margins are far higher.

At least until the music stops.

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T 12.01.15 at 12:01 am

geo @86 and dsquared @88 —

The money given by finance is widely disproportionate to other industries (because the benefits are disproportionate to other industries). The big givers are the rent seekers — finance, IP, and energy. Take a look at republican giving: http://www.nytimes.com/interactive/2015/10/11/us/politics/2016-presidential-election-super-pac-donors.html?_r=0

Or at donations by sector (which underestimates actual finance contributions):
https://www.opensecrets.org/overview/sectors.php

Or the academic study documenting the revolving door between the Fed and finance over 25 years: http://www.ft.com/cms/s/0/d53d3798-9b4b-11e4-b651-00144feabdc0.html

To dsquared’s point, of course there will be coalitions including more than finance but there are often particular provisions benefiting finance and that’s where its money and lobbying efforts go. So, for example, in the case of trade deals there are typically chapters devoted to individual issues of concern to particular industries. With the TTP, Pharma has weighed in big on the IP protection. But the finance industry weighs in bigtime on trade in services. See the language in Chinese ascension to the WTO agreement. Take a look at the NAFTA where Mexican money came pouring in to the US after ratification (much to the surprise of one Brad DeLong.) Even in coalitions there are finance specific issues. I suggest you take a look at who wins in these scrums. Whose interests are prioritized?

The hedge fund industry has managed to save the carried interest provision using a powerful democrats at the point– Chuck Schumer of NY.

The finance industry is furiously trying to kill the rule to make retirement advisers fiduciaries. A once easy pass has now turned into a quagmire since the big money arrived. Dems are flipping.
http://time.com/money/4098870/1-trillion-fight-obama-and-wall-street/
http://www.bna.com/congress-working-dismantle-b57982063477/

Some individual, anecdotal examples:

Summers — More than $6M from DE Shaw
Rahm Emanuel — $16.2M in 2 1/2 years at Wasserstein Perella after leaving White House — no prior finance experience
Eric Cantor — former house leader for the Republicans — boutique New York investment banking firm of Moelis & Co. Canter also received $2M from the finance industry in his 2010 campaign and described himself as the biggest friend to finance in Congress
The last six S.E.C. enforcement chiefs have moved on to top corporate firms and big banks like JPMorgan Chase and Bank of America.
It goes on and on.

I’m wondering where dquared comes by his knowledge of Washington influence peddling. Your earlier cite to Brad DeLong as some influential figure in the Clinton administration was a bit of a giveaway.

So I might ask the question dsquared posed earlier: when you find yourself writing something like this, it’s often a good opportunity to check yourself and ask “do I really understand what I’m going on about? Might I be on the verge of writing something daft?”

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js. 12.01.15 at 1:02 am

dsquared’s explanation has a good deal of plausibility, but as several people have pointed out (see, e.g., Peter K @67, 1st para), the key question is which direction the causality is running in—and here I’m not convinced by dsquared’s analysis. At best, it seems to me you could argue that the causality is running in both directions in more or less equal measure, but that the financial sector is simply the (downstream) beneficiary of ideologically instituted policies (that themselves didn’t involve significant agency on the part of actors in the financial sector) strikes me as quite implausible. At the same time, I’m not sure exactly how you would settle this question.

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Bruce Wilder 12.01.15 at 2:03 am

Akshay @ 95

Schumpeter thought that Keynes was giving theoretical form to his general view that England was facing problems of secular stagnation in the aftermath of the First World War and would be well-advised to adopt a policy of kinder, gentler monetary ease and public investment. So, in that sense, it could be said that Keynesianism is tied to directly to the credibility of a secular stagnation thesis. So, we’re back to left hand, right hand rather than genuinely opposed alternatives.

Keynes, insofar as I know, never actively advocated for the policy of financial repression, which the U.S. actually adopted as a critical set of reforms. If anything, Keynes’s attitude seemed to be that reform should wait until the employment crisis was more fully addressed.

My view is that financial repression would be beneficial to the society, regardless of whether we think conditions of secular stagnation obtain with regard to investment opportunities. Encouraging the Mafia to open opium dens and casinos would not be a sensible remedy for a dearth of employment, and having the finance sector expand payday lending operations or privatize state-funded education are not good ideas either.

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Peter T 12.01.15 at 2:46 am

I think the question is best framed as “what made mostly Anglo elites increasingly prefer finance as the main means of extracting their share of the common pool?”. Not just through the finance sector, but also by developing the financial arms of firms in other sectors to the point where they became the main avenue of profit (eg GE and GM), or by financialising the public and household sectors (Chicago parking meters, government assets and services, education loans…).

It was, as others have observed, politically the easiest option (opaque, often obscure, already largely under elite control). Another part is that financial flows are more easily concentrated than most other forms of power – they can be shared less widely. Perhaps a third part is that other, more traditional, flows were becoming smaller or being contested. OPEC was taking a larger share of the energy pie and manufacturing profits were challenged first by the Japanese, then the Taiwanese, South Koreans, Chinese and others.

A final element is that the collapse of socialism denied counter-forces any appealing counter-narrative. A common thread running through the experience of labour organisers/left-wing politicians/revolutionaries from 1880 to 1970 was “I read a Marxist/Fabian or similar pamphlet and for the first time understood WHY I and my acquaintance were leading shitty lives”. As Bruce remarks, there is no counter-narrative on offer now.

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geo 12.01.15 at 4:22 am

Peter T: there is no counter-narrative on offer now

Yes and no. There are dozens of excellent books, journals, online newsletters, and blogs that will explain to “labour organisers/left-wing politicians/revolutionaries” and anyone else why they and their acquaintance are leading shitty lives. For example, Hacker & Pierson, “The Great Risk Shift” and “Winner Take All Politics”; Fraser, “The Age of Acquiescence”; Taibbi, “Griftopia”; Kuttner, “The Squandering of America”; Ha-Joon Chang, “Economics: The Users Guide” et al; Nomi Prins, “All the President’s Bankers”; Jeff Madrick, “The Age of Greed”; Bartels, “Unequal Democracy”; Yves Smith, “Econned”; Dean Baker, “The Conservative Nanny State”; Akerlof & Schiller, “Phishing for Phools”; Tom Frank, “One Market Under God” et al; The American Prospect, Dissent, Jacobin, The Baffler; and much, much else, including the writings of David Cay Johnston, Kevin Phillips, William Greider, Doug Henwood, Naomi Klein, Michael Lewis, Krugman, Stiglitz, Nader, Chomsky. The ideas are there; they just don’t have the money behind them.

For a full-length argument to this effect, see: http://www.georgescialabba.net/mtgs/1986/11/right-turn-the-decline-of-the/print/. Thirty years old but, I humbly submit, up-to-the-minute.

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Gareth Wilson 12.01.15 at 9:13 am

If it’s just the quality of your life, and your acquaintance’s life, that you’re worried about, you won’t be much of a revolutionary.

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Metatone 12.01.15 at 9:13 am

Perhaps because my area is culture, I’m finding myself agreeing with dsquared very much here.

The root cause here is the shift in ideology. Now the ideology of the Washington Consensus is multifaceted (deregulation, privatisation, abandonment of fiscal policy) and there’s a lot of discussion about the relative weighting of each factor in “where we are now.”

There’s also the effect of the ideology on the administration of business. Clayton Christensen is just one academic who has identified how the new ideology tilted the deck towards “financialised” investments inside companies, over “productive” ones.

I often think that a nice simplification of the Hayek-Friedman neoliberalism is that in government and business it focussed on “efficiency” of a sort, which actually means living off the “stored resources” in the system and not replacing them. In the end, much like a Tour de France rider, you see the body start to eat itself.

Coming back to the government level, from a systems point of view, the ideology that throws away a tool (fiscal policy) and tries to control the system with just one lever (monetary policy) seems automatically guaranteed to not only failure, but the creation of really strange distortions.

(As an aside, the neoliberals were in part able to do this because the economics of the time was incomplete and unable to articulate how to integrate new countries into the existing system. e.g. Japan, but now you see similar strains over China.)

Of course the relevant industry (finance) capitalised on the distortions. And arguably there is somewhere a tipping point where said industry develops so much influence that it becomes a political factor preventing any correction. And, as it happens, many of the priests of the ideology have some relation to the finance sector.

Still, while taking on the political power of the finance sector is important, the actual first step has to be creating a coherent ideological alternative to neoliberalism.

I, of course, would be on my hobby horse and say that a critical part of the alternative has to be working through a coherent theory of how you add new people to an economic system where labour has been structured to be not that valuable. There are still millions in China and Africa and elsewhere essentially outside the economic system. (Not to mention a growing underclass in the developed world.) They have no meaningful amount of capital. Our current economic setup has no notion of how to bring them into the system. We have no jobs to offer them, so they have no prospect of wages. Hence they cannot stimulate the economy, (i.e. their needs cannot be served) because they have neither capital nor wage potential.

106

Metatone 12.01.15 at 9:15 am

To clarify my ending point. A crucial problem is developing an evolution of our current economic system that can handle these challenges. Obviously one can develop revolutionary ideas that solve problems – but our system is very resistant to revolution…

107

Metatone 12.01.15 at 9:37 am

As an aside, yesterday Krugman took on (in passing) one of the key underpinnings of the Hayek-Friedman ideology – and judged it wanting. Economies are not self-correcting in a practical sense of the term, according to him. Yet the H-F ideology is so little visible to us, so much a set of buried assumptions, that this doesn’t set off the level of debate that it should…

108

dsquared 12.01.15 at 10:21 am

I think the question is best framed as “what made mostly Anglo elites increasingly prefer finance as the main means of extracting their share of the common pool?”

I’m honestly not sure what I could say to put this more clearly. A policy of:

a) real wage stagnation as a consequence of outsourcing and trade agreements + China

b) government investment reduction

c) demand management by expansionary monetary policy

Is, de facto, a policy of financial sector expansion. Once you’ve made the first two decisions, you have a choice between either making the third or having permanent recession (actually there might be another way if there was some way of having an investment boom as in the dot coms, but for most of the period under consideration it wasn’t an option). Given the big decisions taken about international liberalisation and the role of state investment, the financial sector was the only game in town.

109

reason 12.01.15 at 10:29 am

dsquared @62
“I think you’re hugely underestimating the extent to which the Washington Consensus was a consensus. It really was. And it was a consensus around a set of policies which (as nobody except Wynne Godley seemed to realise) implied a structurally growing financing sector and structurally increasing leverage.”

This is a view I have been pushing for a while, glad to see you agree.

Are you a fan of http://www.amazon.de/Between-Debt-Devil-Credit-Finance/dp/0691169640 – I’m thinking it is a must read for me, as I have pushing this line for a while. (But I do think the international imbalances is a big part of the issue – with the world’s demand for USDs being a major part of the creation of the distortions.)

110

reason 12.01.15 at 10:34 am

p.s. dsquared @107
Yes that is a clear statement.

The Washington consensus was basically that you should reduce all of taxes, government spending and trade barriers and loosen monetary policy. It worked so well that equilibrium real interests are highly negative and private indebtedness has increased massively. So while the process of getting to this point was in a sense “successful”, we now can no longer follow this policy regime and the political class doesn’t seem to have understood that yet.

111

ZM 12.01.15 at 10:41 am

dsquared,

“If we think this is all about the financial sector, then Euroland (for example) is doing the right thing, and in general (since there has been a massive step shift in financial regulation) we could expect things to get better in the medium term. If this is a more general problem of stagnation and bad policy choices, particularly with respect to government spending, then we’re just making avoidable problems for ourselves by throwing sand in the monetary policy transition mechanism.”

I still don’t think “stagnation” should be seen as a problem, as both in the contexts of environmental sustainability and of global inequality you would want to decrease material consumption in the more advanced economies.

The Guardian even ran a piece saying that polling showed a majority of people thought decreasing consumption was a good idea “”According to recent consumer research, 70% of people in middle- and high-income countries believe overconsumption is putting our planet and society at risk. A similar majority also believe we should strive to buy and own less, and that doing so would not compromise our happiness. People sense there is something wrong with the dominant model of economic progress and they are hungry for an alternative narrative.”
http://www.theguardian.com/global-development-professionals-network/2015/sep/23/developing-poor-countries-de-develop-rich-countries-sdgs

But consumption is a separate issue from the ideological issues you have mentioned — where the governments have wanted to turn previously public institutions or services into private ones, which has increased the use of financial services — for instance Superannuation policy in Australia.

I think you would run into a problem here sort of, in terms of Superannuation funds would not acquire interest in an economy that wasn’t growing. In which case you may as well just fund people’s retirement by taxes as investments, unless you had another reason to favour Superannuation over government pensions, like wanting people to take more of a role as being shareholders to vote at company AGMs or something.

I think this is sort of a general epistemological or ontological problem with economics — although more in the order of economics doesn’t have a proper epistemology or ontology.

Economics favours national economic growth, but without any good reasons. But once you decide that the economic growth is unnecessary then why should you have superannuation instead of government pensions, what are the financial services for then — if your superannuation isn’t going to grow because the economy should get smaller then stay the same — what would the superannuation company financial services workers be doing? Trying to decrease the value of your investments until they have got low enough?

If the growth of financial services is due to macro level policy factors based on ideologies of privatisation and growth — if the macro level policy changes to reflect that environmentally consumption should decrease — then would policy still favour privatisation and if there is no growth what would happen to company shares and superannuation?

112

ZM 12.01.15 at 10:46 am

“Once you’ve made the first two decisions, you have a choice between either making the third or having permanent recession”

so i guess what I am asking is, if you choose a permanent recession until you get to an environmentally sustainable and more equal global economy — how would you manage that happening in the economy?

113

reason 12.01.15 at 10:47 am

P.p.s. Re privatisation.
It seems to me privatisation is not so much an essential part of the Washington concensus but was introduced as a way a squaring the circle of reducing taxes AND reducing government debt (to allow looser monetary policy). Selling assets isn’t really budget discipline, but it can pretend to be (although again like the whole policy mix has proved to be, it is not sustainable, it is a trick you can only do once).

114

reason 12.01.15 at 10:56 am

ZM
To be honest I think ecological sustainability is a completely different issue, and I don’t think it is entirely on topic here. An economically sustainable world, is not necessarily asset poor (I think it will probably have to be asset rich compared to today – think about the investment needed to make your house a passive house) and people will still need to have sources of income. The problem is not ECONOMIC growth as such, it is throughput growth.

Doesn’t it sort of jar you to say that surveys show that people think we should consume less, but in fact consume more. Are they hippocrites, or is it they only mean those rich people up the street?

115

Alex 12.01.15 at 10:57 am

If anyone doubts that there was a consensus about holding back on wages, and implicitly letting people lever-up, here’s IG Metall’s Klaus Zwickel in 1995, in a great piece by Peter Bofinger:

http://www.socialeurope.eu/2015/12/german-wage-moderation-and-the-eurozone-crisis/

“Already in 1995 Klaus Zwickel, boss of the powerful labour union IG Metall, made the proposal of a Bündnis für Arbeit (pact for work). He explicitly declared his willingness to accept a stagnation of real wages, i.e. nominal wage increases that compensate for inflation only, if the employers were willing to create new jobs (Wolf 2000). This led to the Bündnis für Arbeit, Ausbildung und Wettbewerbsfähigkeit (pact for work, education and competitiveness), which was established by Gerhard Schröder in 1998. On 20 January 2000, trade unions and employers associations explicitly declared that productivity increases should not be used for increases in real wages but for agreements that increase employment. In essence, ‘wage moderation’ is an explicit attempt to devalue the real exchange rate internally.”

And Zwickel was a trade unionist.

116

Alex 12.01.15 at 10:59 am

Doesn’t it sort of jar you to say that surveys show that people think we should consume less, but in fact consume more. Are they hippocrites, or is it they only mean those rich people up the street?

Yes, yes, it is. The substitute question they’re answering is “Is vulgarity disrespectable?”

117

ZM 12.01.15 at 11:33 am

reason,

I know that there is a lot of talk about decoupling economic growth from growth in material consumption (what you say as throughput growth I think) — but this hasn’t happened.

In terms of transforming or retrofitting existing infrastructure like houses, commercial buildings, transport fleets etc to conserve and harvest energy and water and grow more food etc — I agree you would initially need what I imagine is a considerable investment to make that transition possible in a time frame that is adequate (< 35 years with progressively staged implementation targets).

But even in this period you would want a decrease in other consumption of goods which are less necessary than houses and transport, and changes in agricultural practices and so on.

And environmentally sound things which could create employment — like more recycling and re-forestation — are not the greatest commercial opportunities I would think.

So, I think that if we move to an environmentally sustainable economy it would necessarily result in a structural transformation of the economy.

In some ways this would be like a recession — but obviously the goal would be to create policy that would allow a decrease in material consumption but not mimic a recession in other less desirable ways (eg. unemployment, unplanned collapses of businesses etc).

With regard to you other question, I read an article a while ago now on what the author termed the "behaviour-impact gap" — most people think that the effort they make correlates to the impact — so they might make some efforts — like recycling quite a bit and turning off lights when they leave a room — and think they are making quite a big impact, but often they are not making as big an impact as they think, and in advanced economies the average environmental footprint is very high, so people might make quite an effort but it would still not be to sustainable levels. That is why you would need some sort of way of quantifying actions and having accountability for people, but whenever I mention rationing no one likes the idea.

I did read though that in China internet shopping has already combined with shopping in premises — so perhaps something like that would allow for quantification and accountability that was more flexible and offered more choice than wartime rationing.

118

Layman 12.01.15 at 12:46 pm

dsquared: “I’m honestly not sure what I could say to put this more clearly.”

There’s nothing wrong with that, as far as it goes. The issue is your pretense that the banksters had nothing to do with it: That they didn’t help create the consensus that led to those policy choices, that they didn’t use that consensus to free themselves from regulation, that they didn’t use their profits to further subvert the political process, that they didn’t engage in fraud to grab ever large shares of the pie, that their actions haven’t enriched themselves while impoverishing everyone else. That they’re victims rather than perpetrators. Why not say the opposite, just as clearly, just one time?

119

Lee A. Arnold 12.01.15 at 1:07 pm

Dsquared # 108:
“a) real wage stagnation as a consequence of outsourcing and trade agreements + China
b) government investment reduction…”

I think we must also look at additional factors, some of which may be included in your list, as shorthand:

1. Increasing computerization (information technology or “IT”)–
Which remands more and more people to employments that are not as amenable to productivity improvements (e.g., hands-on services; residential building construction), thus causing the lack of relative wage growth.

2. Increasing share of business investment that is spent on IT + the huge cost-reduction in that same equipment (starting with the rise of desktop computers in the 1990’s)–
Which slows growth in real investment spending, and sends world elites (not just Anglo) into pure finance and real estate in search of yields.

3. Restrictive laws and corruption in developing countries, which may prevent foreign entrepreneurs from expanding their exports further, so instead, they put their profits into international financial markets —
Which (as in #2 preceding) would increase the “surplus savings” that is “searching for yield”, particularly in global city real-estate markets and derivatives.

4. Growth in healthcare spending (due to tech advancement & demographics) + no controls, in the US, on “medical loss ratio” for US private insurers–
Which was for decades a slushy boon to US private insurers, thus increasing the size of the financial sector. (How many US health insurers were bailed-out by QE purchase of garbage mortgage derivatives?)

Note that before Obamacare, some US insurers were keeping 40% or more of the healthcare dollar, in exchange for little or no value added. Obamacare still lets them keep 20% due to a few Senators of less-than-admirable stature. Under the law in 2017, individual states could conceivably join together to make a risk-pool large enough to have a joint single-payer. Going to a US federal single-payer, sort of like Medicare for all, would be even smarter and cheaper. (And printing the money solely for that monopsony would make a big economic improvement across the board. Healthcare has peculiar supply-and-demand characteristics that would make it easy to print money yet avoid inflation. Health insurance is not like fire or auto insurance.)

5. Intellectual property protection (patents) in IT + the winner-take-all nature of IT–
Which has concentrated the incomes and wealth, and subsequently increased the size of the financial sector, in the middle of an era of quality-of-life improvements for all, despite the wage stagnation for an increasing number. We should limit patent protections, here.

Further, the new era of machine-learning, also known as neural networks or AI, looks set to automatize the very process of innovation. This makes it increasingly likely that we should discard patent protections, all together.

For an amateur example, I just verbally asked my little Android, “What’s the best way to get to the moon?” Answers: physics, business plans, NASA history… And it will be even better, tomorrow. This little phone cost me US$89, three years ago. You high-enders are wasting your money!

In a related development, a harbinger, really: Already, and for the last 7 years, an exploding number of “how-to-do-it” websites and videos show you how to avoid hiring a plumber (for example), giving decent advice in a specialty that I can judge quite well. I don’t need help with my plumbing, but YouTubes showed me how to change my auto brake pads and the water pump, no problems! The hit-counts show that many people have been turning to these during the Lesser Depression, in lieu of having the money to hire someone else — and this will continue to cause downward pressure on incomes-growth in the future.

120

Ronan(rf) 12.01.15 at 1:47 pm

I agree with js that dsquareds position seems plausible, but also (like js) I don’t see how this can all be divided out so easily. This was also greta krippners argument (iirc) who in her book on the topic made a much more policy orientated explanation (closer to dsquareds) for the financialisation of the US economy (though policy makers reactively responding to distributional conflicts in the 70s rather than being driven by ideology) Even she noted, though, that to quantify and rank what was driven by vested interests, by ideology, or by public preferences is basically impossible.
Surely it’s all of the above . The shift in the economy (whatever its cause) changes policy makers , politicians and the electorates preferences by developing a set of interests and ideologies that both support and want to extend the status quo . Seems like a banal point to make, I know.

121

John Quiggin 12.01.15 at 2:03 pm

@120 That’s pretty much my view of this aspect of the issue. I’d prefer discussion of some of the other points now if anyone is still interested.

122

Number 12.01.15 at 2:06 pm

Lee,

Excellent points, and I agree with 1), buy I would use different examples. Health care, particularly morbidity related care, is difficult to do without humans (the Japanese have done a lot of work, but are still years away from robotic home health care workers),ergo poor productivity growth as benefits costs grow faster than income & productivity. Residential construction has actually seen a sea change in productivity as the public US home builders now no longer build-on-site, but rather build in higher productivity factories, and merely “assemble-on-site”. it has had a meaningful improvement in productivity.

123

reason 12.01.15 at 2:59 pm

Aaron Brown @18
“For one thing, I don’t see that the two bubbles and one bust of 1996 – 2015 are self-evidently worse than the more numerous bubbles and busts of 1976 – 1995. You might say the 2008 brush with Great Depression outweighs the hyperinflation and multiple deep recessions of the earlier era”

1. There was no hyperinflation. There was relatively high inflation following oil supply restrictions
2. Look at the GDP and employment growth statistics and you will see there is no comparison. True there were some financial busts, but their impact was relatively limited because of low overall levels of leverage – so the system was more resilient.

But I think the main issue, as I have mentioned, is that we have a gone a path of disinflation and increasing leverage that has now lead us into a dead end. We simply cannot continue on the path we have followed.

124

reason 12.01.15 at 3:04 pm

One thing that I haven’t heard mentioned, is that financialisation is a de facto transfer of ownership of resources. If I go to the bank and borrow money to buy and asset then what happens? The bank creates money and gives it to old owner, and I become the nominal owner but the bank gets to hold the asset as security. And I pay rent (called interest) then to the bank. And continuation of this process inflates the price of the assets and decreases yields. So that the bank is earning lots of rents of assets that they nominally do not own (at least until their clients become insolvent). I think this is where both the liquidity trap and the growth in profits of the financial sector comes from. Is there something wrong with this logic?

125

Doug T 12.01.15 at 3:18 pm

It seems like most of the discussion here so far has been top down–looking at broad ideological or structural changes, and the interplay of those with the financial sector. Which is surely important, and makes for interesting debate. But it seems to me that there might also be some illumination from taking a bottoms up look as well.

Specifically, I mean examining the financial sector and trying to parse out exactly where and how it’s making these increasing profits. What have the growth areas? Is it in real estate/mortgages? Investment management fees? Mergers? Other areas? (And I honestly don’t know enough about the details of the sector to even say if this list is a reasonable one.)

Certainly the big picture factors are important, but the nuts and bolts of where the money is actually coming from could also help evaluate the various hypotheses and point to areas that are worth thinking about in more detail.

126

Akshay 12.01.15 at 3:38 pm

JQ@120: Well, to touch on another issue, how do you precisely see the role of tax evasion? Not understanding modern fiscal evasion constructs, I can imagine that if I were super-rich or a corporation, I could pay a tax adviser to avoid paying taxes on my wealth. But then I would own a pile of money in some tax haven, which I am too lazy and ignorant to manage. So I hire a fund manager, who notices my ignorance and promptly captures most of the yield of managing my assets. Is that the mechanism, i.e. tax evasion –> idle savings –> demand for financial experts? Or do you mean something more sophisticated? In the first case, it seems like a case of wealth inequality leading to a savings glut.

While we leave the topic of the borrowers (in the housing market) to focus on the savers, I guess that institutional investors such as pension funds play a role as well. In ageing societies, we can expect at least these financial players to be growing in relative importance. From a political-economy perspective, pension funds have the interesting property of tying peoples’ fates during retirement to the fate of the stock market. Policies to boost the stock market will then provide an additional boost to the real economy by making people feel wealthier and inducing more spending.

127

T 12.01.15 at 3:49 pm

Wage stagnation started in the 80s. But the China effect doesn’t really kick in until 2000. Manufacturing employment doesn’t fall until 2000 either. If you want to start your story and explanation in 2000, fine. But less so if you want to start it with the “economists and ideologues” in 1980. https://research.stlouisfed.org/fred2/series/IMPCH http://data.bls.gov/pdq/SurveyOutputServlet

On the other hand, the rapid increase in finance’s share of gdp started in the early 80s.
https://upload.wikimedia.org/wikipedia/commons/9/92/NYUGDPFinancialShare.jpg

It’s not like we don’t have an actual historical record to help us work this through. And the finance rent-seeking story seems to fit pretty nicely.

And it’s not as if the financial oligarchy story is something wild and new. Simon Johnson was writing about it in 2009. http://www.theatlantic.com/magazine/archive/2009/05/the-quiet-coup/307364/

128

Aaron Brown 12.01.15 at 4:56 pm

reason @123
1. There was no hyperinflation. There was relatively high inflation following oil supply restrictions

2. Look at the GDP and employment growth statistics and you will see there is no comparison. True there were some financial busts, but their impact was relatively limited because of low overall levels of leverage – so the system was more resilient.

But I think the main issue, as I have mentioned, is that we have a gone a path of disinflation and increasing leverage that has now lead us into a dead end. We simply cannot continue on the path we have followed.

Personally I think that globally the performance of free market currencies from the mid 70s to the early 80s can be described accurately as “hyperinflation,” and that the oil shock was merely a trigger exposing a fundamentally unsound monetary situation. I’m not just talking about the consumer price index, I’m talking about rationing, price controls, withdrawal of valuable goods and services from exchange for money and effective purchasing power depending more on your tax attorney than your bank balance. Similarly, I think that the stagflation of the 70s was far worse than the severe recession of 2007 – 09 (and counting, in some respects), not so much from official statistical aggregations but from the evaporation of opportunity and the descent into real poverty.

But as you say, that’s not the main point. The 197os and the 2000s both had their good and bad points. Your main point is we are currently in a unsustainable situation with too much leverage and disinflation. While I wouldn’t phrase it exactly that way, I agree directionally.

I have two main points. The period of financialization, whether measured from the mid 80s or the mid 90s has not been self-evidently more volatile than the preceding period. You could argue it is more volatile, but someone who took the other side could certainly keep a straight face.

Second, no one thinks financialization reduces volatility. What it promises is increased opportunity and growth, and reduction in poverty. A known cost is that there is more creative destruction, more booms and busts, more forced change.

Therefore, you cannot dismiss the claim that the financial sector produces good to match its profits by waving your hands at “the last 20 years of bubbles and busts.” That’s both because the last 20 years are not obviously more volatile than the preceding periods, and because the existence of booms and busts do not prove the financial system is doing net harm.

It seems to be that if you want to argue that financial system profits are excessive, you have to show that there is a cheaper way to accomplish equally good or better economic results. To make the case self-evident, you need strong examples of that other way actually working, not just theoretical assertions (theoretical assertions may be correct, but they have to be argued, you can’t just point to “the last 20 years” and leave it at that).

The last 20 years have seen extraordinary reductions in global poverty, solid global economic growth, unprecedented decreases in global violence and tremendous innovation. Sure, things could have been better, and perhaps the global financial system didn’t contribute to the good things, or it overcharged for its contributions. I’m just not sure why anyone thinks this is so obvious that it need not be explained.

129

SamChevre 12.01.15 at 7:01 pm

Wage stagnation started in the 80s. But the China effect doesn’t really kick in until 2000.

In the 1980’s, it was the Japan effect.

130

T 12.01.15 at 8:03 pm

@129
The trade deficit with w/Japan in the mid to late 80s was about $50B. The current trade deficit w/China is in the $300B range rising from about $70B in 1999. So it seems the China effect was much bigger. You also see that in the employment in manufacturing data linked to in 127. Also, you did have some significant tech shifts in manufacturing in the 80s. For example, it used to take about 600K US steel workers to make 100 million tons of steel. Today about 100,000 workers.

131

greg 12.01.15 at 8:52 pm

reason @ 123 & 124:

You have disinflation in the real economy, but inflation in the fictitious (financial) economy. They have become separate economies. Money is being taken out of the real economy and pumped into the financial economy. Not only does this drive up the price of financial assets, (like money, BTW. but other assets which do not have a real value in themselves, but only value depending on the health of the real economy. Most tech toys and their industries, for instance. ) but financial assets chasing each other also drive up the price of financial assets.

Imagine a continuum of reality, starting at the left and going to the right, most real on the left, and decreasingly real and increasingly imaginary as you go to the right : Food and energy, on the left end, mining, then manufacturing, transport, etc, retail, hospitality, etc. in some order, high tech in there somewhere, then money in its various forms, bonds, stocks, etc. derivatives, other phantasmagorical financial instruments. It is an enormous bubble of ‘value’ where each item to the right is dependent for its survival on the health of the parts of the economy to its left. If, for instance, the food and energy sectors collapse, none of the rest of it will have any value.

The economy on the right is easy to capitalize and leverage and extract (financial) profits. So all investments are allocated over there. ( Capitalism invests in what is profitable, and only incidentally in what is needed.) The economy on the left, however, is leverage poor, and profit poor, so it is instead being allowed to deteriorate, and even where possible, plundered for its capital.

It is the size of this bubble which is maintaining the value of the dollar. And as the bubble increases relative to the size of the money supply, the value of the dollar also increases. (There is also a deflationary effect due to the trade deficit, since money is continually being taken out of the real economy, and put into the fictitious economy when, say, the Chinese deposit their money in US banks.)

It is all, of course, a manifestation of debt. Were the debt of the real economy honestly accounted for, it would be clear to everyone that there was no possibility that the people who actually produce the things we need could ever paying those f**king bloodsucking leeches even a fraction of what our f**king masters of the universe have defrauded the people of the world out of.

Indeed, our masters own our world several times over.
It just comes down to the day they decide to collect what is owed them.

132

Bruce Wilder 12.01.15 at 9:18 pm

Financialization of the economy can also press considerable inflation into “markets” where insurance comes to mediate transactions. Health care is the oldest case: private, for-profit health insurance in the U.S. has at least doubled the cost of health care relative to the standard set by other advanced economies (e.g. France, Japan, Taiwan, Germany, Canada).

The introduction of insurance into dental services and veterinary services has had similar and quite dramatic effects on the cost of such services.

For the poor, financialization creates pressure to rent everything: furniture, appliances with similar inflation built-in.

The considerable reduction in personal home ownership since 2008 has been followed by increases in rent, and notably increases in rent as a percent of household income. The increase relative to household income where I live, in Los Angeles, is frightening.

133

Bruce Wilder 12.01.15 at 9:25 pm

Aaron Brown: . . . we have a gone a path of disinflation and increasing leverage that has now lead us into a dead end. We simply cannot continue on the path we have followed.

Now without screwing someone pretty badly: it becomes a political stalemate until someone moves the ratchet downward on the 99% or the 1%, as the case may be. In 2008 and its aftermath, in the U.S. about 4% of the workforce was disemployed more or less permanently and the the Federal debt increased by some multiple, and U.S. economic performance is conventionally regarded as relatively good.

134

Bruce Wilder 12.01.15 at 9:46 pm

Part of the fiscal underpinning of a fiat currency is being able to collect taxes. The short answer to what to optimally tax is Henry George: tax economic rents, which are, after all, arguably the secure portion of incomes dependent on the rule of law.

Back in the bad old days (irony intended) 1947-71, the U.S. collected a corporate income tax that was in large part a tax on economic rent. It was an implicit constraint on rentiers and, along with local property taxes, allowed the government to earn a return on those public investments that contributed to general economic growth. It also contributed to the honesty of corporate financial reporting and the stabilization of corporate finance (since the corporate income tax was refundable against subsequent losses).

Of course, the corporate income tax is in tatters, notoriously avoided by many of the most profitable companies. We are regularly told that efficiency demands more consumption taxes. Like the poor and the middle classes are not screwed enough already. When financial fraud creates mountains of bad debt, that bad debt must be converted into full faith and credit obligations of the government, funded by consumption taxes. But, the economic rents that show up in the corporate profits or the incomes of hedge fund managers or the capital gains of billionaires — those are untouchable. State-funded education must be privatized, the funds channelled thru Charter Schools and Higher Education, which was once heavily subsidized by the States is now financed by debt loaded onto the students — well that half of the student population whose parents cannot afford to pay (welcome to the class system 3.0)

We have secular stagnation, because secular stagnation is policy. Technology is not a devil that made us do it, nor did Technology and Globalization do it to us with the supreme indifference of Trends. This was something chosen for us by our Masters.

The value of money depends now on doubling down on predatory and parasitic taxes. It is the monetary equivalent of, Soylent Green is People.

135

Anarcissie 12.01.15 at 11:09 pm

greg 12.01.15 at 8:52 pm @ 131:
‘… Indeed, our masters own our world several times over.
It just comes down to the day they decide to collect what is owed them.

But that would be the end of the game.

136

Peter T 12.01.15 at 11:34 pm

dsquared is probably right about the macro policy, but I think in this, as in many other cases, the ideology and the macro policy came after the shift – the one to justify and reinforce, the other because, as dsquared notes, it was the path of least resistance.

The steam went out of the industrial economy in the UK in the late 60s, which led people like Jim Slater (https://en.wikipedia.org/wiki/Slater_Walker) to transform industrial firms into financial ones (and cannibalise the vulnerable parts of the industrial economy). In the US, people like Jack Welsh at GE were on the same path from the mid 70s.

137

greg 12.02.15 at 2:13 am

Anarcissie @135:

Oh, this game will end.

Are you ready?

138

Anarcissie 12.02.15 at 5:31 am

greg 12.02.15 at 2:13 am @ 137 —
Probably not. I had the real estate bubble figured out in ’03, and got away with a modest bundle, but the next Event is probably going to make all that look like the proverbial Sunday-school picnic, and much of its mechanism is still hidden (from me, anyway).

139

Ze K 12.02.15 at 7:11 am

And finally, monsieur Creosote, a wafer-thin mint.

140

reason 12.02.15 at 8:10 am

Aaron Brown @128
How old are you? I lived through the 70s – now is definitely worse. And arguably the high inflation was the least painful way to cope with the massive change in the terms of trade that occurred at the time. Hyperinflation has a definite meaning and the 70s wasn’t hyper-inflation (people were still saving). Now inflation is definitely too low. If you want to use your own language then feel free to talk to walls.

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reason 12.02.15 at 8:13 am

Aaron Brown @128
And volatility isn’t the point, fragility is the point. It is not the same thing.

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reason 12.02.15 at 8:30 am

Aaron Brown @128
I think the story is easy to explain (and the size of the financial sector in the west has nothing at all to do with globalisation and everything to do with increasing levels of domestic debt – that really is an obvious attempt at misdirection – you need to more subtle next time).
You can increase the money supply within an economy in three ways
1. government fiat
2. balance of payments surplus
3. private lending
And the EFFECTIVE money supply is that which is circulating and not sitting passively in accounts – so the more that is passive (and it seems reasonable to suppose that increasing inequality increases the passive proportion) the more money supply you need. And I guess we agree that you need an increasing amount of circulating money in a growing economy to avoid stagnation.
So in the case of the US you had a large balance of payments deficit and bond issues for new government debt and so you needed increasing private lending in order to expand the money supply. Increasing leverage increases individual insecurity, it doesn’t actually increase volatility (remember the period of increasing leverage was called the “great moderation”). At some point this increase in individual insecurity leads to a massive fall in economic confidence and people will no longer increase their borrowing. This is what I mean by increasing fragility.

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reason 12.02.15 at 8:46 am

Bruce Wilder @133
That was me not Aaron Brown – Aaron was quoting me – he just messed up his italization.

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Aaron Brown 12.02.15 at 9:33 pm

reason @140

I am 59 and lived through the 1970s. In terms of economic failures hitting middle class people in developed countries, there’s no comparison. I sat in gas lines for hours, only to learn that no gas was available. We had candles for the frequent power outages, not because we couldn’t pay for electricity, but because no electricity was available. Many of my acquaintances moved to the underground economy, these were citizens with college degrees and formerly professional jobs. I worked on the federal standby gas rationing plan and can tell you (a) there was some very scary stuff in there and (b) most of us believed it was more likely than not to be put into place. Violent crime rates were three times current levels and property crimes were double. In no US state was it a crime for a husband to rape his wife, up until the day the divorce was final, and in the majority of states a man had a legally-recognized right to physically “chastise” his wife (in all states he could do that to his children, or in many cases, other people’s children). Homosexual activity was a felony, and the laws were often enforced. That’s the kind of stuff that gets left out of GDP growth and unemployment rates.

If you look at the larger global population, more than half the world was under control of totalitarian horror states, and no country had ever emerged from Communist dictatorship to freedom and prosperity (we did have examples of emergence from Fascist horror states, unaffiliated horror states and non-totalitarian socialist states). In the relatively free half of the world, literal paranoid lunatics were in charge of the largest countries, and mutually assured destruction was considered a sane policy. I sincerely and I think reasonably believed that if I were to die in a year (I was healthy and in my teens and 20s) the most likely cause would be nuclear war. There were active shooting wars all over the globe backed by superpowers.

36% of the world lived in “extreme poverty,” and using consistent definitions that number is essentially zero today (or would only cover people in war zones and other places where poverty is hard to define and not the main problem) and less than 10% of the world is living in non-extreme poverty. And most people with adequate food, clothing, shelter and medical care still had little access to information, education or economic opportunity.

There’s no comparison to today. Things are much, much better.

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reason 12.02.15 at 9:41 pm

Aaron Brown,
don’t know where to begin with that diatribe. But lets just say, that most of what you are talking about has nothing at all to do with “hyperinflation” or recession.

146

reason 12.02.15 at 9:44 pm

P.S. I was in Australia, and a lot of what you are talking about is US specific.

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Aaron Brown 12.02.15 at 9:49 pm

reason at 141-143

Sorry for the mixed up italics. I noticed it as soon as I submitted, but couldn’t figure out how to edit.

I’m not sure what you mean by “an obvious attempt at misdirection.” I’m sincerely asking for information, not promoting a position. When the original post said “the last 20 years of bubbles and busts,” I had no idea if that meant in the US or globally.

And volatility isn’t the point, fragility is the point. It is not the same thing.

Now this makes sense to me. Putting it another way, it’s not that the bubbles and busts of the last 20 years did so much damage that it’s laughable to argue the financial system is worth its cost, it’s the potential for future disasters (or perhaps you would say, the near-certainty of future disaster).

One minor point of disagreement is I don’t think increasing inequality increases the proportion of money that is passive. Of people who have positive net assets, cash as a fraction of those assets declines with wealth; and among people with negative net assets, cash as a fraction of income mostly declines as income rises.

Switching from asking for information to arguing, I think you’re directionally correct about the problem but I have far more uncertainty than you about how things will work out. I would agree that some financial activities make the problem worse, and I would also state (I don’t know if you agree or not) that a lot of financial services are costly and useless. However I think that a lot of financial activity is extremely useful, especially in light of fragility, perhaps useful enough to justify the profits of the entire industry.

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Aaron Brown 12.02.15 at 9:55 pm

Reason @143-144

My point is that the economy hurt people far more deeply in the 1970s than in the last 20 years. It’s not so much that CPI rose faster or that GDP rose slower, those things you could argue either way. It’s the impact on people’s lives, whether you’re talking about middle class people in developed countries or everyone in the world.

The things I described were worse in the UK than the US, and probably about as bad in most of Western Europe. Things played out differently in other countries, but the big things were bad for everyone.

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Peter T 12.03.15 at 8:59 am

“the big things were bad for everyone.” Really? Here in Australia the last 20 years has been distinctly worse for most than the 70s. Politically turbulent, yes. Economically, not so much.

I’m surprised no-one has mentioned that the late 70s/early 80s were when resource depletion and the environment came to the fore. I can think of several plausible ways these added a few knots of head-wind to various economies (and most to the British and American, as previous beneficiaries of windfall largesse), and so encouraged a turn to financial extraction.

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TM 12.03.15 at 10:07 am

149, agreed. Ecological limits to growth is the elephant in the room that Piketty and those who follow his analysis studiously avoid mentioning.

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reason 12.03.15 at 10:29 am

Aaron Brown
Which people are you talking about? I think you have specific people in mind (i.e. anecdote is not data). I don’t think what you are saying is in general true.

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reason 12.03.15 at 10:36 am

Aaron Brown @147
“One minor point of disagreement is I don’t think increasing inequality increases the proportion of money that is passive. Of people who have positive net assets, cash as a fraction of those assets declines with wealth; and among people with negative net assets, cash as a fraction of income mostly declines as income rises.”

Cash held by investors is not the only passive money. Cash held by firms is just as passive.

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greg 12.03.15 at 6:13 pm

Anarcissie @138:

Consider the implications of all that idle cash reason is talking about in his recent comments. Q No 1: Why is it idle?

And please check out my blog. Thanks.

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Aaron Brown 12.03.15 at 7:47 pm

reason @151

Which people are you talking about? I think you have specific people in mind (i.e. anecdote is not data). I don’t think what you are saying is in general true.

and Peter T @149

Here in Australia the last 20 years has been distinctly worse for most than the 70s. Politically turbulent, yes. Economically, not so much.

My specific post referred both to middle class people in developed countries ( I admit I was thinking of US/UK/Western Europe/Japan, not Australia, about which I know little) and to global aggregates. However for the purposes of this discussion, I don’t have to prove that the economy of the 70s inflicted more pain on individuals than the economy of the last 20 years; just that the economy of the last 20 years has not been so terrible compared to history that no one can defend financialization with a straight face.f

Ultimately I think this comes down to de gustibus non est disputandum. Depending on where you were, what your economic status was and what your tastes are, you might like the 70s more or less than the last 20 years. And even given that, you might disagree about how much of that difference was caused by the economies of the times. It’s not anecdote versus data, it’s not a question that goes beyond data. If we do resort to data, on the two measures mentioned so far, inflation and global poverty rates, the 70s were clearly far worse.

reason @152

Cash held by investors is not the only passive money. Cash held by firms is just as passive.

That’s actually quite complicated. If you mean “Cash and cash equivalents” on corporate balance sheets, that’s mostly going to be either in repo or securities that other financial intermediaries have repoed. Bank accounts are a small part of it, and physical currency a negligible part. Also, it can be in different currencies. The effect on the money supply, and on money supply of specific countries, of increased balance sheet numbers for cash could go either way.

On the other hand, if you mean M2 cash held by corporations, that’s very active, far more active than M2 cash held by individuals. Big corporations practice just-in-time cash management. Smaller ones keep balances in return for banking services, and those balances are small relative to cash transactions by the business.

Finally, I don’t see what increasing inequality has to do with how much cash corporations hold. Cash decisions are driven by straightforward microeconomics, not long-term macro changes.

Personally, I think the amount of passive cash is likely to be determined mainly by local conditions: anticipated inflation, cost (positive or negative) of holding balances, alternative liquid investments and financial uncertainty. Putting it another way, I don’t think most of it is really passive, it’s just sluggish; and if conditions change, it will drain off to other places or accumulate further.

Slow changes in economic aggregates like inequality probably have second-order effects at most.

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reason 12.04.15 at 8:43 am

Aaron Brown @151
“If we do resort to data, on the two measures mentioned so far, inflation and global poverty rates, the 70s were clearly far worse.”

Now that is really cherry picking (especially when you start with only middle class people in large parts of the developed World (which you cannot possibly know intimately). It is well known that rates of change (i.e. prospects) are much more important to the sense of wellbeing than levels, particularly the rates of change of median wages. The 70s were not only affected by oil supply restrictions but by a rapidly growing workforce – and still provided better prospects than people see today. I think you are really interpreting things a very personal window.

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dax 12.04.15 at 12:34 pm

Financial firms transfer income from governments to themselves, via tax arbitrage. This has decreased since 2008, most notably on US equity held by foreigners. This tends to be actively done, but it’s often not even noticeable to those on either end. E.g. there is an asset (e.g. option on stock) which will cause different tax rates based on the holder. The asset will tend to shift from the highly-taxed party to the lower-taxed one, even if neither understands or cares what the tax characteristics of the other one is (they will notice the other one is willing to send at a price they find attractive, end of story). The fault here lies mostly with governments, for allowing complicated and arbitratable tax rules to be put into effect.

Financial firms transfer income from the household sector to themselves. The household should have expected x% of interest from a particular investment. In fact the expected value was x-y%. The financial firms pocketed some of that y. Some of this can be dishonest – the financial firm knew that x-y was the expected value and profited from a misapprehension by the household sector. But it can also not be – the financial firm might not have known, and have been as deluded as the household sector, although for different reasons. (When one earns a lot of money for doing something, it’s human tendency to think one has earned it, not that one has extracted it dishonestly from someone else.)

The Libor fixing cartels did not produce substantial money for financial firms, because they tended to be random and non-systematic. The one long-lasting, systematic problem with Libor – banks underreported their Libor rates doing the crisis because they feared a higher rate might make it look they had trouble getting funding – resulted in a low Libor rate and benefited the household sector enormously. Anyone who had a loan pegged to Libor during this time received an enormous benefit.

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Aaron Brown 12.04.15 at 3:56 pm

dax @156

Financial firms transfer income from governments to themselves, via tax arbitrage.

. . .

The fault here lies mostly with governments, for allowing complicated and arbitratable tax rules to be put into effect.

Financial firms transfer income from the household sector to themselves.

I would make your first point more general. A lot of financial business consists of arranging things to change regulatory or tax treatments. This explains the entire financial sector in the Cayman Islands, Luxembourg, Bermuda and other offshore locations; plus a good part of it in places like Ireland and Singapore.

I think the profits from these activities should be treated as costs of regulation or deadweight taxation losses, not as excessive financial system profits. In these cases, the financial sector is delivering a service that is well worth the costs to its customers; and the business is extremely competitive.

I wouldn’t call it financial firms transferring income from governments to themselves. As you say, the business and its profits exist due to the way rules are written and enforced. In some cases, the transactions are deliberate consequences of the rules, that’s not a transfer. In other cases, particularly with regard to corrupt or kleptocratic regimes, the “transfer” consists of helping customers avoid government robbery.

Even in the case where the transfer results from an unintended loophole in taxes or regulations made by a reasonably honest government, the proper fix is to close the loophole, not to restrict the ability of financial firms to make money serving their customers. For example, suppose a government paid for all healthcare expenses of its citizens, and people started charging gym memberships, tanning salon services and hair replacement to the government. It wouldn’t make sense to shut down or regulate harshly all the gyms, tanning salons and hair clinics; it would make sense to tighten the reimbursement rules (unless, of course, the government intended to cover those services). If anyone is transferring income from the government it’s the citizens using these services, not the services themselves, which are merely providing legal and honest services for fair prices to willing customers.

I also don’t buy the transfer from the household sector. What you say is true of all middlemen. A car costs $15,000 to manufacture, but the customer pays $25,000, with the difference going to a variety of providers of transportation, financing, warranty and dealer services. For that matter you could go one level further and say the raw materials in a car cost only $2,000, but the customer pays $25,000; or even that the raw materials are things sitting around in the ground and should belong to everyone.

Similarly, if an investor in a mutual fund has interests in economic assets that produce $100 of value in a month, some of that money will go to intermediaries. This is not a transfer from investor to the financial system, the investor pays it for the convenience of having a daily liquidity, diversified mutual fund managed by others rather than, say, a direct interest in an apartment building or a mine. Investors who feel the financial system overcharges for its services are free to buy economic assets directly.

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