Financialization – “a pattern of accumulation in which profit making occurs increasingly through financial channels rather than through trade and commodity production.”
– Greta Krippner, University of Michigan (source Wikipedia)
If you want one word to describe the biggest threat to the American economy, “financialization” would be the prime candidate. This is a threat that has no ideology. The left tends to blame economic challenges on the excessive power of oligarchs. The libertarian right tends to blame economic challenges on excessive regulations emanating from oversized government. But financialization empowered the oligarchs. And financialization is the toxic remedy that has, for a time, enabled oversized government.
Krippner’s analysis of financialization goes beyond its obvious manifestations – the most obvious being the loophole that allows hedge fund managers to avoid paying ordinary income tax on the billions in bonuses they earn when they get lucky placing bets with other people’s money. An excellent in-depth article in Time Magazine published on May 12th, entitled “American Capitalism’s Great Crisis,” quotes Krippner’s deeper explanation of how financialization began:
“The changes were driven by the fact that in the 1970s, the growth that America had enjoyed following World War II began to slow. Rather than make tough decisions about how to bolster it, politicians decided to pass that responsibility to the financial markets. The Carter-era deregulation of interest rates—something that was, in an echo of today’s overlapping left-and right-wing populism, supported by an assortment of odd political bedfellows from Ralph Nader to Walter Wriston, then head of Citibank—opened the door to a spate of financial “innovations” and a shift in bank function from lending to trading. Reaganomics famously led to a number of other economic policies that favored Wall Street. Clinton-era deregulation, which seemed a path out of the economic doldrums of the late 1980s, continued the trend. Loose monetary policy from the Alan Greenspan era onward created an environment in which easy money papered over underlying problems in the economy, so much so that it is now chronically dependent on near-zero interest rates to keep from falling back into recession.”
Carter. Reagan. Clinton. It’s important to document the bipartisan emergence of financialization. It can’t be unwound, or even discussed accurately, simply by referring to conventional ideological schisms. The impact of financialization in America has been to enable private households and government agencies to spend more than they take in, and to make up the difference by borrowing more than they can ever hope to pay back. And through it all, for the past 40+ years, the financial sector has extended the credit, accumulating more power and profit every step of the way. Ideology and partisanship provided the justifications and the means, but they came from the right and the left.
Estimates vary as to how much corporate profit now accrues to the financial sector in the U.S., but range between 25% and 40%. By comparison, in Germany the financial sector earns about 6% of corporate profits. America’s overbuilt financial sector attracts the brightest college graduates. Math majors who might have gone into applied physics, engineering, chemistry, now migrate to Manhattan and work for the hedge funds.
Closer to home, here’s how financialization has harmed ordinary Americans:
- Created an incentive through low interest rates and tax law for people to borrow instead of save,
- Rendered housing and college tuition unaffordable, thanks to low interest rates inducing borrowers to bid up prices,
- Destroyed the ability of thrifty households to save, because only risky investments offer adequate returns,
- The emphasis on shareholder value above all else has depressed wages and driven jobs overseas,
- Attracted brilliant innovators to work for financial firms (which produce nothing) instead of actual industries that create jobs and national wealth.
There’s more – and this is the least discussed but perhaps the most significant consequence of financialization. It expands the public sector, and it helps public sector unions. Here’s how:
- Governments can expand beyond the capacity of their tax revenues by borrowing at low interest rates,
- Government unions can negotiate over-market pay and benefits, relying on borrowing to cover deficits,
- Government pension funds can make risky investments with the taxpayers backing them up,
- As financialization drives middle class citizens into poverty, the government expands its aid programs.
The connection between government unions and the financial oligarchs who currently run both political party establishments may be abstruse, but it isn’t trivial. They have a common interest in a financialized economy; a common interest in seeing what is now the biggest credit bubble – as a percent of GDP – in American history get even bigger. This is explicitly contrary to the interests of ordinary Americans. The awakening grassroots resistance to the financialization of America explains the rise of populism in 2016, and it’s just begun.
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Ed Ring is the President of the California Policy Center.
During the industrial age, labor unions played a vital role in protecting the rights of workers. Skeptics may argue that enlightened management played an equally if not greater role, such as when Henry Ford famously raised the wages of his workers so they could afford to buy the cars they made, but few would argue that labor unions were of no benefit. Today, in the private sector, the labor movement still has a vital role to play. There may be vigorous debate regarding how private sector unions should be regulated and what restrictions should be placed on their activity, but again, few people would argue they should not exist.
Public sector unions are a completely different story.
The differences between public and private sector unions are well documented. They operate in monopolistic environments, in organizations that are funded through compulsory taxes. They elect their bosses. They operate the machinery of government and can use that power to intimidate their political opponents.
Despite these fundamental differences in how they operate, public unions benefit from the still common perception that they are indistinguishable from private unions, that they make common cause with all workers, that they are looking out for us. This is hypocrisy on an epic scale.
Hypocrites regarding the welfare of our children
The most obvious example of public sector union hypocrisy is in education, where the teachers unions almost invariably put the interests of the union ahead of the interests of teachers, and put the interests of students last. This was brought to light during the Vergara case, which the California Teachers Association (CTA) claimed was a “meritless lawsuit.” What did the plaintiffs ask for? They wanted to (1) modify hiring policies so excellence rather than seniority would be the criteria for dismissal during layoffs, (2) they wanted to extend the period before granting tenure which in its current form permits less than two years of actual classroom observation, and (3) they wanted to make it easier to dismiss teachers who were incompetents or criminals.
When the Vergara case was argued in court, as can be seen in this mesmerizing video of the attorney for the plaintiffs’ closing arguments, the expert testimony he referred to again and again was from the witnesses called by the defense! When the plaintiffs can rely on the testimony of defense witnesses, the defendants have no case. But in their appeal, the defense attorneys are fighting on. Using your money and mine.
The teachers unions oppose reforms like Vergara, they oppose free speech lawsuits like Friedrichs vs. the CTA, they oppose charter schools, they fight any attempts to invoke the Parent Trigger Law, and they are continually agitating for more taxes “for the children,” when in reality virtually all new tax revenue for education is poured into the insatiable maw of Wall Street to shore up public sector pension funds. No wonder education reform, which inevitably requires fighting the teachers unions, has become an utterly nonpartisan issue.
Hypocrites regarding the management of our economy
Less obvious but more profound are the many examples of public union hypocrisy on the issue of pensions. To wit:
(1) Public pension systems don’t have to comply with ERISA, which means they are able to use much higher rate-of-return assumptions. Private sector pensions are required to make conservative investments and offer modest but financially sustainable pensions. Public pensions operate under a double standard. They make aggressive investment assumptions in order to reduce required contributions by their members, then hit up taxpayers to cover the difference.
(2) One of the reasons you haven’t seen the much ballyhooed extension of pension opportunities to all workers in California is because the chances they’ll offer a plan where the fund promises a return of 7.0% per year are ZERO. Once they’re forced to disclose the actual rate-of-return assumptions they’re prepared to offer, and why, the naked hypocrisy of the public sector pension plans using higher rate-of-return assumptions will be revealed in terms everyone can understand.
(3) When the internet bubble was still inflating back in the late 1990’s, and stock values were soaring, public sector unions didn’t just agitate for, and receive, enhancements to pension benefit formulas. They received benefit enhancements that were applied retroactively. Public pensions are calculated by multiplying the number of years someone worked by a “multiplier,” and that product is then multiplied by their final salary (or average of the last few years salary) to calculate their pension. Retroactive enhancements meant that this multiplier, which was increased by 50% in most cases, was applied to past years worked, increasing pensions for imminent retirees by 50%. Now, with pension funds struggling financially, reformers want to decrease the multiplier, but not retroactively, which would be fair per the example set by the unions, but only for years still to be worked – only prospectively. And even that is off the table according to the unions and their attorneys. This is obscenely hypocritical.
(4) Take a look at this CTA webpage that supports the “Occupy Wall Street” movement. What the CTA conveniently ignores is that the pension systems they defend are themselves the biggest players on Wall Street. In an era of negative interest rates and global deleveraging, public employee pension funds rampage across the globe, investing over $4.0 trillion in assets with the expectation of earning 7.0% per year. To do this they condone what Elias Isquith, writing for Salon, describes as “shameless financial strip-mining.” These funds benefit from corporate stock buy backs, which is inevitably paid for by workers. They invest with hedge funds and private equity funds, they speculate in real estate – more generally, pension systems with unrealistic rate-of-return expectations require asset bubbles to continue to expand even though that is killing the middle class in the United States. This gives them common cause with the global financial elites who they claim they are protecting us from.
(5) In America today most workers are required to pay into Social Security, a system that is progressive whereby high income people get less back as a percentage of what they put in, a system that is adjustable whereby benefits can be reduced to ensure solvency, a system that never speculates on the global investment market. You may hate it or love it, but as long as private citizens are required to participate in Social Security, public servants should also be required to participate. That they have negotiated for themselves a far more generous level of retirement security is hypocritical.
The hypocrisy of public sector unions isn’t just deplorable, it’s dangerous. Because public unions have used the unfair advantages that accrue when they operate in the public sector to acquire power that is almost impossible to counter. Large corporations and wealthy individuals are the natural allies of public sector unions, especially at the state and local level, where these unions will rubber-stamp any legislation these elite special interests ask for, in return for support for their wage and benefit demands. Public unions both impel and enable corporatism and financialization. They are inherently authoritarian. They are inherently inclined to support bigger government, no matter what the cost or benefit may be, because that increases their membership and their power. They are a threat to our democratic institutions, our economic health, and our freedom.
And they are monstrous hypocrites.
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Ed Ring is the president of the California Policy Center.
“We wanted flying cars, and they gave us 140 characters,” said venture capitalist Peter Thiel in 2011. He put his finger on a central dilemma of the New Economy: its innovations can make money (usually through redirecting advertising sales), but they add little or nothing to the overall stock of human knowledge or long-term happiness. Professor Robert Gordon postulated last year that we may have come to the end of the era of perpetual growth. His theory looked foolishly pessimistic, but as the current sluggish expansion limps on, it begins to look more plausible.
Innovation can be closely correlated with the destination of the smartest graduates. The natural optimism of the young leads them to congregate where the intellectual boundaries are being pushed fastest. Over the past 40 years, by and large the brightest graduates have tended to congregate around consulting and finance, a dispiriting observation. Both of those professions, to the extent they have innovated, have produced innovations that have added cost and overhead to the global economy rather than useful output.
In the early days of strategy consulting, in the 1960s and 1970s, the profession appeared truly innovative, producing analytical frameworks such as the Boston Consulting Group’s growth-share matrix that helped managers cope with disparate portfolios of businesses. However, the poor results produced by the 1960s conglomerates showed that disparate businesses should, by and large, be managed separately. The result, as we all learned in exhaustive detail during Mitt Romney’s presidential campaign, was the rise of private equity investing, in which portfolios of disparate businesses were assembled by an equity investor rather than within a conglomerate. The “funny money” era since 1995 has provided spectacular results to private equity investors, but the level of innovation or economic benefit from their activities must be seriously doubted.
The other area of consulting that has metastasized since the 1970s is that of software management: assisting companies to get their computer systems to work with each other, or indeed to work at all. In some cases, such as a medium sized company I came across in the 1990s which lost two years of operations and profit from trying to install an over-complex software system, these consultants also subtract value rather than adding it. Indeed, the consultants employed by Britain’s National Health System, or by the Obamacare designers, seem to have been completely incapable of getting the system to work properly. This is a very lucrative business; it can be made even more lucrative by designing the system to be as complex and time-consuming as possible. In a way, this is innovation; it is certainly not productive.
Financial services doubled their share of economic activity in the 30 years to 2008 as the derivatives revolution took hold and trading desks became automated and massively faster. However, while the ability to hedge income and liabilities was highly valuable in a few cases, in general hedging was a silly game played by corporate finance departments that had themselves been converted into profit centers. Just as it is questionable whether the gambling activities in Las Vegas truly add anything to the economy, but merely redistribute income from unfortunate punters to the gangsters and low-lifes controlling the casinos, so the true economic value of the vast derivatives sector must be doubtful at best. Like consultants, financial services have increasingly become rent seeking activities, in which a small number of people make extravagant incomes, but add nothing to the real output of the economy as a whole.
While consulting continues to act like “The Fish that Ate Pittsburgh” in terms of its absorption of national resources, financial services at least have begun to retreat since 2008. No longer is Wall Street the destination of choice for the best and the brightest. Instead, after a brief period when the advent of President Obama sent some of them into government (big mistake, guys!), the eyes of the talented are now firmly set on Silicon Valley and its various offshoots across the country. The only problem is that rapid progress in the tech sector requires engineering skills quite beyond the majority of elite job-seekers, who are much more suited to a life of designing consultancy flip-charts or selling dodgy derivatives to the dozier European and Asian banks.
At first sight, a rush by the talented into the tech sector ought to be good news. PCs, cellphones and the Internet may not have enabled our cars to fly, but over the last 40 years they have revolutionized our lives in ways we never dreamed of in 1970. If the Internet did not exist, I would either have to file this column by mail (and expect a team of unionized typesetters to put it into print) or would have to commute every day two hours into New York, my nearest major city. In practice, of course, I would have compromised, and bought a house within a half-hour train ride of midtown, but I would then have subjected myself to outrageous property taxes and probably relatively high crime in the sketchy neighborhood which would be all I could afford. So yes, tech sector, thanks for the Internet.
However, the tech sector’s true boons to mankind were achieved before the best and brightest headed into that sector—not only before the recent influx, but before the first medium-sized influx which followed the unexpectedly bountiful Netscape IPO in 1995. The PC was invented by a couple of college dropouts at Apple, the Internet was invented by a government department and cellphones were developed within a large company that had specialized in car radios. Even the previous paradigm of “best and brightest” achievement in the tech sector, AT&T’s Bell Laboratories, was beaten to the cellphone by Motorola. (Although, admittedly, Motorola’s Martin Cooper had actually managed to graduate college, from Illinois Institute of Technology, a fine institution but currently ranked 109th nationwide).
In 1995-2000 (and even more since 2009) the crème de la crème flocked to the tech sector, as has an unimaginable tsunami of investor cash for any remotely plausible idea. The results so far have been distinctly unimpressive. Admittedly, the first wave of tech innovation produced Google and Paypal, two companies that have genuinely changed the way we operate, although arguably Wikipedia, founded around the same time on a completely uncommercial basis, has been even more pivotal. However this time round, the principal innovations have been in “social media,” a business enabling the less intellectually endowed to spend a high portion of their waking hours communicating the banal.
Most recently, $10 billion-plus valuations have been attached to social media companies, all of which hope to profit by accepting a portion of the finite pool of advertising dollars. Indeed, in today’s markets, profits and even revenues have tended to depress valuations. That’s because they allow investors to calculate a rational-appearing valuation, whereas “revenue-light” applications, which have as of yet penetrated only the free-user market, can triumph though the application of infinite hopes among investors and excellent marketing by the sponsors.
WhatsApp, sold to Facebook for $350 million per employee, appears only a precursor of a host of imitators that outshine among investors the solider, better-grounded companies that may actually be achieving something useful. Meanwhile, Apple and Microsoft, the daddies of tech innovation, content themselves with unveiling products largely identical to their predecessors with only a few extra features such as simply a different size.
The economic reality is that two decades of funny money, ending in six years of money that is positively hilarious, have funneled resources into hyped sectors and asset-growth scams, bypassing the sectors in which true innovation may be happening. A genuinely innovative development, such as the self-driving car, will take at least a decade to hit the road even if the regulators can be prevented from slamming the brakes on it. That’s far too long a timetable to interest private equity investors or the IPO market. Fortunately Google, like AT&T in the 1950s, is prepared to devote a portion of its profits to bringing this vision into reality.
Meanwhile, productivity grows more slowly than in any previous postwar recovery. This isn’t because Robert Gordon’s vision of a world without innovation has crept over us. Instead, sub-zero real interest rates have created an orgy of speculation through hedge funds, leveraged private equity funds and the Silicon Valley IPO industry. Such epic misallocation of capital inevitably makes the economy less efficient and starves legitimate innovation of funding and people. The mortgage securitizers of 2002-07 and the social media entrepreneurs of 2009-14 should be doing something useful. But participating in a wild, speculative bubble is much more likely to make them rich.
Innovation isn’t dead. It’s the force that will cause the U.S. economy to recover from the deep slump to which we are now heading. But for that to happen, fiscal, monetary and regulatory policies will have to be reversed 180 degrees from their current orientations.
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About the Author: Martin Hutchinson is the author of “Great Conservatives” (Academica Press, 2005) which examines the British governments of 1783-1830. He was formerly Business and Economics Editor at United Press International. Martin’s weekly column, The Bear’s Lair, is based on the rationale that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. This article originally appeared on the economics website “The Prudent Bear” and is republished here with permission.