Mariana Mazzucato - The Value of Everything - Making and Taking in the Global Economy

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

BANKS AND FINANCIAL MARKETS BECOME ALLIES

Policymakers’ faith in the value of finance was undiminished by its 2008 implosion. Indeed, their reaction to the global financial crisis was to insist that more of each economy’s ‘capital’ should be assigned to private-sector banks, and to support them with an ultra-relaxed monetary policy, in which near-zero interest rates were supplemented by central banks’ buying-up of government or even corporate bonds to keep their prices high. This massively increased the ‘asset’ side of the world’s main central banks.

Countries aspiring to achieve US levels of prosperity have long been advised, especially by their multilateral creditors, to make ‘financial deepening’ – the expansion and deregulation of banks and financial markets – a central part of their development strategy. At the same time, these creditors termed policies that restricted banks’ growth – such as capping interest rates, or restricting cross-border lending – ‘financial repression’, with the implication that financial liberalization was part of wider liberation. After 2008, as after previous regional financial crises (such as those that hit much of Latin America in 1982–3 and East Asia in 1997), the economists who had urged this liberalization asked themselves whether the unleashing of financial sectors had gone too far. But they invariably concluded that the crises were mere stumbles on a road travelled faster when financial growth was unblocked. So in 2015, the IMF concluded an exhaustive study ‘rethinking’ financial deepening by concluding that while the positive effects of the sector’s expansion might weaken at high levels of per-capita GDP, and/or if it grew too fast, ‘there is very little or no conflict between promoting financial stability and financial development’, and ‘most emerging markets are still in the relatively safe and growth-enhancing region of financial development’. 1

Yet the belief that economic progress requires a growing financial sector, with banks at the heart of it, is counter-intuitive on a number of counts. If financial intermediaries promote economic growth by mobilizing capital and giving it better uses, national output (GDP) could be expected to grow faster than financial-sector output, thus diminishing its share of GDP. This must indeed be the case for many of the most successful ‘newly industrializing countries’, if – as they claim – the US and UK financial sectors have outgrown their home economies through the export of capital and services to the rest of the world. If banks and financial markets become more efficient, firms should make increased use of their services over time, losing their early preference for internal financing of investment out of retained profit. In practice, numerous studies find that firms continue to finance most of their investment (in production and new product development) internally through retentions, because external financers know less about their activities and offset their greater risk by demanding a higher return. 2And over time, financial markets should, by gaining efficiency, be able to expand at the expense of banks, which are usually explained as an alternative mechanism for channelling funds from savers to borrowers when equity and bond markets are insufficiently developed and information isn’t flowing freely. 3Yet even in modern capitalist economies banks have entrenched their role at the centre of the financial universe, to the extent of commanding wholesale rescue when their solvency and liquidity drained away in 2008.

THE BANKING PROBLEM

As we’ve seen, problems arise in national accounting with activities that appear to add value to the economy but whose output isn’t priced. Many of the services provided by government and voluntary-sector organizations fall into this category, as do private-sector products that are made freely available, such as Google’s search engine and Mozilla’s browser. National accounts conventionally ascribe a value to these, notwithstanding the free-market critics’ objection that non-marketed goods and services are cross-subsidized by (and constitute a drain on) the marketed-sector producers, thus subtracting from national productivity. 4

But an equally serious problem arises when prices are charged for (and profits made from) a product or service that doesn’t obviously confer any value. In most parts of the economy, this is classified and condemned as monopoly rent-extraction. The trader who ‘corners the market’ in a product and resells it at a premium by withholding supplies, or stands between buyer and seller for no other purpose than to charge a commission before the two can connect, is condemned for the same unproductive profiteering as the highwayman who relieves travellers of cash before allowing them to pass. Until the 1970s, the financial sector was perceived as a distributor, not a creator, of wealth, engaging in activities that were sterile and unproductive. At that point, through a combination of economic reappraisal of the sector and political pressure applied by it, finance was moved from outside to inside the production boundary – and in the process wreaked havoc.

Governments across nineteenth-century Europe were convinced that banks added value, and were vital for the achievement of industrial modernization and economic growth. They were especially keen to promote investment banks, which were viewed as essential both to channel funds into productive investment and to co-ordinate firms and industries to raise the efficiency and rates of return on this investment. Investment banks’ importance in channelling professional investors’ funds into productive industry rose up the political agenda because early savings banks, which took deposits from households, often lost them to fraudulent or excessively risky money-making schemes and so were steered by regulation into buying mainly government bonds. 5By licensing only a few investment banks, governments granted them the monopoly power needed to co-ordinate expansion of related industries, and to achieve the profit required to absorb high risks. 6The banks’ unique role in development was recognized by some mid-twentieth-century economists, notably Joseph Schumpeter (1934) and Alexander Gerschenkron (1962). 7

The ‘banking problem’ arose because, as the twentieth century progressed, banks’ role in fuelling economic development steadily diminished in theory and practice – while their success in generating revenue and profit, through operations paid for by households, firms and governments, steadily increased. A fast-expanding part of the economy in the middle of the twentieth century was not being accounted for. The economists (like Schumpeter and Gerschenkron) who had ascribed banks a key role in development were nevertheless clear that they achieved this through exercising a degree of monopoly power, collecting rent as well as profit. Mainstream opinion, meanwhile, continued to view banks as intermediaries which, in charging to connect buyers and sellers (or borrowers and savers), made their income by capturing value from others rather than creating it themselves. Indeed today, if we use the value-added formula, we find that the financial sector, far from contributing 7.2 per cent of GDP to the UK economy and 7.3 per cent to the US (as the 2016 national accounts showed), in fact makes a contribution to output that is zero, or even negative. By this yardstick it is profoundly, fundamentally unproductive to society.