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

The economic difficulties industrial economies faced were regarded by some as a crisis of capitalism. What was not anticipated at the time was that financial markets would be hailed as the way out of the crisis. Finance turned into a growth hormone that would restore and sustain economic expansion.

The deregulation and transformation of finance was both a response to, and a cause of, huge social and economic changes which began in the 1970s. Globalization increased competition, particularly in manufacturing, and in Western countries many communities built on manufacturing – from toys to steel – saw those jobs head east to Asia. The rust belts of the American Midwest, northern England and regions of Continental Europe such as Wallonia in Belgium suffered wrenching social dislocation. Energy prices soared, driving up inflation and further increasing pressure on household budgets. The resulting slower economic growth held down wage rises in richer countries, and hence also the taxes raised by governments. Inequalities of income and wealth widened as profits’ share of national income relative to wages grew, in turn partly reflecting the weakening of workers’ bargaining power, for example by restricting the rights of trade unions and diluting labour laws.

The competing financial centres of London and New York worked out that they could attract more business by lightening their regulatory touch, with lower costs of compliance. In the US there was perceived to be a shortage of credit for small businesses and home buyers. In fact the real issue was the price of credit, which economists tended to blame on a combination of regulation forcing costs up and banks’ monopoly power pushing charges up; the response was to allow more competition between lenders. From the 1960s, Federal banking regulators, interpreting Glass–Steagall with increasing generosity, allowed financial institutions to undertake a growing range of activities. Household borrowing began to climb steeply. Under the Heath government in 1971, the UK adopted a temporary policy known as ‘Competition and Credit Control’, whereby quantitative ceilings on bank lending were lifted and reserve ratios for commercial banks were reduced. 16In 1978 minimum commissions were abolished on the New York Stock Exchange, clearing the way for competition and higher trading volumes. A year later, the Thatcher government in the UK abolished exchange controls.

Then, in 1986, Big Bang financial reforms in the City of London did away with fixed commissions for buying and selling shares on the London Stock Exchange, allowed foreigners to own a majority stake in UK stockbrokers, and introduced dual capacity which allowed market makers to be brokers and vice versa. Most of London’s stockbroking and market-making firms were absorbed by much bigger foreign and domestic banks. In the late 1990s, supercharged by the IT revolution, the volume of securities trading rocketed. Commercial banks could now use their huge balance sheets, based on customers’ deposits, to speculate. Their investment banking arms, along with independent investment banks such as Goldman Sachs, developed financial instruments of increasingly mind-blowing complexity.

THE LORDS OF (MONEY) CREATION

Large financial firms were, however, careful to secure a lightening of regulation, rather than the complete deregulation advocated by free-marketeers such as the Nobel Prize-winning economist Friedrich Hayek. Their reasoning was as follows. To maintain their high profits, the big commercial and investment banks still needed regulators who would keep potential competitors out of the market. Existing big players are therefore helped if banking licences are restricted. Ironically, the disastrous big bank behaviour that triggered the 2008 crash forced regulators (especially in Europe) into further lengthening and complicating an already arduous process for obtaining a new licence, frustrating their plans to unleash a hungry horde of ‘challenger banks’. In issuing licences sparingly, governments and central banks were quietly admitting something they were still reluctant to announce publicly: the extraordinary power of private-sector bank lending to affect the pace of money creation, and therefore economic growth.

That banks create money is still a highly contested notion. It was politically unmentionable in 1980s America and Europe, where economic policy was predicated on a ‘monetarism’ in which governments precisely controlled the supply of money, whose growth determined inflation. Banks traditionally presented themselves purely as financial intermediaries, usefully channelling household depositors’ savings into business borrowers’ investment. Mainstream economists accepted this characterization, and its implication that banks play a vital economic role in ‘mobilizing’ savings. Banks are not only empowered to create money as well as channel it from one part of the economy to another; they also do remarkably little to turn households’ savings into business investment. In fact, in the US case, when the flow of funds is analysed in detail, households ‘invest’ their savings entirely in the consumption of durable goods while large businesses finance their investment through their own retained profits. 17

They also had to overlook the fact that money appears from nowhere when firms or households invest more than their savings, and borrow the difference. When a bank makes you a loan, say for a mortgage, it does not hand over cash. It credits your account with the amount of the mortgage. Instantly, money is created. But at the same time the bank has also created a liability on itself (the new deposits in your account), and banks must ensure they have sufficient reserves or cash (both forms of central bank money) to meet requests by you for payments to other banks or cash withdrawals. They must also hold capital in reserve in case loans are not repaid, in order to prevent insolvency. Both of these create constraints on bank lending and mean that banks generally refrain from lending to people and firms that do not fulfil certain criteria such as creditworthiness or expected profitability. Money creation also occurs when you pay for dinner with a credit or debit card. As a matter of fact, only about 3 per cent of the money in the UK economy is cash (or what is sometimes called fiat money, i.e. any legal tender backed by government). Banks create all the rest. It wasn’t until after the 2008 crisis that the Bank of England admitted that ‘loans create deposits’, and not vice versa. 18

So licensing and regulation gave smaller banks a significant cost disadvantage compared to big ones, which can spread the bureaucratic costs (and risks) more widely and raise funds more cheaply. This made it harder for new competitors to enter the market. For existing players, there was a lot of monopoly rent to extract, and they could easily co-ordinate between them to avoid excessive competition without needing formal (illegal) cartel arrangements, while customers trusted them – rarely questioning their practices or financial health – precisely because regulators were watching over them. For example, it took an investigation by the UK’s Competition Commission in 2000 to establish that the country’s Big Four banks had been operating a complex monopoly on services for small businesses, using their 90 per cent market share to extract £2 billion in annual profit and push their average return on equity up to 36 per cent, by mutually agreeing not to compete. 19If banks’ gambles ever endangered their solvency, the government would have to rescue them with public money. This implicit guarantee of a public bailout lowered the biggest players’ cost of raising capital, which further cemented their market power.

FINANCE AND THE ‘REAL’ ECONOMY

For centuries, income earned by charging interest had been viewed as a subtraction from productive enterprise rather than a symbol of it. This was both a moral and an economic judgement. As we have seen, the Roman Church banned the charging of interest for most of the Middle Ages, while Enlightenment philosophers such as John Locke, writing in 1692, saw bankers merely as middlemen, ‘eating’ up a share of the gains of trade rather than creating any gains themselves. 20Even before the formal study of economics began in the late eighteenth century, many intellectuals and writers had concluded that banks did not produce value and often did not operate in the public interest at all.