A response on financialization

14 Jul

In comments on a recent post on financialization, a number of criticisms were raised that are worth exploring further. Readers have reasonably objected that a graph showing increased financialization of the US economy demonstrated less than first appears. These objections break down into at least four claims:

1. Finance has been a part of modern economies for ages, and a major part at least since the late 19th century, what’s so different now?

2. To the degree there is something new, isn’t it a product of increasing complexity and thus a further refinement of the division of labor?

3. The financial class is really the only group that understands the ins and outs, and thus the stakes, in various regulatory and private decisions regarding this area of economic activity. There are experts, and only experts have the competence to make informed decisions. It’s either the experts or the Tea Party, you decide.

4. If there are other interests at stake, what exactly are those interests, and how are they articulated in the particular case of, say, financial regulations? All that has been said on this blog so far is some vaguely democratic stuff about general interests.

We agree that these are important issues, but cannot respond to all of these objections at once. Question 1 is for separate posts. Suffice to say we think something distinctive has happened since the 1970s in national and global finance (one thing being the more global character of finance). These trends are importantly different from, say, the period from 1870-1914 that gave rise to concepts like ‘finance capital’ and ‘monopoly capital.’

Questions 2 and 3 go together. It is misleading, in our mind, to view the current financial architecture as a kind of natural development of the division of labor and economic complexity. Current markets are the product of a host of conscious political decisions, especially regulatory and de-regulatory choices. One could choose any number of examples, but few recent ones include the Gramm-Leach Bliley Act (1999), which eroded the boundaries between investment banking, commercial banking, and insurance provision; and the 2004 SEC decision to raise debt-to-capital ratios. These decisions significantly altered the structure of financial markets, allowing for certain kinds of financial ‘innovation,’ which it must be said many people even in finance don’t seem to have understood. So the structure of financial (and all economic) markets is the product of the laws the institute them, and the incentives these create.

A further reason we have doubts about the expertise argument is that everything suggests that they have not been using this expert knowledge in the public interest, but rather to their private interest.  As we have noted on this blog before, dramatic rises in incomes at the top over this period have gone hand-in-hand with stagnating real wages and rising consumer debt. It would seem one of the most significant elements of financialization has been its distributional implications, not the improved risk management or allocation of resources. Put another way, there is no reason after this crisis to particularly trust the experts!

Which brings us to our response to question 3: people might not understand everything, but they can understand enough. That is to say, not only is it misleading to view the growth of finance as a natural development of economic complexity (question 2), but it is also wrong simply to say these market are too complex for most people to understand (question 3). True, most people can’t be expected to know about or even understand the ins and outs of Tier 1 capital ratio requirements, or the kinds of collateral required for overnight repo agreements. But that does not mean a) they cannot be given better information, and get better educated than many are now (see, for instance, well-known misperceptions about inequality) and b) that they cannot know their own interests and c) that they cannot be organized on the basis of these interests to put pressure on their government to better serve them. Echoing one of the commentators on this blog, we would say the greater problem is not the people’s incompetence, but rather their relative apathy. The popular response to this crisis – Tea Party aside – has been decidedly tepid. But when representatives and regulators fear they will lose their jobs, or worse, they tend to do at least a better job of keeping the worst at bay. Or put another way, as plenty of post-crisis evidence has suggests, the problem was not the lack of knowledge amongst regulators, but a willingness to look. That is not a problem of incompetence v. expertise, but a political problem. One suspects they look harder when there is more popular pressure on the government. But now we are talking about things like social movements and popular protests, which are too quickly written off as the noise of incompetent mobs.

One final point. Question 4 was about what kinds of regulations and economic structures would be more in the public interest. Not just who are we talking about, but concretely what are their interests? If financialization has been generally bad, what is the proper response? That is a harder question, though it is easy enough to start by saying most people do not have an interest in more tax cuts for the wealthy and more spending cuts in social services. That, however, is only one part of the question and does not directly address how to respond to financialization itself. This is a question we do not ourselves have clear and complete answers to, but we are confident enough to say that we have no confidence in our existing rulers, or current experts, to solve those problems.

6 Responses to “A response on financialization”

  1. Art July 14, 2011 at 2:12 pm #

    Two brief responses. “People might not understand everything, but they understand enough.” What I hoped to provoke with my earlier comments was a clearer definition of what you mean when you use “people” as a subject in a statement like this. Are we talking about some empirical “people,” whose attitudes are measurable by polling or voting? Because if we are, I contend that “people” do not understand “enough”: recent polling on the debt ceiling, for example, has elicited highly irrational answers–irrational in the sense of internally contradictory. Even Obama has uttered nonsensical statements comparing the national budget to the budget of a family: “We must live within our means,” etc. The new French budget minister, Valérie Pécresse, made similar statements the other day. So I contend that “people”–from the masses to the elites–do not know enough to govern sensibly on technical issues, and that the interested expertise of financiers needs to be checked by “counter-expertise” accountable in some institutional sense to “the People,” according to whatever mystical procedures we choose to distill a general interest from the empirical mass of concrete individuals.

    Second, I’m not sure how to read your rhetorical question “if financialization has been generally bad.” Is this an assertion–“financialization HAS been generally bad”–or a question–“In what respects has financialization been bad?” Because I would argue that financialization has NOT been generally bad, if by financialization one means the relatively freer flow of capital around the globe to which you allude when you describe structural changes in the banking system attendant on specific legislation. To argue that financialization in general has been bad is to do as the Republicans do when they claim that the Community Redevelopment Act caused the crash because it made capital more accessible to lower-income people seeking to buy homes. Relaxed capital controls played an important role, I contend, in reducing the gap between rich and poor nations and lifting millions upon millions of people out of poverty. To be sure, all sorts of detestable practices accompanied that relaxation of controls, and some of those have now been exposed by the crash. But the issue is whether “the system” in toto must be toppled, or whether it can be controlled by intelligent political intervention. The debate is thus similar to the debate that divided socialists in the first part of the 20th-century: social democratic reformism or revolutionary communism, counter-expertise applied from within with electoral leverage or rejection led by an external vanguard purporting to interpret what “the people” want.

    Or am I overdramatizing the stakes?

    • thecurrentmoment July 15, 2011 at 1:14 pm #

      Taking your second point first, we agree that growth, especially in places like China, has been a good thing, and that it has been connected to the freer flow of capital. However, we are not convinced that the *only* way China could have industrialized is through the current financial arrangements. Moreover, the freer flow of international capital, as it has developed since the mid-1970s has not exactly been an unmitigated good thing (e.g. Stiglitz’s Globalization and Its Discontents). It went hand in hand with a wave of third-world debt crises, structural adjustment programs, lost decades, not to mention more recently the East Asian financial crisis, a collapse in Russia, and now the decidedly more extreme and enduring credit crunch and global stagnation. Of course, we do not think this can all be chalked up to the freer flow of capital alone. But to suggest that we shouldn’t complain about the dramatic increase in inequality, and social and economic stagnation, within Northern countries because there has been a concomitant improvement in global poverty seems to us a decidedly one-sided reading of recent international economic history.

      Also, although we have not nearly developed this point enough, to us financialization is something more than just freer capital flows. It seems to us a particular transformation in the global political economy, which goes hand in hand with a more disciplined labor force, a different conception of the social compact, and a dramatic increase in inequality.

      Finally, we agree with you that counter-expertise is needed. That’s certainly something we are groping towards, and trying to find wherever it lies. But the way you phrase it in your comment now sounds different from your original thought, which implied that those who actually do finance are experts, and most people don’t understand it, so the competent ones ought to have the lion’s share of the regulatory input. This is surely the fox guarding the henhouse. But our deeper point was that expertise cannot be so easily separated from political agency and social mobilization. There are, in fact, a number of good counter-experts out there, or even just moderately good counter-experts out there, but they are not the voices being heard, or at least they are not dominating the conversation. Why? That’s a political problem. When there are no political threats, or even moderate challenges, to the system as it is currently organized, those in positions of power tend not to do much even to correct their own destructive tendencies. So our view is that there is a problem of apathy and power, not just competence and knowledge alone.

  2. ian July 15, 2011 at 4:11 pm #

    On the question of popular competence, some of the discussion over the past few posts seems to blur together two quite different issues: irrationality and expertise. It would be hard to disagree that meaningful financial regulation of any kind requires expertise well beyond that of the average citizen, or even legislator. This is quite different, in principle at least, from the claim that modern democratic publics are highly irrational as such regarding finance. It’s true the first issue will always present some sort of principle/agent problem to be resolved, but I don’t see why in principle it poses any special challenge for democracy. The competence to regulate, say, nuclear power plants is probably as just specialized as finance, but people don’t need to share the full technical expertise of the nuclear regulators to make meaningful and informed decisions about what kind of regulation they want, or at least minimally that their decisions obey the law of non-contradiction. So the second suggestion is that it’s not lack of expertise per se but some kind of bedrock popular irrationality that presents itself on financial questions. I think you would all agree that there’s lots of irrationality out there on financial matters, with plenty of evidence in opinion polls and politicians. The fundamental disagreement seems to be this: is this irrationality a general condition in modern democracy, requiring counterpowers to govern the people in their name, or is it a result of an extreme disconnect between being affected by, and having a sense of agency over, the economy?

    • thecurrentmoment July 15, 2011 at 4:27 pm #

      Excellent points. One thing we would say, and which is supported by quotes in Art’s comment above, is that irrationality seems to be shot through the political system, as prevalent among those who rule as those ruled. We would further argue that this irrationality has as much to do with the problem of political agency, or what you put as ‘having a sense of agency over the economy’, as it does with ignorance and incompetence. What has been taken to be a kind of populist position on this blog in defense of ‘the people,’ has really been a point about power and agency. The dominant popular response to the crisis seems to have been that most are not so much emboldened as they are cowed by forces that seem not just beyond their control, but impossible to control. The most assertive response has been more or less the defense of incomes and wealth (the assault on taxes and social spending, as well as a preference for monetary rather than fiscal stimulus) by those who have most of it (even the Tea Party ‘movement’ seems to be a movement of property owners). The possibility of more rational responses, especially by those who have not benefited from the way the economy has been organized in the past decades, seems to us to have less to do *just* with more knowledge and expertise and more to do with defending the idea that any are of the economy can be properly and reasonably controlled by a collectively acting citizenry. It is for that reason that we are suspicious of arguments about expertise. They push against the very idea that ordinary citizens could engage in any meaningful way with the economic forces that have destroyed or at least reshaped their lives. Moreover, as a simple empirical matter, even when we are just talking about counterpowers governing in the name of the people, it is unlikely they will ever exercise their power in a way consistent with those they represent unless the represented continuously demand, in an active, mobilized way, that they be properly represented. e.g. The actually social democratic aspects of the New Deal only really took shape after massive strikes and farmer protests.

      • Art July 15, 2011 at 4:55 pm #

        Yes, good points all, and I don’t have time to reply adequately. But consider the example of nuclear power. Let’s grant that non-experts can grasp in sufficient depth the pros and cons of relying on nuclear energy. Voters can then decide either to build nuclear plants or not. If the answer is no, there is no further role for experts, even if many voting in the negative do so for reasons that the “experts” might deem “irrational.” If the answer is yes, then of course the voters will want the design of safeguards entrusted to the “best” experts and presumably will also want to monitor the work of said experts to preclude the well-known perverse consequences of regulatory capture, etc. Popular agency–a word I dislike, because it abstracts away from actors and interests–is preserved.

        Ian’s more basic question is whether “the economy” is different in this respect from other political subsystems. I think the answer is yes, in part because there is no “expert” consensus about how it works. But that is not to say that there are not better and worse “expert” responses to whatever broad choices the political system dictates. I’ll try to develop this thought further when I have time, but right now I have a boat to catch.

      • The Current Moment July 19, 2011 at 11:31 am #

        Ian makes a good point in bringing up nuclear power. It may be that because of the role of finance in contemporary political economy, there is a tendency to defer to expertise in this field more than in others. The pros and cons of nuclear power are considered generally easy to grasp and so the subject of public debates and votes in referendums (e.g. in Italy recently). But finance is another matter, playing so heavily as it does on contemporary relations of power and prestige. Certainly in the UK, it is remarkable how the City of London is considered beyond the pale of serious criticism whereas what remains of the UK’s manufacturing sector is regularly dismissed as uncompetitive and hardly worth the effort. The question of expertise is therefore tied into the wider society and reflects its irrationalities and biases.

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