Guest post by Daniel Ben-Ami
From influential mainstream economists to self-proclaimed Marxists it has become widely accepted that financiers run the economy and dominate politics in the Anglo-Saxon world. In America it is often argued that Wall Street is the most powerful force in society whereas in Britain the focus is on the influence of the City (with a capital “c” to denote London’s financial centre).
Although the critics of finance represent different shades of opinion, their arguments are remarkably similar. It is said that financial institutions, particularly investment banks, have managed to sweep aside regulatory measures designed to curb their immense power. Often these financial interests are identified with a free market, “neo-liberal” ideology which, at least on a rhetorical level, favours a minimal state. So for Simon Johnson, a former chief economist at the International Monetary Fund (IMF), finance has successfully engineered a quiet coup in which the American people have come to share its mistaken beliefs. Meanwhile, David Harvey , a well-known radical academic, talks of a “state-finance nexus” which essentially allows the financial sector to dominate society.
Although the financial sector is undoubtedly an important area to investigate such critiques are analytically flawed. They reflect a one-sided understanding of finance and typically lead to conservative political conclusions.
At the most basic level the critics tend to overestimate the importance of the financial sector, let alone just banks, in the economy. Although financial institutions have undoubtedly increased in importance since the 1970s they still account for a minority of economic activity. According to a recent British study financial services in the UK account for 10% of economic output with another 3.9% in the related areas of accounting services, legal services, management consultancy and maritime services. The same study showed American financial services at 8.4% of output although alternative figures previously quoted on this blog put the entire finance, insurance, retail, rental and leasing sector at about 21%. Even if the latter is correct, and it is a broad definition, it would still mean that almost 80% of the economy is non-financial.
But the problem with the notion of all-powerful finance goes beyond the numbers. It also underestimates the extent to which financial institutions and non-financial companies have become inter-twined. On the one hand, financial institutions have increasingly become involved in non-financial businesses. For example, numerous different types of investment funds have taken over much of the ownership of corporate America and corporate Britain. The size of the global fund management industry was estimated at about $105 trillion in assets at the end of 2009. On the other hand, non-financial companies, particularly larger ones, have become heavily involved in financial activity. This manifests itself in numerous different ways including extensive risk management operations and the extension of credit to consumers.
What seems to be happening is not so much an increase in the power of financial institutions but a financialisation of the economy as a whole. An urgent task of any new economics should be to examine the character of the underlying forces driving this transformation.
The overemphasis on financial institutions also tends to lead to a blindness to structural economic problems. Criticism of banks is typically followed by a call for more extensive regulation rather than an investigation into the barriers to economic growth.
Such a flawed analysis can only lead to political dead ends.
thecurrentmoment 
Just a quick comment: even if it is true that 80% of the economy is non-financial and that there is a financialisation of the economy as a whole, the fact remains nevertheless that almost all other economic actors are heavily dependent on banks. The financial class is so powerful and has a privilledged relationship with the state apparatus because of this dependency.
It is certainly the case that non-financial sectors of the economy depend upon the banks. But that dependency isn’t inevitable and has varied a great deal over time. After all, a traditional role for banks is simply as an intermediary, channeling funds from savers to investors. The much more extensive role played by financial institutions today goes far beyond this more basic function. At the same time, the outlook of finance is very different from that of industry – more short-termist, for instance. And yet that outlook has colonized industry as firms eschew investment in favour of translating profit into dividends for shareholders and/or high salaries for executives. Another permissive condition for the role of the financial sector in individual consumption patterns is the low rate of increase in wage levels. That has opened up demand for credit. So the power of the banks, as such, seems to rest upon wider changes within the non-financial economy.
My comment is more of a question about GDP, Balance of payments, and what metrics we use to analyze the economy. The growth of the economy in the last 30 years has been mostly (falsely) attributed to the efficency of markets, the movement of money, and the increased sophistication of bankers. It is unclear to me, however, that any of these innovate banking endeavors actually contribute to GDP growth. The US economy over the last 170 years or so has a CAGR of about 3% and this seems like quite a natural growth rate from increased output of that “80% of the economy” which in non F.I.R.E. The huge boom cycles in bond markets, internet, biotech, housing, is all unsustainable growth that is only possible through these new banking endeavors. When the bottom falls out we are left with only what is real in the economy. The aforementioned is just an unscientific observation. So my question is what measures of economic output actually matter? It seems to me that I (of investment) and C (of consumption) are worth analyzing more closely when we talk about economic health and GDP. In the US (I) has dropped way off and been offset by consumption (particularly non-durable goods, like services). It seems to me that the financial sector has made this consumption possible and also is responsible for hot money (stock market) which contributes 0 to GDP. The public markets are just an exchange of dollars between financial institutions, and not a pool of wealth that companies can tap and use funds to invest further.
Sorry for the ramblign excellent work
I think the terminology is confusing here. Just to clarify I think it is necessary to distinguish between:
* Financial institutions. Banks, commercial as well as investment, are a part of this but it is important to note there are many other types including insurance companies, fund management groups, etc. Wall Street itself only makes up a small proportion of the total.
* Finance more generally defined – essentially the flow and manipulation of money in the economy. My argument is that the whole of the economy is becoming financialised. Rather than their being a “financial class” representing financial institutions it would be more accurate to say that non-financial and financial capital have in many respects become integrated.
* The real economy. Essentially the world of production. The mainstream economic discussion conspicuously fails to say much about the relationship between financial institutions, finance and the real economy.
Hope this helps.
But what of the growing inequality gap? Perhaps not an all powerful financial class but it would certainly seem that the rich are getting richer and the poor…well not so much. Ordinary workers have seen their share of GDP fall by a 1/4 at the same time as the share going to the top 1% of earners increased by 1/2.
Even some right wing commentators are starting to question what is going on….http://www.matthewtaylorsblog.com/uncategorized/the-inequality-gap
I’m not sure that this post says anything that the people it purports to criticise have not already said. Its main points appear to be that finance occupies a minority share of GDP, and finance extends beyond mere financial institutions due to the financialisation of formerly non-financial institutions. These points are noted by, for example, David Harvey in his latest book.
Yet, nonetheless, it does seem that Western economies and states are geared towards finance – despite the purportedly small role of banking, etc, in constituting GDP. You only have to look at the way European governments have scrambled to reassure ‘the markets’ by adopting austerity measures, bailing out banks, guaranteeing sovereign debt, etc, to show how slavish states have become, and how economic strategy is entirely directed towards retaining the ‘confidence’ of a relatively small number of financial institutions.
This only seems an obdurate ‘puzzle’ if you think that power is directly proportionate to one’s contribution to GDP. If you think that, then yes, citing GDP percentages does appear to debunk the ‘myth’ of a powerful financial class. And yet, it still appears to exercise a great deal of power. So the two things clearly don’t go hand-in-hand. Somehow, the financial class does seem to wield enormous influence over public life in spite of its relatively meagre contribution to collective wealth. The puzzle of how a parasitic elite can distort the exercise of state power despite being a small minority is a rather old one, and one which various Marxist state theorists have provided various answers to. Harvey still provides one of the best accounts by which the state-finance nexus emerged.
I am surprised that Lee Jones should seek to downplay the differences between myself and the mainstream view of finance represented by the likes of David Harvey. Even though Harvey may formally nod towards some of the points I made his argument is fundamentally different. The thrust of his case is that that the financial sector has come to dominate the American economy and even society as a whole. Or, to put it in plain English, Wall Street has come to dominate Main Street. In contrast, I am arguing that the trend towards financialisation – which imbues all kinds of companies rather than just financial institutions – is driven by developments in the economy as a whole. The entire elite has become financialised rather than financial institutions having come to dominate society on their own.
It is also a mistake to take politicians’ claims on the power of finance at face value. Governments often do talk in terms of the influence of Wall Street or the City, and they do bail out banks, but that is no reason to accept such points uncritically. As with every other area, any such claims need to be interrogated. Just because something, in Lee’s words, “appears to” or “seems to” be true does not mean that it is. The media, along with most academic commentators, are simply describing the appearance of a phenomenon rather than seeking to demystify it.
GDP is clearly a flawed measure in many ways but Lee’s alternative is apparently to ignore basic empirical reality. Like so many others he asserts the enormous power of finance but is unwilling to submit the evidence to even a few simple tests.
Hi daniel, sorry to be a stick in the mud but it looks to me like you didn’t even bother to read Harveys book – Enigma of capital and the the crisis of capitalism.
In which, he clearly outlines and describes – in detail – the relationships and shared history between nations & states, financial institutions, traditional familial power, social power and labour power et al to the wider relationships that make up the western model as a whole as it moves geographically from place to place creatively destroying and creating new spaces in a perpetual quest for growth, he specifically mentions the spacio-temporal relations between what he calls the 7 spheres of society (lent heavily from marx), i think like many others before you that you focus too much on the numbers and not enough on the words.
Lee Jones makes the point well, this critique is no critique of harveys critique.