The Withering Away of the Financial Industry

Few would dispute that technology is one of the most important determinants of economic and social development. Thus the impact of the invention of the printing press on the evolution of the Renaissance and the Enlightenment in Europe between 1500 and 1800 was clearly crucial, as was the development of steam power from the 18th century in driving the Industrial Revolution and the related social and political upheavals.

It is perhaps equally uncontroversial to say that one of the consequences of that Industrial Revolution, in turn, was to give powerful impetus to the rise of bourgeois capitalism, based on the ownership of finance capital, as the dominant form of socio-economic organisation from about 1800 – replacing the traditional, medieval model of feudal aristocracy, based primarily on the ownership of agricultural land. This process was famously – and approvingly – described by Marx and Engels in the Communist Manifesto (1848). Around the same time the essential superstructure of the capitalist economy – including stock exchanges and companies acts (incorporating the right to limited liability) – first became established at the heart of Western economies.

In the century and a half since then financial institutions have come to be seen as central to the working of national and international economies alike, bodies where it is generally understood all the most important decisions on investment and the allocation of resources are taken.

The power of finance

This position is the basis of the dominant role of the capital markets in determining the pattern of economic activity and investment – and thus ultimately in the distribution of income, wealth and political power. This notion is reflected in the famous statement attributed to a member of the great Rothschild banking dynasty in the 19th Century, “Give me control of a nation’s money and I care not who makes the laws.” Hence the abiding perception that it is the financial sector that not only dominates all other sectors of the economy but effectively determines, or at least limits, the exercise of political power. A graphic illustration of how this power works in practice is provided by the presently unfolding crisis in Greece, where a government newly elected with a commitment to drastically revise the clearly ruinous economic strategy of austerity pursued by its predecessor was told by its creditors that it could not modify this strategy even though it had proved demonstrably self-defeating, leading the country only deeper into total bankruptcy.

Such dominance of the financial sector, it may be noted, originally derived from an implicit perception that capital had become the scarce factor of production by the mid-19th Century, just as the earlier perception that agricultural land was the scarce factor of production underpinned the dominance of the landed aristocracy under the feudal order. As in the case of the old feudal ruling élite, the power and importance of the financial sector is further reflected in the fact that its senior executives generally receive much higher material rewards than their counterparts in other sectors of the economy. This dispensation they of course justify on the basis not only of the supposed continued scarcity of the product they are supplying – risk capital – but also of the supposedly rare talents of the individuals concerned and the personal risks they are running through their investment decisions. Increasingly, however, the self-serving bias of such claims has come to be recognised by the public, not least because of the need for massive state intervention to bail out the banking industry since the start of the global financial crisis (GFC) in 2007-8, giving the lie to any lingering belief that bankers are taking risks with anything but other people’s money.

Hence it is apparent that the belief that finance capital is a scarce resource is the basis of the disproportionate power and wealth of the ruling élite and that this is in turn based on an illusion which has been carefully nurtured and perpetuated by a political establishment (including the mass media) that is obviously dominated by the same élite. In this the financial industry’s situation is little different to that of the agricultural sector in Britain prior to 1846, when the landed interest was still politically powerful enough to sustain the view that maintaining the wealth of that sector – still protected by the Corn Laws from the threat of growing foreign competition – was of vital importance to national security. Once the balance of political forces had shifted in favour of financial, commercial and industrial interests the repeal of these protectionist laws heralded the final passing of the landed interest’s dominance and the rapid marginalisation of the British agricultural sector.

The glut of capital

What few Western economists have yet grasped – to judge at least from their public pronouncements – is that the GFC is a symptom of the dwindling economic relevance of finance capital over the last 40 years or more. This has been reflected in a steady decline since the 1970s in the share of fixed capital formation (new investment) in the national output (GDP) of the world’s industrialised economies (OECD countries). The present writer can lay claim to being one of the first economists to draw attention to this phenomenon in his 1998 book The Trouble with Capitalism.

Even the few other economists who have recognised this phenomenon have been reluctant to grasp its most significant implication, namely that the productivity of capital has risen as a result of technological change and that consequently the need for it relative to any given unit of output has diminished, while at the same time overall global growth has evidently entered long-term decline.

What this means is that the problems of capitalism go well beyond the familiar one (identified by Marx) of inherent instability due to its cyclical tendency to over-investment and overproduction – “boom and bust” – now recognised as a weakness by even the most ardent defenders of the system. Rather the probability has to be faced that, thanks to technological change, the surplus supply of capital has now become structural (i.e. more or less permanent). Yet few latter-day economists or historians appear able openly to consider this possibility, which would clearly mean that capitalism has now been rendered as outmoded as feudalism was in Marx’s day.

The reluctance of the establishment to confront this stark reality is understandable. For the implication of such trends is that most of the financial institutions and instruments that have been put in place over generations – and the well paid jobs that go with them – are now obsolescent and will soon be totally redundant. As noted in an earlier post (Twilight of the Investors – November 2012) since World War II the fate of the world economy has become progressively more tied to that of the ever-expanding financial sector, as individuals have been incentivised to invest their savings in a variety of instruments – from mutual funds and pension funds to hedge funds and private equity – on the assumption that this would provide them with security in retirement. In the process the most highly educated and intelligent members of the workforce have been drawn to devote themselves to fund management and other questionable activities in the service of this ever more financialised economy.

The savings delusion

It is significant that the huge growth of investment funds derived mainly from the personal savings of millions of ordinary people in industrialised countries has been a phenomenon of the post-war era. Previous generations had had to rely almost exclusively on state-financed schemes based on the pay-as-you-go principle, in which workers’ contributions were paid out directly to cover the benefits of those already in retirement (as under the British state pension and US Social Security system). From around 1950, starting in the US, people in relatively rich countries became sold on the idea that they could and should save more for their retirement through investment funds that promised them a high return, particularly in view of the tax breaks they were offered. At a time of generally rising affluence and corresponding growth in the value of corporate assets and fund values – such as prevailed up to the mid-1970s – it is not surprising that such a proposition proved attractive. What was hardly understood was that a) this apparent success depended on maintaining more or less continuous economic and market growth without significant cyclical downturns and b) saving for retirement was in any case inefficient and unnecessary, given that experience had already shown that state-run pay-as-you-go systems are far simpler and more cost-effective.

In short, the whole apparatus of individual savings and investment was conceived purely as a benefit to the financial sector and should never have been sold to the general public – nor would have been if that vested interest had not enjoyed such disproportionate political power. By 1975, however, the comfortable delusions of the post-war boom had started to be exposed by the reality of financial upheaval and recession on a scale not seen since the 1930s. Yet those whose wealth and social prestige depended on this artificial structure of income distribution were not about to allow market forces – or historical materialism – to consign them to oblivion, any more than the French aristocracy of the ancien régime were prepared to surrender their parasitic and privileged position in society without a fight.

Terminal decline

Viewed in this light the history of the last 40 years can be portrayed as a prolonged struggle of the ruling élite to perpetuate their power by means of any available technique of market manipulation, distortion or deception to sustain the impression both that capital is still very much needed and that those who decide how it is to be deployed and allocated within the economy are the indispensable “wealth creators” who are worth every penny of their fabulous remuneration. At the same time they have inevitably been driven by the logic of the market to use every conceivable device to inflate their reported profits as much as possible. In the process they have been compelled increasingly to resort to

  1. investment in purely speculative ventures – as opposed to productive enterprise – which are really indistinguishable from gambling;
  2. criminal manipulation / rigging of markets (notably interest rates, foreign exchange, precious metals and stock markets);
  3. mis-selling of insurance, pensions and other financial products to their banking customers.

The ability of the élite to pursue such strategies has been greatly facilitated by the actions of the authorities – with whom they are of course symbiotically linked – in

a) relaxing legal restraints on market abuse and manipulation – many of which had been introduced following the Wall Street crash of 1929-31 – including the right of banks to operate as market traders on their own account and the right of companies to buy back their own shares and thereby manipulate their market value;
b) turning a blind eye to actual fraud (there have been no criminal prosecutions of high-profile financial-sector executives following the débâcle of 2008);
c) allocating public resources to underwrite markets and subsidise favoured private-sector projects to insure investors against loss.

Over and above this record of serial betrayal there now hangs the shadow of the paralysing global debt burden, itself the result of the latitude given to the financial industry to borrow and lend indiscriminately, confident in the expectation that any major credit failure could be averted by taxpayer intervention – as in every case since the Lehman Brothers collapse of 2008. Once it becomes clear that these unfathomable debts cannot in fact be paid and must be largely, if not wholly, written off we may hope and expect there will emerge from the wreckage a new economic order in which the financial sector will occupy as marginal a place as the agricultural sector.

2 thoughts on “The Withering Away of the Financial Industry

  1. Both astounding and insightful writing and research by Mr. Shutt. The question is will we ever learn in the wake such ruinous avarice in the remaining financial giants and indolence in government’s lack of safeguards to protect the common man continue post 2008 collapse? what are the indicators that validated change has in fact occurred?

  2. I remember, years and years ago, decades ago really, whilst studying economics at University, arguing the the Thatcher/Reagan ‘economic revolution’ was nothing of the sort… but almost exclusively a political revolution designed to massively redistribute society’s wealth, a bit like the Enclosure Movement. The economics was a form of theatre designed to divert attention away from the elite’s attempts to maintain their powerful position, in an economic system that was seemingly ‘doomed’, unsustainable and coming off the rails, for many of the reasons you’ve underlined. My tenetative analysis, I seem to remember, didn’t go down well and I began to feel like a heretic and unbeliever who, at the same time, was also being groomed for a senior position in the Jesuits.

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