Contribution to the Workshop of the Rosa Luxemburg Foundation "Keynesian Economics as Alternative Economy" (February 24-26, 2006, Berlin)
This chapter will suggest firstly, that the financial changes taking place in many countries have been widely misunderstood and secondly that the consequences of these changes for employment relations, although often adverse, are not necessarily so.Aspects of Financial ChangeWhat is sometimes referred to as the "financialisation" (for one analysis see Froud, Johal and Williams, 2002) of socio-economic systems involves a number of phenomena. Three economic aspects of financial change are frequently referred to; it is important to distinguish between them. (There are also important cultural and linguistic aspects – such as the widespread perception that financial institutions and financial markets are central locations in society today.) The Growth of FinanceFirstly, there is simply the growth of finance and of the financial sector. There is more finance about in that economic agents today hold more financial claims on each other than in the past, relative to GDP as a measure of economic development. Expenditures, both for investment and consumption, are more likely to be supported by credit or other forms of finance than in the past. The balance sheets of households and businesses carry a higher level of both financial assets and liabilities relative to real assets such as buildings or equipment.This expansion of finance involves an expansion of the financial sector, of the corporations and other institutions which collect monetary resources from the public and channel them either to the agents who will use them or onto the financial markets. This is now a larger sector by all measures – the percentage of the workforce it employs, the share of national income for which it accounts and the size of the financial flows and financial assets and liabilities involved. This expansion goes along with the expansion of closely related activities such as real estate: some commentators speak of a spreading FIRE (finance, insurance, real estate).Disintermediation and SecuritisationThe second aspect of change is in the nature of finance. Financial markets, for company shares, for bonds and other debt instruments, for foreign exchange and for derivatives, such as options and futures based on these assets, play an increasingly important role in the financial system; at the same time classical bank finance – the advance of credit from a bank, based on the deposits it receives from the public, is becoming relatively less important in quantitative terms. This shift, sometimes referred to as disintermediation, is linked to a liberalisation of finance which allows investors in securities and issuers of securities to operate in many countries. The move away from classical bank intermediation should not be regarded as implying a decline in the importance of banks as institutions. In fact the big banks are the key players in the whole transformation. Although deposit-taking and bank credit today make up a smaller proportion of the banks' activities, they are involved in every aspect of the security market-based finance which has emerged in recent decades. The banks issue securities on their own behalf and on behalf of corporate customers; they make markets in many securities; they provide many of the services linked to security trading, such as investment analysis, fund management and settlement of transactions. This change in the nature of finance, however, also involves the rise of other financial corporations to rival the banks – these are the institutional investors: pension funds, insurance companies and investment companies such as unit trusts in Britain or mutual investment companies in the US. In classical bank intermediation the provider of funds, the depositor, has a claim on the bank, not on the borrower who actually uses the funds. He or she relies on the solidity of the bank to make the claim safe and liquid. In the security-trading financial system which has to some extent displaced classical bank intermediation, the provider of funds relies on the existence of a deep and wide market in securities to secure the same objectives. In the "secondary" markets, which account for the vast bulk of security trading, investors are able to liquidate their positions by selling to other investors. The "primary" markets, where new securities are issued are very much smaller – but it is usually price movements on secondary markets which set the terms on which corporations or governments can raise new money on the primary markets.It has been known theoretically for a long time that portfolio diversification can reduce some of the risks of investment for a given expected rate of return. In practice effective diversification is costly and only the richest investors could achieve it on an individual basis. The institutional investors (Davis and Steil, 2001) offer the same advantage to the middle classes by aggregating thousands of small positions into an overall portfolio. But a savings plan with an institutional investor differs from a bank deposit in that it is the customer not the intermediary institution, who, in the first instance, bears the risk of the investment.This process of disintermediation or securitisation is not easy to explain. Why did one form of finance expand at the cost of the other? A full answer will not be attempted here, but it is interesting to see that this process might be cumulative: the ease with which securities can be traded, and hence the liquidity of an investment in securities, depend crucially on the scale of the security market. Thus, if security-based finance secures an advantage over bank intermediation, that advantage will tend to increase over time.High Interest RatesThe third aspect of "financialisation" which will be discussed is financial tension – the pressure of financial constraints on economic agents. The same era – roughly the last quarter of the twentieth century – which saw the growth of finance and the changes in financial structure which have been referred to were also marked by exceptionally high interest rates and thus by extraordinary pressure on debtors and on agents seeking finance. The most catastrophic result of these tensions has been the third world debt crisis, still unresolved some twenty years after it struck. But there have been other victims – for example, the EU member states failed to find a clear common response to rising interest rates in the world economy and this put their socio-economic systems under enormous pressure: both Keynesian economic intervention and high welfare standards became very difficult to finance. Likewise, the pressure for downsizing and closures in their manufacturing sectors were, although not caused, greatly exacerbated by the cost of credit. Because the era of financial transformation coincided in this way with that of very high interest rates many commentators have closely associated, or even identified, the two developments (for example, Duménil and Lévy, 2004). This is one source of the misunderstandings that will now be explored.
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