There has been much discussion in recent months about the apparent slowdown in Australian productivity growth. Rather than dredging up the usual wish-list of the business community (more deregulation, more privatisation, and more deunionisation), it's time to look at the deeper, structural factors behind stagnant productivity. In this commentary, Dr. Anis Chowdhury, Associate of the Centre for Future Work, looks to the perverse role of our overdeveloped financial sector in slowing down productivity-enhancing investment and innovation.
Financialisation and the Productivity Conundrum
by Anis Chowdhury
There has been much angst at the slower or stagnant productivity growth experienced recently in Australia. Ross Gittins, the Sydney Morning Herald’s much respected Economics Editor, summarised some of the discussions reflecting on the causes and remedies of the productivity problem in his recent piece, ‘Productivity problem? Start at the bottom, not the top’ (SMH, 2 March 2020).
The phenomenon of slow productivity growth is neither unique to Australia nor recent. It has been observed globally over the past few decades, especially in the developed world, as highlighted in recent reports on global economic health (e.g. United Nations, World Economic Situation and Prospects 2020, and the World Bank’s Global Economic Prospects 2020). The trend accelerated since the global financial crisis (GFC) of 2008-2009, as emphasised by Maurice Obstfeld, IMF’s former Chief Economist, at the joint BIS-IMF-OECD conference on weak productivity (10 January 2018).
The UN report notes that “as firms around the globe have become more reluctant to invest, productivity growth has continued to decelerate.” It attributes much of the slowdown to significantly lower contributions from capital deepening (investment in machinery, technology, etc.). Subdued productivity growth is also proposed as one of the reasons for slow growth of real wages and falling share of labour income in GDP, contributing to rising inequality – although even more rapid productivity growth is no guarantee, of course, of rising wages or greater equality.
The World Bank report observes that to rekindle productivity growth, a comprehensive approach is necessary for “facilitating investment in physical, intangible, and human capital; encouraging reallocation of resources towards more productive sectors; fostering firm capabilities to reinvigorate technology adoption and innovation; and promoting a growth-friendly macroeconomic and institutional environment.”
While similar observations can also be found in the OECD and IMF reports, none offer explanations as to why this is happening, that reach beyond orthodox excuses – like uncertainty due to Brexit and US-China trade tensions. The Bank of International Settlements (BIS), OECD and IMF also included such factors as unconventional monetary policy (very low or negative real interest rates) and financial frictions (e.g. firm-level financial fragilities and tightening credit conditions) as possible causes of weak investment and the productivity slowdown since the GFC.
However, one can trace the deeper cause of the long-term declining trend in productivity growth since the 1970s to financialisation: that is, the dominance of finance over the real economy. This is visible globally in the increasing role of financial motives, financial markets, financial actors and financial institutions in the operation of the domestic and international economies.
Beginning with the collapse of the Bretton Woods system in August 1971, when President Nixon unilaterally withdrew US commitment to gold convertibility of currencies, the process of financialisation gathered pace in the 1980s. This coincided with the neoliberal counter revolution against Keynesian economics, and the coming to power of Margaret Thatcher in the UK and Ronald Reagan in the US. All this ushered in an era of multinational corporation-led globalisation. In turn, this led to rapid growth of international trade, foreign direct investment and capital flows – all mutually reinforcing – and the consolidation of finance’s domination over the real economy.
Several features of this era of financialisation have direct implications for productivity. They include:
- Rapid expansion of financial markets, and the proliferation of financial institutions, instruments and services with the de-regulation and liberalisation of the financial system, blurring the distinction between speculative and patient investors;
- The banking sector becoming more concentrated, less regionalised and more internationalised with the decline of mutual, co-operative and State ownership of banks and financial institutions;
- Financial intermediation shifting from banks and other institutions to financial markets, thus the axiomatic ‘invisible hand’ of supposedly anonymous, self-regulating financial markets replacing the ‘visible hand’ of relationship banking;
- Nonfinancial corporations increasingly deriving profitability from their financial as opposed to their productive activities;
- Financial institutions increasingly becoming owners of equity, and real decision-making power shifting from corporate boardrooms to global financial markets pursuing shareholder value;
- Managerial remuneration packages increasingly becoming linked to short-term profitability and share price performance rather than to longer-term growth prospects.
These features, by and large, have adversely affected levels of real capital investment and innovation, due to the inexorable pressure of financial interests for the pursuit of short-term profits and dividends. Shareholders (most of whom are financial institutions) demand from corporations a bigger, faster distribution of profits. The lower retention of profits ratio, and share buybacks to boost share price together imply reduced internal finance for real investment, R&D, and technology upgrading.
Corporate managers act in the interests of the financial sector as they too profit personally from increasing stock market valuations – often linked to reduction of employment. This has meant chronic job insecurity and underinvestment in on-the-job training. Increased insecurity also discourages workers to invest in their own skill upgrading.
Thus, the overall effect of financialisation on investment, technology adoption, skill upgrading has been negative, with adverse consequences for productivity and decent jobs.
An overgrown financial system also costs the economy on a daily basis by attracting too many talented workers to ultimately unproductive careers in the financial sector. Talented students are disproportionately attracted to finance courses in preference to liberal arts or social sciences; moreover, bright engineering and science graduates are increasingly engaged in the financial sector, where they can earn many times more. Research at BIS shows that when skilled labour works in finance, the financial sector grows more quickly at the expense of the real economy – disproportionately harming R&D intensive industries.
In his Fred Hirsch Memorial Lecture (15 May 1984), Nobel Laureate James Tobin doubted the value of “throwing more and more of our resources, including the cream of our youth, into financial activities remote from the production of goods and services, into activities that generate high private rewards disproportionate to the social productivity.”
Luigi Zingales titled his 2015 presidential address to the American Finance Association, ‘Does finance benefit society?’. While acknowledging the need for a sophisticated financial sector, he doubted whether the growth of the financial sector in the last forty years has
been beneficial to society. He argued on the basis of both theory and empirical evidence that a large component of that growth has been pure rent seeking.
According to Gerry Epstein and Juan Antonio Montecino, the US financial sector captured rents “through a variety of mechanisms including anticompetitive practices, the marketing of excessively complex and risky products, government subsidies such as financial bailouts, and even fraudulent activities… By overcharging for products and services, financial firms grab a bigger slice of the economic pie at the expense of their customers and taxpayers.”
Robert Jenkins listed more ‘misdeeds’ of UK banks. These range from mis-selling (e.g. of payment protection insurance, interest rate swaps), manipulation of markets (e.g. precious metals markets, US Treasury Market auction/client sales, energy markets), aiding and abetting tax evasion and money laundering for violent drug cartels, collusion with Greek authorities to mislead EU policy makers on meeting Euro criteria, and more.
All this sounds too familiar to us in Australia after the Hayne Royal Commission into misconduct in the financial services industry.
A drag on the real sector
The power of finance has become a drag on the development of the real sector in a number of ways.
First, the manner in which the financial sector has grown has not been conducive for
real investment and savings. Finance has failed to act as an intermediary between savers and investors, and to allocate and monitor funds for real investment.
Second, the growth of financial markets and speculation have diverted resources into
what are essentially zero-sum games.
Third, the rush to financial liberalisation and the failures of the regulatory systems produced more frequent financial crises, with increasing depth and width. An over-abundance of (cash) finance is used primarily to fund a proliferation of short-term, high-risk investments in newly developed financial instruments, such as derivatives — Warren Buffett’s ‘financial weapons of mass destruction’ that blew up the global financial system in 2007–08.
Thus, real capital formation which increases overall economic output has slowed down, as profit owners, looking for the highest returns in the shortest possible time, reallocate their investments to more profitable financial markets.
With financial speculators now panicking in the face of the spread of the COVID-19 virus, in the context of inflated and debt-heavy financial valuations, we could be poised for another chapter in this repeating saga.
No amount of corporate tax cuts or suppression of labour rights in the name of structural reform will solve the productivity conundrum. What is really required is the taming of finance.
Finance can positively contribute to economic progress, but only when the ‘ephor’ is ‘governed’ and ‘directed’ by State regulation to structure accumulation and distribution into socially useful directions.
The earlier era of financialisation during the late 19th century and early 20th century ended with the Great Depression. John Maynard Keynes wrote in ‘The Grand Slump of 1930’, “there cannot be a real recovery . . . until the ideas of lenders and the ideas of productive borrowers are brought together again . . . .”. He thought, “seldom in modern history has the gap between the two been so wide and so difficult to bridge.”
Fortunately, the policymakers listened to Keynes and regulated finance to serve the real economy. This produced nearly three decades of the ‘golden age’ of capitalism, ending in the 1970s.
But the gap between finance and the real economy is now even wider and more difficult to bridge. It will require a lot of political will and courage to confront the very powerful finance capital which has changed the rules of the game to facilitate rent-seeking practices of a self-serving global elite.
Dr. Anis Chowdhury is an Adjunct Professor at Western Sydney University (School of Social Sciences) and the University of New South Wales (School of Business, ADFA), and an Associate of the Centre for Future Work.