The Need for De-financialization
The arguments presented above can be summarized in terms of the nature of financialization over the past few decades, that many of the aspects of financialization have been detrimental to economic performance in terms of tending to slow economic growth and investment; thereby becoming more prone to financial crises and the associated losses of recession, and devoting resources, often highly trained labour, to trading activities in securities etc., which bring little economic benefits. In this section the focus is on ways in which the financial sector can be restructured and downsized to be more conducive to serving economic, social and environment needs.
The idea that the financial sector is in some sense too large and does not focus on its key roles is not a new one, though it is one that has frequently been dismissed by economists and politicians (not to mention by the financial sector itself). Over three decades ago, in his Fred Hirsch lecture, Tobin (1984) voiced sceptical views of the efficiency of our vast system of financial markets and institutions, which as he noted “run against current tides—not only the general enthusiasm for deregulation and unfettered competition but my profession’s intellectual admiration for the efficiency of financial markets” (p. 2). Tobin considered efficiency under four heads: information-arbitrage, fundamental-valuation, full- insurance and functional. He argued that securities markets do very little to enable the translation of household saving into the funding of investment. Only a small part of the large volume of transactions of securities and equity markets is involved with the financing of real investment. He remarked that “in many respects ... the system serves us as individuals and as a society very well indeed” but he 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” (p. 14).
Stiglitz (1994) argued “that much of the rationale for liberalizing financial markets is based neither on a sound economic understanding of how these markets work nor on the potential scope for government intervention. Often, too, it lacks an understanding of the historical events and political forces that have led governments to assume their present role. Instead, it is based on an ideological commitment to an idealized conception of markets that is grounded neither in fact nor in economic theory” (p. 22). He argued that financial innovations often contribute little to the achievement of economic efficiency, and may well be welfare-decreasing. He gave as an example technology which permitted faster transactions may do little for economic efficiency but absorbs resources which could have been used elsewhere. Overall he postulates that “Improvements in secondary markets do not necessarily enhance the ability of the economy either to mobilize savings or to allocate capital” (p. 22).
Zingales (2015) poses the question in the title ofhis paper which formed the basis of presidential address to the American Finance Association of ‘does finance benefit society’, and then comments that for an academic economist the answer would appear to be obvious”. But he argues that there is a need to “acknowledge that our view of the benefits of finance is inflated. While there is no doubt that a developed economy needs a sophisticated financial sector, at the current state of knowledge there is no theoretical reason or empirical evidence to support the notion that all the growth of the financial sector in the last forty years has been beneficial to society” (p. 3). He continues by arguing that there is both theory and empirical evidence that a component of that growth has been pure rent seeking, and that a task of academics is to use research and teaching to reduce the rent-seeking dimension of finance.
Kashkari (2016), President and CEO of the Federal Reserve Bank of Minneapolis, argues that although too big to fail banks “were not the sole cause of the recent financial crisis and Great Recession, there is no question that their presence at the center of our financial system contributed significantly to the magnitude of the crisis and to the extensive damage it inflicted across the economy.” (p. 5). He then argues that the problem of too big to fail has to be solved in light of the scale of job losses, home foreclosures and fiscal costs. He argues that there is a range of options which need to be seriously considered. These include the break-up of large banks into smaller less connected entities, the “turning of large banks into public utilities by forcing them to hold so much capital that they virtually can’t fail (with regulation akin to that of a nuclear power plant)” (p. 5), and the taxation of “leverage throughout the financial system to reduce systemic risks wherever they lie” (p. 5).
The evidence cited above pointed in the direction that the further growth of the financial sector would likely constrain rather than enhance growth. As Black (2010) pointed out in the context of the USA, “forty years ago, our real economy grew better with a financial sector that received one-twentieth as large a percentage of total profits (2 %) than does the current financial sector (40 %)”. Those I have just cited above could be viewed as suggesting in various ways that the financial sector has become too large in terms of its use of resources relative to the economic and social benefits provided by the financial sector. Financial instability and the associated costs of financial crisis have resulted from finan- cialization and financial liberalization. As the financial sector has shifted towards the generation of, and then high-volume trading, in derivatives, securitization, etc., it has shifted away from the facilitation of savings and the financing of investment. It is then perhaps not surprising that the growth of the financial sector (relative to GDP) is not linked with economic growth as the growth of the capital stock is no longer being facilitated by the operations of the financial sector. The ways in which the financial sector has changed over the past four decades can be contrasted with what are often said to be the key functions of the financial system. Minsky (1993), for example, identified six functions of a banking and financial system: “operating the payments mechanism, including the mechanism for making payments at a distance.
- • Providing safe and secure outlets for transaction balances and household savings.
- • Financing housing and providing consumer credit.
- • Providing commercial banking services such as loans and sundry services to business.
- • Providing investment banking services, including determining feasible liability structures for firms and acting as an intermediary in the placement of the part of the liability structure that is not bankable.
- • Providing trust services as well as portfolio advice and asset management for households” (p. 34).
The thrust of the approach here is to develop the roles of a range of alternative financial institutions whose focus is more on those roles than on the development of, and then extensive trading in, financial assets. It also has to be remembered that the financial institutions are the channels through which funds flow from surplus units to deficit units, and the direction in which the funds are channelled is heavily dependent on the credit allocation decisions made by the financial institutions. In the next subsection I offer some remarks on credit allocation by financial institutions on the grounds that different types of financial institutions will make different credit allocation decisions, and the suitability of a diversity of financial institutions The thrust of the approach here is to develop the roles of a range of alternative financial institutions whose focus is more on those roles than on the development of and then extensive trading in financial assets. It also has to be remembered that the financial institutions are the channels through which funds flow from surplus units to deficit units, and the direction in which the funds are channelled is heavily dependent on the credit allocation decisions made by the financial institutions. In the next subsection some remarks are offered on credit allocation by financial institutions on the grounds that different types of financial institutions will make different credit allocation decisions, and the suitability of a diversity of financial institutions arises from the diversity of decision making. In this respect, the line of argument advanced by Groeneveld 2015) is followed when he writes that “diversity in ownership and business orientation leads to diversity in risk appetite, management, incentive structures, policies and practices as well as behaviours and outcomes. It offers greater choice for customers and society through enhanced competition that derives in part from the juxtaposition of different business models” (p. 6).