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Finance and the Destruction of Shared Prosperity
To understand how finance has undermined a shared and sustainable prosperity requires some historical context. Prior to 1980, the U.S. economy could be described as a Keynesian wage-led growth model. Under the logic of this model, growth in economic productivity drove growth in wages, which fueled demand. That drove full employment, which provided the incentive to invest, which drove productivity growth, and so on. (See Figure 16–1.)
Figure 16–1. The Virtuous Circle Keynsian Growth Model, 1945–75
Within this economic model, finance was essentially a form of public utility governed by New Deal regulation. The role of finance was to (1) provide business and entrepreneurs with finance for investment, (2) provide households with mortgage finance for home acquisition, (3) provide business and households with insurance services, (4) provide households with saving instruments to meet future needs, and (5) provide business and households with transactions services.
After 1980, however, the Keynesian wage-led growth model and the public utility model of finance were gradually pulled apart and dismantled. A first critical change was the implementation of economic policies that helped sever the link between productivity growth and wages. A second critical change was the dismantling of the New Deal system of regulation—through deregulation—combined with a refusal to regulate new financial developments and innovations. As a result of severing the once-strong link between productivity growth and wages, average hourly wages and compensation stagnated after 1980 despite continuing productivity growth. (See Figure 16–2.)
The new model can be described as a “market fundamentalist” policy box that fences workers in and pressures them from all sides. (See Figure 16–3.) On one side, the corporate model of globalization has put workers in international competition via global production networks that are supported by free trade agreements and capital mobility. On the other side, the “small” government agenda has attacked the legitimacy of government and pushed persistently for deregulation regardless of dangers. From below, the agenda of labor market flexibility has attacked unions and labor market supports such as the minimum wage, unemployment benefits, employment protections, and employee rights. And from above, policy makers have abandoned the commitment to full employment, a development reflected in the rise of inflation targeting and the move toward independent central banks controlled by financial interests. The result is a new system characterized by wage stagnation and income inequality in which the problem of demand shortage has been papered over by debt-financed consumption and asset price inflation.
Figure 16–2. Productivity and Real Average Hourly Wage and Compensation of U.S. Non-supervisory Workers, 1948–2011
Figure 16–3. The Neoliberal (“Market Fundamentalist”) Policy Box
Finance has played a critical role in both creating and maintaining the new economic model, whose main characteristics are worsened income distribution, the increased importance of the financial sector relative to the real economy, and the transfer of income from the real economy to the financial sector. During the past 40 years, the financial sector has increased both its share of gross domestic product (GDP)—reaching more than 20 percent in 2007—as well as its share of profits relative to the non-financial sector. (See Table 16–1.)
The process whereby financial sector interests have come to dominate the economy is widely referred to as “financialization.” This process had three main conduits, related to the financial market structure, corporate behavior, and economic policy. (See Figure 16–4.)
First, finance (commercial banks, investment banks, hedge funds, insurance companies, mutual funds, etc.) used its political power to promote the policies on which the new model rests. Thus, finance lobbied for financial deregulation; supported the shift of macroeconomic policy away from focusing on full employment to focusing on inflation; supported corporate globalization and expanding international capital mobility; supported privatization, the regressive tax agenda, and the shrinking of the state; and supported the attack on unions and workers.
More specifically, globalization policy created a global economy through trade agreements like the North American Free Trade Agreement (NAFTA) that lacked effective labor and environmental standards. The regressive tax agenda was evident in the decline in corporate income taxes, the shifting of the tax burden onto lower income households via increased payroll and sales taxes, and the lowering of top personal tax rates. The attack on workers was exemplified by the decline in the minimum wage and by labor laws that favored corporations against workers trying to form unions. The shift to a focus on inflation was evident in the U.S. Federal Reserve's prioritization of inflation concerns over unemployment concerns.
Second, finance took control of American business and forced it to adopt financialchange was accomplished via increased actual and threatened use of hostile takeovers, hedge fund activism, and increased use of massive stock option awards for top management that
Table 16–1. Growth of the U.S. Financial Sector, Selected Years, 1973–2007
Figure 16–4. Main Conduits of Financialization
aligned management's interest with that of Wall Street. The resulting change in business behavior was justified using the rationale of shareholder value maximization. The result was a widespread use of leveraged buyouts that burdened firms with unprecedented levels of debt; the adoption of a shortterm business perspective and impossibly high required rates of return that undercut long-term real investment; growing reliance on off-shoring and the abandonment of a business commitment to community and country; and the adoption of exceedingly generous Wall Street pay packages for top management and boards of directors.
Third, the deregulated financial system provided the credit that financed borrowing and created asset price bubbles. Examples of these bubbles include the stock market and Internet bubbles of the late 1990s, and the commercial real estate and housing price bubble of the 2000s. These bubbles effectively filled the “demand shortage” that had been created by years of wage stagnation and increased inequality. Instead of being able to rely on purchasing power, many households ended up financing their purchases by going ever more deeply into debt. Household debt rose as a share of GDP from 45.3 percent in 1973 to 98.2 percent in 2007, just prior to the most recent financial crisis.
(See Table 16–2.)
Table 16–2. Growth of U.S. Household Debt, Selected Years, 1973–2007
Viewed in this light, financialization is at the very core of current economic difficulties. Finance drove the policies that undermined shared prosperity, and then fueled a 30year credit bubble that papered over the demand shortage caused by worsening income distribution. That created an unstable financial system that collapsed when the credit bubble burst. And now, as it emerges from the depths of the financial crisis, the U.S. economy is stuck in stagnation because of deteriorated income distribution and the massive structural trade deficit that, together, undercut the domestic demand needed for full employment.
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