The complexity of assessing government value added pales in comparison with this glaring weakness in the SNA: a confusion between profits and rents. Disentangling the two is fundamental to understanding value. As we saw earlier, classical value theory held that income from activities outside the production boundary was unearned. Rent – which was regarded as unearned income – was classified as a transfer from the productive to the unproductive sector, and was therefore excluded from GDP. But if, as marginal utility holds, the ‘services’ of a landlord or hedge fund manager are treated as productive, they magically become part of GDP.
The SNA generally links what people earn with the industries which pay them. Steel workers are paid by steel makers, shop workers are paid by retailers, insurance workers are paid by insurance companies, and so on. But income from property, dividends and lending, for example, is different because the people receiving it are not necessarily directly linked to its source (rent, dividends, loan interest etc.). If a steel firm rents an office, the rent it pays could go to firms in other sectors, to the government or even to households. A rich investor can derive income from dividends paid by any number of productive companies. A creditor – such as a bank – can lend money to several businesses or households and receive income as interest from them. All these types of income cannot be pinned down easily in the product account.
Although the SNA 2008 tried to deal with this difficulty, it did not state that, for example, property income is a reward for production, merely that ‘Property income accrues when the owners of financial assets and natural resources put them at the disposal of other institutional units.’37
PATCHING UP THE NATIONAL ACCOUNTS ISN’T ENOUGH
So while, in theory, balancing the national accounts between income and expenditure requires a clear sense of where the production boundary lies – where value is created – in practice the boundary is far from clear. National accounts as they stand are certainly much better than nothing and, among their merits, do permit consistent comparison between countries and over time. But despite all the effort that has gone into developing it, the SNA lacks a coherent and rigorous underlying value theory.
Government agencies such as the Bureau of Economic Analysis (BEA) in the United States and the Office of National Statistics (ONS) in the United Kingdom employ armies of people to estimate GDP, making decisions about what is producing new value that enlarges the wealth of a country. We are mesmerized into seeing this as the domain of a highly specialized profession that uses sophisticated modern statistical methods to provide precise parameters for the value that our society produces. The growth rate of our economies is forecast years in advance using complicated mathematics, with potential ‘outputs’ measured and GDP estimated to a tenth of a percentage every quarter.
In reality, the national accounts have been subjected to repeated attempts to patch them up and make them more relevant to changing needs and economies. Accounting for environmental damage has been mentioned. Accounting for happiness is another case. Lest the idea seems impossible, or at least nothing to do with economics, it’s worth recalling something basic: there is no point to the economy unless it helps people to lead better lives – and that quite reasonably means, at least in part, happier lives. The American economist James Tobin (1918–2002), who won the Nobel Prize in Economics in 1981 and was a Professor of Economics at Yale University for many years, wrote:
The whole purpose of the economy is the production of goods and services for consumption now or in the future. I think the burden of proof should always be on those who would produce less, rather than more, on those who would leave idle men or machines or land that could be used. It is amazing how many reasons can be found to justify such waste: fear of inflation, balance-of-payments deficits, unbalanced budgets, excessive national debt, loss of confidence in the dollar.38
Making decisions about which goods and services to include in GDP involves returning to the concept of the production boundary at the centre of classical economic thought – distinguishing productive from unproductive activities – and the theory of value that justifies such a distinction. Is a theory just assumed, as in the work of Petty and King? Or is it spelled out, as in Marx? And how can national accountants be persuaded that an activity that was previously seen as a transfer of existing value is actually creating new value? And above all, what do we mean by growth?
The way we define and measure growth is of course affected by our theory of value. And the resulting growth figures may guide the activities that are deemed important. And in the process possibly distort the economy.
GDP is worrying citizens and politicians everywhere: is it going up? Falling? And by how much? Understanding how GDP is constructed is thus crucial.
Unlike statisticians at the time of Smith or Marshall, modern governments have a wealth of data and a sophisticated system of national accounts that tracks the economy and the growth of each of its sectors. On the one hand, this makes it possible to see in great detail who does what in the economy – who is a ‘value creator’ and just how much everyone contributes to the national product. On the other hand, because of the way in which these accounts are set up, they are no more an objective metric of value than Quesnay’s categorizations, or Smith’s, or Marx’s.
In essence, we behave as economic actors according to the vision of the world of those who devise the accounting conventions. The marginalist theory of value underlying contemporary national accounting systems leads to an indiscriminate attribution of productivity to anyone grabbing a large income, and downplays the productivity of the less fortunate. In so doing, it justifies excessive inequalities of income and wealth and turns value extraction into value creation.
Put bluntly, any activity that can be exchanged for a price counts as adding to GDP. The accountants determine what falls into this category. But what criteria do they use? The answer is a hodge-podge which combines marginal utility with statistical feasibility and some sort of common sense that invites lobbying rather than reasoning about value. It is this that determines where the production boundary is drawn in the national accounts.
The next chapter focuses on the most egregious case of boundary-hopping: that of the financial sector, formerly seen as unproductive, now a creator of value.
4
Finance: A Colossus is Born
If the UK financial system thrives in the post-Brexit world, which is the plan, it will not be ten times GDP, it will be fifteen to twenty times GDP in another quarter of a century.
Mark Carney, Governor of the Bank of England, 3 August 2017
A large and growing financial sector has long been presented as a sign of UK and US success, credited with mobilizing capital to drive their economic development and generating exports at a time when manufacturing and farming had declined into net import. In the 1990s, comparable financial-sector expansion became an ambition for other countries seeking to follow the development path of these early industrializers, and to lessen dependence on the import of capital and services from the world’s ‘financial centres’ located in the UK and the US. Underpinning this expansion is the belief that a country benefits from an ever-growing financial sector, in terms of its growing contribution to GDP and exports, and as total financial-sector assets (bank loans, equities, bonds and derivatives) become an ever-larger multiple of GDP.
The celebration of finance by political leaders and expert bankers is, however, not universally shared among economists. It clashes with the common experience of business investors and households, for whom financial institutions’ control of the flow of money seems to guarantee the institutions’ own prosperity far more readily than that of their customers. For those without large fortunes and for many with ‘assets under management’, the notion of finance adding value has rung increasingly hollow in the long shadow of the global financial crisis that began in 2008. This required governments around the world to rescue major banks whose ‘net worth’ had turned out to be fictitious; with the bailouts cont
inuing to impose heavy social costs, ten years on, in the form of squeezed public budgets, heavy household debt and negative real returns for savers.
But for much of recent human history, in stark contrast to the current enthusiasm for financial-sector growth as a sign of (and spur to) prosperity, banks and financial markets were long regarded as a cost of doing business. Their profits reflected added value only to the extent that they improved the allocation of a country’s resources, and cross-subsidized a reliable payments system. Recurrent financial crises exposed the regularity with which they threw resources in unproductive directions (basically to other parts of the financial sector itself), ultimately disrupting the flow of money and goods in the real economy. The fastest-growing financial activities in 1980–2008 were asset management (making more money by investing in liquid financial assets and property, for the segment of the population earning enough to save) and lending to households, rather than to businesses. Finance also diverted many highly trained scientists and engineers away from work in direct production, by offering them on average 70 per cent more pay than other sectors could afford. The improbable level to which financial-sector profits rose, before and after the latest crisis, reflects a deliberate decision during the twentieth century to redraw the production boundary, so that previously excluded financial institutions were now included within it – and, having redesignated finance as productive, to strip away the regulations that had previously kept its charging and risk-taking under control.
The current chapter looks at the expansion of banking, and the way in which political decisions to recognize its value in national accounts (although based on economically contentious assumptions) helped to drive a deregulation which fuelled its ultimately over-reaching growth. In the next two chapters I explore the relationship between this growth and the financialization of the rest of the economy.
BANKS AND FINANCIAL MARKETS BECOME ALLIES
Policymakers’ faith in the value of finance was undiminished by its 2008 implosion. Indeed, their reaction to the global financial crisis was to insist that more of each economy’s ‘capital’ should be assigned to private-sector banks, and to support them with an ultra-relaxed monetary policy, in which near-zero interest rates were supplemented by central banks’ buying-up of government or even corporate bonds to keep their prices high. This massively increased the ‘asset’ side of the world’s main central banks.
Countries aspiring to achieve US levels of prosperity have long been advised, especially by their multilateral creditors, to make ‘financial deepening’ – the expansion and deregulation of banks and financial markets – a central part of their development strategy. At the same time, these creditors termed policies that restricted banks’ growth – such as capping interest rates, or restricting cross-border lending – ‘financial repression’, with the implication that financial liberalization was part of wider liberation. After 2008, as after previous regional financial crises (such as those that hit much of Latin America in 1982–3 and East Asia in 1997), the economists who had urged this liberalization asked themselves whether the unleashing of financial sectors had gone too far. But they invariably concluded that the crises were mere stumbles on a road travelled faster when financial growth was unblocked. So in 2015, the IMF concluded an exhaustive study ‘rethinking’ financial deepening by concluding that while the positive effects of the sector’s expansion might weaken at high levels of per-capita GDP, and/or if it grew too fast, ‘there is very little or no conflict between promoting financial stability and financial development’, and ‘most emerging markets are still in the relatively safe and growth-enhancing region of financial development’.1
Yet the belief that economic progress requires a growing financial sector, with banks at the heart of it, is counter-intuitive on a number of counts. If financial intermediaries promote economic growth by mobilizing capital and giving it better uses, national output (GDP) could be expected to grow faster than financial-sector output, thus diminishing its share of GDP. This must indeed be the case for many of the most successful ‘newly industrializing countries’, if – as they claim – the US and UK financial sectors have outgrown their home economies through the export of capital and services to the rest of the world. If banks and financial markets become more efficient, firms should make increased use of their services over time, losing their early preference for internal financing of investment out of retained profit. In practice, numerous studies find that firms continue to finance most of their investment (in production and new product development) internally through retentions, because external financers know less about their activities and offset their greater risk by demanding a higher return.2 And over time, financial markets should, by gaining efficiency, be able to expand at the expense of banks, which are usually explained as an alternative mechanism for channelling funds from savers to borrowers when equity and bond markets are insufficiently developed and information isn’t flowing freely.3 Yet even in modern capitalist economies banks have entrenched their role at the centre of the financial universe, to the extent of commanding wholesale rescue when their solvency and liquidity drained away in 2008.
THE BANKING PROBLEM
As we’ve seen, problems arise in national accounting with activities that appear to add value to the economy but whose output isn’t priced. Many of the services provided by government and voluntary-sector organizations fall into this category, as do private-sector products that are made freely available, such as Google’s search engine and Mozilla’s browser. National accounts conventionally ascribe a value to these, notwithstanding the free-market critics’ objection that non-marketed goods and services are cross-subsidized by (and constitute a drain on) the marketed-sector producers, thus subtracting from national productivity.4
But an equally serious problem arises when prices are charged for (and profits made from) a product or service that doesn’t obviously confer any value. In most parts of the economy, this is classified and condemned as monopoly rent-extraction. The trader who ‘corners the market’ in a product and resells it at a premium by withholding supplies, or stands between buyer and seller for no other purpose than to charge a commission before the two can connect, is condemned for the same unproductive profiteering as the highwayman who relieves travellers of cash before allowing them to pass. Until the 1970s, the financial sector was perceived as a distributor, not a creator, of wealth, engaging in activities that were sterile and unproductive. At that point, through a combination of economic reappraisal of the sector and political pressure applied by it, finance was moved from outside to inside the production boundary – and in the process wreaked havoc.
Governments across nineteenth-century Europe were convinced that banks added value, and were vital for the achievement of industrial modernization and economic growth. They were especially keen to promote investment banks, which were viewed as essential both to channel funds into productive investment and to co-ordinate firms and industries to raise the efficiency and rates of return on this investment. Investment banks’ importance in channelling professional investors’ funds into productive industry rose up the political agenda because early savings banks, which took deposits from households, often lost them to fraudulent or excessively risky money-making schemes and so were steered by regulation into buying mainly government bonds.5 By licensing only a few investment banks, governments granted them the monopoly power needed to co-ordinate expansion of related industries, and to achieve the profit required to absorb high risks.6 The banks’ unique role in development was recognized by some mid-twentieth-century economists, notably Joseph Schumpeter (1934) and Alexander Gerschenkron (1962).7
The ‘banking problem’ arose because, as the twentieth century progressed, banks’ role in fuelling economic development steadily diminished in theory and practice – while their success in generating revenue and profit, through operations paid for by households, firms and governments, steadily increased. A fast-expanding part of the economy in the middle of the
twentieth century was not being accounted for. The economists (like Schumpeter and Gerschenkron) who had ascribed banks a key role in development were nevertheless clear that they achieved this through exercising a degree of monopoly power, collecting rent as well as profit. Mainstream opinion, meanwhile, continued to view banks as intermediaries which, in charging to connect buyers and sellers (or borrowers and savers), made their income by capturing value from others rather than creating it themselves. Indeed today, if we use the value-added formula, we find that the financial sector, far from contributing 7.2 per cent of GDP to the UK economy and 7.3 per cent to the US (as the 2016 national accounts showed), in fact makes a contribution to output that is zero, or even negative. By this yardstick it is profoundly, fundamentally unproductive to society.
The ‘banking problem’, therefore, presented an oddity for national accountants. Traditionally, commercial banks and most investment banks make much of their income from interest differentials: they receive higher interest on the loans they make to customers than the interest they pay on funds they borrow. The charging of interest is justified in several complementary ways. It is said, for instance, to be a ‘reward for waiting’, compensating lenders for not being able to enjoy their money immediately because they’re allowing someone else to use it. It may also be a reward for taking risk. If money is not spent right now, it might yield less satisfaction later: if, for instance, those who use it in the meantime should lose all or part of it, or if its purchasing power is eroded by rising prices or a falling exchange rate. Unless kept in a sock, all unspent money tends to be lent to others, with no guarantee that money lent now will be repaid in full and on time. Borrowers might lose it on a failed business venture, or simply steal it and refuse to repay. Far from being ‘usurious’, therefore, the payment of interest can be interpreted as the lender’s reward for running the risk of never seeing their money again. The greater this risk, the higher the interest they are justified in charging.
The Value of Everything (UK) Page 13
