From American Affairs Journal, Winter 2021/Volume V, Number 4:
We are a technology company.
—Lloyd Blankfein, CEO of Goldman Sachs, 20151What exactly is financialization? How does it relate to what’s happening in the rest of the economy? Does it hinder growth, and if so, how? At the end of the nineteenth century, many on both the left and right regarded finance as a vampire sucking the lifeblood out of “real” businesses, workers, and, in Britain’s settler colonies, local economies. Indeed, Stanford literature professor Franco Moretti has argued that the classic 1897 Bram Stoker novel Dracula, which birthed the modern vampire mythos, reflected British manufacturers’ fears of competition from new American and central European firms (primarily German) backed by powerful banks.2 Contemporaneous and more prosaic American and German economists also observed how finance encompassed and encumbered nonfinancial firms. The final third of Thorstein Veblen’s still relevant Theory of the Business Enterprise (1904) dissects how U.S. financial elites used the stock market to consolidate and control industry. Shortly after, in 1910, the Marxist and later Weimar-era finance minister Rudolf Hilferding comprehensively analyzed banks’ preeminent power in the German economy.3
One century later, the same debate and language has resurfaced. Matt Taibbi famously called Goldman Sachs “a great vampire squid wrapped around the face of humanity.”4 But with Hollywood totally dependent on financial firms to capitalize its increasingly expensive and risky gambles, the focus in popular culture has shifted from vampires to the zombie firms they leave behind—bloodless, battered, neither bankrupt nor bountiful, shuffling around aimlessly in search of better corporate governance that might restore them to their prior profitable state.5
Academics of course also picked up this discourse, albeit under the less evocative labels “financialization” and “shareholder value model.” These arguments boil down to four main points. First, financial firms and nonfinancial corporations (NFCs) have opposing interests. Second, fights for control over NFCs in the stock market have forced NFCs to boost dividend payouts and share buybacks to the detriment of productive investment—the shareholder value model writ narrowly—and this is particularly true for American firms. Third, decreased investment necessarily hinders economic growth by reducing both productivity gains and aggregate demand. Fourth, households borrowing to supplement feeble wage growth can temporarily substitute for the missing aggregate demand, but at the cost of potential financial crises like that of 2008. The transformation of more and more income streams—student loans, credit card receivables, auto loans, leases—into securitizable assets connects all four themes. The financialization literature sees American households as the poster children for reckless borrowing, followed by U.S. NFCs using debt to execute share buybacks. By contrast, abstemious Germans and Japanese have less financialized economies.
This is a reasonable read of the situation. But as in Stoker’s Dracula, misdirection conceals the identity of some of the villains and the nature of the problem. In Dracula, of course, the eponymous villain hails from the darkness of central Europe. Our heroes by contrast are all English, excepting one American, Quincy Morris. But Morris cuts a rather ambiguous figure. While he is kin to the English protagonists—not a Morrisberg or Morrisoni or Morrisovic—he seems to possess too much knowledge of vampires, and his efforts to help defeat Dracula all go suspiciously awry. As Moretti points out, the final page of the novel leaves Morris dead, and thus, presumably, all vampires vanquished, not just the central European ones.
Just so a slice of the NFCs that are theoretically in opposition to vampire finance today, and just so a slice of financial firms. The lines of conflict do not line up as neatly as the academic literature and popular imagination might suggest. If we return to the four arguments above, the reality is not that finance uniformly opposes and bleeds NFCs, but rather that a set of firms—exploiting what Michael Lind has called “tollbooth” power—opposes a much larger set of firms, zombies included, lacking this power.6 Put simply, the profit data show that a handful of key financial firms that increasingly look like “tech” firms, and a handful of key tech firms that increasingly look like financial firms, have been capturing the bulk of profits in the U.S. economy.7 These two vampires underinvest, slowing growth.
Second, and counterintuitively, the profit data similarly show that in most rich countries the broad financial sector captures a larger share of cumulative national profit than does finance in the United States. Figure 1 shows the share of cumulative profit captured by either all financial firms (NACE codes 64–68, basically finance, insurance, and real estate) or just traditional banks and holding companies (NACE 64) as a percentage of cumulative profits captured by all nationally headquartered firms with annual revenue over $100 million in any year between 2011 and 2019. That share is lower in Germany, Japan, and Switzerland relative to the United States, but the gap between the United States and Germany is only 3 percentage points, versus a much larger gap at the right side of the figure. Third, the United States has consistently outgrown most of those other rich economies regardless of how you measure that growth. So there may be some truth to the “vampires equal slower growth” argument, but the United States is hardly the poster child for that claim. In any case, the evidence here is quite mixed. Most of the countries in which banks capture a large share of local profits had faster growth from 1995 to 2019 than the ones with smaller shares.....
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....So while there may be some truth to the argument that household debt substitutes for investment, the growth, investment, and household debt data don’t really line up in the expected way, unless we take a “quantity has a quality of its own” point of view. Here the much larger size of the U.S. population and economy does matter. Even with average or below-average levels of household and corporate debt, total U.S. bond debt (which includes much securitized household debt) accounted for 39 percent of global bond market value in 2017.8 Getting the mechanisms precisely right matters for policy that aims at faster growth rates, particularly as the long history of capitalism suggests that some degree of financialization is absolutely critical for growth.
Follow the Money
Financialization arguments advance both demand-side and supply-side mechanisms for slower U.S. growth after the 1970s. Both arguments rest on the diversion of NFC profits into the hands of financial firms. Under pressure from “shareholders”—read Wall Street—NFCs have shifted from what William Lazonick has called a “retain and reinvest” model of corporate behavior to a “downsize and distribute” model.9 Lazonick’s titles—“Profits without Prosperity”—and subtitles—“Predatory value extraction, slowing productivity, and the vanishing American middle class”—convey much of the argument. Before the 1980s, firms retained profits and continuously invested them in new products and process improvements, though Lazonick overlooks the contemporaneous conglomerate empire building and profound technological stagnation in the automobile sector. Today, firms shrink their physical capital and labor footprints to cut costs, and then distribute the additional profit to shareholders. The shareholder value model thus crippled firms’ ability to invest for growth.
In principle, draining profits from NFCs through large dividend payouts and share buybacks should promote an efficient use of capital in the larger economy. The economically rational shareholders receiving payouts from torpid firms should reinvest them into other firms capable of faster productivity growth and expansion. But data show precisely the opposite. Dividend payouts and buybacks have risen considerably as a share of profits from the 1990s to the present, but net fixed investment—a major contributor to both GDP and productivity growth—has fallen by nearly half from the 1980s to the 2000s. The 461 firms that managed to stay in the S&P 500 from 2007 to 2016 spent more than half their net income on share buybacks and a further two-fifths on dividends, retaining only 6 percent for reinvestment.10 Instead of productive investment, the cash from dividend payouts and share buybacks has flowed into the purchase of various sorts of positional goods—prime properties, artwork, etc.—and into existing financial assets. The prices for these kinds of assets have rocketed up since the 1990s....
....MUCH MORE
