Financialization and democracy

Written by Nicolas Guignard

This essay was written in one hour for one of my final exams at Sciences Po (Business & Society course) given the prompt :

For some, financialization represents the explosion of financial trading with a myriad of new financial instruments; for some, the ascendancy of ‘shareholder value’ as a mode of corporate governance; while others use it to refer to the increasing penetration of financial motives and financial calculations in everyday life and the increasing political and economic power of a particular class grouping: the rentier class. Finally, for Krippner herself, the term refers to a ‘pattern of accumulation in which profit making occurs increasingly through financial channels rather than through trade and commodity production’ (Krippner 2004: 14). Describe the different historical processes that are subsumed under this term. How are they linked? What is the role of central banks in this process? Also, reflect upon the advantages and drawbacks of a term that is so encompassing.

I am republishing it today in a slightly modified version for it to be more easily understandable. However, if you wish to fully grasp the significance of every point, I urge you to read the academic articles this essay is based upon (see further readings section).

“Financialization is squeezing more earnings from a dollar of sales without squeezing at all, but through tax arbitrage or balance-sheet arbitrage. Financialization is the zero-sum-game aspect of capitalism, where profit-margin growth is both pulled forward from future real growth and pulled away from current economic risk-taking. Financialization is the smiley-face perversion of Adam Smith’s invisible hand and Joseph Schumpeter’s creative destruction.” said chief investment officer at Second Foundation Partners Ben Hunt.

Financialization is a wider and more encompassing word than what Ben Hunt is implying. The term was first coined in the 1990's to describe the rise of finance. Financialization along with marketization and globalization no doubt are the three key trends of the neoliberal era.

The neoliberal order (1981-today) has replaced the Keynesian compromise which existed all through the ’30 Glorieuses’ (1945-1973), and can be characterized by the alliance between money owners and skilled technicians through the deregulation of the financial institutions. As Marxist economists Duménil and Lévy put it, the ‘capitalist class’ (capital owners) managed to secure the alliance of the technicians (financial experts, regulators, …) by ‘sharing the cake’ with them (allowing them to become richer by paying them for their skills). Hence, since the Voelker shock of 1981 we have been living in new stage of capitalism: neoliberalism, characterised by deregulation, departitioning and disintermediation, epitomized by the Greenspan put: let the market be free and ‘mop up’ after the crisis.

Strengthened by Reaganomics (Ronald Reagan’s economic policy), finance was able to grow in importance and its profits skyrocketed. This was however not without consequences for the world and for democracy. We should however first tackle the question of the definition of financialization before analysing its effect on representation in liberal democracy.

Financialization is a process which can be used to describe the rise of finance and the explosion of the number of financial tools. Indeed, finance is now the number one industry in the United States, and the Great Financial Crisis (2007-9) shook the world’s economy to its core. This was essentially the first time that a financial crisis led to an economic crisis, whose magnitude is only surpassed by that of the Great Depression of the 1930’s. Less regulations induced by Reaganomics have made this possible as well as new tools allowed by technological advancement. Among those are high frequency trading, derivatives (CDO, CDS, swaps futures, forwards, …) along with index funds and ETFs (which represent roughly half of the roughly 12trn USD in funds). This explosion of tools was accompanied with a sharp increase in both private and public debt. Finance has gained in importance, and has become global, essentially turning the world into a giant, interconnected market.

For Natasha van der Zwan (van der Zwan, 2015), financialization has three facets: corporate governance, accumulation regime and the financialization of everyday life. Corporate governance is this new vision of the firm as being more and more seen as a ‘nexus of cash flows’, whose only purpose is to increase those cash flows. Doesn’t our Corporate Finance textbook state that the only goal of a CEO is to maximize a company’s market value? Moreover, the repartition of value-added reveals a slight shift toward shareholders, which are now the almighty controllers of corporations, while employees, mainly because of globalization and higher unemployment rates, as well as the decline of trade unions, hold less power. Marx’s alienation of the proletarian worker is becoming more of a reality, and never since the 19th century had the divide between workers and capital owners been so clearly defined. The accumulation regime reveals the shift from Fordism towards a financial growth regime (Aglietta 1997, Boyer 2000). This mechanism is that of the decrease of the importance of investment and the rise of the appreciation of assets. As stock markets skyrocketed and gained in importance as a source of funding for corporations, companies need more than ever to gain trust from investors. Deutsche Bank’s troubles in 2015-17 epitomized this, as Deutsche Bank was stuck in a vicious circle of market depreciation since it lost shareholders’ trust, furthering the decrease of the price of the company’s value, and so on and so on. Lastly, the financialization of everyday life refers to the rise of credit, from student loans to subprimes, as well as the new way pension and retirement funds are financed: through investing in ‘safe’ financial products (which, as 2008 showed, may very well not be as safe as the rating agencies indicated). Overall, debt from corporations, financial intermediaries, households and governments is at an all-time high. As long as interest rates remain low, this may be sustainable (even if the burden of debt weighs heavily on many economic actors), but the slightest rise in the central bank’s policy rate could lead to a wave of defaults and collapse.

This can very much be linked with Duménil and Lévy’s definition of neoliberalism as the class alliance between technicians (wall-street bankers, SEC employees, …) and capital owners. Capital owners gained support from the technicians through giving them a slight percentage of their wealth in exchange for wealth management skills. This is a mix between the “bankers did it” and the “technocrats did it” hypothesis, in which both classes realized they would benefit from their alliance. But financialization was not without consequences for democracy.

Historically, capitalism and democracy have undergone a concomitant development, and liberal democracy (the mode of governance in much of the western world) is a synthesis of those ideologies, with values such as protection of private property, freedom of speech and thoughts, as well as a strong welfare state at its foundation. This was one of the key progress made after World War 2: having witnessed how mass unemployment, misery and economic distress (experienced during the Great Depression) could lead humanity to the “bottomless pit of inhumanity” (Kershaw, 2016), statesmen made a point to ensure economic safety and ensure individuals’ wellbeing after the end of the war. The Marshall Plan, the creation of social securities across the western world and the adoption of minimum wage regulations are the epitomes of this era. All of those policies were funded by the incredible years of growth much of the western world experienced until the 1973 oil-shock.

But since both oil shocks, the international system of trade and finance has been deeply transformed. The Bretton-Woods system collapsed, and a terrible wave of unemployment, recession and inflation led most western economies to ‘stagflation’. Thankfully, the Chicago School (Friedman, Hayek & Co) had the solution, which was put into application by Reagan in the United States and Margaret Thatcher in the UK. A drastic cut of taxes, economic deregulation, and a fight against inflation were on the menu, along with a massive wave of delocalisation. This last element transformed the world in the 80’s and 90’s with the opening of China and its development as the workshop of the world. In the western world, this led to a sharp decline of the secondary sector (along with trade unions) and a rise of the tertiary one. This would lead to a mass unemployment and precarisation of the workers previously working in the manufacturing sector, and a rise of low-payed, low-skilled workers in the tertiary sector (call centers,...) but also a drastic reduction in the price of goods. Globalisation was born. At the same time, conventional Keynesian policies showed their limit as in 1981 with the Mauroy stimulus in France, where external constraints induced by globalisation led to all of the stimulus being absorbed by an increase in trade deficit instead of an increase in investment.

Those transformations led, as Pierre Rosenvallon (Rosenvallon, 1981) points out, to a triple crisis of the welfare state: legitimacy (the welfare state is least and least popular), efficiency (it fails in its mission of equity, and redistribution) and funding (states rely more and more on debt to fund their social system). Thus, the welfare state which in Europe had mostly been based on a Beveridgian model (universal - everyone is entitled -, uniform - everyone gets the same -, united - everything is centralized and handled by the state -) shifted in the 80’s and 90’s to a Bismarckian model (handled by employers and private institutions, based on previous cotisation). With the welfare state questioned and the shift toward workfare, one of the pillars of liberal democracy was gone, while the disappearance (in the US) and weakening (in Europe) of trade unions has led to a crisis of representation for the workers and the shift of their vote from the left to the far right. Traditional governing parties are enduring deep crisis in most of the western world, from being voted out of power in France (where a party created ex-nihilo by a formerly obscure banker secured executive and legislative power in 2017), to being forced into unstable alliances to contain extreme parties (Germany, Sweden, Belgium, ...), or like in the US where the bipartisan system is undergoing a terrible crisis which could lead to the break-up of parties. Those traditional parties have mostly been replaced by populist alternatives, or have themselves become populist, in a trend that can only be qualified as dangerous for liberal democracy.

This rise of populism can be explained by several factors. First, the financial economy is very disconnected from the real economy, and only benefits a tiny percentage of the population. This coupled with low capital and income taxes has led to an increase of inequalities to unprecedented levels, with 0.1% of the population owning as much wealth as the bottom 50%. Moreover, those 0.1% have enormous economic and political power, creating a conflict of interest when former bankers such as Henry Paulson, the US Secretary of the Treasury “killed” the main challenger of his former employer (the 2008 bank bailout did not include Lehman Brothers, a rival of Goldman Sachs for which Paulson served as CEO), or when Jose Manuel Barroso goes to work for Goldman after failing to take adequate banking regulation while holding EU-office. This leads to a representation crisis for the masses, where no matter which party they vote for, that party will serve (or so it is perceived) the interest of a tiny minority, thus failing to address the concern of the rest of the population.

Then, the neoliberal order has decreased inequalities between countries (as predicted by Solow, most emerging economies are catching up with developed ones), but coincidentally led to a sharp increase in inequalities within countries. This is the founding of the now (in)famous elephant curve, showing how the middle and lower classes in developed countries have basically seen no increase in their purchasing power since the 1980’s. The increase of others' power purchase relative to theirs made those classes feel ‘left-over’, the losers of globalisation. Beside, those strong inequalities, as Rawls pointed out, lead to a crisis of representation, and undermine equality of chances, a founding pillar of liberal democracy. Studies show that to reach the top 1% when starting from the bottom 1% in France, there needs to pass 7 generations. Inequalities may also harm growth as shown by Patrick Artus (Croissance zéro, with Marie-Paule Virard, 2015) and Thomas Piketty (The Capital in the 21st century, 2013), as seen in most of Europe in the last decade, where the growth rate neared 0%. This makes capitalism an increasingly 0-sum game, since the pie is not increasing in size, only its repartition matters.

Finally, market mechanisms, as Slovenian philosopher Slavoj Zizek pointed out, fail to tackle the challenges the world is now facing. Indeed, the neo-liberal logic of deregulation is in contradiction with that of representative democracy, with elected officials representing the people who would then be in control of the decision making. Besides, capitalism is entering a deep, multifactor crisis. Climate change is threatening its promise of everlasting growth, while the low interest rates, the burden of debt and the lacklustre growth in most of the world’s developed economy further undermine it. On a geopolitical level, rising tensions and the awakening of strong nationalist feelings may further hinder the free market.

To conclude with, we can say that Prince Charles was right in talking of negative externalities that need urgent tackling. Financialization is a process which occurred over the past 40 years and transformed the economy to such an extent that it is now damaging representative liberal democracy. The paths of democracy and neo-liberal capitalism are diverging, due to interests that no longer work hand in hand. On the one hand, capitalism promises everlasting growth, return on investment at any cost and has sharply increased inequalities while liberal democracy increasingly promotes values of equality (both economic and social, and environmentalism. The world is at a crossroad and will most likely move away from the neoliberal paradigm in the coming decade. However, the new paradigm has yet to be found, and the transition will most likely not be painless. It is easy to criticize the current economic model, but much harder to substitute it with a better one.

Further readings:

Aglietta, Michel. Régulation Et Crises Du Capitalisme. Odile Jacob, 1997.

Artus, Patrick, and Marie-Paule Virard. Croissance zéro: Comment éviter Le Chaos? Fayard, 2015.

Boyer, Robert. “Is a Finance-Led Growth Regime a Viable Alternative to Fordism? A Preliminary Analysis.” Economy and Society, vol. 29, no. 1, 2000, pp. 111–145., doi:10.1080/030851400360587.

Duménil, Gérard, and Dominique Lévy. “Néolibéralisme: Dépassement Ou Renouvellement D'un Ordre Social?” Revue Actuel Marx, vol. 40, Feb. 2006, pp. 86–101.

Esping-Andersen, Gosta. “Social Foundations of Postindustrial Economies.” Oxford University Press, 1999, doi:10.1093/0198742002.001.0001.

Griffin, Donal. “Deutsche Bank’s Woes May Be ‘Insurmountable,’ Berenberg Says.” Bloomberg.com, Bloomberg, 16 May 2016, www.bloomberg.com/news/articles/2016-05-16/deutsche-bank-s-problems-may-be-insurmountable-berenberg-says.

Harari, Yuval N. Sapiens. Harper, 2014.

Hayek, Friedrich A. The Road to Serfdom. Routledge & Kegan Paul, 1944.

Kershaw, Ian. To Hell and Back. Penguin Group USA, 2016.

Piketty, Thomas, and Arthur Goldhammer. Capital in the Twenty-First Century. Seuil, 2013.

Rosenvallon, Pierre. La Crise De L'etat-Providence. Seuil, 1981.

Zwan, Natascha Van Der. “Making Sense of Financialization.” Socio-Economic Review, vol. 12, no. 1, 2014, pp. 99–129., doi:10.1093/ser/mwt020

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