Make finance the servant, not the master

The governor of the Bank of England Mark CarneyAP Photo/Matt Dunham, Pool.

The governor of the Bank of England Mark CarneyAP Photo/Matt Dunham, Pool.

This piece is a response to John Mills’ challenge, ‘We need to rebalance the British Economy‘.

In her first big party conference speech, Britain’s new prime minister rode the wave of populist revolt that swept Britain before 23 June, 2016. “This is our generation’s moment” she said: “To write a new future upon the page. To bring power home and make decisions…here in Britain. To take back control and shape our future…here in Britain.”

But the prime minister only went halfway to meeting the concerns of more than seventeen million British ‘leavers’. For May’s vision is not just to “bring power home and make decisions… in Britain”. It is also “of a confident global Britain that doesn’t turn its back on globalisation but ensures the benefits are shared by all. And that Britain” she said emphatically “the Britain that we build after Brexit – is going to be a Global Britain.” (My emphases).

The prime minister’s approach builds on Tony Blair’s view that there was no need to stop and debate globalisation: “you might as well debate whether autumn should follow summer” he said to the Labour Party Conference in 2005. Or Gordon Brown’s recent Guardian plea that “we need a national conversation, and a national commission, on making globalisation work for Britain.”

Like her Labour predecessors, the new prime minister clearly signalled that she will do nothing to tame the global financial tail that wags the British economic bulldog. While she was willing to acknowledge that ‘global citizens’ are ‘citizens of nowhere’, her government will not address the much deeper economic and political malaise facing Britain – namely, financial globalisation.

Financial globalisation is the system whereby ‘citizens of nowhere’ – active in global capital markets – determine the life chances and living standards of citizens around the world. In other words, the system which permits financiers to use capital mobility to enjoy absolute advantages over all other sectors of a domestic economy, and which thereby elevates financiers to the position of masters not only of economies like Britain’s but also of the global economy. Capital enjoys this power because unlike trade or labour, flows of capital face very few barriers to movement, and can therefore quickly migrate to where returns or capital gains are highest. By contrast, flows of trade and labour face geographic, political, regulatory, physical and even emotional barriers to movement. It is this that makes capital dominant over trade and labour in the global economy, and increasingly so in a domestic economy like Britain’s.

And it is this dominance of finance over the real economy that has persuaded many industrial capitalists that if ‘you can’t fight ‘em, join em’. The result is that the economy has become increasingly financialised; Capitalists have tried to find ways of mimicking the finance sector’s ability to make gains effortlessly from debt and speculation. They make large amounts of their profits by accumulating unearned income from ‘rent’ on pre-existing assets, including land, houses, commercial buildings, vehicles, databases, brands, works of art, yachts etc. Those that do not own pre-existing assets that can be rented out are obliged to earn income – invariably from their labour.

Offshore capital abhors boundaries.
A stock ticker screen at the London Stock Exchange in the City of London. Picture by Philip Toscano PA Archive/PA Images

A stock ticker screen at the London Stock Exchange in the City of London. Picture by Philip Toscano PA Archive/PA Images

We should be mindful, as ecological economist Herman Daly once remarked, that policy-making in taxation, greenhouse gas emissions, pensions, criminal justice, welfare, etc, requires boundaries. British pensions and benefits are not payable to e.g. Brazilian citizens. Criminals could render the justice system meaningless if there were no barriers set by borders. HMRC cannot tax South African citizens resident in South Africa. However, while policy requires boundaries, global finance abhors boundaries.

We can be almost certain that Mrs May’s finance-friendly government will not bring offshore capital back onshore – to operate within the boundaries of British government law and policy-making. There will be no substantial re-structuring of Britain’s finance sector.  On the contrary, it is very likely that British taxpayers will be expected to continue to finance and subsidise the footloose activities of these ‘citizens of nowhere’, and to bail out the City of London’s institutions in the event of failure. Contrary to the fine words in Mrs May’s conference speech, there is even talk of taxpayers footing the bill for the City of London to continue operating within the EU, when other traders will be excluded from access to the Single Market. If the British government persists in this deference to the City, both the government and voters can look forward to a continuing decline in real living standards while global elites deploy mobile capital, new technology and algorithms to gouge rent from every conceivable British asset – and from British workers in a range of sectors, and in their homes.  The income from these ‘rents’ will not be reinvested in the British economy, but will be channeled to wherever tax and regulation are lowest, and wherever in the world speculative returns are highest.

The power of finance.
Participants in the London Stock Exchange's float in the City of London during the Lord Mayor's Show. Picture by Laura Lean PA Archive/PA Images

Participants in the London Stock Exchange’s float in the City of London during the Lord Mayor’s Show. Picture by Laura Lean PA Archive/PA Images

While the recent fall in sterling may be welcome relief for exporters, its rapid decline is nothing less than a defiant reaction by financiers in global capital markets to the Brexit vote. It is but the latest manifestation of the power of these financiers to dictate political preferences and to act, in effect, as masters not just of the economy, but of British democracy.

Financial globalisation has weakened and unbalanced the British economy, and that in my view, explains more fully the Brexit vote. For it is my contention that financial globalisation has led to the decline of British industry, the decline in investment, the rise in unemployment or insecure employment, and to the fall in labour’s share of the economy. Above all, it is financial globalisation that has caused regular, overlapping and increasingly catastrophic crises.

Key decisions by Britain’s public authorities to re-regulate (not de-regulate) the British economy in the 1970s had the express purpose of advantaging the City of London and disadvantaging industry – especially the export sector, as Davies and Walsh explain in their 2014 paper ‘The role of the state in the financialisation of the economy’.

One of the most significant of the changes was the removal of controls over capital flows in and out of the country. A second change was the transformation of banking to allow bankers to lend, not on the basis of the value or viability of a project, but instead on the basis of whoever was willing to pay the highest price (or rate of interest) on a loan. As a result, borrowing for investment became prohibitively expensive, afforded only by the few.

In addition as Davies and Walsh demonstrate, other changes were made to advantage finance:

“Stamp duty on the purchase of shares and bonds was cut in stages from 2 to 0.5 per cent. Dividend payment controls were abolished in 1982. In contrast, although corporation tax was cut for all businesses, this was paid for specifically by removing capital investment allowances for machinery and plants – measures which primarily hit manufacturing. There were steady value-added tax (VAT) rates rises on goods and services, but financial and insurance services were made VAT-exempt. This doubly disadvantaged industry next to finance as the former made much greater use of real world goods and services than the latter.”

As its architects intended, these changes to the financial system took place without much public or academic debate. Partly as a result of this stealth, the process of financial globalisation was not, and is still not well understood by either economists, or politicians – a fact that reflects badly on the mainstream economics profession. Aeronautical engineers have an understanding of the climate and engineering conditions that affect the safety of passengers. By contrast, economists, especially microeconomists, do not share the same concern for the safety and wellbeing of citizens operating within market economies. Whereas no aeronautical engineer would abandon passengers to the vagaries of the weather or to untested technology, economists breezily delegate management of the financial system and of the British economy to ‘the invisible hand’.

As a result of the transformation of the economy in the 1970s, globalised financiers have starved firms of affordable finance, which in turn has led to cuts in investment in both skills and infrastructure. Management of the exchange rate is no longer the responsibility of Britain’s public authorities. Instead this critical economic tool was privatised, and the currency – like many others – is now subject to the whims of speculators in capital markets. The result of these changes was entirely predictable. Labour’s share of the economic cake was slashed; inequality intensified and divergences between British regions deepened, fuelling public outrage. Worse, I will assert here, it is financial globalisation that has ratcheted up both Britain’s but also the world’s toxic emissions.

What is a balanced economy?

If we want to balance the power wielded by the financial sector over our economy, we must be clear that rebalancing the economy also means re-thinking the relationship between the economy and growth. An alternative, more balanced economy will not be based on the untenable and environmentally disastrous concept of ‘growth’, let alone ‘green growth’. Instead, a balanced economy is one that promotes sustainable economic activity – in particular full, meaningful employment aimed at substituting labour for fossil fuels. As the economist Robert Pollin explains

“spending on green investments creates approximately three times as many jobs as spending the same amount of money on maintaining our existing fossil fuel sector. The reasons are straightforward. First, clean energy investments are simply more labour intensive. Also, a higher proportion of overall spending on the green economy remains within the domestic economy as opposed to purchasing imports.”

So a rebalanced British economy is one in which Britain’s demand for goods and services meets the nation’s well-managed supply of finance, labour, commodities, products and services.

‘Growth’ and the language of market fundamentalism. 
Picture by Joe Giddens PA Wire/PA Images

Picture by Joe Giddens PA Wire/PA Images to an official report.

Before the Second World War the concept of ‘growth’ scarcely existed, as Geoff Tily explains in his PRIME essay On Prosperity, Growth and Finance.

“National accounts and measures of national income (the forerunners of GDP) were devised in the 1930s, in the wake of the great depression. Policymakers and economists were preoccupied by getting the economy and financial system to function and addressing a crisis in unemployment. Later in the Second World War economic statistics were needed to try and prevent inflation, given that all resources – especially labour – were fully utilized. Then, later in the Bretton Woods era, full employment was regarded as the proper goal of economic policy-making.”

With financial liberalization all this was to change. Financiers could make extraordinary capital gains from financial speculation – far more than the average industrial capitalist could make in profits. This was largely because financiers can gamble and make gains in money markets without engaging with either the land – in the broadest sense of the word – or labour. Industrial capitalists by contrast have to engage with both land and labour. The substantial capital gains made from speculation by increasingly deregulated financiers were then pitted against the lower profits made by industrial capitalists from investment, employment and output. As financiers became more dominant, competition with industrial capitalists intensified.

It is hard to pinpoint the exact timing for the shift of emphasis, but under the surface changes were underway from at least the 1950s. The pressure on industrial capital was applied by both the finance sector, but also by friends in the economics profession, and in particular economic commentators. The latter began to reframe the key concept of levels of economic activity, and invented the term growth. Growth follows the trajectory of capital gains more closely than it follows that of more volatile profits. Capital gains – like those made from winning the lottery – can rise exponentially (until they crash). Profits rise and fall as capitalists battle the land and labour.

In the UK one of the most prominent campaigners for the concept of ‘growth’ was Samuel Brittan of the Financial Times: he proudly identified himself as a ‘growthman’.  At a time of full employment, he and other economists castigated the government (and industry) for what they regarded as an economy less profitable or dynamic than that seen in other countries. To apply pressure on those active in the real economy, they had to raise the bar of economic expectations. Full employment was not a sufficient goal. It was to be abandoned.

The concept of growth was subsequently adopted as the goal of all economy policy by the newly-founded OECD in 1961. In that year the organisation agreed an extraordinary fifty per cent growth target for the whole of the 1960s, as Tily explains:

“The aim of fixing the level of employment and output to sustainable levels had been abandoned. Instead the world had officially been set a systematic and improbable target: to chase growth. Nobody seems to have paused to consider whether growth derived as the rate of change of a continuous function was a meaningful or valid way to interpret changes in the size of economies over time.”

Whereas in nature growth is part of the process of life that begins with birth, moves to maturity and ends in death, in economics ‘growth’ is expected always to expand, and to be boundless.

‘Growth’, inflation and consumption.
Sunflower Electric Cooperative's coal-fired power plant. Picture by Charlie Riedel AP/Press Association Images

Sunflower Electric Cooperative’s coal-fired power plant. Picture by Charlie Riedel AP/Press Association Images

The result of the new unmanaged ‘growth’ strategy of the 1970s was disastrous: a decade of uncontrolled inflation followed, as management of the exchange rate was abandoned, and as too much ‘easy’ money chased too few goods and services. 1970s inflation is always wrongly blamed on Maynard Keynes and the unions, but in truth these policies were anti-Keynesian. It was the 1971 decision to remove controls over bank lending that caused a massive expansion of credit (often for speculation) and that fueled inflation. The almost simultaneous decision by Britain’s public authorities to abandon responsibility for managing the exchange rate, and instead to switch to ‘flexible exchange rates’ meant that sterling fell 16% between 1971 and 1974. Import prices rose by 79%; consumer prices by 35%. The unions tried to ensure wages kept up, but they were to be defeated. Loss of control over bank lending was a key factor in 70s inflation, but so was the now out-of-control exchange rate.

These changes hurt consumers, workers and manufacturers, but greatly enriched and empowered the finance sector. Vast sums of money were made from buying and selling sterling; by speculating on whether the currency would rise or fall and by ‘buying cheap’ in one currency and ‘selling high’ in another. Even greater sums were made from lending at high rates of interest. But then, once the public authorities gave up acting as ‘guardians of the nation’s finances’ why would speculators invest in Britain for the long-term? Why would they engage with either the land or labour in the process of manufacturing – when vast sums could be made short-term, by gambling on tiny movements in the value of any marketable asset?

The ‘growth’ and inflation of the 1970s, was followed by decades of rapidly expanding consumption, falling real incomes, de-industrialisation and rising income inequality. Britain became less self-sufficient, and more dependent on imports. We began to rely on ‘the kindness of strangers’ to finance the nation’s rising overdraft with the rest of the world.

Policies for what were effectively exponential growth took their toll not just on the real economy, but on the ecosystem as ‘easy money’ at high rates of interest (think of credit cards) facilitated a massive expansion of consumption and, to satisfy that demand, extraction of the earth’s scarce assets. Which is why ‘green growth’ is an oxymoron, and should never be used by those concerned to protect the commons. Instead we should replace the language of ‘growth’ with the term ‘economic activity’ – to include employment, investment and output.

The real aim of rebalancing the economy will be to increase activity – especially skilled, well-paid, meaningful employment – within a framework that subordinates finance to the role of servant, not master of the economy; and that builds an economic framework of national self-sufficiency within the finite and sustainable limits of the ecosystem.

The stark utopia of financial globalisation.
Financial information displayed nside the London Stock Exchange. Picture: AP Photo/Matt Dunham

Financial information displayed inside the London Stock Exchange. Picture: AP Photo/Matt Dunham

The policy prescriptions for returning the British economy back into balance are both viable, tried and tested. We know they work, because they have worked before, in our very recent history: a period known by all mainstream economists as ‘the golden age’ of economics: 1945 – 71.

Of course the argument will be that “it is not possible to turn the clock back”. But if we survey the current political scene in both Europe and the United States it is possible to see, before our very own eyes, the clock being turned back. Once again electorates are turning in desperation to ‘strong men’ for leadership and protection against the predatory forces of financial globalization. These are rightly perceived to be beyond the control of democratic governments. They are not of course, but both social democratic as well as conservative governments in Europe and the US have subordinated the interests of domestic economies to the interests of those active in global capital markets – ‘the citizens of nowhere’.

In Europe in the 1930s, as Karl Polanyi argued in a famous passage from The Great Transformation, the masses turned to authoritarian leaders like Mussolini and Hitler for such protection from “the self-regulating market’. For Polanyi

“the self-adjusting market implied a stark utopia. Such an institution could not exist for any length of time without annihilating the human and natural substance of society; it would have physically destroyed man and transformed his surroundings into a wilderness. Inevitably, society took measures to protect itself…..”

Societies protect themselves from market fundamentalism.
Former chancellor George Osborne attends the inauguration of the ceremonial market opening in London. Picture by Stefan Wermuth PA Wire/PA Images

Former chancellor George Osborne attends the inauguration of the ceremonial market opening in London. Picture by Stefan Wermuth PA Wire/PA Images

Today the people of Europe are once again turning to populist, protectionist anti-immigrant leaders, for protection.  France’s Marine Le Pen leads the National Front, a party founded by Nazi collaborators that promotes protectionism. In Hungary Viktor Orban leads his right-wing, protectionist and anti-immigrant Fidesz party. Norbert Hofer of the nationalist and anti-immigration Freedom Party has been given another chance by the Austrian courts to become the first far-right politician elected head of state in Europe since World War II. Jaroslaw Kaczynski leads Poland’s right-wing Law and Justice party, which has embraced economic interventionism. In Greece the neo fascist party, Golden Dawn openly uses violence to pursue its aims. And in Britain UKIP and the right-wing of the Tory Party have campaigned for Britain to “take back control”.

In the United States ‘America First’ is the slogan of the Donald Trump campaign – a campaign that will not go away after the presidential election. His campaign slogan is taken from the 1930s ‘America First’ campaign backed by the anti-war Left, and which counted Charles Lindbergh as one of its leaders. Lindbergh blamed Jewish people for drawing America into war, and warned “their greatest danger to this country lies in their large ownership and influence in our motion pictures, our press, our radio, and our government.” Today ‘America First’ is once again the slogan of the Trump campaign – but this time it is Muslims that are blamed for US weakness. Trump proposes to renegotiate trade terms; strengthen the military; make American energy independent, and build a wall against Mexican immigrants.

The rise of populist, nationalist, and even fascist political parties is a predictable response to the ‘stark utopia’ of a self-regulating globalized financial system. A major incentive for pushing back on the war-mongering of political populism would be the introduction of policies for managing and regulating the global financial system to restore political, economic and social stability and balance.

This argument in turn is based on a simple democratic one: that elected governments have a duty to their people, and to their domestic economy – not to invisible players in global capital markets. Governments, like aeronautical engineers, have a duty, and are accountable for the management of the domestic economy and for keeping it safe for the population it governs. To abandon such duties is to vacate the nation’s political space and to invite populist, authoritarian parties to ‘take control’.

Bringing offshore capital onshore. 
Picture by AP Photo/Lee Jin-man)

Picture by AP Photo/Lee Jin-man)

The most important policies for rebalancing the British economy require management of capital flows in and out of the UK: capital control. In other words, monitoring and restrictions (perhaps in part using ‘Robin Hood’ taxes) applied by the authorities on flows of mobile capital – to act as ‘sand in the wheels’ of such mobility. Such taxes are vital to slow down and manage flows of ‘hot money’ into and out of Britain, where valued property acts as an attractive tax haven for laundered, and often illicit flows of speculative capital. Unbridled flows can cause the exchange rate to rise, or to fall suddenly, hurting both exporters, investors and consumers. They can of course be reversed quickly, as we have seen happen since the EU vote, and in so doing can destabilize the economy. These flows have been left to ‘the invisible hand’ with governments apparently helpless in the face of instability and disorder.

Above all, capital mobility renders all domestic taxation policy-making meaningless. If firms (like Apple, Starbucks, Facebook or Amazon) or wealthy individuals can simply move their money abroad, tax policies are rendered futile. Campaigning for big oligopolies to pay taxes is meaningless without campaigns for capital control.

Second, the Bank of England must re-introduce a range of macro-prudential tools – regulations that aim to mitigate risks to the financial system as a whole. These are needed to manage the production and distribution of money, and to discourage credit-financed speculation – in property and other pre-existing assets (stocks and shares, bonds, works of art, vintage cars, brands etc.). The use of such tools is necessary if society is to ‘take back control’ of the management of the financial system from bankers. Above all, they are important if the Bank of England is to regain control over the whole spectrum of interest rates – not just the ‘Bank of England policy rate’ – which applies only to bankers. All rates, short and long, safe and risky and real – should be managed in the interests of Britain’s domestic industry and of sustainable activity. High rates of interest demand high rates of return on all forms of economic activity – and explain why so much of the ecosystem is plundered (think of forests, fisheries and the land) to finance debt repayments.  Low, affordable rates will make the financing of climate change projects viable, and will support a wide range of activity, including public projects and services.

Third, democratic governments must begin once again, to coordinate and cooperate at international level, to manage exchange rates, global imbalances and the global financial system. Its management and stability can no longer be left to the insatiable greed and rapacious instincts of the ‘citizens of nowhere’: Vulture Funds, Private Equity firms, Silicon Valley billionaires, global investment bankers and speculators.

“Let finance be national.”
The Bank of England. Picture by Anthony Devlin PA Wire/PA Images

The Bank of England. Picture by Anthony Devlin PA Wire/PA Images

If Britain is to maintain political, social and ecological stability then it is absolutely essential for the British government to manage the financial system, not leave it to the anarchy of unregulated financial markets. Proper governance of the financial system will make finance for productive investment affordable. Management of the financial system will help stabilize the exchange rate – much as was done during the Bretton Woods era. Management of the exchange rate can begin to address Britain’s massive (6% of GDP) current account imbalance, and help to rebalance the economy away from financial globalization, and towards greater domestic self-reliance.

Such governance is necessary if we are to return the British economy to balance: one where well-paid, meaningful employment is available for all who are able to work – regardless of which region of the country they happen to live in. Employment at liveable wages, and supportive of families and communities, will be our most valued measure of balance and stability. This is because full, meaningful employment is not just vital to social and political stability – but also to environmental stability. One has only to think of the way in which mass youth unemployment has laid waste to much of the Middle East. If we are to transform the economy away from dependence on fossil fuels, then substituting labour for insecure energy sources will be a central part of that transformation.

Management of the financial system will support a wide range of economic policies that can restore social as well as political balance and stability to Britain. These include effective taxation of the owners of wealth to help reduce the rampant inequality that now dogs Britain. Policies and activity that can provide hope, meaning and respect to those millions whose roar of anger and despair was heard so clearly in the vote for Brexit. Policies that, given the finite nature of the world’s natural resources, can ensure a degree of self-sufficiency for the people of Britain; can diminish the threat of conflicts and sustain peace between Britain and her neighbours.

For as Keynes once famously argued:

“Ideas, knowledge, science, hospitality, travel–these are the things which should of their nature be international. But let goods be homespun whenever it is reasonably and conveniently possible, and, above all, let finance be primarily national.”

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