Today we have a relay courtesy of the Real News Network. Gerald Epstein of UMass Amherst and the PERI Insitute talks with Paul Jay about the financialization ofthe economy. It is historical perspective on the centrality of debt in the boom, crash and future of the world's economies from then to now.
TRANSCRIPT OF THE ORIGINAL INTERVIEW COURTESY OF THE REAL NEWS NETWORK:
Gerald Epstein is codirector of the Political Economy Research Institute (PERI) and Professor of Economics. He received his Ph.D. in economics from Princeton University. He has published widely on a variety of progressive economic policy issues, especially in the areas of central banking and international finance, and is the editor or co-editor of six volumes.
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay in Baltimore.
What happens to an economy and a society when the finance sector becomes increasingly dominant? Some people call much of the finance sector parasitical. And if that's the case, then what happens when parasitical capital becomes so dominant?
Here's a graph that gives some sense of just how important a question this is. You'll see in this graph that starting around 1860, 1880, the GDP share of the U.S. financial industry starts to grow. It more or less goes up steadily until around the crash of '28, '29, '30, in that area, where it reaches something like about 6 percent of GDP. It goes down steadily and reaches a dip at around just after 1940 and during the war, and then starts to climb again continuously. Sometime around 1980 it gets back to that 6 percent peak, but it keeps going. By early 2000s, based on this graph, it hits over 8 percent. And then we have the crash in 2008.
Now joining us to talk about these numbers and more is Gerry Epstein. He's coordinator of the political—codirector, I should say, of the Political Economy Research Institute. He's a professor of economics. And he joins us now from Amherst, Massachusetts. Thanks for joining us, Gerry.
GERALD EPSTEIN, CODIRECTOR, PERI: Thanks for having me, Paul.
JAY: So, first of all, talk about this graph. Why are these numbers significant? So why should we care that the finance sector gets so big? Maybe that just shows us the economy's doing well.
EPSTEIN: Well, this graph by Thomas Philippon at NYU is a very important one, because it illustrates this problem that Keynes, among others, talked about. You know, Keynes said that there's enterprise and there's speculation. Speculation is undertaken by the financial sector, enterprise by manufacturers and other parts of the real economy. And he says when enterprise is dominant, when speculation is just a bubble on the sea of enterprise, the economy can grow and it can develop. But when enterprise is just a little bubble on the swirl of speculation, that can destroy the economy. And we saw that.
If you look at this graph that you started with, when finance became a larger and larger share of the economy, it was associated with the crash of the 1930s. And then, when it kept going up and up and up again by 2008, we again saw another crash.
And it represents, among other things, this dominant short-termism of speculation and, most importantly, of private debt in the economy, which makes it much less stable.
JAY: Now, the issue of the percentage of GDP is one thing, but percentage of profits is also astounding.
EPSTEIN: That's right. If you look at some other data, what you'll see is that by around 2007, 2008, the profits going to the financial sector was 40 percent or more of total profits in the United States. So when you have such a dominance by one sector of the economy—which, by the way, does not really produce much of anything; it's an intermediate product; it's supposed to be helping the rest of the economy grow—when you have it taking over so much of the profit and such a large part of the economy, it can lead to a number of significant problems.
JAY: Now, one of the things I thought was very interesting about this graph is that it isn't something new that finance gets so big, that—if you look at the first part of the 20th century, the same process took place. And I know there's a lot of weight put on Glass–Steagall as the legislation that was passed in the 1930s that tried to mitigate this, but this idea that finance becomes so dominant, I've seen some people analyze that this is kind of a natural phenomenon with capitalism, that when you get industry at such a massive scale and the need for massive amounts of capital to buy the kind of equipment it takes to do auto manufacturing or any of the mass manufacturing processes, that that necessarily puts finance in this driving-seat position in relationship to the rest of the economy.
EPSTEIN: Well, certainly finance is important to capitalism, and finance under certain conditions can play a very productive role. Joseph Schumpeter, the famous economist, thought that finance played really dynamic role in financing innovation and financing the real economy. And so part of what one sees in these data from the 1860s, 1880s, is in fact the role of finance in helping to finance a lot of very important, real activity in the U.S.—manufacturing, the building of the railroads, canals, a lot of infrastructure, the whole development of the United States as the workshop of the world during that period. So, clearly, finance, when it's well-organized and functioning in the service of the economy, is very important.
So part of what we saw in those early data from that graph is finance playing that role. But then eventually what happened in the 1920s and so forth is that finance started playing a highly speculative role on the stock market and so forth. And that's what Keynes was talking about in that quote that I mentioned. And so when finance becomes primarily a speculative activity, that is, investors making bets on what other investors are doing rather than actually financing jobs and real investment, then it becomes a problem.
JAY: And the banks would play this role of they would loan money to company A, and then they'd loan money to company B to buy stuff from company A, and they'd be greasing the wheels on all sides, which I guess is part of what some of the legislation was meant to mitigate. But I guess my point is: is it not inherent in this stage of capitalist development?
EPSTEIN: It's a danger, just as you said. You know, if you look across the world, there are different kinds of financial systems, different kinds of relationships between finance and industry. And historically in Germany and in France and Italy there were much closer relations between the banks and the industrial companies, the manufacturing companies and so forth, and there were ways in which that kind of close relationship was bettered, that the banks could take a longer-term perspective on investment, they didn't have such a short-term perspective that required returns, you know, every quarter or every month. And so for the industrial development in Germany and France in the 19th and early 20 century, this kind of longer-term connection was actually productive. Same in Japan—we had this kind of longer-term connection between finance and industry.
But what you're saying is absolutely right. When finance begins to get the upper hand and to agglomerate business so that it can become a monopoly and exploit consumers and workers, when they start using this leverage to grease the political system and to engage primarily in speculation and not longer-term investment, this creates not only massive inequality of incomes but inequality of power.
And I think that's what we saw in the United States and increasingly in other countries: we saw that there was a deregulation of finance here in the United States that was really promoted, starting in the 1980s. You pointed to the graph where the shares started going up around 1980 with—when Ronald Reagan became president, Paul Volcker was head of the Fed. And then, when Carter and Clinton came in, they got rid of many more controls over finance.
And so then finance became really an engine of speculation, an engine of agglomeration. Part of this was helped by the economics profession. This thing started called the shareholder value movement, the idea that companies should do whatever—they should start acting like financial firms, industrial firms like General Motors or GE, to start acting like financial firms, and should maximize the short-term earnings of their shareholders and forget about the stakeholders, the workers and others. And the economics profession thought that this was really the way to maximize the productivity of the industrial economies.
And so what we saw as a result of this is that CEOs of corporations started caring just about their stock options and the short-term returns that they could get on their stock rather than making the long-term investments in their corporations. William Lazonick, among others, has written about this. And this has facilitated an enormous increase of inequality by both the financiers and the CEOs of these companies. In fact, what we saw was a financialization of nonfinancial companies.
JAY: And this idea that finance, you know, helped create everything, that's only partially true, because most of the big infrastructure projects, from roads to canals to power, dams and such, was all public money. It wasn't that—it wasn't the banks were the only source of finance to spur manufacturing or the creation of these things. Public finance played a decisive role in many parts of the economy.
EPSTEIN: Yeah, that's right. In fact, I think that's part of the reason why by the middle of the Great Depression, Keynes had gotten to the point where he was saying, you know, if he had his way, we'd really reduce the role of private finance, socialize most of this big investment, socialize most of finance, because that's the surest way, in his view, to reduce this role of speculation and to maximize the longer-term term perspective for society as a whole.
You know, we do have this big problem now, as we have this aging population, the baby boomer population—the U.S. is aging, and elsewhere in the world—who are trying to figure out how to save for their old age. And we've totally privatized or almost totally privatized the mechanisms for transferring wealth from when you're young to when you're old so you can retire.
And with the financial industry, one of the reasons it's grown so much is that by financial liberalization, by reducing the amount of socialized savings, or Social Security and defined benefit plans and so forth, they've managed to grab most of these savings that people my age have tried to put into the system to figure out how we're going to survive when we're old.
And what they've done with most of these savings is siphoned off massive incomes for the CEOs and for the financial sector, made poor investments in the real economy. And so in the end, when those people, my generation or a little bit younger, retire, there's not going to be a lot of wealth created for people to retire on.
And again, this gets back to what Keynes was saying. Our ability to retire really depends on how productive our economy has been over the previous 20 years and how the rewards of that productivity are shared among the population. We need to return to a financial system and an economic system where we can really invest in true productivity in the economy, where those returns can be shared widely. And only then will people have real income, real wealth to retire on.
JAY: But when you say "return", we're at a point now where finance capital is so powerful, and not just as a percentage of the GDP, but so powerful politically, that you can barely pass the flimsiest regulation to try to control what's happening, whether it's in derivatives markets or other forms of banking activity. You know, the joke has been they own Congress. I guess it's not a joke. It's a sad truth. [incompr.] get to that point, it's not—what can you return to? Don't we have to move toward something new?
EPSTEIN: Right, we have to move to something new. And what we have to look at—let's look at the Occupy movement, for example. There's a new initiative there that I think is very important. It's called Strike Debt. And it's using the fact that when you look at these financial returns, these financial profits, you have to understand that the other side of that is debt and the fact that households are indebted, mortgages, student debt, small businesses, a huge amount of debt, and the way the whole legal system has been restructured and the political system, as you said, has been restructured, where now the dominant goal of much of our political and legal system is to make sure that people try to—have to repay this debt. And so what Strike Debt is saying is, no, there has to be debt resistance; we have to have change in laws so that it's easier for households and students to go bankrupt, to wipe the slate clean.
You know, as David [greIb3`] in his book Debt: The First 5,000 Years pointed out, historically, if you look back thousands of years, societies get overindebted. They tend to—they start to weigh down the progress of the society. And leaders of the political system have to call jubilees. We have to strike the debt, and I think we're at that point now in the United States. Certainly they're at that point in Europe. And we have to be part of this movement to really—to give debt relief to the vast majority of Americans who are now weighed down by debt. And it's this debt that is one of the major burdens that's making it very difficult for our economy to get going again.
JAY: AlL right. Thanks for joining us, Gerry.
EPSTEIN: Thank you.
JAY: And thank you for joining us on The Real News Network.