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ECONOMY

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By Lynn Stuart Parramore / AlterNet July 22, 2013

30 COMMENTS

How Big Finance CrushesInnovation and Holds Back OurEconomyBold economic thinkers warn that it's time to tame thefinancialization monster.

Author's note: This post is based on papers

presented and remarks made during a

*conference panel I moderated

featuring William Lazonick of U Mass­

Lowell, Jan Kregel of the Levy Institute and

Damon Silvers of the AFL­CIO.

Whatever happened to innovation in

America? President Obama told us that our

future depends on it. Across the political

spectrum, everyone pretty much agrees that innovation is vital to prosperity.

So why aren’t we getting the job done? Clearly, we’re in desperate need of clean

technology that won’t poison us. Our information and communications systems are

not up to snuff. Our infrastructure is outdated and crumbling before our eyes. We’re

not investing enough in these areas, and it shows. Yet they’re necessary not only for

America’s economic health, but for stability and prosperity around the globe.

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The U.S. used to be the envy of the world

when it came to innovation, making things

that dazzled the world and enhanced the

lives of millions. But the Information

Technology & Innovation Foundation, a

bipartisan think­tank that ranks 36 countries

according to innovation­based

competitiveness, tells us we’re getting

pushed aside on the global innovation stage.

In 2009, to the surprise of those conducting the study, the U.S. ranked #4 in

innovation, behind Finland, Sweden and Singapore. In 2011, the U.S. ranking was

unchanged. Worse, the U.S. ranked second to last in terms of progress over the last

decade.

Research by the Organization for Economic Cooperation and Development

(OECD) also shows that the U.S. is not making as many cutting­edge products as it

used to, and that other countries with strong investment in the foundations of

innovation, like education and research and development, and fewer of the things

that hinder it, like income inequality, are making greater strides than we are.

What went wrong?

William Lazonick, an expert on the history of the American business corporation,

points out that the U.S has enjoyed, over its history, an extremely productive

economy. We still have important productive assets, but we’re now taking

money out of our productive economy instead of investing in it. The shift has

happened over time, but the mechanisms of extraction have become dangerously

efficient. A giant financial sector and wealthy class are sucking money, vampire­like,

out of the productive sector, where the goods, technologies and services that we

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want are created.

Financiers may appear to be simply “making money out of money,” but if you look

closely, you can see that they are really getting rich on the backs of people

producing useful things, like consumer electronics, and capital goods like factories

and equipment. Good jobs, the health of the overall economy and society, growing

incomes for the poor and middle class—all of these things have been put aside in

the quest for more financial profits. The game is unsustainable. And it’s turning out

badly.

To get the economy humming, argues Lazonick, you want to fuel the kind of growth

that allows people to enjoy higher living standards. You want an economy that is

stable and allows everyone to share in prosperity. But nowadays, the executives who

are running large industrial corporations like GE, Dupont, Cisco and Microsoft are

focused on making as much money as they can in the short­term for shareholders,

and more importantly, themselves.

Unsurprisingly, they support the policies that allow them to do this: things like low

taxes, risky speculation, sky­high executive pay, and pulling investment out of

education and infrastructure. What happens to our economy in the long­term is not

really their concern. There’s a motto on Wall Street: “I.B.G.­Y.B.G.” or “I’ll Be Gone,

You’ll Be Gone.” As long as you’re making money right now, what happens tomorrow

is not your problem.

It’s everyone else’s problem. Witness the decline in the number and quality of jobs,

the middle class evaporating, and the financial instability that brought about the

Great Recession.

A look back

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It wasn’t always like this, as Lazonick and Damon Silvers have pointed out. It used to

be that Wall Street made its money issuing long­term bonds that governments and

corporations could then use to invest in America’s productive assets. Sure, there

was trading in stocks and bonds, but you didn’t get huge increases in wealth

funneled to Wall Street as a result. There was some speculation involved, but it was

expensive for individuals to trade and such trading wasn’t designed to get huge

amounts of volume.

The commercial banking system was well

regulated, and household savings could be

channeled to businesses at fairly good rates

of return. Financial institutions were relatively

stable and they could help industry to

produce technological advances and

economic development. Up until the 1960s,

most Americans understood and accepted

the importance of the federal government in

helping to jumpstart innovation through things like defense and aerospace spending.

Some of that money got channeled through universities, and some of it was directed

to large corporations, which, like GE, could “bring good things to life.”

But in recent decades, several monkey wrenches got thrown into this system,

starting in the 1960s with the trend of conglomeration, in which corporate titans built

empires that gobbled up scores and even hundreds of companies. In the 1970s, as

inflation grew and the Japanese economy took off, Wall Street shifted from investing

to trading, and later, in the 1980s, executives came to adopt a harmful ideology

known as “shareholder value,” which held that shareholders are the only people who

deserve returns from corporations — forget about the taxpayers and the employees

without whose support, sweat and risk such companies would not exist. Corporations

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started focusing on manipulating stock prices to realize short­term gains, and

conducting stock buybacks to enrich executives at the expense of research and

development or investing in the skills of workers.

Wall Street banks started moving into higher margin businesses. They were no

longer regulated utilities, but high­risk, high­return institutions. This destabilized their

basic credit intermediation function. Up to the 1970s the productive system

dominated the financial system. But from the 1980s on, the balance of power was

reversed.

The financialization monster

Think about it: what GE product did you recently purchase that enhanced your life?

In the era of financialization, big companies like GE have turned their attention to

making quick Wall Street profits instead of fabulous products. In the 1980s, for

example, GE’s Jack Welch rapidly expanded the company’s business into issuing

credit cards, mortgage lending and other financial activities. It wouldn’t be long

before financial operations accounted for almost half of the company's profit.

Eventually we ended up with a situation in which, as my colleague Joshua

Holland has noted, a corporate executive will starve the company of needed

resources and hinder its ability to be productive in the interest of short­term gains. In

his book The Speculation Economy, Lawrence Mitchell of George Washington

University points out that a recent survey of CEOs of major American corporations

revealed that nearly 80 percent would have "at least moderately mutilated their

businesses in order to meet [financial] analysts’ quarterly profit estimates."

Silvers notes that as financialization fever took over, the U.S. developed a

dangerous imbalance between private and public finance, and we promoted public

policy founded on the strange idea that there really is no such thing as a public good.

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We embraced the idea that capital markets are more efficient if regulators step

aside, and we subscribed to the faulty notion that deregulation of financial institutions

would help the economy prosper.

Without regulation and strong unions to ensure that the U.S. kept steadily and

thoughtfully channeling money into productive investments like training workers and

creating stable jobs with reasonable incomes, the economy essentially became a

casino and the gap between the rich and the rest grew wider. We became known

less for innovation that enriched people’s lives than for creating complicated financial

instruments that are designed to rip people off. From 2004­2008, for example, when

other advanced economies were pouring money into clean technology, the U.S.

financial markets were rapidly innovating new financial products that served to

extract yet more wealth from the productive parts of our economy.

The wrong kind of innovation

Paul Volcker once famously quipped that the ATM is the only useful financial

innovation he’s seen in the last 20 years. It seems that while we haven’t gotten

around to things like clean technology, we’ve created lots of innovative ways for

ordinary people to lose money—things like lines of credits on homes that tend to

thrust people into debt more quickly and force them to bear the burden of Wall

Street’s obsession with making bigger returns at any cost.

Jan Kregel and Leonardo Burlamaqui have

examined how as the financial sector has

grown larger, the U.S. has ceased to be a

center for developing new knowledge.

Finance is no longer playing the role of the

“handmaiden of creative destruction” that

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allows industry to produce technological

advance and economic development.

Kregel and Burlamaqui also observe that the financial services industry has special

features which create economic instability in a variety of ways, for example, using

things like derivatives packages to shift risk from financial firms onto those less able

to bear that risk. Bubbles followed by catastrophic crashes become inevitable:

eventually, the weight of financial speculation becomes so great that it overwhelms

the system, as we saw in the late 1920s, and in the 2007­08 financial crisis. When

these crises occur, speculation decreases for a time, but as we can see now, the

financial sector is hell­bent on restoring profits— not for the sake of the economy and

jobs, but for the sake of their incomes.

Damon Silvers has also pointed out that the costs of financial bubbles include the

effects of the failure to productively invest capital, including the decline of

government investment in research and development. Income inequality keeps

growing, and Wall Street types push the false idea that any money they make is

made fairly and that the government should never intervene. Wages are pressed

down and yet wealth keeps on building— but only for the very few.

What to do?

Bottom line: the U.S. financial sector no longer serves the productive sector—in fact,

it may be killing it. But can it be stopped?

Taming the financialization monster won’t happen through volunteerism. Through our

increasingly corrupt political system, the titans of the financial sector pull more of the

strings in Washington, and they’re not likely to speak out against things like

skyrocketing executive pay, one of the forces driving income inequality, vaporizing

jobs, and diverting money from more productive channels. According to a report by

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the Economic Policy Institute, American CEOs now earn 273 times the average

worker’s salary. Thirty years ago, the average chief executive of a large public

company took in less than 30 times the pay of the typical worker. Have CEOs really

become that much more valuable?

As Lazonick points out, social norms have to change. In Japan, stratospheric

executive pay is considered unacceptable because there’s an understanding that

making a company work is a collective endeavor. That’s an important social value. In

Europe, there’s a movement to curb executive pay at bailed­out banks. Senior staff

at banks that enjoy state funding would only be able to earn 15 times the national

average salary or 10 times the wages of the average worker at the bank. Bonuses

would be capped at twice fixed salary.

That’s a good idea, and something we need to be discussing in the U.S., where

executive pay is not only extremely high compared to the rest of the world, but often

arbitrary and shockingly detached from performance.

Lazonick thinks what we really need is a whole new mindset about the economy. He

recommends several things that would help get us back on track:

Understand that markets don’t create value, but that organizations investing inproductive capabilities, like business, governments, and households do.

Ban stock repurchases by U.S. corporations so corporate financial resourcescan be channeled to innovation and job creation instead of wasted for thepurpose of jacking up companies’ stock prices.

Realize that the shareholder value ideology is destructive and will cause us tolag behind other countries that don’t subscribe to it.

Regulate employment contracts to ensure that workers who contribute to theinnovation process get to share in the gains from innovation.

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Create work programs that make use of and enhance the productivecapabilities of educated and experienced workers whose human capital wouldotherwise deteriorate through lack of other relevant employment.

Move toward a tax system that channels some of the money made on the gainsfrom innovation toward government agencies that can invest in the publicknowledge base needed for the next round of innovation.

We’ve still got plenty of innovation left in us, but we have to change our priorities and

make the financial economy subordinate to the productive economy. That would go a

long way toward getting Wall Street off our backs and allowing America to once

again be a place where energetic people thrive and work together to produce great

things.

**At a recent conference in Rio de Janeiro,

“Financial Institutions for Innovation and

Development,” sponsored by the Ford

Foundation Initiative on Reforming Global

Finance, the Multidisciplinary Institute for

Development and Strategies (MINDS) and

the Brazilian Development Bank (BNDES),

economists discussed innovation and how

financial markets, business enterprises and

the state interact with and invest in the process of creating and producing useful

things.

Lynn Parramore is contributing editor at AlterNet. She is cofounder of

Recessionwire, founding editor of New Deal 2.0, and author of "Reading the

Sphinx: Ancient Egypt in Nineteenth­Century Literary Culture." She received

her Ph.D. in English and cultural theory from NYU. Follow her on Twitter

@LynnParramore.

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