Neoliberalism and Financialization By David M. Kotz Department of Economics University of Massachusetts Amherst Amherst, MA 01003, U.S.A. March 29, 2008 Telephone: (413) 545-0739 Fax: (413) 545-2921 Email address: [email protected] This paper was written for a conference in honor of Jane D'Arista at the Political Economy Research Institute, University of Massachusetts Amherst, May 2-3, 2008. Neoliberalism and Financialization 1 1. Introduction The neoliberal era is now more than a quarter-century old, dating from around 1980. Among the unsettled issues concerning neoliberalism is its relation to the growing role of "finance" in the economy that has accompanied neoliberalism. This aim of this essay is to advance our understanding of this relation. A common view is that the rise of neoliberalism is explained by the growing role and power of finance in the political economy of capitalism. According to Dumenil and Levy (2004, 1-2), "...neoliberalism is the expression of the desire of a class of capitalist owners and the institutions in which their power is concentrated, which we collectively call 'finance,' to restore ... the class's revenues and power..." Some analysts view the rise of what might be called "financial dominance" as the underlying development that explains not only the emergence of the neoliberal order but also the associated form of globalization in this era (Dumenil and Levy, 2005, 17). This essay presents a different view. The changing role of finance in the economy in recent decades can, in our view, best be captured, not by the idea of dominance by the financial sector, but by the concept of "financialization," which suggests an expanding role for finance in economic activity. It will be argued here that the immediate cause of the financialization process of recent decades is found in neoliberal restructuring, rather than financialization explaining the rise of neoliberalism. However, financialization also has deeper roots that are unrelated to neoliberalism. This interpretation of the relation between neoliberalism and financialization clarifies what would otherwise be puzzling differences between the form of financial dominance that arose in the late nineteenth/early twentieth centuries and the financialization of the current neoliberal period. Section 2 explains what is meant by neoliberalism, making use of the social structure of accumulation theory of periodic changes in the institutional structure of capitalism. Section 3 explains what is meant by financialization. Section 4 considers the origin of neoliberalism and of Neoliberalism and Financialization 2 financialization, as well as the relation between the two. Section 5 analyzes the differences between financial dominance in the late nineteenth and early twentieth centuries and the financialization of the neoliberal era, in light of our interpretation of the neoliberalism-financialization relation. Section 6 offers concluding comments. 2. Neoliberalism and Social Structures of Accumulation The particular institutional form of capitalism has changed periodically since capitalism emerged several centuries ago. Neoliberalism can be understood as the latest institutional form of capitalism. The social structure of accumulation theory offers an analysis of the periodic changes in the capitalist institutional structure (Kotz, McDonough, and Reich, 1994). A social structure of accumulation (SSA) is interpreted here as a coherent, long-lasting capitalist institutional structure that promotes profit-making and forms a framework for capital accumulation.1 According to the SSA theory, each SSA functions effectively at promoting profit-making for several decades, but at some point it ceases to do so. This brings a period of crisis, which eventually gives rise to a new SSA. Each SSA exists at the level of global capitalism as well as within individual countries, although with some institutional variation across countries. The construction of the post-World War II SSA was completed by the late 1940s and worked effectively through around 1973. That SSA was characterized by active state regulation of economic activity both within states and in the global system, well developed welfare states, significant capital-labor cooperation, and a co-respective form of competition among large corporations. The postwar SSA was a significant departure from the past, when the state had played a more limited role in the economy and individuals were left largely to fend for themselves. The postwar system is often referred to as "regulated capitalism" because of the historical break entailed by the great expansion in the role of the state in that period. Around 1973 the postwar SSA entered a period of crisis, and in the late 1970s a new SSA Neoliberalism and Financialization 3 began to take shape, initially in the USA and UK. It came to be called "neoliberalism," since its main features resemble the pre-Great Depression "free-market" version of capitalism. In most of the world, although not in the USA, the term "liberal" refers to the view that the state should stay out of the economy. The neoliberal SSA was well established by the early 1980s (Kotz and McDonough, 2008). This SSA represented a sharp break from the previous one. Its main features are the removal of barriers to free movement of goods, services, and especially capital, throughout the global economy; a withdrawal by the state from the role of guiding and regulating economic activity; privatization of state enterprises and public services; the slashing of state social programs; a shift to regressive forms of taxation; a shift from cooperation between capital and labor to a drive by capital, with aid from the state, to fully dominate labor; and the replacement of co-respective behavior by large corporations with unrestrained competition. Neoliberalism has an associated ideology of worship of the so-called "free market" along with a denial of any positive role for the state apart from its coercive functions. The neoliberal SSA has entailed a major restructuring of the global capitalist system as well as a transformation of domestic institutions in the USA, the UK, and many other countries. However, some capitalist countries have only moved marginally toward the neoliberal model, such as the Scandinavian countries and Japan.2 The neoliberal institutional structure qualifies as a SSA, since it is a coherent, long-lasting capitalist institutional structure that has brought a rising rate of profit in the leading capitalist countries3 and has formed a framework for capital accumulation.4 3. Financialization A literature has arisen recently about the phenomenon of financialization. Definitions of this awkward term vary among authors. Perhaps the best, and most inclusive, definition is given by Epstein (2005, 3): "...financialization means the increasing role of financial motives, financial Neoliberalism and Financialization 4 markets, financial actors and financial institutions in the operation of domestic and international economies." The wording of this definition of financialization suggests a quantitative expansion of the role of finance in the economy, but it is not clear whether this means that the role of finance changes qualitatively. That is, is there a part, or aspect, of the economy, which can be called "finance," which undergoes a change in its relation to the remainder of the economy, which might be called the "nonfinancial sector?" If such a change does accompany the "increasing role" of finance as stated in the preceding definition, what kind of change is it? Possible changes include the following: 1) finance becomes more powerful in relation to the nonfinancial sector; 2) the link between finance and the non-financial sector becomes either tighter or looser. To address this question, we will examine the historical background to the emergence of financialization in the neoliberal era, drawing largely on the U.S. case. During the 1920s the financial sector in the U.S. was largely unregulated, and the latter part of the decade saw widespread financial fraud and speculative excess. At the end of the 1920s the stock market collapsed, followed by the banking system a few years later. As the Great Depression wore on, the view became influential that the excesses of unregulated finance had been a major factor in the severity of the Depression. This view greatly influenced the new regulation of finance that became part of the postwar SSA. Financial institutions in developed capitalist countries were typically state owned or closely regulated by the state in the postwar SSA. In the U.S. there were state controls on interest rates, financial institutions were segmented by type of business permitted, entry into financial markets was closely regulated, and banks were protected against failure by the state. The tight regulations forced the financial sector to concentrate on promoting capital accumulation in the nonfinancial sector. Starting in the 1970s activity in financial markets and the profits of financial institutions began to rise relative to non-financial economic activity and profits. Foreign exchange transactions Neoliberalism and Financialization 5 in the world economy rose from about $15 billion per day in 1973 to $80 billion in 1980 and $1,260 billion in 1995. Those figures were 15 per cent of world trade in goods and services in 1973 but less than 2 per cent of world trade in 1995, implying that the explosion in currency trading has been primarily for financial transactions, not the purchase of internationally traded goods and services (Bhaduri, 1998, 152). In the USA the pre-tax profits of financial corporations rose from an average of 13.9 per cent of all corporate profits in the 1960s to 19.4% in the 1970s, fell slightly to 17.2 percent in the 1980s, and then rose to 25.3 per cent in the 1990s and 36.8 per cent of all corporate profits during 2000-2006 (U.S. Bureau of Economic Analysis, 2008).5 Dumenil and Levy (2005, 38) found that in France the rate of profit of financial corporations was far below that for nonfinancial corporations in the early 1980s, but by the late 1990s the financial profit rate had far surpassed that for nonfinancials.