Finance and/as the Real Economy

Bookforum recently offered an an eclectic collection of recent articles on the financial crisis. It links to William K. Black, who is as provocative as usual. He believes that finance, rather than serving the “real economy,” actually undermines it:

The finance sector is an intermediary — essentially a “middleman”. Like all middlemen, it should be as small as possible, while still being capable of accomplishing its mission. Otherwise it is inherently parasitical. Unfortunately, it is now vastly larger than necessary, dwarfing the real economy it is supposed to serve. Forty years ago, our real economy grew better with a financial sector that received one-twentieth as large a percentage of total profits (2%) than does the current financial sector (40%). . . .

[For example], The financial sector’s fixation on accounting earnings leads it to pressure U.S manufacturing and service firms to export jobs abroad, to deny capital to firms that are unionized, and to encourage firms to use foreign tax havens to evade paying U.S. taxes.

Black lists five “fatal flaws of finance” that make it a drain on the productive activities in the economy. But other commentators may question his effort to separate the “real” from the “finance” economy. Compensation in both areas is driven much more by law than we are usually willing to admit. As Bernard Harcourt has argued, we ignore the real determinants of advantage and disadvantage at our peril, “naturalizing and masking the regulatory mechanisms inherent to all markets that massively redistribute wealth.” (Harcourt’s comparison of 18th century French bread market regulation and contemporary futures markets nicely illuminates the problem.)

If I had one wish for the legal academy in the next decade, I’d hope we can do more to show how law (rather than “market demand,” “innovation,” or other naturalizing accounts) is the basis of so many great fortunes. We will be cleaning up messes from the past decade throughout much of the next one, and legislative and regulatory decisions will continually (and necessarily) influence who the big winners and losers will be.

Debates over relative dessert are going to be at the core of political decisionmaking in the 2010s. For a taste, compare the views of two economists, Gregory Clark and James Galbraith, on the value of labor in today’s economy. For Clark, the great social question of the 21st century is how to get the “makers” to pay for the “takers:”

[T]he economic problems of the future will not be about growth but about something more nettlesome: the ineluctable increase in the number of people with no marketable skills, and technology’s role not as the antidote to social conflict, but as its instigator. The battle will be over how to get the economy’s winners to pay for an increasingly costly poor.

By contrast, Galbraith’s book The Predator State questions whether there is a market-driven value behind any given individual’s compensation:

[T]he setting of wages and the control of the distribution of pay and incomes is a social, and not a market, decision. It is not the case that technology dictates what people are worth and should be paid. Rather, society decides what the distribution of pay should be, and technology adjusts to that configuration. Standards––for pay but also for product and occupational safety and for the environment––also promote the most rapid and effective forms of technological change, so that there is not trade-off, in a properly designed economic policy, between efficiency and fairness.

As an example of Galbraith’s point of view, consider an employer deciding whether to invest in more productive capital or relocating to find cheaper labor. If there is always a ready supply of cheaper labor, investment in technical productivity is relatively costly.* As Alan Tonelson has argued, a “race to the bottom” is nearly inevitable when no standards govern wages and the safety of products and workers. Sadly, I think the policy consensus in DC now is set by those who share Clark’s assumptions that the increasingly costly poverty of the “losers” in the US economy is a necessary concomitant of inexorable economic trends, rather than an avoidable result of policies that have systematically dismantled the Great Compression.

*Relatively costly for private investors, that is. A dirigiste state may mandate investment in technology and access to resources. Perhaps the biggest story of the decade will be the extraordinary spectacle of the world’s superpower investing in McMansions, war, SUVs, and useless financial instruments, while its putative rival built up its capacity to meet real human needs. Admittedly, the US policies may have made a great deal of sense if the goal was to bring its citizens’ buying power closer to the Chinese level, as a prelude to further integration of the two economies.

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