1999
Why Finance Matters for the Common Good?
Paul H. Dembinski; Marina Ponti
Financial
techniques and instruments have allowed investment and trading activities to
expand in time and space. Without them, neither economic growth nor economic
globalisation would ever have taken place. Over the centuries, finance and
financial institutions have become increasingly specialised, culminating in the
emergence of a veritable financial system. In modern-day economies, this system
fulfils three main functions:
·
It ensures the flow of payments on which economic activity depends to run
smoothly. In doing so, the financial system facilitates the use of money as a
means of payment.
·
It ensures that the available monetary resources are used effectively
across the economy by placing excess liquidity of some agents at the disposal-on
a temporary basis and for reward-of other actors who have trading or investment
plans but who lack the necessary liquidity. By doing this the financial system
enables money to operate as a veritable store of wealth.
·
It creates financial assets (ie, transferable contracts embodying rights
and obligations), estimates the inherent risks, determines their prices, and
facilitates their exchange. By pricing assets, the financial system extends the
function of money as a standard of value to a specific category of transactions.
This
description of the financial system emphasises its secondary, derivative nature.
On the one hand, in each of the above ways it acts as a functional extension of
money, whose efficiency and radius of action are increased as a result. As an
extension of money, finance is dependent on it and remains subordinate to money
which has ultimately a public aspect. On the other hand, it is the vocation of
the financial system to serve other economic (ie, commercial and industrial)
activities, which it helps, as it were, to keep well-lubricated and flowing
smoothly. The traditional lack of autonomy of the financial sector explains the
relative lack of interest that economists have shown in it. This is why, to this
day, financial assets and transactions involving them are absent from national
accounts.
Five
centuries after financial activities started to expand in Northern Italy, a new
"window of opportunity" to
these activities was opened up some thirty years ago, in the form of
technological breakthroughs in the processing and transmission of data. The
financial sector has taken full advantage of these new opportunities, as its
unprecedented vigorous expansion over the past fifteen years shows. During this
period, finance has developed three to seven times faster than other economic
activities.
Growth
of various economic and financial items, between 1980 and 1995, in nominal terms
Item
Growth
Turnover
of «Fortune 500» enterprises
140%
Total
assets of «Fortune 500» enterprises
230%
Nominal
GDP of OECD
300%
Value
of world merchandise trade
440%
Capitalisation
of world stock markets
970%
Turnover
of world stock exchanges
1170%
Value
of foreign exchange transactions (Forex)
2100%
Observatoire
de la Finance, various
sources
Today,
finance is the spearhead of the so-called "globalisation" process and,
as such, enjoys unprecedented visibility and prestige.
The scale of the changes now taking place inevitably raises questions about the
true nature of finance. Is it a purely quantitative phenomenon, or are we
dealing with a totally new technological and political situation in which the
relationship between financial activities and other areas of economic, political
and social life has been fundamentally altered? Has finance ceased to be
dependent on politics and economics and become an autonomous, or even a
dominant, force?
The
recent explosive growth in the influence and importance of the financial sector
implies a profound change in the relationship between finance and the pursuit of
the common good.
The notion of "common good" embraces two separate concerns: on the one
hand the social concern, where the question is what the financial sector brings
to the community; and on the other the personal concern, where the question is
how finance contributes to the growth and self-realisation of each and every
member of society. Accordingly, the relationship between the financial system in
its present state and the common good poses new questions, opens new horizons
and calls for new inquiries. At least three avenues of research can provide a
basic structure for looking at how finance contributes to the common good.
Direction
One: the relationship between politics and finance
On
August 15th 1971, President Nixon took the US dollar off the gold standard,
thereby exposing public policy-through the dollar-to market forces. This
decision (which, it need hardly be added, was merely a stage in a much longer
process) marked a profound change in the relationship between finance and
politics.
Finance
rushed in to fill the hole that Nixon's decision had made in the Bretton Woods
system. It was aided by a number of factors, including technological progress in
data transmission and processing and increasing international harmonisation of
laws and regulations. Taking the dollar off the gold standard was the
springboard for the large-scale development of national, and above all
international, financial activities. Like it or not, the discord or weakness of
the governments of the day set in motion the collapse of central-bank control
over the creation of money and the value of national currencies. Today this
process is culminating in what may be termed the "privatisation of
money".
The
changing relationship between finance and money is about to result in the
amalgamation of two fields which were once legally and institutionally
subordinate to one another. While this
amalgamation of money and finance implies a certain degree of
"privatisation" of money, finance in turn now has more immediate
implications for the common good-a dimension that traditionally applied only to
money. This new state of affairs requires redefining the powers and means of
action that are available to national, international and supranational public
bodies, particularly as regards the supervision and regulation of financial
activities.
Exposing
national currencies to market forces means submitting public policy to external
assessment. There is nothing wrong with such assessment in itself; indeed, it
may help to prevent governments from pursuing aberrant policies. It does raise
two questions, however. Should policy makers accept the subordinate position to
which they have been relegated by the markets? And are financial markets the
most appropriate authority to assess public policy? In this connection, one
cannot help noting the asymmetry between those who use a national currency on a
daily basis as their unique means of payment and those who use it as an asset
among others only to maintain or increase their wealth. There is a growing
ambiguity about the roles of finance, which is globalised and in private hands,
and money, a local means of payment and a symbol of sovereignty, which-in theory
at least-is there to serve the overall national interest.
Direction
Two : the economistic paradigm
Until
recently, any attempt to investigate financial issues was tantamount to
trespassing on private property. First there were the financial professionals,
who were keen to maintain something of a smokescreen around their field of
activity. Next came a small circle of academics, who allowed the emergence of a
paradigm which has since come to prevail among university economists. Known in
short as the Modigliani-Miller-Arrow-Debreu paradigm, it continues to dominate
supposedly scientific journals and to determine appointments to teaching
positions. The list of "guardians of the temple" is a long and
impressive one, from the prestigious cohort of Nobel prizewinners to researchers
who are all too often constricted by their own methodology. Despite undeniable
theoretical breakthroughs, this concentration of effort by sophisticated
academics and professionals has imperceptibly resulted in finance becoming
divorced from its economic context, both as a subject for study and as an
activity.
This
leaves economic science poorly equipped to weigh and analyse the many complex
links between the financial sector and the rest of the economy. Consequently, it
is not in a position to answer one of the key questions facing today's world. In
order to stand up to this challenge, economic science will need to develop a new
paradigm for research and analysis. Even though there seems little chance that
such a new paradigm will emerge from within the discipline, nevertheless
problems cannot be solved by looking the other way.
This
is a time of change, and yesterday's cast-iron certainties are giving way under
the pressure of indisputable fact. Finance
can no longer be treated as a separate activity cut off from other dimensions of
social and economic life. Although the financial sector still finds it hard
to accept fundamental challenges to its traditional way of thinking, cracks are
now starting to appear in the ivory tower.
The very growth of the financial sector is forcing those outside it to look more
closely at the nature of that growth and the issues that it raises-whether or
not the guardians of the temple of mainstream economic thinking like it.
Direction
Three: the financing of other economic activities
Like
other components of the financial system, stock exchanges have been expanding
almost continuously for the last 20 years. Yet most of this growth (including
that of so-called "emerging" markets), in terms of either
capitalisation and volume of transactions, cannot be satisfactorily accounted
for by "fundamental" economic data. In fact, the number of listed
companies, their contribution to GNP and their industrial profitability have
essentially remained unchanged.
The
influx of liquidity into stock exchanges-including emerging stock markets-can be
explained firstly by the spread of modern savings instruments such as investment
funds, and secondly by the banks' abandonment of their traditional role as
lenders. This has profoundly affected the way in which the financial system
performs its function of converting savings into investment.
Many
banks today would sooner sell their clients’ shares of investment funds than
make them a firm commitment on a savings account and then lend the money-at
their own risk-to some little-known small or medium-sized enterprise. While
perfectly comprehensible from the banks' point of view, this change in the way
in which savings are converted into investment may have an adverse impact on the
economy as a whole, and thus on society.
It
is reliably estimated that over 90% of the
transactions on leading stock markets merely involve changes in the ownership of
securities which are already in circulation-in other words, they are largely
second-hand markets. This means that
transactions involving new securities seldom account for more than 10% of the
total. While a certain degree of liquidity is undoubtedly essential if
markets are to operate smoothly, only transactions involving new securities can
give companies the finance they need and so truly convert savings into
investment.
Stock-market
listing enables companies to significantly reduce their financing costs (both
debts and equity capital). As a result, listed companies can obtain financing
much more cheaply than unlisted ones, which are usually small and medium-sized
enterprises. Not surprisingly, listed companies find it easier to substitute
capital for labour than do unlisted ones. Behind this financially impeccable
logic lies the risk of a drift towards a two-tier economy-and a two-tier
society.
On
the one hand, there are the major companies, which are highly intensive in
financial capital and mainly employ highly skilled staff. On the other hand,
there are the smaller companies, which have higher financing costs and are
relatively labour-intensive. These employ local labour, which is less mobile and
often less skilled.
This
is a little-explored feature of the operation of the financial system. Yet, as
the spectre of a two-tier society and
economy looms larger, it is an increasingly urgent issue.
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