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A public policy blog from AEI
Throughout the recent election, politicians painted Wall Street banks as the reigning lords of the American economy, such that Bernie Sanders urged we break up the banks in order to protect the little guy. Save Main Street! In her 2016 book, Makers and Takers: The Rise of Finance and the Fall of American Business (shortlisted for the Financial Times/McKinsey & Co Book of the Year prize), journalist Rana Foroohar argues that this trend of “financialization” has incentivized companies to engineer their balance sheets and their bottom lines – corporate short-termism — to the detriment of real job creation, business investmen, and long term growth. Hillary Clinton would agree. We discusse.
Foroohar was an assistant managing editor at Time and the magazine’s economics columnist, and starts soon at the Financial Times as chief business columnist and associate editor. She is also a global economic analyst for CNN. Lightly condensed bits of our conversation are below; check out the whole thing on my Ricochet podcast.
PETHOKOUKIS: Let me just start out by reading just a bit from one review of your book, and you can say if this review pretty much captured it or what they missed, and you can go on from there.
Traditionally, finance served the needs of business by providing capital and investing in long-term growth. But starting in the postwar decades and ramping up from the Reagan era onward, finance began to take care of themselves first. The banks’ primary activity became moving debt around, a risky strategy that hurts the ability of businesses to grow. As proof, you cite the fate of companies such as General Motors, General Electric and Xerox, whose myopic thinking led to a decline in innovation and their place at the pinnacle of global business. Instead of serving business, financialization became an end in and of itself, a closed system, unmoored, intangible economic activity. OK.
My summary of the summary is tht we spend way too much on moving around money and adjusting balance sheets, not enough actually innovating and developing and making things. Is that about right?
FOROOHAR: That is about right. That’s a great intro actually. And, you know, I’ll throw out just one statistic which kind of sums things up for me. Sometimes you get a metric that just really makes your eyes pop.
And when I was reporting and researching this book, I came across an academic study that found that, today, only about 15% of all the money flowing out of the big US financial institutions actually ends up in business investment. So if you step back and you think about it, 15% of the money in finance going to business investment, well, what’s the rest of it doing? It’s being used for trading, the buying and selling of existing assets, issuance of debt, bidding up of housing bubbles – all the things that Adam Smith, the father of modern capitalism, would not necessary have wanted it to be doing.
I mean, if we go back to the roots of the capitalist system, a healthy financial sector that is a helpmate to business is a really crucial part of that. Finance is supposed to allocate all of our savings, all of our capital as workers in a society properly, productively. And I would argue, and I think statistics have shown and any number of examples that I’ve hopefully illustrated in my book have shown that we’ve moved far, far away from that system.
What was the catalyst that turned this into what it is now or what it has become?
So when we think about the rise of Wall Street, often that gets correlated with Reagan economics, with trickledown economics, you know, with a kind of a shift in the ’80s towards the age of greed. And, sure, that’s part of it.
But I’m actually saying – I’m going back further, and I’m pinning this shift to the ’70s and actually to a period in US history where the economy began to grow more slowly. You know, starting really in the early ’70s, US trend growth, economic growth began to slow down. And that was happening for certain good reasons. You know, post-World War II, Europe back was back on its feet, the emerging markets were starting to emerge. There was just, you know, what Fareed Zakaria would call the rise of the rest. There was more global competition and the US growth as it became, you know, a developed rich nation was slowing. So we were then at a turning point.
Policymakers – by the way, on both sides of the aisle. I would say this is very much a bipartisan thing – could have taken some hard decisions to say, all right. Here we are. We are a fully developed economy; we have new global competition. How do we want to grow as a society? What kinds of businesses, what kinds of investments do we want to make to really sustain equitable growth in our economy?
Policymakers passed the buck, both Democratic and Republican policymakers. Actually, I would argue that, in some ways, the shift in interest rate policy even under the Carter administration was one of the pegs for the shift that I’m talking about. But policymakers passed the buck and they passed the buck to Wall Street. And they said, you know what? We don’t want to upset any of our voting blocs. We don’t want to make tough decisions about, you know, who’s going to get what in society, so we’re going to let the markets decide.
And I would argue that that then began to be part of this cult of efficient markets, the idea that the market always knows best, that the market is always efficient. Well, you know, certainly if we’ve learned one thing in the last eight years, it’s that the market is not always efficient. And that’s not to say government always knows best. I mean, one of the things I’m clearly trying to say in my book is that, actually, finance is what we make of it. It is a system of rules, and we make the rules, and we can change them. We can make finance more productive and really shift our system back to what it was, I would argue, prior to the early 1970s.
It doesn’t sound like there was a government policy or set of policies that encouraged it. Are you more saying that this was happening and then government should have done something differently in the late ’70s?
You know, I think that one of the things that’s very difficult to understand and communicate about this debate is there’s not one silver bullet problem, not one silver bullet fix. You know, some people would say, when we began to deregulate interest rates, that really unleashed Wall Street. Other people would say that when we began to change the ways in which corporate compensation could be awarded – you know, allowing buybacks, for example, stock buybacks to become legal, they were market manipulation ack in 1982, allowing more corporate comp to be paid out in tax deferred stock options, tax deductible debt. Some people would say that that was the turning point.
The truth of the matter is there were a lot of small legislative shifts basically over the last 40 years that coincided with a rising bull market which was happening for reasons that I think actually have nothing to do with that deregulation but were more a matter of macro shifts in the economy that are now played out, the rise of the emerging markets, the entrance of women into the workplace, you know, various demographic things that are now tapped out.
Markets were rising, deregulation was happening. So there was a lot of change taking place. Things seemed to be going along very well for a certain period of time, but what you can see is as finance grew from the 1980s onwards as a percentage of our economy, it’s now about 7% roughly of US GDP, creates only 4% of all US jobs, by the way, but takes a quarter of US corporate profits. So if you need any sense of monopoly power, there’s another statistic for you.
As it was rising during that time, a number of metrics of business health were actually falling. So the percentage of R&D that companies spent – sorry – percentage of revenue that companies spent on research and development was falling; the number of startups per capita was falling. Any number of measures of entrepreneurial zeal and risk-taking in our economy was falling. And I would argue that that was because we took our eye off of business and put it on finance. And really, we need to switch those two things. We need to change that pyramid.
So are you saying that all the tumult in the ’80s – we should have avoided that, that was bad?
Well, you know, again, it’s a very nuanced process. And I think that even before the 1980s, there were shifts occurring. But, yeah. I think that what happened in the’80s is we sort of threw kerosene on some issues. I mean, definitely I think certain ways in which anti-trust was handled back then was an issue.
But I would maybe once again kind of point your attention to this shift – rule shift in 1982 around stock buybacks because this is sort of a timely example and a good way to understand the process of financialization.
Stock buybacks, obviously, are when firms go back – you know, go into the open markets and buy back their shares. And that artificially jacks the share price up. It always does that. You can look just at, for example, Apple, which is the lead chapter of my book. Over the last several years has spent tremendous amounts of money buying back its own stock and then jacking the price up. That tends to enrich the wealthiest Americans, the investor class, but oftentimes it’s enriching people that had nothing to do with the founding of that company. So we’re not talking about investors that are entrepreneurs and job creators. We’re talking about in many cases a speculative group of shareholders, activists, investors. You know, they used to be called barbarians at the gate but who were benefiting from this huge influx of capital into the markets.
Well, at the same time, research and development in these companies, not just Apple but in many companies in America is going down as a percentage of revenue so that investment, that seed corn is actually falling.
Now, this whole process was illegal before 1982. That rule then changed under the Reagan administration. But if you jump to the 1990s, under the Clinton administration, you got more kerosene poured onto this sort of financialization process when there was a conversation about the compensation – you know, how corporate executives would be paid. Even back then there was a discussion, as you know, about the growing wealth divide and certain members of the Clinton administration, like Joe Stiglitz, for example, thought that there should be caps on corporate compensation; others argued, you know, more the Rubin-Summers camp argued that, well, certain kinds of pay should be performance based, perhaps tax deductible.
And so you have this burgeoning of share options – by the way, that was something that was pushed by Silicon Valley, a lot of liberals lobbied for that to happen. So, again, you get this kind of kerosene thrown on this process of corporate governance where managers, people that are running the largest companies in the country have every incentive to jack up share price for two or three quarters, but not necessarily look 10, 20, 30 years down the road and see what’s really going to benefit this company, what’s really going to benefit society over the long haul.
And, by the way, that’s a real issue. When our major competition globally tends to be at this point state-run economies, you know, countries like China where you can take the long view. You know, family-run companies in emerging markets, where people are looking at a 10, 20, 30-year horizon. And I hear from a lot of CEOs in this country that it hamstrings them so much to have to think just about share price quarter on quarter rather than the longer-term best interest of a company.
Now I’m going to push back a little because I sort of buy your premise on even days. On an odd day, I’m a little bit more skeptical. We happen to be doing this podcast on an odd day. It’s probably better for the podcast that I’m a skeptical mode. I guess I would say first and talking about sort of this transition. In the early ’80s, you know, the Dow was like 800. And it basically had gone nowhere since the late ’60s. And if you adjust it for inflation, it was probably down by two-thirds. Now, we’re right around 20,000.
And if I had told someone back then that the Dow was going to go from roughly 1,000 to 20,000, I think they would say that the book to write would be a book called The Rise of American Business, not The Fall of American Business. So just that one statistic would make me think that somehow we’ve done something right over the past 35, 40 years, and it hasn’t quite been the catastrophe for the American private sector.
Well, it certainly – you know, if you want to pull that metric, absolutely you can make that argument. But I would say that, in some ways, that’s predicated on the notion that the share price is the best indicator of the health not only of business but of the overall economy. I would actually point to another metric.
I would say that US trend economic growth, US average wages have actually been falling and stagnating depending, you know, in terms of wages what class of worker you’re talking about. It’s been falling for some time. Most working class people haven’t gotten a raise in real terms since 1968. A lot of middle-class people haven’t gotten one since the early 1990s. Now, there are a lot of factors in that – globalization, the rise of technology, which has dislocated a lot of jobs higher and higher up the food chain.
But I would argue again that if you think about business investment and productive capital allocation as the real seed corn of our growth, I would argue that that has been changing and that you can see a lot of companies as they have moved away from really focusing on their core business, really focusing on not just moving money around, but creating the new, new thing, creating real investment, that their competitiveness globally has fallen, that market share has fallen. I’ve got a number of examples about this in the book.
And also, the amount of debt out there in the economy has risen. This is an issue. I think, you know, we haven’t heard a lot about debt. Interestingly, in the last presidential cycle, Rand Paul was the only one that was, you know, early on kind of banging on about it. But I actually think that debt is a real issue. The rise of debt in our economy, unproductive debt is a real issue.
You’re talking mainly private sector debt here or do you mean private sector and public?
Well, you talk about – I’m talking about both kinds of debt actually, but, you know, it’s interesting because the rise in debt, the pace in rise of debt is the biggest predictor of financial crises, globally. And if you look just at the private sector right now, the amount of corporate debt out there is actually very high. And we’ve already had some hiccups in the junk bond market because of that.
Now, a lot of people say, you know, hey, the market’s almost at – you know, it’s at 20,000. You know, what are you worried about? Well, that’s kind of exactly what I’m worried about because if you look at economic fundamentals, nothing on Main Street has really changed. There’s nothing different in the growth story than there was eight years ago when the economy was really struggling.
What’s different? Well, the Fed dumped $4 trillion into the economy over the last eight years, which, you know, yeah, that will jack share prices up, you know. And interest rates are still historically low even though they’re probably going to start rising at some point. They probably won’t rise as fast as they have in the past. I think that there is a real disconnection between Wall Street and Main Street. And, by the way, I think most intelligent investors out there would agree with that. Most people think there will be a correction in the market. It’s just a matter of when and how.
Are there countries out there you think that are getting it right?
So, again, I don’t think there’s one perfect example of a financial system that we should emulate, but I’ll point to two or three examples of certain aspects of other systems that we might want to think about. And one would be Canada.
So if you go back actually, you know, to the roots of our financial system, one of the reasons that there is risk in our system is because of the square off in the days of the founding fathers between Hamilton and Jefferson. You know, Hamilton wanted a big integrated nationalized financial system. Jefferson was more in favor of this sort of small agrarian interest, didn’t want a lot of concentration of power.
What we ended up with is kind of a hash up where you had national banks but a lot of commercial banks were not allowed to gain scale early on. Later, arguably with the repeal of Glass-Steagall, which was the Depression-era banking legislation that, you know, separated trading and investment, you got maybe too much concentration and too many business lines being combined.
In Canada, you had a different system. You had a system where trading and commercial lending were separated, but commercial lending was actually allowed to achieve scale nationally. Canada’s never really had a major financial crisis. So that’s one thing to think about.
The other example I might point to is Singapore. There you have a system where you actually pay government workers and regulators salaries that are high enough to attract real talent into the system, you know, so that you get a balance between risk-taking on Wall Street and policing in government. And, you know, I think that those are just two examples I might point to. There are many others.
Just before we went on, I went on to the Forbes website and I looked up the Forbes list, and they do a list of the most innovative of companies. And I looked on that list and I looked at the top 10 and I see nine American companies. And one of my favorite charts looks at which economy is able to produce very wealthy entrepreneurs. So these are people who got rich by creating value, not by manipulating money.
And no other large advanced economy produces as many, based off of the size of the population. So looking at that, everything you say may be right that we would be better if we were not as so financially heavy, but yet we still seem to be a pretty dynamic economy. I know that productivity statistics may not say it and I know there’s a very active debate whether they’re missing things in this digital economy, but I think there’s a plausible argument that despite all this financialization – and some people then might say maybe because of it – with venture capital — when people ask the question, gee, why is the US able to produce so many fast-growing, high-impact tech companies versus Europe, they always say, well, we have these great capital markets here, venture capital.
So isn’t there a plausible argument that we’re doing something right?
Well, you can certainly argue that there are a lot of things that are great about the American economy. I would not argue otherwise. I was actually a foreign correspondent working and living in continental Europe for 10 years. And, believe me, there are many aspects of business there that I would not want to emulate. So don’t get me wrong about that.
But I would argue that actually we could unleash much higher trend growth. I mean, it’s interesting. That’s of course been a part of the debate. Donald Trump, you know, becoming the president-elect by arguing that we could be at 4% growth rather than 3 if we just unleashed the economy. Now, I may not agree with all of his policies about how to do that, but I agree that the US trend growth could be higher if we actually took some steps to change parts of our process that are hindering us.
And, you know, I would say that financialization in recent years has become part of the problem. You know, if you look – there are any number of large-scale, long-term international studies by the BIS or the IMF or the World Bank that show that when finance becomes even half the size as a percentage of the economy that it is in the US, it starts to have a growth-hindering effect.
And I would go back again to that statistic I gave you earlier. Finance is 7% of the economy, creates 4% of all jobs, but takes a quarter of all corporate profits. Does that sound fair to you, because it doesn’t to me? That sounds like monopoly power of a kind that you don’t have in any other industry. And to answer your question, I actually didn’t count venture capital as part of financial sector in this book. It is a tiny – if you look at it as a percentage of the overall capital flows in America, its tiny, tiny. So I agree with you. We actually have, you know, in many parts of the country a very active, viable, productive venture capital sector but it’s such a tiny part of our overall financial system that it’s not an apples-to-apples comparison.
And, as you mentioned earlier, tying this into the idea of short-term thinking, there is one statistics that kind of jumps out at me. I look at R&D spending and I think last year it was at the highest share ever as a share of GDP. If this was as big a problem, wouldn’t that number be very, very low? And why would it be going up if companies were actually thinking short-term?
It’s funny because I actually love that you’re –
Yeah. I will persuade you. And I love that you’re pointing this out because in some ways this is actually really illustrative. It shows you, you know, lies, lies and statistics, right? We can each of us pull a statistic to show our point.
The one that I would pull would be to look not as a percentage of US GDP, but rather as a percentage of the overall revenue of the companies themselves. As companies get bigger and more powerful – and, by the way, they are bigger and more powerful than ever before – the corporate share of the overall economic pie is at record levels, whereas the labor share is at postwar lows. That has been falling. So you can look at it in many ways.
But, actually, let me pivot – I’ll do a pivot – journalistic pivot and shift to something else which I think may be more convincing to you. One of the statistics that I found very interesting in researching this book and in particular thinking about the issue of short-termism was to look at the behavioral differences between public companies and private companies, right? Family-owned private companies, really, any kind of private company versus publicly owned companies that are under all this Wall Street pressure to keep their share prices high. How do they behave differently?
Well, here’s how they behave differently. Private companies over the last 20 years or so in America have spent twice the amount of money as a percentage of their overall revenue on really productive investments in the economy, things like building new factories, investing in new technologies, research and development, worker training – twice as much as public companies, apples for apples.
And to me, I look at that and I say, well, what’s the difference? Well, the difference is Wall Street. And you ask any – I challenge you. Go ask anybody who runs a family-owned business in this country, they will agree with that. They will say, yeah. I don’t want to be under the market pressure because, you know what? The market pressure is to do whatever it takes to bolster the share price quarter by quarter and not really think about what’s going to keep my business competitive in five or 10 years, let alone what’s good for the community that I live in or the national economy as a whole.
But do we want to return to that pre-mid-’70s kind of capitalism if we could? Again, I think you had a lot of sleepy US corporations that were not under very tough competitive threat, sort of fat and happy companies that were eventually just really steamrolled by very aggressive countries, Japan being one example. There had to be a change in corporate America. Those companies had to become more efficient. If you were going to remain an open economy, corporate America was going to change.
So how would have things looked differently? How would the economy look different?
So I’m absolutely not arguing for a return to the ’70s. You can’t return to the ’70s, just like, you know, when people talk about, well, if we only had Glass-Steagall, the banking regulation again, we’d never have another financial crisis. Well, that’s not true either. You know, sure, it would be interesting to think of some modernized Glass-Steagall that might help us to reduce banks’ ability to do risky trading, but that’s not going to prevent the S&L crisis, for example. And neither am I arguing that we should try and hope to return to the 1970s in terms of the business economy.
But what I am saying is this: when you look at where wealth and capital are going in our society, they are, I would argue, not going anymore to productive investments that will push the overall national economy forward. You know, we have a system now in which corporate America is holding about $2 trillion of cash abroad. There’s a big debate – and this was, again, part of the reason that Donald Trump got elected – big debate over how to get that cash back. That’s crucial to really fomenting a sustainable recovery because, frankly, the public sector just doesn’t have the mojo to do it. You know, I mean, I think, great, if we can get an infrastructure through; great if we can get more fiscal spending, but the public sector has more debt than it did before the financial crisis.
If we look out there globally, the consumer has, you know, recovered, but we don’t want to get into a consumer debt bubble of the kind that we did pre-2008. So we really need to look to the corporate sector and corporate investment as a way of generating economic growth and job growth.
Well, when corporations are under pressure from Wall Street to channel their capital to the wealthiest investors rather than to think about what is going to be good overall for their own growth, what is going to be good for innovation, what is going to be good for creating a group of consumers that can actually buy products – I mean, you know, just to go back to the old, you know, Fordism argument, when you have an economy like ours, it is 70% consumer spending and people haven’t gotten a raise in 40 years in real terms, well, eventually the math doesn’t work, you know. You have to think about putting capital somewhere aside from at the very top of the pyramid. And I would argue that that’s what we need to be thinking about when we think about what’s growth going to be in two years, four years, five years.
Right. So you mentioned companies having all those cash. So you’re confident that that there are productive uses for that money that are not happening because they’re under pressure from activists and investors to boost the stock price, return capital to investors — that if not for that, there are all manner of productive uses for that money in either investments they could be making, other maybe smaller companies they could be buying, all kinds of uses. They’re just not because of that pressure.
That’s a somewhat simplistic way of putting it. It’s not just activist pressure. It’s an entire system of financialization, but, yes. And, you know, it’s not just me that thinks this. I mean, ask Warren Buffett, you know. He thinks there’s plenty of productive uses of capital for American companies right here at home. Carl Icahn thinks that. I mean, there are plenty of smart investors, much smarter people than me, who say the same thing.
And I also, you know, I travel around, I’m from the rural Midwest. I look out. I see those productive uses. I see that there are parts of this country that could be just as competitive in terms of labor as many less expensive labor markets when you think about things like energy costs and just-in-time supply chains. I think that there is a lot that we could do in this country.
And I think that there are also ways of thinking about corporate – (audio break). I mean, I’ll give you one example. You know, a few years ago, because of some very complex outsourcing of supply chains amongst retail companies like Walmart and H&M, both U.S. and European companies, there was a big disaster in Bangladesh, a factory that had very poor safety standards collapsed and killed about 2,000 workers. Well, a lot of these companies didn’t even know they were doing work – outsourcing work to those countries in those faulty factories because they had such complex supply chains.
That something that gets taught in business schools. You know, business schools, you know, that have very financially oriented training programs for MBAs say, put your workers where it’s cheapest, marshal your capital, treat human labor as a cost rather than an asset. I actually think the smartest businesses are beginning to realize, you know what? The world is awash in capital. There’s plenty of money rolling around but really great labor, really productive workers, robust local economies – that’s in shorter supply. And if you can tap into that, that’s a great way to grow.
I think that’s actually a good point that capital being so cheap – Clayton Christensen has written about this, that businesses have been very slow to figure that out, and maybe that’s playing a role in some of this short-term thinking.
I also wonder, maybe we already are seeing a market solution to this. I was just reading a story about the decline of public companies. They call it the de-equitization of the American market.
Yeah. I read that story.
Where companies are staying private longer. Maybe it’s already happening, where markets are adjusting. If companies don’t think that being in this public market is good because of all this pressure, they’re just staying private.
Well, I think you’ve made a great point and I think that that is already happening. The thing that worries me, though, is that, you know, when companies stay private, the actually limits the amount of – the percentage of the population that can take part in that kind of wealth creation. So I would love to see public companies as well be able to function in a way that would be healthier for society. I mean, kind of all of our 401ks depend on it, right?
So just one more thing. I work at a think tank. I like public policy. Is there a big idea, a big public policy idea that would lead to the de-financialization of the economy?
Well, let me put forward two ideas.
It doesn’t sound like it’s Glass-Steagall from what you said.
I don’t think so. I don’t think so. And I actually – I mean, I’m a liberal, but, to be honest, unlike most liberals, I really don’t believe that, you know, post-facto regulation of everything is the way forward.
For starters, you know, Wall Street is always smarter than the regulators. They’re always one step ahead. You’re always fighting the last war. That’s not to say we don’t need certain kinds of smart regulation and protections, but I don’t think that that is the solution.
What I would say is two things. One practical solution I think we should be thinking about is shifting away across all types of policy away from subsidizing debt and towards incentivizing equity. Now, I’m not saying that that’s not a complicated change but I think if you start to really through the tax code and think about all the ways in which we subsidize really stupid kinds of debt at both the consumer and the corporate level and just shift it, just say, you know what? We’re not going to incentivize debtors. We’re going to incentivize savers, both at the consumer and the corporate level. I think that you could really see some powerful shifts there.
The other thing I would say is more of kind of an existential thing is just think about the fact that – go back to Adam Smith. Finance is supposed to help business. Finance is not the end game. When finance becomes the end game, you know you usually have a problem in your economy.
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