Anis Chowdhury & Jomo Kwame Sundaram
COVID-19 has exposed major long-term economic vulnerabilities. This malaise – including declining productivity growth – can be traced to the greater influence of finance in the real economy.
The deep-seated causes of the current resurgence of inflation, inequalities and contractionary tendencies have not been addressed. Meanwhile, reform proposals after the 2008-2009 global financial crisis (GFC) have been largely forgotten.
Declining productivity
Productivity growth has been declining in major economies since the early 1970s. As the World Bank noted, well “before the … pandemic, the global economy featured a broad-based decline in productivity growth”.
World labour productivity growth slowed from its 2007 peak of 2.8% to a post-GFC nadir of 1.4% in 2016, remaining under 2.0% in 2017-2018. This slowdown has hurt over two-thirds of advanced, emerging market and developing economies.
Except for a brief productivity spike in some countries around the turn of the century, labour productivity growth in developed Organization for Economic Cooperation and Development (OECD) countries was declining, with trends low, but stable after the GFC.
Why the slowdown?
For Robert Gordon, this was mainly due to declining total factor productivity growth (TFP) – or slower technical innovation, organizational improvements and labour skill growth – in recent decades, particularly in industrial nations.
For the World Bank, reduced investment and TFP growth deceleration have been roughly equally responsible for the productivity slowdown. Slowing working age population growth and limited education progress have also contributed.
The United Nations noted, “as firms around the globe have become more reluctant to invest, productivity growth has continued to decelerate”. It blamed the slowdown on reduced investments in machinery, technology, etc.
Slower transitions to more diverse and complex production have also delayed progress. Some supply shocks due to ‘natural causes’ – of which 70% were climate change related – have also hurt productivity growth.
Growing inequality has weakened demand, slowing economic and productivity growth. As workers’ spending declined with labour’s income share, demand has been sustained by more public and private borrowing.
The International Monetary Fund (IMF)’s April 2017 World Economic Outlook confirmed this trend. Productivity growth declines have lowered real incomes, reducing consumer spending, demand and growth.
A joint report of the Bank of International Settlements (BIS), OECD and IMF also blamed unconventional monetary policies – very low, even negative real interest rates, and corporate bond purchases. Thus, corporate financial fragilities have weakened investment and productivity growth, especially since the GFC.
Deeper malaise
More sustainable and inclusive growth policies can help increase productivity. But blind faith in ‘market solutions’ since the 1980s has worsened resource misallocations, sectoral imbalances and job-skill mismatches.
One-sided demand stimuli – through more deficit spending or monetary expansion, without complementary supply-side measures – have only made limited impact. Also, supply-side measures to enhance growth need appropriate regulatory reforms – not wholesale deregulation.
Deregulation has often strengthened product market oligopolies while labour’s bargaining strength has generally declined. Growing corporate power has reduced labour income shares as executive salaries have risen since the 1980s.
Paranoia viz deficits and debt has cut public spending. Public investment remained flat during the early 2000s, rising slightly after the GFC, before declining until the pandemic. Worse, public spending cuts have not been offset by more private investment.
Slower capital stock increases cut potential growth in advanced economies from the 1980s. Debt and deficit paranoia has cut public services, social protection, public education and healthcare – hurting the vulnerable most.
Negative externalities
Markets have also failed the environment, undermining sustainability. Inadequate investments in renewable energy and sustainable agriculture have resulted in food and energy shortages – now exacerbating inflationary pressures.
Financialization, tax cuts and deregulation have also encouraged speculative activities, share buybacks and other portfolio purchases. Unconventional monetary policies have also enabled unviable ‘zombie’ firms to survive.
Thus, there has been rising protectionism and harmful beggar-thy- neighbour policies – such as competing corporate income tax rate cuts while weakening environmental protection and labour rights.
Meanwhile, much needed productive investments, especially in infrastructure, technology and innovation, remain underfunded. National problems have been worsened by failure to improve multilateral economic governance.
Financialization
Declining productivity growth was due to finance’s creeping dominance over the real economy from the 1970s. With banking more internationalized and concentrated, traditional financial intermediation by commercial banks has been undermined by market allocation and ‘universal banking’, combining both commercial and investment banking services.
Financialization has thus subverted economic motives, markets and institutions, adversely affecting progress, balanced development and long-term productivity growth in various ways:
• Corporate decision-making and firm behaviour are increasingly influenced by short-term financial market indicators, e.g., share market prices, rather than medium- and long-term prospects;
• Non-financial corporations increasingly profit from financial, rather than productive activities;
• ‘Non-traditional’ financial activities (e.g., stock market investments) of commercial banks have increased their exposure to systemic, including external risks;
• The distinction between short-term speculation and patient long-term investment has become blurred;
• Executive and even managerial remuneration has been increasingly linked to short-term profitability, as measured by share prices, not longer-term considerations.
Such features have adversely affected real investments and innovation, due to finance pursuing short-term returns. Thus, financialization has negatively affected investment, technology adoption and skill upgrading, with adverse consequences for productivity and decent jobs.
Misallocation
The financial system has also undermined the real economy by syphoning talent from it, with attractive inducements. Thus, talent has gone to finance at the expense of the real economy, especially harming technological progress.
James Tobin challenged “throwing more and more of our resources, including the cream of our youth, into financial activities remote from the production of goods and services, into activities that generate high private rewards disproportionate to the social productivity.”
Then American Finance Association president Luigi Zingales showed financial growth in the last four decades has basically been rent seeking, i.e., securing profits without adding any value.
Finance has captured rents “through a variety of mechanisms including anticompetitive practices, the marketing of excessively complex and risky products, government subsidies such as financial bailouts, and even fraudulent activities… By overcharging for products and services, financial firms grab a bigger slice of the economic pie at the expense of their customers and taxpayers”.
Banking abuses have been innovative, ranging from collusion, abusive practices, market manipulation, rigging interest, exchange and other rates, passing risk to unsuspecting customers, aiding and abetting tax evasion and money laundering.
Real economy drag
Finance has thus retarded development of the real economy in various ways. First, financial development has not been conducive to intermediating between savings and real investments. Markets allocate funds by criteria other than promoting investment in the real economy.
Second, financial markets and speculation do not generate or otherwise add real value. Third, financialization and regulatory failure have generated more frequent and damaging financial crises.
Seeking to maximize returns, fund managers and their ilk mainly invest in response to short-term financial trends. Presumed to be best left to markets, actual capital formation – increasing economic output – and productivity growth have slowed, to the detriment of most.
Anis Chowdhury is an Adjunct Professor, Western Sydney University & University of New South Wales (Australia). He is the former director of the Macroeconomic Policy and Development Division, United Nations Economic and Social Commission for Asia and the Pacific (UN-ESCAP)
Jomo Kwame Sundaram is a prominent Malaysian economist. He is Senior Adviser at the Khazanah Research Institute, Visiting Fellow at the Initiative for Policy Dialogue, Columbia University, and Adjunct Professor at the International Islamic University.
