The Dutch anthropologist and writer Joris Luyendijk is right to point out that if we insist on seeing financiers simply as villains, we miss an essential point:
We like the idea of financiers as parasites and as psychopaths but it is more unsettling than that… the real problem is not individual rogue traders, but is far deeper and more systemic. It is the financial system itself which is sick…
The stock market drives capitalism not only to make a profit but to keep increasing it, as trading in shares would not make sense without it. So, a stable situation is not a possibility. As Carl Weinberg, chief economist and managing director at New York-based consultancy High Frequency Economics puts it, volatility is a necessary condition if markets are “to make money”. If poorly regulated, such a market inevitably creates bubbles that eventually burst. But what if this time they have somehow got it right? It is true that, particularly since the ‘Big Bang’ deregulations of the 1980s, they have been proven wrong over and over again, but this does not completely exclude the possibility that they just might have got it right and the stock market will keep rising forever. Even if this highly unlikely scenario turns out to be true, the financial sector will still need to be regulated for the following reasons:
- Not only do those unproductive, parasitic activities make money faster than work does, but they also make everybody else poorer: if there is a fixed amount of money and somebody’s ‘slice’ is growing, the slices of others inevitably have to shrink. Of course, the amount of money does not need to be fixed – it can increase. This, however, creates inflation (or hidden inflation if the velocity of money is kept in check). In any case, you get less for your work.
- The present shareholders model is not good for business as shareholders are not motivated by the long-term survival of the company, but short-term gains.
- The system typically offers few pillars to which one can anchor its morality; the primary compass point is how much money one can make. This is not good for society nor for the business. Hostile takeovers are an example. If a company has been prudent and paid off a large share of its debt, then a raider could potentially use that as their own asset for grabbing control of the company, loading it with debt to pay for the takeover, stripping it of saleable assets and then selling the remains (Boyle & Simms, 2009, 142) – this leads to defensive loading of companies with debt in order to stave off hostile takeovers. A crazy world.
That said, investment can be a good thing, so we need to bolster the already dwindling belief in the future by preventing those who do not contribute to the future from taking advantage of it. In other words, we need to reduce non-productive investments and encourage the productive ones.
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Reducing non-productive investment
More or less the only circumstance in which stock purchases lead to productive activity is corporate issuance of Initial Public Offerings (IPOs) – the first time that the stock of a private company is offered to the public. These, however, represent only a tiny portion of stock market activity nowadays. Douglas Orr, professor of economics at the City College of San Francisco, pointed out that in 2007, just before the financial collapse, $43.8 trillion in stocks changed hands while only $65 billion was raised in IPOs – just 0.14% of the total. Orr also argues: “The biggest propaganda coup of the 20th century was convincing the media and the general public to call the speculators on the New York Stock Exchange ‘investors’.” This needs to be reversed, not least because the complex financial instruments, according to Lord Turner, former chair of the UK’s Financial Services Authority, are socially useless activity. There are several ways of achieving this:
- The role of long-term investors can be enhanced by restricting voting to those already holding shares when a bid is made, which could make hostile takeovers much more difficult. This is already on the agenda of some political parties.
- High street banking should be separated from speculation to protect retail services from volatile international capital markets (this is, in effect, a call to re-introduce a version of the Glass-Steagall firewall[1]).
- Exotic financial innovations in derivative securities such as credit-default swaps should be licensed or banned. Just as the Food and Drug Administration vets new drugs, so financial products should also be before being offered.
- Complex financial products do not reduce risk, but shift or obscure it, which makes the system more inefficient and unstable. So this complexity needs to be reined in.
- Leverage and liquidity regulations (also known as prudential regulations) need to be strengthened in order to reduce the risk that financial institutions can take.
- Any incentives that encourage risk-taking need to be removed, along with controls on excessive speculative activity.
- Interest rates should increase substantially on a large portion of a financial firm’s debt when it takes more risk, thereby reducing profits, thereby deterring management and the board from risky behaviour.
- Short-selling (selling securities that you do not own) should be made illegal.
- Margin requirements (the proportion of the money that has to be paid upfront when buying shares) should be increased (Chang, 2011, 241).
- Shareholders’ profit can also be limited. Owen D. Young, Chairman of GE from 1922 to 1939 and again from 1942 to 1945, proposed just that almost one hundred years ago: “…Stockholders are confined to a maximum return equivalent to a risk premium. The remaining profit stays in the enterprise, is paid out in higher wages, or is passed on to the customer.”
- Speed bumps should be put in place to slow the flow of capital that prioritises speculations over productive loans. This can be done if investment is required to stay in place for a certain amount of time (e.g. at least two years).
- Profit that is not re-invested needs to be heavily taxed to reduce parasitism further and encourage investment. This system already exists in many countries, but is rarely sufficiently implemented. Ideally, investors should earn enough to encourage investment, but not earn obscene profits which create a class that can tip the balance not only of economic but also of political power.
Encouraging productive investment
An unproductive investment can be broadly linked to distributed profit (profit given to shareholders), and a productive investment to retained profit. The main source of financing is supposed to be retained profits, but in the UK and the US, the ability of corporations to invest has been significantly reduced. Distributed profit rose from about 40% between the 1950s and 1970s to 94% in the US and 89% in the UK between 2001 and 2010. The above suggestions to reduce non-productive investment should have a positive effect on productive investment, but there are further ways to stimulate it.
- Moving from a shareholders’ to a stakeholders’ model for investors would be an important step. Something like that is already practiced in Islamic finance, where every investment is treated as a kind of joint venture. You bring a proposal, a bank brings in money, and you both share the gains (or losses) based on the success of the project. This is good because it is in the bank’s interest that the venture succeeds. This move is also stimulating as the benefits for individual, communal and corporate investors can go beyond just monetary gains.
- A Goldilocks zone for the ratio of retained and distributed investment can be established (e.g. distributed investment should not drop below the rate of inflation or rise above retained investment unless all the stakeholders agree).
- Investments that lead to multipliers (an investment that has multiple effects or leads to a virtuous cycle) should be prioritised. A multiplier can refer to gains beyond purely financial ones (e.g. improving health or education, which also contributes to the economy in the long-term).
- Investment needs to be ethical and sustainable, and not disadvantage the context in which it operates (the local community, society, the environment, etc.). As everything is connected in one way or another, nothing is truly external – so treating something simply as an externality cannot be acceptable.
- Long-term investors should be empowered through tax regulations, ‘loyalty shares’ (additional voting rights and other benefits), and the introduction of non-transferable or locked in investment schemes.
- Alternative lenders, such as credit unions, social banks, community banking partnerships, and Fairtrade banks (e.g. Triodos Bank), which practice micro-lending and offer micro-credits, can also play a role (Boyle & Simms, 2009, 144).
- Not only shareholders (if they exist) but stakeholders too should be consulted in the event of takeovers and mergers. Involving employees is already fairly common practice in the EU (the film 7 minutes is based on such an event).
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In conclusion, as Andrew Simms, Fellow of the New Economics Foundation, put it, “An obvious forward step is to shift the balance of corporate ownership and governance away from the domination of the shareholder model” (Simms, 2013, p.403). Tackling this kind of domination does not require giving up on shares, but establishing the boundaries of their trading (only financial products that lead to the exponential separation between the investment and the production need to be removed). There is a place in society for investors, but they need to contribute to society as everybody else does and should not grow bigger or faster than the rest. This needs some safety valves to be put in place. Just as there are limitations on, say, lorry driving (such as speed restrictors, working hours limits, tachometers and so on) to reduce the risks to other road users, so too we need to limit investors, as they also present potentially an even greater risk to everybody else.
~ What we can do now ~
- Take control of your finances, or at least make sure that your funds are not invested in non-productive activities.
- Join or support credit unions and ethical banks. Big Society Capital and the Green Investment Group are examples of organisations whose purpose is to connect investors with socially or environmentally useful economic activities. We can engage with such organisations or, where they don’t exist, create similar ones.
- Invest directly in companies with a social purpose. An increasing portion of the population is opting to invest in businesses that demonstrate an explicit commitment to social and/or environmental goals. Known as double- and triple-bottom-line investing, this practice has been picking up momentum in recent years. Responsible investing – widely understood as the integration of environmental, social and governance (ESG) factors into investment processes and decision-making – is estimated to be worth over $20 trillion in total market value. Furthermore, stocks of sustainable companies tend to significantly outperform their less sustainable counterparts. For ethical investment, EIRIS Foundation is a global leader in providing data on ESG that socially conscious investors can use to screen investments.
- Support and use organisations such as Ethex, a ‘positive savings and investment platform’, and the Social Stock Exchange – which calls itself the world’s first regulated exchange for business and investors seeking to make positive social and environmental impact (Scott, 2017, p.63).
- Lobby the government and other possible investors to build on existing support for socially productive investments (e.g. asking the government to match capital raised by a community to invest in a local project).
- Lobby to extend initiatives such as the UK’s Public Services (Social Value) Act (a requirement that public services contracts should factor in social and environmental impacts) to the management and disposal of assets.
- Those of us who are thinking about investing in or starting up a business can get familiar with, take full advantage of, and help improve the various tax reliefs available for start-ups and socially beneficial ventures. These include Community Investment Tax Relief, Social Investment Tax Relief and Gift Aid. Many investors haven’t even heard of these schemes! Other tax incentives, such as the Enterprise Investment Scheme and Venture Capital Trusts, could be made to work even better for co-operatives or community energy schemes, for example.
- Engage with the Right to Invest scheme, which gives local communities the opportunity to invest in local transport, housing, social care or renewable energy projects. The scheme is spreading from Denmark to the UK and beyond.
[1] It used to separate, in the US, the activities of the commercial banking (e.g. mortgages) and investment banking (e.g. trading in shares) but is largely abolished now.
