Samuel Cohn: Global Social Trends

Daniel Bin has written a fine book on hyper-financialization and political arm-twisting for profit in Brazil. The book is entitled The Politics of Public Debt: Financialization, Class and Democracy in Neoliberal Brazil (Boston, Brill, 2020).

An obscure study of Latin American problems, right?

Wrong.

This is the Brazilian version of a massive problem that we have in the United States. The proper term for what Bin is writing about is financialization. It is a problem that affects most of the advanced nations of the world, and a large percentage of the middle-income nations. It has massive adverse effects on the United States. It is a leading cause of slow economic growth, unemployment, and massive social inequality.

Financialization plays out differently in Brazil and in the United States. However, the current policies of the American government make a Brazil-style crisis look increasingly inevitable. A look at the hard-core dynamics of Brazil is in many cases a look into a crystal ball; their present is very likely to be our future.

Let us consider:

First, The general phenomenon globally in the U.S. and globally

Second, The particularly pathological forms this took in Brazil

Third, Why the U.S. may be in line for a Brazil-style crisis.

The Global Problem of Financialization

Financialization occurs when the percentage in the economy of financial services is large relative to the percentage in the economy of production of actual goods. Agriculture and manufacture make real products that people buy and benefit from. So do productive services such as entertainment companies that make movies and concerts or schools that provide classes. Financial services narrowly produce gains from the purchase and sale of assets. No actual goods are created. The profits and losses that come from financial activities are strictly on paper.

Financial services are not completely useless. Modern economic life requires credit. Financial services such as banking and equity markets provide that credit. Modern economic life requires protection from risk. Financial services such as insurance provide important buffers against risk.

However, extreme financialization leads to pathology.

1. Banks and financial institutions receive fees for doing deals. Economic decisions become driven by opportunities for fees rather than the intrinsic logic of the business. An investment bank can get a gigantic fee for merging two companies. To get executives to agree to the deal, the bank offers the executives massive personal benefits, often in the form of stock shares. The bankers and the executives get rich. However, the merging of the companies may not have made sense – and the new combined company may now be carrying a large debt burden. The Harvard Business Review estimates that 75-90% of all corporate mergers fail. The merger and acquisition movement has led to the weakening of many otherwise strong companies.

2. Fast-trading speculation puts an emphasis on short term profitability. Cutting costs and cutting labor allows an asset to improve its profitability immediately after acquisition, allowing for a rapid sell-off for a quick gain. Workers lose their jobs. Product quality and consumer service suffer. Increased unemployment leads to a reduction in overall consumer expenditure. This lowers aggregate demand, reducing GDP growth and further increasing unemployment.

3. The high rate of profitability of financial firms coupled with lower profitability of other forms of economic activity concentrates economic advantage and power in the hands of both financial institutions and individual financiers. This leads to massive economic inequality. It also produces political inequality as financial institutions and bankers become extremely strategic political donors.

4. These donors press for greater deregulation and freedom for financial institutions. This freedom can be abused. The great financial meltdown of 2008 was based on widespread fraud in both mortgage and derivatives markets. Arbitrage, trading based on asymmetric imperfect information, is highly profitable. Deregulation leads to business deals based on deceit and subterfuge – with economy-wide consequences when these deals go sour.

The consequence of all of this is a scenario where the financial class gets richer while everyone experiences stagnant or declining wages and precarious employment.

Financialization, Public Debt and the Rise of a Self-Aggrandizing Elite in the U.S. and Brazil

Daniel Bin’s book is about the adverse consequences of financialization in Brazil as seen through the perspective of government debt. Government debt is one of the most important sources of political leverage for the banking community. That leverage is used both to provide massive economic rewards for the banks and bankers involved – and a concentration of raw political power in the hands of the financial class.

This is just what happened in the United States. The Brazilian experience differs in form but not in end result. The American story is told by Greta Krippner in her 2011 Capitalizing on Crisis: Political Origins of the Rise of Finance. (Cambridge, Harvard.)  In the 70’s and 80’s cities and states run by Liberal Democrats had generous government benefits. These benefits caused them to run deficits when the economy would go sour. During recessions, social needs would go up while revenues would go down. To cover these recession-based deficits, governors and mayors turned to the Wall Street banks. The banks obliged them by creating new forms of bonds and other public indebtedness to cover those temporary shortfalls. Over time, Liberal Democrats became very dependent on the goodwill of Wall Street for the continued survival of state and city public spending.

Fast forward to the 1990’s. Those governors and mayors who worked with the banks in the 70’s and 80’s, have now advanced in their political careers. They are senators, key congressmen or hold important positions in the Executive Branch. In the 1990’s, the bankers came to Washington, asking for payback concessions – generally in the form of financial deregulation, and increased economic opportunities for Wall Street banks. The former mayors and governors had every motivation to give the bankers exactly what they wanted. This is what led to the financial deregulation of the 1990’s. The deregulation led to the enormous increase in the wealth and power of banks and bankers that characterizes the present age.

In Daniel Bin’s Brazil, the problem was debt, both foreign and domestic. In the 1990’s and 2000’s, Brazil’s level of indebtedness was crippling. The level of public debt is still high.  However, in 1994, government deficits had led to inflation rates of over 2000%. Monetary disorder was crippling the Brazilian economy.

At this point, the role of financial capital was beneficent. Brazilian and international bankers worked with the government to create a very necessary refloating of the currency. Brazil’s financial status was rescued. So far, so good.

However, the power and influence of financial capital did not go away after the crisis. Brazil still owed money. To prevent the withdrawal of international capital from the Brazilian economy, the Brazilian state guaranteed very generous financial terms for the debt holders. This sounds neutral in theory. In practice, it led to all sorts of pathologies. As Bin shows:

A. The terms for debtholders were far more generous than the profits available from industrial undertakings. Money systematically moved out of the productive economy of Brazil into financial instruments linked to credit markets. The Brazilian economy struggled as a result.

B. Local bondholders with political power moved to shift Brazil’s exposure from foreign capital to themselves. In principle, this would have produced greater financial sovereignty for Brazil. However, this domestication of debt meant that local bondholders could use political and electoral clout to negotiate very favorable terms for themselves. Debt owners become ever more wealthy and ever more powerful.

C. The financial elite used this power to demand a reduction in government programs for the poor. They also asked for reductions in pensions and reductions in government investment in industry. Privatization led to enormous opportunities for deal-making and substantial fees for Brazilian banks. The reductions in spending on old age security, poverty programs, education and health led to lower standards of living and quality of life for the rest of the Brazilian population.

D. Debt politics lead to reduced democratic participation. Most people have a hard time understanding financial economics. Decision making devolved to “authorities’ such as economists working for the Treasury or development banks. These authorities were intimately tied to São Paulo financial networks. These experts were allowed to get what they wanted because what they were asking for was in their words “technically correct”. These new authorities were sincere in believing in what they were recommending. However, their recommendations almost always led to an enrichment of their friends and an enrichment of their associates in their financial class.

E. Debt and debt-based securities always got favorable tax treatment. Public debt however always had to be paid out of government revenues. This basically meant that other taxpayers – generally workers and the middle class – had to work to pay the taxes that were then shipped off to the local and international financial elite. The government became a transfer agent for a huge shift of financial resources from the lower and middle classes to the elite.

I largely agree with Bin’s version of what financialization and public debt did to Brazil. I cavil about some of the details. Financialization was not entirely awful for Brazil. Brazil before the 2000’s had always been constrained by credit markets that were kludgy,and inefficient. The supply of credit was completely constrained. Residential mortgages were nearly impossible to obtain. This limited the housing supply and raised rents higher than they needed to be. Consumer credit cards were few and far between. Having to pay cash for major purchases lowered the availability of consumer durables. Banking was notoriously inefficient. Simple consumer transactions requiring waiting in endless multiple lines and the payment of ridiculous fees. The expansion of mortgages, consumer credit and retail banking significantly expanded the economy and dramatically improved the quality of life for the upper working class and the middle class.

Likewise, Bin paints workers as the primary victims of debt shenanigans. The middle class has suffered in its own way from extractive taxation, and the shrinkage of public education and public employment.

Those are side details however. On the main points, Bin and I are on the same page.

Will the United States Have a Brazilian-Style Crisis?

Does Bin’s account have any relevance to the United States?

Some elements of this could be in our future.

The United States has never been so indebted. Government deficits are at record levels. America is hardly immune to economic or financial crisis.

When debt and financial crises hit, the “neutral authorities” all recommend therapy that involves measures of rebuilding financial confidence. This means increasing the rewards to holders of public debt. It also means reducing all other forms of public expenditure, particularly expenditure on old age pensions, health, education and welfare.

In the United States, the fragility of the Social Security system and the continuing rise in health care costs provide additional ammunition to wannabe cutters.

As Krippner shows, the financial classes have already gained extremely substantial power in American politics. They have consistently used this power to advocate positions that enrich themselves, such as the Bush and Trump tax cuts. They have also consistently advocated for the reduction in government spending on the middle and lower classes.

These arguments are made under every and any financial condition. However, they gain greater credibility in times of financial crisis. Measures taken “for the general financial stability of the nation” will be just as self-serving, presented in the same neutral technocratic jargon that was used by the bankers in Brazil.

The form of our financial crisis will be uniquely American. The results of our financial crisis will be Brazilian all the way.