The Dominance of Finance

This is partly a review of Capital Resurgent and Crisis of Neoliberalism by Duménil and Lévy, A Brief History of Neoliberalism by David Harvey, and The Golden Rule: The Investment Theory of Party Competition by Thomas Ferguson. The reason why I am writing about all these books together is that they fit together to provide a coherent explanation of the rise of finance capitalism in our time. What we are looking for is an analytical framework that accounts for the momentous changes that took place in the nature of Capitalism and the juridico-political regime beginning in the 1970s. Any framework involves keeping only a few variables to keep the analysis tractable. This is not a problem as long as we have strong reasons to believe that the ignored variables are overwhelmed by the dominant variables, our model will still have strong predictive power. Another analytical rule of thumb to bear in mind is that when models that account for different phenomena on their own fit together in a consistent fashion it provides further evidence of their validity. Which is why this analysis is so exciting. Let us begin without further ado.

Financial hegemony

Duménil and Lévy’s Capital Resurgent:The Roots of the Neoliberal Revolution is the canonical reference for anyone interested in these issues. The emergence of neoliberal policies–capital mobility, labor market flexibility, international free trade with a focus on investor rights, fiscal discipline for governments and the privileging of the rights of bondholders and investors over populations–has a specific explanation in their analysis. Here is the short version.

Western capitalism saw a period of rapid material expansion in the post-war period. This was characterized by growth in productivity, high rates of investment and profit. Moreover, these gains were shared across a broad swath of society; mostly through rapidly rising working class wages but also through redistributive policies of high taxes on the rich and increasing welfare spending. Beginning in the late 1960s there was a secular decline in the profit rate of Western corporations which came about due to a slowdown in material expansion. This shows up not only in profit rates but also a lower growth rate in labor productivity (from 2.1% in 1965-74 to 0.9% in 1975-84) and capital productivity (net output divided by capital stock) which declined steadily from its peak in 1966 to 1982 by about 30%. Furthermore, there was a wealth crash in 1965-75 that deeply eroded upper class wealth and power. The share of assets held by the top 1% almost halved in that decade.

Duménil and Lévy (and other prominent thinkers such as Chomsky and Harvey) believe that this led to an organized effort by upper classes to restore class power and revenues. This claim is dependent on the validity of the class analysis it rests on. This takes a particular form in Duménil and Lévy. In their analytic framework there are three distinct classes: financial elites, managerial elites and the popular masses. They see the post-war, “New Deal” regime as a class compromise between the managerial class and the masses–managerial capitalism characterized by Keynesian policies for macroeconomic management (especially a commitment to fight unemployment), state guarantees for welfare, strict constraints on financial interests and capital mobility, and high taxes on high incomes. Managers of nonfinancial corporations enjoyed a high degree of autonomy from finance, using their retained earnings to finance their expansion. The accumulation of surplus inside corporations and it’s redeployment in the industrial sector powered the material expansion of the post-war period. Unions enjoyed a nontrivial degree of power which allowed them to negotiate a growing real wage rate as long as the expansion continued apace.

The claim is that this class compromise broke down with the structural crises of the 1970s and was replaced by another–one within the upper classes–between the financial elites and the managerial elites with the finance guys on top. There are two aspects of this shift. The first is the official neoliberal state policies which began in earnest after the September 11, 1973 coup in Chile and were later applied back home in the West after the election of Reagan and Thatcher. Key components of this policy mix include deregulation of finance and capital markets, an assault on labor unions and promotion of “labor market flexibility”, a dismantling of the welfare state, a commitment to combat inflation and protect financial interests, and last but not the least “structural adjustment” and austerity measures for the masses. This aspect is the more visible one. We will come back to it shortly.

The second component is the direct relationship between finance and nonfinancial corporations. Here, the centrality of the 1979 coup is crucial. But even before that could happen the bargaining power of capital and investors had to increase. This is exactly what happened during the course of 1970s. Like pieces in a game of chess, bargaining power depends on mobility and flexibility. The fixed exchange rate system broke down in 1973. Capital controls were relaxed in the US in 1974, Britain in 1975. During the 1970s a significant portion of US capital migrated to the City of London engorging the basically unregulated Eurodollar market which freed a giant pile of US dollars from control by the Federal reserve. Alongside, there was some deregulation of financial speculation in the Carter years. It must also be noted that it was during the 1970s that the container revolution took place. The US military developed standardized containers to ship supplies for the war in Indochina. These were coming back empty so they starting loading up with cheap goodies in Japan. This is the origin of the container revolution which has completely changed the structure of major corporations. Almost all are now characterized by global supply chains, which, more than “international trade” has integrated the world economy. (Import and export numbers do not include intra-firm operations.)

Once capital was freer to redeploy and move around the vanishing profit rate became intolerable to financiers who started making more demands on corporate managers. The pressure to restore profitability increased sharply even as new avenues to suppress wages and organized labor opened up (by relocating factories to East Asia). Financiers pooled their financial resources into private equity firms which were basically institutions to amplify capital power. A major innovation was the leveraged buyout (LBO) whereby a takeover could be financed by using the target firm’s assets as collateral. One by one entire sectors of the economy were “rationalized” by mergers and acquisitions. (This is a euphemism in the business literature–an industry is “rationalized” when it becomes oligopolistic and therefore sufficiently profitable.) Financial analysts reviewed corporate plans to restructure, outsource, cut payroll and generate “shareholder value”. Even supermassive giants like GE were eventually forced to rationalize their operations, shed a large part of their sprawling empire and focus on “core competencies”. Instead of “company men” who had risen from the ranks to the top echelon of corporations and knew the business in and out, finance replaced them by CEOs who had their “eye on the ball”, the ball being the bottom-line of course. To cut a long story short, managerial capitalism collapsed under the action of capital power.

As elaborated in The 1979 Coup, the holders of financial assets confiscated all the excess profits of the nonfinancial corporations as interests and dividends. The captains of industry acquiesced in this extraction because they were brought into the plutocratic world shaped by Wall St, this is precisely what accounts for the skyrocketing compensation of CEOs. This also explains why even after the rate of profitability increased, there was no resumption in capital accumulation and investment–private investment in the economy comes overwhelmingly from the retained surpluses of nonfinancial corporations–this surplus was confiscated by finance. In theory, this capital ought to be redeployed in growing sectors of the economy. This happened to a marginal extent in the emerging sectors of the new economy and emerging markets undergoing material expansion, but most surplus went into real estate speculation and financial arbitrage–exactly the “signal crises” of Braudel. To a large extent, this explains the lower rates of productivity and output growth in the West since 1980.

So far so good. Now Duménil and Lévy take their class analysis too seriously and expect the current crises to upend the existing class compromise. In fact, they think it will be inverted with a return of the managerial elite to power and constraints on financial interests–what they call neomanagerialism. This is nonsense. The interests of CEOs and top executives of globalized multinational corporations are now identical with those of finance. They are not about to revolt against Wall Street. To analyze this, we need a thicker description of the political economy. This is where Ferguson comes to the rescue.

The investment theory of party competition

In Manufacturing Consent: The Political Economy of the Mass Media, Chomsky and Herman lay out an analytical framework. Instead of seeing the media as delivering news and entertainment to an audience they look at it as a market–media corporations sell audiences to buyers who are generally other corporations (advertisers). Inter alia, looking at the industry in this framework has immediate implications about what we expect to see in newspapers and on TV. Thomas Ferguson does a similar thing with electoral competition. In the mainstream political science analysis, candidates for political office are seen as political entrepreneurs who appeal to different segments of the voters (Google the Downsian model of party competition and the median voter theorem et cetera). The key insight of Ferguson is that candidates and parties seeking power appeal not to voters (who come into play later) but to investors, who are the fundamental constituency. The core proposition is that “parties are more accurately analyzed as blocs of major investors who coalesce to advance candidates representing their interests.” [Emphasis in the original.]

The business elites who are the “major investors” of campaigns don’t just bankroll the endeavour, they provide candidates with credibility and legitimacy. The coming out of well-known business leaders acts as a signal for other investors to fall behind a particular candidate. Once a candidate gathers substantial support from investors he starts getting more coverage from corporate media and the campaign gets kick started in earnest. Obviously if a candidate fails to raise enough money and gather enough support from business elites, the campaign runs out of money and the operation grinds to a halt before making anything more than a blip on the public mind. Candidates who face a lack of interest or worse opposition from certain industries have to modulate their policy platforms to attract investors.


“Elections are contests between several oligarchic parties, whose major policy proposals reflect the interests of major investors, and which minor investor-voters are virtually incapable of affecting, save in a negative sense of voting “no confidence”. The investment theory does not confuse investors/employers with politicians/employees. It expects very modest moves towards the public on all issues affecting major investors, rock like stability towards the vital interests of these investors, and many efforts to adjust the public to the parties’ view rather than vice versa. Furthermore, it expects that whole areas of policy will not be contested at all. Once these central implications are digested a revised approach to the definition of “party systems” and critical realignments becomes immediately available. Party systems are the systems of action organized by major investor blocs, several of which can be distinguished historically.”

The first of these was the Jacksonian system of 1812 in the Era of Good Feeling which collapsed with the Civil War. Southern planters had the upper hand in the Early Republic, but northern commercial and industrial interests became increasing dominant.  The system collapsed spectacularly with the Civil War and the dominance of the Railroad interests became entrenched along with that of the Republican party. This is the ‘system of 1860’. The economic turmoil of the Great Depression of the late nineteenth century led to the breakdown of this equilibrium and a new configuration of forces emerged: the ‘system of 1896’. This party system was dominated by a broader coalition of northern industrial interests which was to survive for nearly thirty years. 

Spiralling conflict over labor and foreign policy in the ’96 system led increasingly to the disintegration of the Republican party, so that by 1928 the partisan alignments of 1896 had disappeared altogether. An emergent bloc of investors came together around Roosevelt and the New Deal to establish the  ‘system of 1936’. This system collapsed during the structural crises of the 1970s. A critical alignment took place with a major reconfiguration–most investors coalesced around the Republican party and Reaganism–the  ‘system of 1980’.

This analysis is done in terms of industrial sectors and their competing interests. For instance, one maps industries on an axis of protectionism vs internationalism, and/or and axis of wages as a percentage of value added (which determines how much you want to crush labor). The New Deal coalition thus consists of investment banks, oil, paper, capital-intensive industrials like GE, and tobacco.

Here is Ferguson on the birth of the system of 1980:

“The atmosphere of intensifying crises enormously advantaged the only political party for which massive welfare cuts were thinkable–the GOP. Multinationals which were perfectly prepared to support Democrats during the New Deal era abruptly cut off their support, or intensified their commitment to Republicans. At the same time so did the traditional protectionist bloc. Not surprisingly, the first result was confusion, as all sorts of “New Right”, “Old Right”, and “neoconservative” cultural and political entrepreneurs competed to tap the rivers of cash that rapidly began flowing. Under the inflexible pressure of political deadlines, however, a more or less articulate compromise emerged within the Republican party.

The Reagan administration concentrated on economic issues that sent broad rivers of cash flowing to all its supporters in the business community: the military buildup, deregulation, personnel changes at the NLRB, and the centrepiece of its economic program–the tax cuts. After some fits and starts, the Reagan administration fell in line with Volcker’s high interest rate policies.”

Since the election of Reagan, specific sectors have remained major investors in the GOP, especially Oil and the Defence industry. The Democrats have only managed to capture the White House twice. In both these cases it was the financial sector and globalized multinationals which swung decisively to the Democrats and enabled it to win. Both Clinton and Obama came in with sweeping declarations of commitment to New Deal policies only to “move to the center” and pursue a neoliberal agenda in the interest of globalized corporations and the financial sector. This is no coincidence.

A key observation is that sometimes a single industry can become so dominant so as to be a major investor of both political parties, and/or dominant over sufficient industries to be a “hegemonic bloc”. This was the case with Railroads and the system of 1860. What has become strikingly obvious is that the financial sector alone constitutes a hegemonic bloc of investors that dominates the current regime–the system of 1980.

Assembling the jigsaw

Once we juxtapose these two frameworks we see immediately how the two components of finance led neoliberal globalization–the dominance of finance over industry and neoliberal state policy–came together and reinforced each other. Now it is clear where Duménil and Lévy get it wrong. Since finance has become hegemonic, we cannot expect the current party system to institute policies to curb financial interests (say a Tobin tax or bringing the capital gains tax to the level of income taxes). And since the interests of the CEOs of nonfinancial corporations are now aligned with those of finance, there is no threat of neomanagerialism.

Coming back to the claim that neoliberalism was a project for the “restoration of class power”, one finds oneself in a bit of a conundrum. Given the form of the post-war compromise–with control in the hands of corporate and state planners and Keynesian management of the macroeconomy–why did the response to the structural crises not take the form of an attack on wages and welfare spending whilst still constraining financial interests? That would’ve been in the interest of the ruling elites who were overwhelmingly dominant in 1966. The answer to this must be sought in the nature of that dominance. It seems reasonable to think that the post-war period was a special departure from the normal course of Capitalism. In particular, modern industrial Capitalism in 1940-66 was based on a specific sort of material expansion suited to state planning and management. There were technological and structural reasons for the emergence of managerial capitalism, à la J.K. Galbraith. When that material expansion came to a close, the raison d’être of managerialism ended as well. It was just a matter of time before there was a reckoning with the holders of capital. The speed with which it happened tells us that we were still very much in Capitalist history. There is no doubt that there was a restoration of class power but it was more specific than that. This was a restoration of Capital power, an intensification of Capitalism [A point on which there is universal agreement with Duménil and Lévy].

Historical financial hegemonies

Duménil and Lévy compare the current period with earlier ones and find striking parallels. Kevin Phillips has also compared the current period to the Gilded ages of 1890-1906 and the 1920s. These were also periods of financial hegemony with similar outcomes for wealth and inequality. However, there are critical differences. As we learned from Braudel, finance and international trade knitting the world-economy together are privileged as the “real home of Capitalism”. The earlier financial hegemonies can be thought of as successive periods through which Capital was consolidated and redeployed. These are also periods when the modern banking system emerged and capital markets expanded and matured.

The current financial hegemony is different. First of all, the scale is completely different. The financial sector is orders of magnitude larger than at any time in history, so the dominance is much more intense. Secondly, growth in productivity has slowed down considerably as one would expect at the terminal end of a material expansion. For precisely this reason Capital has moved to speculation and financial arbitrage, or is being redeployed at other sites of material expansion, basically East Asia. This is because this is the real deal, the “signal crises” of the American cycle of accumulation. This does not mean the end of American hegemony for specific reasons I have discussed elsewhere.

This article marks the culmination of something I have been investigating this whole year. Only now do I feel a sense of closure. I am deeply indebted to the insights of Robert Reich, Giovanni Arrighi, Kevin Phillips, David Harvey, Noam Chomsky, Dominique Lévy, Gérard Duménil, and Fernand Braudel.

[Update: Noam Chomsky spoke at Occupy Boston and Krugman gets it right in his column.]

[Update: I would say that our implicit predictions for the 2012 cycle are being borne out if they weren’t so damn obvious. In any case, this stuff is really hard to miss.]


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