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Business News/ Opinion / Will America de-financialize?
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Will America de-financialize?

One can tentatively stick one's neck out and predict that inequality is more likely to drop than rise further in the US

Photo: BloombergPremium
Photo: Bloomberg

Financialization has arrived in India. Well, almost. On Friday, the Securities and Exchange Board of India (Sebi) released its annual report for 2015-16. It reported that India held a significant place in the arena of world derivatives markets. At $10.6 trillion, the turnover in equity derivatives alone in 2015-16 was more than five times India’s gross domestic product (GDP).

The National Stock Exchange of India alone accounted for half of the world’s volume in stock index options. Including interest rate and currency derivatives, total turnover in derivatives would be higher. If it is any consolation, in 2014-15, the total turnover in equity derivatives in India was around $12.4 trillion.

A weaker Indian rupee and a near-total collapse in derivatives turnover in the Bombay Stock Exchange (BSE) in 2015-16 had caused a decline in the turnover in dollar terms. Globally, the ratio of outstanding derivatives contracts to GDP was as high as 10 in 2007-08. We know how that story ended. India does not have to reinvent the global wheel on financialization of its economy.

At least, that would be the advice of professors Peter Lindert and Jeffrey Williamson. Their recent book, Unequal Gains: American Growth and Inequality Since 1700, makes a strong case against financialization. I bought the book because I was interested in the evidence on how financialization had played a direct role in the rise of inequality in the US. Causal evidence is hard to produce, especially for the first episode in the early 19th century when inequality in the US surged. The authors provide tentative evidence.

However, the evidence is more compelling for the period between 1910 and 1970 when inequality in the US declined substantially. De-financialization and financial regulation played a big role. Similarly, the re-financialization of the US economy on a massive scale since 1970 has played a direct role in worsening inequality. That income inequality since the 1970s rose markedly in the US despite improvement in racial, spatial or gender inequality narrows the potential culprits considerably. In terms of the book’s conclusions, the point about inequality and growth not being correlated one way or the other is important. In other words, pursuit of growth does not have to result in widening income inequality.

The professors make three policy recommendations to reduce inequality without sacrificing economic growth. One is investment in public education. Second is taxing inheritance and the third is regulating finance.

They quote Andrew Carnegie, who was against inheritances and bequests: “The parent who leaves his son enormous wealth generally deadens the talents and energies of the son, and tempts him to lead a less useful and less worthy life than he otherwise would… Wealth left to young men, as a rule, is disadvantageous."

One can tentatively stick one’s neck out and predict that inequality is more likely to drop than rise further in the US, for at least two reasons.

One is slower growth in the US labour force. Other things being equal, that will tend to allow wages to rise faster. It is quite likely for two reasons: one is the baby boomer retirement and the other is the rising income and opportunities in countries like India that would slow down employment and income-seeking emigration from their shores to the US.

The other is the relatively poor prospects for American financial markets in the next several years. Demographics and possible collapses in the bond and stock markets will slow down asset market returns for quite a prolonged period and, if nothing else, that would rein in finance. I have more hopes on that than on political will and executive action to rein in the financial sector. They admit that the cause of income equality would not be directly helped by financial regulation but it would do so indirectly because the income floor under those near the bottom would be raised by the prevention of unemployment caused by financial busts. They are emphatic that financial deregulation since the 1970s played a big role in widening inequality just as they are about financial re-regulation reducing inequality between 1910 and 1970.

Hillary Clinton is unlikely to oversee tighter regulation of finance. In this regard, both Democrats and Republicans sing from the same hymnbook. Further, financial types have made substantial contributions to her campaign. Hedge funds are prominent among them. Their poor performance in recent years with their wrong bets in financial markets is cause for hope for those looking for an end to the governance of, by and for elites. They may be betting on the wrong horse in the US presidential election too.

On the other hand, there is a greater chance that Donald Trump would rein in finance. That stems from his understanding of the damage to American workers that the rise of China has caused. The persistent rise in the American trade deficit, the decline in manufacturing employment in the US, the rise of finance and the rise of China are linked.

If Trump took the axe to a link in that chain, others may fall apart too. Therein lies the hope for an end to the rise of finance and inequality.

V. Anantha Nageswaran is an independent financial markets consultant based in Singapore.

Comments are welcome at baretalk@livemint.com. To read V. Anantha Nageswaran’s previous columns, go to livemint.com/baretalk

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Published: 23 Aug 2016, 12:01 AM IST
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