Can Private Finance Really Serve Humanity?

By Jomo Kwame Sundaram and Anis Chowdhury

KUALA LUMPUR and SYDNEY, Jul 14 2020 (IPS) - The recent explosion of private finance has nursed the hope, dream or illusion that it can be mobilized for the public good, e.g., to achieve the Sustainable Development Goals, associated with Agenda 2030. However, such hopes ignore how changes in financial investing have deeply transformed corporations, national economies and prospects for the world economy and social progress.

Private finance boom

Private capital has exploded with financial deregulation from the late 20th century. Global financeincreased 53% from 2000 to 2010, reaching some US$600 trillion (ten times annual world output), and was projected to reach US$900 trillion by the end of this year.

In its 2018 annual report, Principles for Responsible Investment (PRI) – an investor initiative in partnership with UN offices – estimated that investors with over US$80 trillion in combined assets had committed to integrate ‘environmental, social and governance’ (ESG) criteria into their investment decisions.

According to the IMF, between US$3 trillion and US$31 trillion in assets are managed by ESG funds, depending on the definition used. It also notes problems in evaluating ESG criteria, such as reducing emissions or raising labour standards, and hence fears ‘greenwashing’ financial investments with false claims of ESG compliance.

From active to passive investing

From 2006 to 2018, almost US$3,200 billion left actively managed equity funds globally, while over US$3,100 billion has gone into equity index funds, constituting “an unprecedented money mass-migration from active to passive funds”. The shift has given index providers considerable private authority and influence in global capital markets.

Mutual index funds have been available since the late 1970s, while the first exchange traded funds (ETFs) were launched in the early 1990s. The growth of passive or index funds has greatly accelerated in the decade since the global financial crisis (GFC).

Attracted by the much lower fees charged, passive fundshadUS$11.4 trillion globally by November 2019, five times more than in 2007. Jan Fichtner, Eelke Heemskerk and Johannes Petrydiscusssome implications of this money mass-migration to index funds for corporate governance, market competition and investment flows.

Wall Street’s new titans

Consequently, corporate ownership is increasingly concentrated and largely held by the ‘big three’ passive asset managers: BlackRock, Vanguard and State Street, already the largest owners of US corporations. In 2019, actively managed US funds were overtaken by passive funds. Some estimate that index funds will have over half the US capital market by 2024.

Describing passive investors as the true “titans of Wall Street”, Jill Fisch, Assaf Hamdani and Steven Solomon fear that passive investing’s rise raises new concerns about conflicts of interest due to ownership concentration and common ownership of rival firms, thus undermining competition.

In traditional investment funds, managers decide how and where to invest, e.g., which shares to buy. Instead of depending on fund managers, passive funds track selected constructed indices. This is increasingly done algorithmically, instead of reflecting or responding to price and other movements.

Index providers set standards

When investors invest via index funds, their decisions are effectively shaped by the indices the passive funds track. The three most influential index providers are the MSCI (Morgan Stanley Capital International), the FTSE (Financial Times Stock Exchange) Russell and the S&P (Standard and Poor) Dow Jones.

The main emerging markets indices have tremendous influence, particularly the MSCI Emerging Markets Index, which includes large and medium-sized companies in 26 countries, including China, India and Mexico. Thus, MSCI effectively sets criteria for countries aspiring to qualify as emerging markets, requiring financial authorities to ensure free access to and exit from national stock markets for foreign investors.

Deciding what to include in indices is not just an objective or technical matter, but inherently political and subjectively discretionary, typically benefiting some over others. Setting criteria for inclusion thus endows index providers with the authority and power to greatly influence regulation and policies.

Indices influence capital flows

In the past, index providers only supplied information to financial markets. But with passive funds, index providers have considerably more authority in markets. With trillions of dollars invested worldwide, capital has been reallocated by index providers’ decisions, as innocuous as they may seem.

These often influence international capital flows much more than economic fundamentals. Massive portfolio investments typically flow into the financial markets of countries chosen for inclusion.

When China was added to key emerging market indices in 2018, reportedly after heavy lobbying, it was expected to attract portfolio capital inflows of up to US$400 billion.

Adding Saudi Arabia to the benchmark MSCI emerging markets index in 2018 was expected to bring up to US$40 billion into its stock market. This did not materialize, perhaps due to the Jamal Khashoggi murder scandal, treated by financial markets as a ‘reputational risk’.

Thus, the big three’s indices greatly influence global investment flows. Meanwhile, investors may unwittingly acquire controversial or problematic investments, either by investing in index funds, or by choosing options heavily invested in such funds.

Divesting for progress?

Clearly, the three biggest passive fund managers and three major index providers greatly influence portfolio investment choices, while the world remains largely oblivious of their biases, influence and impacts, wishfully hoping for the best possible outcomes.

BlackRock, the world’s largest investor, with US$7 trillion in funds under its management, gained approving attention by announcing divestment of its actively managed funds from firms making more than a quarter of their revenue from coal.

But, as most BlackRock funds passively track indices, these continue to invest in coal until such stocks are removed from the indices. Moreover, its CEO has made clear that it will continue to invest in controversial assets, including coal.

Following BlackRock, Vanguard and State Street have also announced they will increase their ESG funds. But ESG criteria are defined, interpreted and acted upon by the index providers, who use different, often problematic and non-transparent methods and data.

UN ‘blue-washing’?

ESG-rating firms disagree about which companies qualify, producing different sets of ostensibly ESG compliant stocks. Meanwhile, the IMF has not found any consistent differences in rates of return between the investment portfolios of ESG funds compared to conventional ones.

In August 2019, Vanguard dropped 29 stocks, noting they had been ‘erroneously’ classified as ESG by FTSE Russell. The rejected stocks included a gun manufacturer, a private prison operator, a restaurant and a pharmaceutical company.

Neither Vanguard nor FTSE Russell explained how and why the ‘error’ had happened, or the criteria involved. Most ESG indices include ‘industry leaders’ in almost all, including the most controversial sectors, only excluding the very worst offenders, which are quite subjectively, if not arbitrarily determined.

The Economist has noted, “Tobacco and alcohol companies feature near the top of many ESG rankings. And many funds marketed on their green credentials invest in Big Oil…the scoring systems sometimes measure the wrong things and rely on patchy, out-of-date figures. Only half the 1,700-odd companies in the MSCI world index reveal their carbon emissions”.

Unless there are more meaningful and effective means to ensure that private finance equitably and appropriately serves public needs, indiscriminate UN endorsement of ostensible efforts to mobilise private finance for sustainable development runs the serious risk of legitimising a massive fraudulent exercise in financial ‘blue-washing’, referring to the colour of the UN flag.

Also available online at IPS.

Financialization: Tackling the Other Virus

By Jomo Kwame Sundaram and Michael Lim Mah Hui

KUALA LUMPUR and PENANG, Jul 9 2020 (IPS) - The 1971 Bretton Woods (BW) system collapse opened the way for financial globalization and transnational financialization. Before the 1980s, most economies had similar shares of trade and financial openness, but cross-border financial transactions have been increasingly unrelated to trade since then. Although Covid-19 recessions have rather different causes and manifestations from the financially driven crises of recent decades, financialization continues to constrain, shape and thus stunt government responses with deep short-, medium- and long-term consequences. 

It is thus necessary to revisit and contain the virus of financialization wreaking long-term havoc in developing, especially emerging market economies. No one is financing work on a vaccine, while all too many with influence seek to infect us all as the virus is touted as the miracle cure to contemporary society’s deep malaise, rather than exposed for the threats it actually poses.

Financialization

Global financialization has spread, deepened and morphed with a changing cast of banks, institutional investors, asset managers, investment funds and other shadow banks. Transborder financialization has thus been transforming national finance and economies. 

The changing preferences of financial market investors have been reshaping the uneven spread of market finance across assets, borders, currencies and regulatory regimes. To preserve and enhance their value, new financial asset classes and relationships have been created. 

Within borders, banks and shadow banks are lending to households, companies and one another, while national frontiers do not matter for securities and derivative markets, often financed via wholesale money markets. 

Over the last four decades, the scope, size and concentration of finance have grown and changed as mainly national regulatory authorities try to keep up with recent financial innovations and their typically transnational consequences. 

Managing discontents

Financialization has involved reorganizing finance, the economy, and even aspects of society, to enable investors to get more from financial market investments, effectively undermining sustainable growth, full employment and fairer wealth distribution. The following measures should help slow financialization and limit some of its adverse effects: 

Strengthen international financial regulation

While financialization has become transnational, financial regulation remains largely national, albeit with some transborder effects of the most powerful, e.g., US tax rules and Fed requirements. Transnational finance has often successfully taken advantage of loopholes and ‘arbitrage’ to great profit. 

Multilateral cooperation to strengthen effective and equitable regulation will be difficult to secure as voting power in the only multilateral institution, the IMF, remains heavily biased against developing countries. 

Strengthen national capital account management

Transnational financialization has made developing countries more vulnerable to transnational finance and its rent-gouging practices, while also causing greater instability, and limiting policy space for development. 

Although the IMF’s Article 6 guarantees the national right to capital account management, all too many national authorities in developing countries, especially emerging markets, have been deterred from exercising their rights effectively.

Improve national regulation of finance 

Improving effective, equitable and progressive national regulation of finance, particularly market-based finance, remains challenging, especially in emerging market economies where typically divergent, if not contradictory, banking and capital market interests seek to influence reforms differently in their own specific interests. Strengthen bank regulation

There were few banking crises from the 1930s to the 1970s after banking was strictly regulated following the 1929 Crash. With financial deregulation from the 1980s, major financial and currency crises have become more frequent. More effective regulation and supervision are urgently needed, not only of banks, but also of ‘shadow banks’, that account for a large and growing share of transnational finance. 

Make finance accountable

Instead of improving regulations to achieve these objectives, the growth and greater influence of finance have led to regulatory capture, with reforms enabling, not hindering financialization, including its adverse consequences. Political financing reforms are also urgently needed to limit the influence of finance in politics. 

Promote collective, not asset-based welfare 

Financialization has been enabled by the reduced role of government. Nationalizing or renationalizing pension funds and improved government ‘social provisioning’ of health, education and infrastructure would reduce the power and influence of institutional investors and asset managers. 

Ensure finance serves the real economy

The original and primary role of finance – to provide credit to accelerate productive investments and to finance trade – has been increasingly eclipsed by financial institutions, including banks, engaging in securities and derivatives trading and other types of financial speculation. 

Such trading and speculative activities must be subjected to much higher and more appropriate regulatory and capital requirements, with commercial or retail banking insulated from investment or merchant banking activities, e.g., insulating Main Street from Wall Street, or High Street from the City of London, instead of the recent trend towards ‘universal’ banking.

Promote patient banking, not short-termist profiteering

National financial authorities should introduce appropriate incentives and disincentives to encourage banks to finance productive investments and trading activities, and deter them from pursuing higher short-term profits, especially from daily changes in securities and derivatives prices.

This can be achieved with appropriate regulations and deterrent taxes on securities and derivatives financing transactions. An alternative framework for banking and finance should promote long-term investment over short-term speculation, e.g., by introducing an incremental capital gains tax where the rate is higher the shorter the holding period. 

Ensure equitable financial inclusion 

While financial exclusion has deprived many of the needy of affordable credit, new modes of financial inclusion which truly enhance their welfare must be enabled and promoted. 

Ostensible financial inclusion could extend exploitative and abusive financial services to those previously excluded. In some emerging market economies, for example, levels of personal and household debt have risen rapidly, largely due to inclusive finance initiatives.

New financial technologies

Financial houses are profitably using new digital technologies to capture higher rents. While technological innovations can advance financial inclusion and other progressive development and welfare goals, thus far, they have largely served financial rent-gouging and other such exploitive and regressive purposes. 

For example, while big data has been used to track, anticipate and stop the spread of infectious diseases, it has also been more commonly abused for commercial and political purposes. 

National regulators must be vigilant that ostensibly philanthropic foundations and businesses are actively promoting ‘fintech’ in developing countries without sufficient transparency, let alone consideration of its mixed purposes, implications and potential. 

Minimize tax avoidance 

Besides curtailing and penalizing tax avoidance practices at the national level, tax accountants, lawyers and others who greatly enable and facilitate tax evasion and related abuses should be much more effectively deterred. 

Strengthen multilateral cooperation to equitably enhance national fiscal capacities 

Governments must cooperate better multilaterally to more effectively and equitably tax transnational corporations and high net worth individuals. Such cooperation should effectively check illicit financial flows with strict regulations to deter private banking, banking secrecy, tax havens and other international facilitation of tax evasion. 

Existing initiatives need to be far more inclusive of, sensitive to and supportive of developing country governments. OECD led initiatives previously excluded developing countries, but their recent inclusion, while an advance, remains biased against them.

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Financialization: Tackling the Other Virus

Donald Trump, Working Class Hero?

By Anis Chowdhury and Jomo Kwame Sundaram SYDNEY and KUALA LUMPUR, Jul 7 2020 (IPS) - In his early February annual State of the Union address, US President Donald Trump typically hailed his own policies for increasing wages and jobs to achieve record low US unemployment. Directly appealing to labour for a second term, Trump claimed exclusive credit for the US “blue-collar boom”.

‘Blue-collar boom’

During his previous two State of the Union speeches, Trump also directly appealed to blue-collar Americans who put him in the White House in November 2016. As Trump claims manufacturing workers have been the main beneficiaries of his economic policies, including his trade and other policies, this seemed likely to dominate his re-election campaign. In fact, US manufacturing growth had slowed to its lowest level in August 2019 when the purchasing managers’ index fell for the first time since September 2009. Despite his bombast, Trump has failed to reverse the continuing decline in manufacturing’s share of GDP.

Nominal wages have risen by an average of 2.2% since Trump took office, but real wages fell 3.9% after adjusting for inflation. Real labour compensation, including fringe benefits, has declined 4.3%! Meanwhile, more than 53 million Americans, or 44% of all workers aged 18-64, earn low hourly wages, getting barely enough to survive. US unemployment fell to 3.5% in December 2019, its lowest level since 1969, before rising again. However, the story behind the headline unemployment figure is less impressive.

For example, in January 2020, 1.3 million individuals who wanted work, were not counted as unemployed because they had not actively sought work in the preceding four weeks. This figure shot up to 9.4 million in May 2020, declining to over 8.6 million in June.

Of these, ‘discouraged’ unemployed, who believed that no jobs were available for them, more than doubled from 337,000 in January 2020 to 681,000 in June.

Trump himself had ridiculed official unemployment data in 2015, describing them as “phony”, lambasting the practice of excluding people who have given up looking for a job from unemployment statistics. The headline unemployment figure also does not include those working part-time who want to work full-time.

The high US incarceration rate lowers its jobless rate by about 1%. The US has the world’s highest incarceration rate, with more than two million in prisons. Many are discouraged African-American and Hispanic unemployed workers, jailed for minor crimes, often petty drug offences.

US workers better off?

Three-fourths of the post-Second World War (WW2) decline in the labour share of GDP (i.e., paid as wages, salaries or employment benefits) has happened since 2000, after little change in the second half of the 20th century! Overall US labour share of nonfarm business income fell from 65.4% of GDP in 1947-50 to 61.1% in 1994-98, before rising to 63.3% in 2000, and falling thereafter. After recovering from a nadir of 52.4% in 2013 to around 57% during Obama’s second term, labour’s share fell to 53% in 2018.

Low unemployment has undoubtedly raised nominal wages, but after adjusting for inflation, the median household income was roughly the same as two decades before, while the average real wage has barely changed, rising just 0.42% from December 2016 to September 2019.

Meanwhile, the value of fringe benefits – including health insurance, retirement and bonuses – declined by 1.7% during Trump’s first three years. 1.9 million more Americans lack health insurance coverage, raising the total to 27.5 million, i.e., 8.5% of the US population in 2018.

Thus, despite declining joblessness before the pandemic, aggregate real compensation fell 0.22% under Trump. Average real hourly earnings of US$23.24 in March 2019 were not higher than at its peak in March 1974. With the pandemic, real (seasonally adjusted) average hourly earnings for all employees dropped 0.9% from April to May 2020, while nominal earnings of private nonfarm payroll employees fell 66 cents to US$29.37 in June 2020 from US$30.03 in April.

Meanwhile, labour income inequality has increased, with declining real incomes for the unskilled and poorly skilled, as remuneration gains have mostly and increasingly gone to the highest-paid, mainly executives.

Infecting the numbers

Following policy responses to the Covid-19 pandemic, the US labour force participation rate (share of civilian population aged 16 and older working or looking for work) fell from 63.4% in January 2020 to 61.5% in June, well below the pre-financial crisis peak of 66.4% in January 2007, and the post-WW2 high of 67.3% in early 2000.

Job growth has slowed with Trump’s trade wars, with significant job losses in electorally key states. While 2018 saw 223,000 new jobs created monthly, this average fell to 184,000 in the last quarter of 2019. The 1.2 million ‘long-term unemployed’ (jobless for at least 27 weeks) accounted for 19.9% of the unemployed in January 2020, rising to 1.4 million in June.

Apparently, the US jobs survey mistakenly counted 4.9 million unemployed as employed! If corrected, the unemployment rate would have risen to 16.1% in May, and the rate for April would have been more than 19.5% – instead of 14.7%.

According to the Peterson Institute for International Economics (PIIE), even the very large increase in official unemployment since March is underestimated. Adjusting for the extra 4.9 million unemployed, and 6.3 million who have left the labour force since February, the PIIE’s more ‘realistic unemployment rate’ was 17.1% in May, the highest in over seven decades!

However, despite admitting the error, the US Bureau of Labor Statistics (BLS) has not corrected the official numbers “to maintain data integrity”. As the BLS regularly updates its estimates, its decision not to do so in this case has triggered calls for investigation.

As part of the US$2 trillion stimulus package, US$350 billion in ‘forgivable’ loans have gone to small businesses to retain staff. Businesses could access the funds if they retained or rehired laid off workers by the end of June, raising the month’s job numbers. Many employers acknowledge they will lay off these workers once the subsidies run out. Nevertheless, the job retention programme may be extended beyond October to cover the early November polls. Meanwhile, the Becker Friedman Institute at the University of Chicago estimates that 42% of people “furloughed” will never get their old jobs back, while only 30% of those laid off will land new jobs later this year.

Spinning for a second term

Unsurprisingly, Trump is elated with the latest BLS unemployment figures released on 2 July, showing declines for a second consecutive month from 13.3% in May to 11.1% in June. Trump greeted the news, bragging, “Today’s announcement proves that our economy is roaring back”.

In his ‘victory lap’, Trump described the June jobs report as “affirmation of all the work we’ve been doing”, probably hoping it is the ‘good news’ he has been desperately seeking since his ratings started slipping due to his pandemic mismanagement.

He specifically highlighted the “historic” sharp drop in Black unemployment, falling from 16.8% in May to 15.4% in June. Trump also cheered the soaring stock market, largely fuelled by US Fed monetary policy, claiming the economy was on “a rocketship”.

Yet, if enough low-wage workers do not buy into Trump’s story, he will be in trouble come November. But it is not yet clear how US workers view their situation and options, who they will blame, how far Trump will go to secure re-election, and how the electorate will vote.

Read online here: http://www.ipsnews.net/2020/07/donald-trump-working-class-hero/