In commenting on the crisis I have largely steered clear of more detailed debates on re-regulating the financial sector. It’s a crucial area, but one in which I lack expertise. One commentator who has followed these debates closely and I find informative is Bruegel’s Nicolas Veron. (I also recommend the new initiative Finance Watch.) Nicolas’s latest post, though, touches on broader issues.
He discusses the need for a banking union, i.e. a federal framework for banking policy, as a necessary corollary to monetary union and in addition to the needed fiscal union. This is, I believe, correct. (I would add that some coordination of wage and price setting is at least equally important.) I also agree that it will probably be a long time coming.
But what I want to discuss here is Nicolas’s assertion that eurozone governments need to choose between banking union and financial repression and that their desire for the latter is an obstacle to the former.
Financial repression: come again?
Some background. Financial repression is a term used to refer to policies that contain or reduce government debt essentially by imposing costs on savers. In various ways savers (individuals, pension funds, banks) are forced or incentivised to buy government bonds. This reduces their yield (compared to a ‘market’ outcome) and means the government can finance debt more cheaply. A rather different approach with the same effect is to more or less consciously create unanticipated inflation, reducing the value of longer-term assets paying a fixed yield, of which government bonds are the most important. Bad for bondholders, good for government and taxpayers, at least in the short and medium run. Both of these elements played a significant role in reducing government debt in advanced capitalist countries after the second world war and into the 1970s.
It is not hard to see why financial repression is back on the agenda. (The debate and the use of the term were kicked of by this paper by Reinhart, Kierkegaard and Sbrancia.) Governments (and taxpayers) are groaning under the weight of debt. Raising taxes and cutting services is unpopular (and in a recession has perverse effects). A dose of inflation and ‘bashing the bondholders’ seems much more attractive.
Putting financial repression in context
Now it is clear that financial repression requires actice government involvement in the activities of the domestic financial sector. This is why its use declined as finance was progressively liberalised and internationalised from the early 1980s. And this is why Nicolas Veron sees a contradiction between two policy goals, banking union to stabilise the European financial sector and its economy more generally, and financial repression to reduce the government debt burden, ultimately in pursuit of the same goals.
I would make two critical: one specific, the other more general.
There need not be such a clear trade-off, perhaps none at all. Given the starting point of internationally globalised finance, national regulatory regimes were subject to ‘regime competition’, as mobile capital threatened to leave if it did not get the type of regulation it liked. Given that starting point, it would seem plausible to argue that by establishing European rules and frameworks, at least some elements of ‘financial repression’ could be reestablished, elements that may have been jettisoned in the regulatory ‘race to the bottom’ caused by globalisation. So I think that Nicolas basic premise of an invidious choice is mistaken, although reaching the necessary compromises may indeed delay the introduction of banking union.
The more general point is that I believe that the use of the term ‘financial repression’ is misleading. For starters, it is about the unsexiest term for a policy I have ever heard. And that is deliberate: it was coined as a way to describe policies that were implemented by some developing-country governments but seen very negatively by international institutions (in essence because they diverted capital from the ‘productive’ private to the ‘unproductive’ public sector). See also Paul Krugman on this. But I think a much more fundamental point needs to be made. In advanced capitalist countries post WWII financial repression (squeezing government bondholders) was part of much broader ‘social contract’ in which government was aligned much less than is now the case with ‘financial capital’ (savers, rentiers, financial institutions), but to a much greater extent with ‘real capital’ (corporations, top managers and also trade union leaders). In other words, the ‘repression’ – I would prefer a word like constraints – was imposed more generally on rentiers: those who derive income merely from the fact that they own financial assets. The squeezing of government bondholders was just a part of that social compact whereby financial wealth-holders were offered steady but small returns, large returns were earned by those that (successfully) invested in real projects in manufacturing and services, and, not least, wage-earners’ living standards rose in line with the growth of labour productivity, which was comparatively rapidly thanks to the fast pace of capital accumulation.
This regime was spectacularly successful for many decades, but was overthrown progressively from the 1980s as capital owners asserted their interests increasingly effectively. It was progressively replaced by one in which the interest of rentiers was considered paramount (‘shareholder value’), banks could promise ‘investors’ annual returns of 15% and more, and real investment was as often as not seen as a grave threat to a company’s short-term returns.
This model has now broken down and needs to be rebuilt. We need to return to a system in which, under the changed conditions prevailing today, “finance is less proud and industry more content” as Winston Churchill put it at the previous high-point of liberalism. So-called ‘financial repression’ is just one piece of that mosaic.