/ 29 June 2004

Too big for its suits

A foolish man I know who inherited money decided to use it for a productive enterprise that employs people, creates new wealth and improves the lives and prospects of his community.

“Foolish” because his income and capital could have grown faster and without effort or risk to himself had he “invested” it through a fund manager in the financial sector.

In the current global economy the financial sector has a toxic effect — just by doing its job. No one’s fault: it’s just the way it works.

Because the stuff this sector works with — money — can roam the world, it can make itself scarce, hence artificially valuable. So governments must woo capital-owners by competing with other governments to enhance the share of the national cake that goes to people with money — especially by ensuring low wages and taxes.

Since money was allowed to travel, about 30 years ago, all the increase in productivity, and more, has gone to the owners of capital. Worldwide, wage and salary earners have lost income and assets, both relatively and absolutely, compared to those who earn profits on capital.

More people are destitute, more are “working poor” (earn less than a poverty income) and more middle- class people survive by consuming savings and assets.

Only the wealth at the top increases. People with capital expect to get around 25% in dividends and/or asset appreciation by “investing” through financial institutions that scan the world for profits.

Aren’t those institutions doing a good job investing rich people’s savings in economic development worldwide? Most people think asset managers are growing employment, production and trade by investing in enterprise. They aren’t. They hardly ever take up a new share offer by an existing company or put money into starting a new company. “Venture” capitalists do that.

What they do is buy and sell shares in existing companies, making their profits by creaming the difference. They buy and sell currencies in the same way.

The money they pay goes not to the company or the country concerned, but to the person who previously owned the shares or currency. This does not build, or employ, or finance trade. It is not investment in the sense many shareholders fancy it is.

Property is another area of “investment” by the financial sector. Hence the huge inflation in housing prices.

Why is this so profitable? First, so much of this money is floating around that it bids up the price of assets in which it trades. Pension funds in South Africa alone have the same value as our gross domestic product. Billions are traded each day on our stock exchange, and trillions in international currency transactions.

Second, many multinationals that receive this “investment” are monopolies — often because of patent laws — and that keeps their prices high.

Third, many company directors give themselves bonuses linked to the value of their shares, so they ensure profits take precedence over long-term investment policies. Asset- stripping and acquisitions are popular profit-boosting measures.

What are the results of this concentration of wealth in the financial sector? First, it concentrates political power — the sector has mighty and unwarranted influence with governments everywhere. That is why governments keep their exchanges open to allow their people’s savings to be drained to greener pastures. That is why the media consults the financial sector for expert comment, as though it were objective.

Second, the huge profits and earnings in that sector become a benchmark for other sectors. Other private-sector executive directors have had 30% increases every year since 1994, and research shows these are hardly linked to company performance.

From there it spreads to parastatel and government remuneration. Our airports authority has just raised its executives’ salaries by 20% to 40%, on the basis of “market-related” trends.

The extra millions these people will earn will cause staff unrest — as it has at Telkom, where the “shareholders first” imperative saw profits rise 177% on the basis of staff cuts and price increases. This is all about competing for shareholders, fattened by the financial sector.

Most dangerous of all, the sector’s profits are based largely on creating debt. As it expands and its profits increase, so does the indebtedness of the populace. This year’s record bank profits globally reflect rises in personal loans, mortgages and credit-card debt. In Britain, household debt now stands at 135% of post-tax income.

Some of my best friends are in finance. But the sector needs cutting down to size.

Margaret Legum chairs the South African New Economics Network board.