The good: Thomas Palley's "Financialization revisited"

"Financialization revisited: the economics and political economy of the vampire squid economy" by Thomas Palley. 

Download page: https://www.postkeynesian.net/working-papers/2110/

Maybe the best economics I ever read.

"... a safety net for financial capital has been in the making for four decades, and it has increasingly displaced the post-World War II system that aimed to create a safety net for labor."

-- Thomas Palley

 

Thomas Palley can write. And Financialization revisited is in English: Nothing is laid out in those gibberish equations that I always skip until I have to just stop reading. Instead, he uses diagrams: flow charts showing economic interactions.

Moreover, Palley's paper presents some of the best economics I've ever read.

One of the first things he gets to is the definition of "financialization". He provides three definitions, with sources:

• Krippner: "profits accrue primarily through financial channels";
• Epstein: "the increasing role of financial motives, financial markets, financial actors and financial institutions"; and
  
• Palley: "domination of the macro economy and economic policy by financial sector interests."
  

All of the above.

As an example of good writing, I turn to page 10. One of the effects of financialization, Palley writes,

is the change in the income composition of GDP. That composition is illustrated in Figure 3 which shows a tree diagram describing the functional distribution of income. Financialization has been associated with an increase in the capital share at the expense of the labor share. Within the capital share, interest payments have increased at the expense of profits. Additionally, the financial sector share of profits has increased at the expense of the non-financial sector’s share of profits. Within the wage share, the share paid to the managerial and professional class has increased at the expense of the share paid to workers non-managerial workers. The latter constitute about eighty percent of employment in the US economy. This wage share redistribution is reflected in the increased inequality of personal income distribution.

The effect of financialization on income composition fills the paragraph. On my first read, I went thru that paragraph three times, more captivated each time. But Palley's diagram really does help the reader (me) see what he's showing us:

In this diagram, financialization pushes income leftward.

Another example of Palley's good writing, from page 14:

The seventh column in Figure 1 concerns financialization’s impact on capital accumulation, which is closely connected to its impact on growth as accumulation is a critical determinant of growth.

He could have ended the sentence at the comma. Instead he adds something more, to make sure we understand that capital accumulation is "a critical determinant of growth." I'm not an economist. I often need to be reminded of such things. 

I'm especially glad to see confirmation of that crucial connection, as I rather recently blogged about Carroll Quigley, stressing exactly that point. Now I have second-source confirmation.

Palley's writing is good because it tells me what I need to know.

 

One more example of Palley's writing. Page 16:

In particular, central banks are a critical part of the financialization landscape. Not only have they been involved in the deregulation of finance which has structurally facilitated financialization, they are critical to the financialization cycle. When the economy crashes, central banks are called upon to put a floor under financial markets. Thereafter, when the economy gets trapped in stagnation, central banks are called upon to reflate asset prices and jump-start a new cycle of lending.

In the first sentence there is an observation. The second makes sense of the observation, providing two specific ways in which centralbanks are a crucial part of "the financialization landscape." The remaining sentences expand the thought further, providing examples to show how centralbanks are "critical to the financialization cycle."

First, Palley makes an observation. Then he makes sense of it. Then he provides relevant examples. By the end of the paragraph, we are convinced the observation in the opening sentence is correct.

Good writing.

It was a typo in my notes: "centralbank". But I couldn't bring myself to correct it. It's not just a bank. It's not just a special kind of bank. It's a totally different animal, the centralbank. From now on.

Palley's Business Cycle

Paul Krugman writes of two kinds of recession:

... there’s a definite change in the character of recessions after the mid-1980s. Before then, recessions were basically brought on by the Fed, which raised interest rates sharply to curb inflation ...
Since then, however, inflation has been well under control, and booms have died of old age — or more precisely, they have died because of overbuilding and an excessive level of debt.

A definite change in the character of recessions: a significant thought, surely.

 

Thomas Palley, page 15:

Palley (2005) argues financialization has created a new business cycle driven by household borrowing and asset price inflation. The theoretical framework for such a cycle is developed in Palley (1994, 1997a).    Descriptively, the new business cycle is characterized by much longer upswings, combined with much sharper downturns that are triggered by bursting of asset price bubbles and by accumulated debt burdens that undermine AD. Moreover, the cycle is prone to instability, which calls for policy interventions that put a floor in place and reset the economy.

A most significant thought.

Palley fills a few blanks (page 5):

... financialization transforms neoliberalism. In particular, it fills the aggregate demand (AD) gap created by neoliberalism. As observed by Palley (2013, p.6): 

“The neoliberal model undermined the income and demand generation process by shifting income from wages to profit and by widening wage inequality. That created a growing structural AD gap, and the role of finance was to fill that gap.” 

That filling is accomplished by borrowing and asset price inflation, both of which are facilitated by financial market deregulation. Filling the demand gap also leads to the creation of a new business cycle (Palley, 2005) in which central banks become the guarantors of the system, and that guarantee is exercised by underwriting and inflating financial asset values ...

And page 18:

The “borrowing” and asset price inflation associated with provision and use of debt finance initially strengthens AD , but ultimately weakens AD via the resulting debt burdens and income distribution effects. That compels fresh policy interventions to jump start the process anew. This pattern has repeated in the four full U.S. business cycles of the financialization era (1981 - 1990, 1991 - 2000, 2001 - 2008, 2009 – 2020).

The pieces of his idea fit together so easily, so perfectly, that I was tempted to adopt the explanation immediately -- something I never do.

Very good writing. And a most interesting idea.

Inequality

I notice Palley's paragraph that describes Figure 3, quoted above, ends up at inequality. I notice his new type of business cycle emerges in part from inequality arising from the neoliberal policy. And I notice on page 28 Palley saying

Debt is the key instrument of the vampire squid economy whereby income is redistributed to upper income groups...

I want to mention, therefore, the topic of inequality.

I wrote a post in 2014 that opened with these words:

Lots of activity lately on the topic of income inequality, as I noted the other day. But do you really suppose we could have such inequality without all the debt? I don't.

In comments, somebody quoted my question and replied:

I would say this is exactly backwards.

So I said debt explains inequality, and the reply was inequality explains debt. Oh, well. 

Palley handles the topic so much better. Thomas Palley says Debt is the key instrument, the primary mechanism by which income is redistributed upward. I can live with that. If you want to reduce or prevent the inequality, you have to keep debt within workable bounds. Don't let an imbalance arise. Don't let debt gain on GDP:

Graph #1: GDP (red) and All Sectors Debt (blue) on a Log Scale
Red and Blue run Parallel until the Latter 1970s
Then Debt Starts Gaining on GDP

"Debt," Thomas Palley says, is "the vehicle for extracting value from households and corporations." He says things so very well.

Plus, he thinks about the same things I think about. He explains what I think, better than I do. And he fills gaps in my thinking, gaps I didn't even notice. I will be reading more of Thomas Palley.