We live in an era of financialization. Since 1980, capital markets have expanded around the world; capital shuttles the global instantaneously. Shareholder concerns drive executive decision making and compensation, while the fluctuations of stock markets are a source of public anxiety. So are the financial scandals that have regularly occurred in recent years: junk bonds in the 1980s; lax accounting and stock manipulation in the early 2000s; and debt securitization today. We also live in an era of rising income inequality and employment risk. The gaps between top and bottom incomes and between top and middle incomes have widened since 1980. Greater risk takes various forms, such as wage and employment volatility and the shift from employers to employees of responsibility for pensions and, in the United States, for health insurance. There is an enormous literature on financial development and another on inequality. But relatively few studies consider the intersection of these phenomena. Standard explanations for rising inequality--skill-biased technological change and trade--account for only 30% of the variation in aggregate inequality. What else matters? We argue here that an omitted factor is financial development. This study explores the relationship between financial markets and labor markets along three dimensions: contemporary, historical, and comparative. For the world’s industrialized nations, we find that financial development waxes and wanes in line with top income shares. Since 1980, however, there have been national divergences between financial development--defined here as the economic prominence of equity and credit markets--and inequality. In the U.S. and U.K., there remains a strong positive correlation but in other parts of Europe and in Japan the relationship is weaker.
What accounts for swings in financial development and inequality and the relationship between them? Economic growth is one factor. Another is the politics of finance. The model presented here is simple but consistent with the evidence: Upswings in financial development are related to political pressure exerted by elite beneficiaries of financial development. Political objectives include policies that favor financial expansion—and finance-derived earnings--and the shunting of investment gains to top-income brackets. Against financial interests is arrayed a shifting coalition that has included middle-class consumers, farmers, small business, and organized labor, upon which we focus here. When successful, these groups cause a contraction in the economic and political significance of finance, which registers in the distribution of income and wealth. In other words, politics drives the swings in financial development and mediates the finance-labor relationship.
Political contests occur not only in the public arena but also within firms. We expand the politics of financial development to include contests over corporate resource allocation through the mechanisms of corporate governance. Corporate governance affects the distribution of a firm’s value-added among shareholders, executives, workers, and retained earnings. Here too, organized labor is an important player. In both public and private arenas, labor wields influence via its bargaining and political power and, more recently, via its pension capital. Our historical framework draws from Karl Polanyi’s classic study of markets and politics in the nineteenth and early twentieth centuries. Polanyi challenged economic liberalism by showing that market expansion in the Western countries was not a natural development; it was embedded in politics and society. He also showed that markets are not self-regulating. Undesirable side-effects--instability, monopoly, externalities--can not be rectified by the market itself. As a result, every market expansion is followed by spontaneous countermovements to “resist the pernicious effects of a market-controlled economy.” Polanyi called this the double movement: “the action of two organizing principles in society … economic liberalism, aiming at the establishment of a self-regulating market ...[and] the other was the principle of social protection aiming at the conservation of man and nature as well as productive organization.” Writing in the early 1940s, Polanyi could not foresee the relevance of his ideas to our present age. Today, laissez-faire ideas, including those relating to financial markets, again are with us as are countermovements to contain the market’s failings.
The focus of this study is on financial markets in the world’s richest nations. Much of the material is based on the American experience, although there are comparisons to Europe and Japan. Part I analyzes the mechanisms that link contemporary financial development to rising inequality and risk. Part II considers the political and ideological bases for post-1980 financial development and corporate governance. The next two parts are historical, focusing on the period from the late nineteenth century though the 1970s: Part III describes financialization and Part IV traces political movements to contain it, emphasizing the contributions of organized labor. Part V takes us back to the present. It considers the efforts of organized labor to re-regulate finance and reshape corporate governance, in part by using its pension capital.
1) IMF, World Economic Outlook: Globalization and Inequality (Washington, DC 2007), 48. 2) Karl Polanyi, The Great Transformation (New York 1944): 132.