Novelists and historians have been more willing than economists to recognize this dynamic. Honoré de Balzac quipped in Le Père Goriot that behind every family fortune is a great theft, long forgotten or indeed “never been found out, because it was properly executed.” But not all such origins are forgotten. A century ago Gustavus Myers’ History of the Great American Fortunes uncovered how many family fortunes were taken from the public domain by colonial land grants, bribery and insider dealing — and how such fortunes quickly take a financial form.
Having gained enough control over government policy to privatize public assets, the financial sector provides credit to buy the right to install tollbooths on hitherto public roads, railroads, airlines and other transport infrastructure, phone and communications systems. The aim is to extract monopoly rent instead of providing basic services freely or at subsidized rates. Financialization means using this rent extraction for debt service.
Avoiding war’s financial cost leads to classical liberalism
Until the world went off gold in 1971, waging war and paying interest to foreign bondholders required payment in bullion. Gaining monetary bullion by running a trade surplus required competitive pricing of industrial exports. This meant minimizing the cost of labor and its living expenses. Imperial economies that spent vast sums on wars and colonial rivalries raised money by taxing cities and consumers to pay interest on their war debts.
In Book V of The Wealth of Nations, Adam Smith describes how each new war loan in England was given a specific dedicated excise tax to pay its interest. By the time of the Seven Years War between the French and British in America (1754-63), such war making and taxing was raising labor’s cost of living and hence the basic wage, as did the creation and sale of monopolies. High taxes and prices deterred the development of industry, limiting the ability to wage war. That was the basic conundrum that inspired Britain to transition to “free trade imperialism.”
The perception that military fighting had become a losing proposition economically led early liberals such as Smith to oppose royal wars, colonization and the taxes levied to pay their costs. The cost of imperial overhead was more than most empires were worth. Smith urged Britain to give the American colonies their independence so as to free it from having to bear the cost of their defense. His contemporary Josiah Tucker described the colonies as “a millstone around the neck of England.” It was cheaper to give them political liberty, using credit and investment as more efficient modes of exploitation.
A rising element of cost in the modern world reflects the pricing of infrastructure services. Public investment traditionally has sought to minimize such costs. But banking viewed great infrastructure projects such as railroads and canal building (capped by the Panama and Suez Canals) as major opportunities to profiteer at the economy’s expense. Underwriting fees and speculative gains have been as important as interest extraction, while fraud and kleptocracy always have been rife. That is how America’s railroad barons, monopolists and trust builders became the nation’s power elite a century ago, and how post-Soviet oligarchs seized public assets after the neoliberal 1991 “reforms.” This is what makes financialization antithetical to classical economy’s value and price theory.
Financial avoidance of public taxes and duties
Now that land ownership has been democratized — on credit — a majority of most populations (two-thirds in the United States, and over four-fifths in Scandinavia) no longer pay rent to landlords. Instead, homeowners and commercial property investors pay most of the rental value to bankers as mortgage interest. In the United States, bankers obtain about two-thirds of real estate cash flow, largely by reducing property taxes. The more the financial sector can reduce the government’s tax take, the more rent is available for new buyers to pay interest to banks for loans to buy property. This explains why the financial sector backs anti-tax “Tea Party” protests.
It is much the same in industry. Financial analysts pore over corporate balance sheets to measure the cash flow over and above the direct cost of production and doing business. This measure is called ebitda: earnings before interest, taxes, depreciation and amortization. Owners and their creditors aim to make as much of this income tax exempt — and they achieve this largely by making interest a tax-deductible expense.
Creditors always have sought to break free of tax liability. Lower property taxes leave more rent available to pay bankers, and making interest payments tax-deductible leaves more corporate cash flow available to be paid to bondholders than to stockowners receiving dividends. Banks now receive most of the rental value of land as mortgage interest, at the expense of the tax collector, while bondholders obtain a rising share of corporate profits (or more accurately, of overall ebitda — earnings before interest, taxes, depreciation and amortization) also at the tax collector’s expense.
All this lowering of taxes on finance and real estate widens government budget deficits. If bankers can also block governments from creating public money to finance these deficits, the shortfall must be met by borrowing from private bankers — or else, taxes may be raised on labor and industry. And in due course as public debts grow too large to be paid out of shrinking tax revenue, creditors demand that governments balance their budgets by privatizing public assets and enterprises. The effect is to turn the public domain into a vast set of rent-extracting opportunities for banks to finance.
This is the kind of resource grab the IMF and World Bank imposed on Third World debtors for many decades. It is how Carlos Slim obtained Mexico’s telephone monopoly to impose exorbitant charges on business and the population at large. It can be seen most recently in the demands by the European Union, European Central Bank and IMF to force Greece and Cyprus to pay their foreign debts by selling whatever land, oil and gas rights, ports and infrastructure remain in their public domain. What is privatized will become an opportunity to extract monopoly “tollbooth” rents.
This financialization and rent extraction is quite different from what classical economists defined as “profit” made by investing in plant and equipment and employing labor to produce goods and services. The financial sector makes its gains by its privilege of credit creation to obtain interest, fees, and commissions, paid largely out of land rent and monopoly rent. All these forms of revenue are external charges on top of production costs.
The role of debt in the war against labor
As labor’s wages rose above subsistence levels a century ago, economic futurists depicted a post-industrial leisure economy. Left out of account was that the passport to middle-class status involved democratizing property ownership and education on credit, driving labor into debt to buy housing and, more recently, to get an education.
Financial exploitation of labor also occurs when corporate raiders buy out stockholders with high-interest “junk” bonds as their weapon of choice. The effect is to turn industry into a vehicle for bankers to load down with debt. Corporate raiders may pay their creditors by seizing or downgrading employee pension funds from defined benefit plans (in which workers know how much they will receive when they retire) to “defined contribution plans.” In the latter, employees only know how much is to be paid in each month, not what will be left for them after financial managers take their cut. (It’s a big cut.) Pension maneuvering becomes a tactic in class warfare when companies threaten to declare bankruptcy if employees do not renegotiate their pension rights, wage levels and working conditions downward.