The last century has arguably undergone a deep entrenchment of the world economy’s financialisaton by the servicing of its facets, ranging from debt in the form of bonds to risk options as alternatives of generating greater returns. But with this has come greater intricacies of how we view the world economy, and with it, how far it is really shaped by the apparent rise of the financial industry, especially in terms of how much it can control the anarchy and uncertainty that often comes with economics.
Contemporary economics has witnessed a growing amount of reliance on financial services in the way it utilises and facilitates capital. This becomes ever more noticeable when elucidating it through case studies, especially through the emergence of tax havens as a means of offshoring capital. Tax havens’ importance to the world economy is comprehensive when knowing that “half of the world’s stock of money either resides in tax havens or passes through them”. This fact, in the words of Palan, means tax havens “provide important legal platforms for globalizing financial and, increasingly, other types of services” across the world economy that political authorities struggle to resist.
The same can be said for loan packages being offered through new methods of securitising them, such as subprime mortgages or ‘collectivised debt obligations’ (CDOs) that were innovated by Lewis Ranieri of Salomon Brothers that later led to the mortgage crisis of 2008. The rapid rate they were issued at across the economy since their introduction in the early 1980s is staggering. The volume of GSE-backed mortgage-backed securities between 1980 and 2007 had gone from $200 million to $4 trillion, with $2 trillion’s worth of residential mortgage debt being securitised by 2007. In the words of Niall Ferguson, the introduction of CDOs was “the dawn of a new era in American finance”, and in turn, a watershed for how world economics was to be largely regulated by the forces of laissez-faire capitalism and how it was to circulate through the several options the financial industry had to offer.
The dominance of finance has therefore led many in the Marxist school of economics to assume much of the economy has become centralised into the hands of the bourgeoisie due to the system’s apparent contradictions. As Ticktin notes, the finance industry’s “export of capital to the third world, particularly China, has not compensated”, causing the world economy to become “cannibalistic and began to devour itself”, leading to its “downturn” to emerge.
Whilst there has been an apparent proliferation of the finance industry’s influence, this however does not mean that its ‘shaping’ of the world economic system extends to the point of wholly controlling it. The boom and bust cycle inherent in the world economy can be blamed on the contradictions of the capitalist system, but it can also be merely due to the lack of complete utilisation of information that even the financial services do not have the luxury of possessing. As Hayek noted on the “peculiar character of the problem of a rational economic order” that the financial industry attempts to engage with, its services struggle to comprehend or predict some detriments to the economy due to new market knowledge being “dispersed bits of incomplete and frequently contradictory knowledge which all the separate individuals possess”. Thus, when talking about how far the world economy is shaped by the financial industry, there must be the consideration of how much it ‘really’ shapes it by how much it can ‘control’ the economy when not possessing all possible resources of the knowledge economy.
This can reflect both the influence finance seeks to wield along with the failures it has made through its attempts to shape the world economy further. Ambitions in improving risk analysis and ‘hedging’ techniques is such an example. When the Black-Scholes model proposed its seemingly fault proof formula of ‘dynamic hedging’ that Long-Term Capital Management (LTCM) was to use in the 1990s, it assumed it can perfectly predict the world economy’s behaviour and its possible investment risks, essentially giving a prospect of the economy itself being fully controllable through financial services such as LTCM. The fallacy however is its misassumption to believe that such things are predictable through humans being natural rational actors. Like what Vogel stated when describing Minsky’s views on such situations, the “tumult of financial markets cannot simply be assimilated by the balancing interaction of rational actors and systemic reason”. It is no surprise therefore that LTCM was defunct within four years of existence after the 1997 Asian Crisis and its failure to predict it, the same for Lehman Brothers in 2008. Financial services cannot entirely shape the world economy when it fails to grasp knowledge that is required to efficiently control it.
In retrospect however, the frequent economic crises and their proliferating occurrences can be both blamed on the increasing role finance is playing but also by the growing intricacies that globalisation is introducing, something which the financialisaton of the economy is merely a by-product of. Referencing back to the Black-Scholes model, Taleb notes that it simply made “a well-known formula palatable to the economics establishment of the time, little else, and in fact distorting its essence”. In other words, it was merely repackaging traditional techniques of economic management into seemingly new ways of attracting investment. The same can be said for subprime mortgages as CDOs. The paradox of this is that it was increasing the role of financial institutions yet were using traditional methods that seemingly appeared new. Whilst Katzenstein and Nelson suggest using “conventions” as a way of “delineating the set of circumstances”, even this has its problems for it “cannot eliminate uncertainty”, especially when referring to Taleb’s Black Swan theory that believes the world economy is “dominated by the extreme, the unknown, and the very improbable” and its future being “increasingly less predictable”. This is an inherent trait of globalisation and one that represents both the greater role the finance industry may play in it but also confusing this role at the same time, decreasing its significance in how far it can really determine the position the world economy is in and what direction its future faces.
The contemporary world economy, therefore, whilst witnessing a significant increase in its financial services, cannot be deemed as being ‘entirely’ shaped by such services alone. To believe so is assuming that the industry can control it with omnipotence. This is impossible when considering discrepancies in information, which individual actors possess but don’t always share. Without this, the financial industry, despite its tools and power, cannot shape and control it to its maximum level.