Economics - Innovation - Inclusive Growth - Public Purpose
De-financialising the real economy

De-financialising the real economy

FT Alphaville are continuing their Mission Finance series on the Mission-Oriented Finance for Innovation this week. Here is my second blog on why we can’t just focus on finance: we need to de-financialise the real economy.


Today our mission-oriented finance for innovation conference begins at the Houses of Parliament. Vince Cable, UK secretary of state for business, innovation and skills will be kicking off this evening arguing that a serious commitment to funding innovation means doubling innovation spend.


He hopes this will allow the UK to move from its below OECD average R&D/GDP position to an above average position, closer to that of Denmark, Germany and the US (which stand between 2.5-2.8% while the UK lags at 1.7&). ) This is encouraging news and shows that the UK is hopefully on the path towards ‘rebalancing’ away from an economy biased towards financial services, towards growth of innovation and productivity in the ‘real economy’.


In the past, I have called this a move away from finance for destructive creation towards finance for creative destruction.


The key problem that he and other international policy makers have is to make sure that such rebalancing tackles finance on two equally important sides. On the one hand, rebalancing so that finance funds the real economy. This means addressing the dire situation that figure 1 shows below, i.e. the degree to which finance has been financing itself leading to the exponential rise in the value added made up of financial intermediation, compared to that of the real economy (everything but finance and agriculture).





This graph comes from Andy Haldane’s work at the Bank of England, which stresses the need to create less speculative finance and more long-term finance. Indeed, at our event tonight Haldane will be addressing ‘the cost of short-termism’ and what to do about it.


Haldane’s keynote will occur after that of Luciano Coutinho, the President of Brazil’s state investment bank (BNDES). State investment banks such as KfW and BNDES are one of the many forms that long-term patient finance is taking around the world.


Carlota Perez, one of the world’s foremost economic historians, will be Haldane’s discussant, and will argue that long-termism needs a direction—markets alone did not get us the IT revolution, nor will they get us the ‘green growth’. Considering new indicators for economic performance, that capture the ‘directions’ objective is very difficult in a world where any role for the public sector to ‘choose’ which way to go gets branded as ‘picking winners’ or ‘crowding out’—as I argued in my first Mission Finance blog, if the point of pubic policy is to not only to fix market failures but also to create and shape markets, indicators of performance that capture this market creating role are fundamental.


There is also the need to bring top minds into government so that strategies are led by deep knowledge on both the technological side and the economic side. You can read a policy brief by Perez and me on these topics, on the conference resources page.


The second key issue that rebalancing must address is not just how to get more value added from the ‘real economy’ and less from ‘financial intermediation’ (finance financing finance), but also how to de-financialise the real economy itself!


Bill Lazonick will be addressing this issue in his intervention on day three of the conference, with an excellent FT Alphaville Mission Finance blog by him tomorrow. This problem is most evidently manifested by how much private companies are spending on ‘financialised’ practices like sharebuybacks (to boost stock prices, stock options and executive pay): Fortune 500 companies have spent $3tn over the last decade on share buybacks, with many companies in IT and pharma spending more on share buybacks than R&D.


Bill’s work has shown that this is indeed the lead factor behind the rise of executive pay—i.e. the exponential rise of the incomes of the top 1 per cent. In our recent journal article on risks and rewards we argue that this has nothing to do with skills or talent-but the power of value extraction. Our Mission-Oriented Finance for Innovation conference will be debating how to get governments and business to think big again.


Admitting that innovation has not only a ‘rate’ but also a ‘direction’ will be key to this debate. If markets cannot be trusted to alone find the right direction, how can we enable the public sector to use all its instruments (taxation, R&D spend, procurement, regulation, etc.) to enable not only more value creation but also to allow that value creation to be rewarded over value extraction?


© Mariana Mazzucato


Tags: Financialization, Industrial Policy, Mission-Oriented, Patient Finance, State Investment Banks, UK


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