This is the English version of an article originally published by La Repubblica on August 8, 2016.
There is serious concern about Italy’s banks and whether the bad debt they are carrying signals trouble for the Eurozone. In facing up to its troubled financial system Italy’s political leaders could also benefit from a moment of reflection on what the role of finance could, and should, be in a dynamic and functioning economic system. As finance is central to the capitalist system, the lessons for Italy’s financial system are broader than the role of its banks. I will concentrate on 5 key points.
First, money is not just a medium of exchange, replacing barter and then gold. Money lies at the centre of the economic system which is, as understood especially by the great economist Hyman Minsky, based on debt. It is through debt creation (as long as it is backed and guaranteed by a higher authority, historically government) that money is endogenously created. Thus the characteristics of debt—who lends to who and how—are central to understanding the characteristics of the modern capitalist economy.
Second, finance should, in an ideal world, be creating debt in order to finance growth of activity in the real economy. Instead, what has happened since the 1970s de-regulation of global finance, has been that finance has, over time, been increasingly financing…finance. That is, it has been financing itself. Indeed, in most of the western world, the growth of financial intermediation as a percentage of gross value added, has over the last two decades outpaced the growth of the real economy. That is until the bubble burst in 2007. Finding ways to redirect finance towards productive activity in the real economy is thus crucial.
Third, in Italy, the effect of financialization has been made even worse by the presence of entrenched interests and “clientelismo” governing Italy’s economic system. Projects receiving loans are often not judged objectively, with criteria that are based on viable potential returns and the productive nature of an investment. Rather, they are often judged by clientilistic and nepotistic relations – as was made evident with the bank Monte Paschi di Siena (although this is really just the tip of the iceberg). Indeed, lets remember that the term “clientelismo” comes from the Latin clientes which means not modern day clients, but parasites feeding on presents (regalias) from the rich and powerful who, as described by the latin writer Giovenale, every day would visit their patronus for the morning salutatio. Italy’s sick banks are thus both a cause and a symptom of its never ending clientalist culture.
Fourth, when growth is low—as it has been in Italy for the last two decades where both GDP and productivity have hardly grown at all—the above dynamic by which finance finances itself (or lends based on dodgy criteria in the real economy) becomes even worse. If finance has fewer good opportunities for investment in good companies and good projects in the real economy, then finding those opportunities in the speculative world of finance becomes even more appetizing. Indeed, research conducted in a large EC project on finance and innovation I coordinated some years ago showed that in many countries the problem is often not one of the supply of finance for firms, but the lack of good firms demanding finance. For example, most small medium enterprises that are innovative and productive, DO find the finance that they require. There are simply too few of those types of companies. Why? High growth innovative firms tend to prosper more in countries with dynamic innovation eco-systems, with strong links between science and industry, with high public investment in education and vocational training, high private spending on training programs for workers, strong R&D, and patient strategic long-term finance. When these are lacking growth will not follow – no matter how much emphasis a government puts on reducing red tape, or making labor markets less rigid (e.g. the Jobs Act). And when the real economy does not grow, finance becomes a betting casino.
Fifth, it is essential that emphasis be put not on the quantity of finance, but on its quality. The term credit crunch is misleading. There has never been a lack of credit; but there has been bad credit. What companies need to become productive and grow is patient, strategic, long-term, committed finance. Historically, early stage high-risk finance has mainly come from different forms of public finance, which have later crowded in private finance such as venture capital. In Israel, through a public venture capital fund called Yozma. In Germany through the public bank KfW. In Finland through public investment agencies like Sitra. In the USA through innovation agencies like DARPA but also through the Small Business Innovation Research program that through procurement creates a market for the most innovative small companies. Italy lacks all of this. It does not have a serious innovation agency. And Italy’s public bank Cassa Depositi e Prestiti (CDP) has not proved to be an investment bank of the sort that exists in China, Germany or even Brazil. The CDP is, in the end, just a lender and investor of last resort, saving companies that are in trouble, and subsidizing investments that are not happening in the private sector. This emphasis on subsidizing, rather than the provision of high risk investment, has increased the inertia of the system, rather than wakened it up from its dozing. The role of public policy should be to create additionality: making things happen that would not happen anyway. Its role should not be to fund an inertial (or clientilistic) private sector, and/or to invest in areas that the private sector should but doesn’t due to its inertia. By acting as an investor of first resort, different forms of public finance can crowd in the private sector, waking up business animal spirits.
If we analyse how debt in Italy works—who lends to whom and how—we can better understand what some of Italy’s key problems are and what solutions still need to be found. Finance must be redirected towards viable productive projects in the real economy, rather than self-serving clientilistc relations within finance and in industry. The problem is not the supply of finance, but its demand. To create that demand, a stronger innovation eco-system is required. Central to that system is the provision of long-term, strategic finance to high growth companies so that Italy’s small companies can grow instead of remaining small and unproductive. Policy should create additionality, crowding in the private sector to do its job of investing in new opportunities—rather than complaining about government bureaucracies and red tape with one hand, and continuously asking for handouts with another.
A new book I have co-edited with Michael Jacobs, Rethinking Capitalism: Economics and Policy for Sustainable and Inclusive Growth, addresses many of these issues in more depth, with contributions from Joseph Stiglitz, Andy Haldane, Stephanie Kelton, Randy Wray and me among others. It’s out now.