Joseph Mariathasan: Finance, Society and Sustainability
Nick Silver, in his recently released book Finance, Society and Sustainability, argues that the financial framework behind the Anglo-Saxon economies of the US and the UK in particular is the construct of flawed economic theories which purport to efficiently allocate society’s capital.
Instead, says Silver, the finance sector allocates savings and investments to maximise its own revenues, with a resulting collateral damage to the economy, society and the environment.
John Kay led a review of the UK equity markets and long-term decision making, published in 2012. One conclusion was that UK equity markets were no longer a significant source of funding for new investment by UK companies.
Silver argues that this means asset managers who dominate the market are not actually doing the job they are supposed to be doing – yet the people who work in this field are highly paid not to do their job. His book then attempts to explain how this has happened.
Much of Silver’s book is a description of the UK’s financial system covering equity and bond markets, the major institutional investor bases of pension funds and insurance companies, and the role of intermediaries in the form of banks and asset managers. He argues that, ultimately, savings are not being channelled by companies into productive investments, while banks are channelling their loans predominantly into property, giving rise to property bubbles in the UK.
The price of all financial assets has been boosted by a steady decline in interest rates, while the price of individual companies’ shares has been boosted by share buy-backs, reduced investment and reduced staff costs.
The financial framework is, as Silver describes, based around a few key theories, namely: the Capital Asset Pricing Model, which postulates relationships between risk and return; the Efficient Market Hypothesis, which argues that securities are usually fairly priced reflecting information available; and the Black-Scholes option pricing model, the most widely used general model for pricing options.
But, says Silver, the financial system operates on a set of norms which equate all human values with financial value, and measures value as the market price. This is proving catastrophic for the economy, society and the planet.
Financiers, says Silver, work in “Potemkin markets”, where every aspect is dominated by government. Financial markets are largely the creation of governments, they fulfil certain services for governments and they run in a way specified by governments.
The problem is that, while governments encourage people to save for a pension to reduce the fiscal burden arising from an ageing population, it is not working because they have only managed to persuade the rich people to save – the very section of society who would not be a burden when they retire as they can afford to look after themselves.
This, says Silver, is the result of the savings glut caused by governments encouraging people to save in combination with the actions of central banks in trying to repair the damage caused by the same savings being mismanaged. Interest rates have been driven to close to zero, making pensions unaffordable. Given the high charges of the finance industry, Silver argues that it is people who do not save for a pension who are the sensible ones.
Silver’s key argument is that the current financial system is a by-product of financial intermediaries allocating capital to maximise their own revenues, with no guarantee that this will be in the best interests of society or the economy – in fact, it is likely that it will not be.
Silver certainly raises many issues which should be debated more widely and are at the heart of many government policies. The problem with his book, however, is that the final chapters suggesting ways forward appear to be a random collection of ideas. They range through Scandinavian-style pension models, introducing a financial transaction tax or Tobin tax, finding alternatives to fractional reserve banking, better accounting of externalities, and ideas such as impact investing.
I am reminded of Winston Churchill’s assertion that “democracy is the worst form of government, except all those others that have been tried”. Silver has certainly pointed out very many valid flaws in the Anglo-Saxon financial framework which need to be addressed. But he has not come out with a coherent description of anything better.