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What is Political Economy of Global Finance?

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The financial crisis shows that politics and finance are connected and 'political economy' (PE) is back in focus, providing a framework for viewing finance from a political perspective. The problem is the term is hard to define as academics have used it in a variety of ways. The idea of 'political economy of finance' seems to fall at the first hurdle, but the problem can be solved by returning to the original definition of PE, which provides a unique insight into the financial crisis.

PE can mean the relationship between countries trying to attract investment and global companies. It can also mean the application of economic theory to the problems of society. These ideas are valid, but they are not true PE, not relevant to crisis and not distinct from economics. The true definition of PE comes from the work of the early economists Adam Smith, David Ricardo and Karl Marx. There are common ideas in their work, such as identifying groups or 'classes' (landowners, capitalists, workers etc.) and adopting a 'top down' holistic view. Studying the relationships between these groups, both cooperative and conflicting, was the original starting point of economics.

The first step in updating PE is identifying investors as a group which opens a new perspective as economists theorize investors as 'individual decision makers'. If investors are conceived as a group it is much easier to grasp ideas like 'Goldman Sachs rules the world' (a must see video clip). To an extent everybody is an investor through pensions, unit trusts etc., but investors are not equal as their relative importance is determined by their wealth. There are millions of retail style investors, but within this group is a core of wealthy capitalist investors, numbered in thousands not millions. 'Investors' refers to the wealthy core differentiated from retail investors by the size of the opportunities they consider, the quality of the advice they receive, the level of risk they can assume and their aims. Retail investors strive for financial security while capitalist investors pursue the pure capitalist purpose of increasing capital.

There is plenty of evidence that investors are a group. The term 'equity' indicates that investors are equal, their legal rights are identical in law, i.e., they are a group. Accounting rules are gradually being coordinated globally as investors everywhere have the same accounting needs. Corporate governance rules serve all investors, i.e., investors as a group. Investors hold diverse portfolios, including all major stocks, and consequently their portfolios are similar, so they are a group.

Managers are another key group in PE as investors delegate day to day decisions to them. PE looks at the relationship between managers and investors at a group level, whereas economists have viewed it company by company. Share prices and Earnings Per Share are reasonably reliable ways of measuring the success of managers, forming part of a system of accountability that is imposed on managers, backed up by audited annual reports, corporate governance and stock market rules. The idea of management power is partially an illusion. If a management team make good decisions, investors are happy for them to continue unfettered. When profits fall, managers feel the full glare of investors' scrutiny, and investors' power is revealed. In business schools successful managers are rightly celebrated but this gives an exaggerated view of management power. The true picture is obtained by balancing periods of business success with periods of failure and observing the ebb and flow of managerial discretion.

Workers and consumers are also groups and there is a case for thinking of the rapidly expanding financial services industry as a group. It's logical to think about the global financial system, including financial markets, instruments and institutions, as a closely interconnected group. These points produce a model of global PE as follows:

Investors

Financial Services industry

Managers

Workers

Consumers

This model highlights the global relationship between investors and others, involving both cooperation and conflict, identifying tensions in global business, and countervailing powers. To understand the conflict between investors and consumers consider a consumer on an average income. The prices charged by capitalist retailers take an increasing share of weekly pay and energy bills are a genuine source of worry. Investors need consumers to buy goods and consumers need companies to supply, this is cooperation. There is a limit to what consumers will pay in the light of the dividends that investors extract, this is conflict. This tension waxes and wanes, rising when consumer incomes are falling, or when consumers notice that price rises are correlated with rising profits.

There is also a tension between investors and managers. The tools of accountability that investors employ are imperfect and investors' propensity to allow managers discretion increases in boom time. The tension between investors and financial services similarly waxes and wanes with the economic tide and there are also tensions between investors as a group.

Regulators and politicians need to rethink global finance as a reciprocal relationship between investors and others and this will help reveal the causes of financial instability.

Dr. Aneirin Sion Owen