By Gilad Isaacs · 28 Mar 2014
It has become commonplace for South African policymakers, business leaders and pundits, to extoll the virtues of South Africa’s “world-class” financial system. Indeed, in post-apartheid South Africa the financial sector has grown at almost double the rate of the economy as a whole. Before we applaud such dynamism we must consider whether the greatly expanded role of finance in our economy helps or hinders our ability to tackle the enormous developmental challenges we face.
The triple crises of unemployment, poverty and inequality are perpetuated by the manner in which the economy is organised. Two key characteristics are low levels of investment – insufficient money dedicated to developing new or existing businesses – which has fallen from 27% of GDP in the 1970s and early 1980s to 17% in the democratic era, and the heavy concentration of the economy around mining, industries linked to mining, energy and finance. The “financialisation” of the post-apartheid economy has been crucial in precipitating the former and maintaining the latter.
Financialisation refers not only to the growth and proliferation of financial institutions, actors and products, but to the increased centrality of financial markets in all aspects of social, economic and political life, and the manner in which the interests of financial markets have been imposed. Today we take credit cards, pension funds and stock market updates on the hourly news for granted, we accept that a business should be judged by its share price and that governments must appease “the markets”; this was not always so.
We witness financialisation in the transformed operations of financial institutions, financial markets, non-financial corporations and households, and the relationships between these sectors. It is an international phenomenon of the last three to four decades with common global features and local specificities.
Government policy has actively promoted financialisation. In South Africa financial market liberalisation – reducing domestic regulation and international barriers to capital moving between countries – has been a cornerstone of government policy over the past two decades.
South African financial institutions have been transformed. They do not, as traditionally argued, serve primarily to pool savings and channel those towards long-term productive investment, that is investment in growing or starting factories, farms, mines, lumber mills, small businesses, transport services and the like. Rather they have increasingly engaged in short-term speculative investment and the extension of credit to households.
Domestic financial markets have also undergone transformation. The JSE has more than doubled its size relative to the total economy, and commodity, currency and derivative markets have been established and have burgeoned.
This has an impact on the “real” economy in profound ways. For example, the increased global speculation in commodity markets (essentially betting on the price of commodities such as gold, platinum and maize) means that the prices of these commodities have become separated from actual production costs and demand. This can cause instability and volatility in these markets with the potential for bubbles and crashes, and encourage firms to play the stock market (where rewards may be higher) rather than invest long term. Considering the centrality of mining in South Africa, the consequences are potentially dire.
We have also witnessed precipitous increases in capital flows between countries. Democratic South Africa has failed to attract substantial long-term foreign direct investment in new enterprises. Rather, liberalisation has induced short-term capital in and out flows, supported by high interest rates, and producing exchange rate volatility and crises (as experienced recently). In addition, liberalisation has allowed South African corporations to move funds abroad on a grand scale, both legally and illegally. All of these have severely restricted productive investment.
Institutional investors (pension funds, insurers, hedge funds and private equity) have assumed a new prominence in South African markets, with their assets quadrupling since the early 1990s and their share of ownership on the JSE doubling. Institutional investors tend to see the companies they buy as “bundles of assets” that can be bought and sold with more concern for their share price than for long-term growth prospects.
Such “short-termism” has also deeply affected non-financial corporations (NFCs) (that is, companies which are not banks and investment houses but firms involved in mining, manufacturing, construction etc.). Worldwide we have seen a prioritisation of “shareholder value”. This entails attempting to boost the share price and distributing dividends to shareholders even at the expense of long-term investment.
One way of inflating a share price is for a company to buy back their own shares, using funds that previously would have gone towards long-term investment. In 2011 the world’s 40 largest mining companies spent $26 billion on such “share buybacks”, which were legalised in South Africa in 1999. Dividends paid out by South African NFCs rose from 25% of their gross operating surplus in 1995 to a height of 45% in 2007. Anglo American, arguably South Africa’s most important company, saw a drop in profits of $6.2 billion in 2012 but still increased its dividend payout by more than 10%, and spent $10.5 billion on share buybacks over a period of four years.
The same firms have also increasingly engaged directly in financial market trading and speculation. Their holding and trading of financial assets has risen significantly, as has the portion of their income that they receive from financial market activity. In addition, the financial assets they hold, and their borrowing and lending more generally, are increasingly short-term in nature.
All of these trends have “crowded out” long-term productive investment, and it is long-term investment that is needed to grow businesses and create jobs.
South African households have also become financialised and subject to the whims, volatility and interests of financial markets.
Household debt has risen from 54% of disposable income in 1990 to 75% in 2013. This has fuelled consumption, which drove economic growth in the 2000s, but for sustainable growth you need investment, not only consumption. Between 1997 and 2008 this debt also fuelled the world’s most exuberant real estate bubble. Real estate bubbles not only pose a threat to economic stability (as the recent financial crisis in the US vividly illustrates) but also drive up land and housing prices. This makes well-located land more costly and perpetuates apartheid-era housing patterns with the poor located at the periphery of cities.
Wealthy households have also increasingly acquired financial assets, either directly or via their pension or insurance funds. This means more money at the fingertips of large investors and exposes households to financial market instability. But it also means the benefits of financial market inflation accrues to a minority of wealthier households; the richest 10% hold 85% of financial assets, making inequality in financial assets one and half times higher than income inequality - itself the highest in the world.
The consequences of all these facets of financialisation are dire.
First, financialisation channels funds into financial market speculation, increases short-termism, and prioritises shareholder value, all of which reduce productive long-term fixed investment. Without such investment the economy cannot diversify away from its reliance on minerals, energy and finance and grow in a manner that creates decent jobs. These processes also place pressure on management to cut costs which leads to retrenchments, wage reduction, a casualisation of the labour force and a lack of investment in skills training.
Second, businesses and households are increasingly exposed to the volatility and instabilities inherent in financial markets. Third, financialisation accentuates inequality through funnelling wealth into financial assets and concentrating these in the hands of a small minority.
Finally, the pervasive power of financial markets make policymakers (sometimes unwillingly, sometimes as willing accomplices) beholden to those markets. This both undermines democracy and buttresses the free-market economic policies that have so spectacularly failed to improve the lives of the vast majority of South Africans.