Index of Power Update, 2018-19: China #2

[Note added 14 September 2021: An update to the Index of Power, with some improvements to data, especially that of using total foreign investment assets, not just FDI, is published here.]

 

This is an update of the statistics for my Index of Power, using data for 2018-19 and discussing what a country’s ranking reflects. The major change is that China’s rank has shifted up and it has now taken the UK’s place at number 2 in the world. The US still remains in a commanding position, well ahead of the other major countries, but its lead has shrunk in the latest reading, especially versus China. Countries in positions four to ten, when the Index was last updated in early 2018, remain in the same rank positions with the new data.

The Index highlights the dramatic inequality of power in the world. In the top group, only China, the UK, Japan, France and Germany have an index value that is more than 20% of that for the US. Only 30 countries have a total index value that is more than 2% of the US number; the world’s remaining 170 or so countries count for even less.

Index of Power

Index evolution

I first constructed this Index in early 2012 and named it an ‘Index of Imperialism’. My objective was to use readily available data to gauge different dimensions of the international status of countries. Since then, I have changed the title of the Index and also some of the components, but the underlying logic is the same.

The title was changed to the ‘Index of Power’ because this seemed a better description of what it was measuring. It didn’t make much sense to call the lower ranking countries ‘imperialist’, but only little ones, or having an implicit assumption that the higher a country’s ranking, the more imperialist it was.

I had always pointed out that any description of a country as imperialist would have to depend upon first assessing its role in the world economy. Taking Luxembourg as an example, it is only a small cog in the world system (number 24 in the new Index), but it is an integral part of the European-based imperial machine and plays a particular role within it. The Index number, nevertheless, is meant to reflect relative positions of power in the world economy.

Which brings me to which aspects of political and economic power are covered. Largely they are based on economic data, and they are also biased in favour of those measures that reflect a country’s international reach. These do not directly measure political power, but it is evident, for example, that a bigger economy will tend to have more weight in its dealings with the rest of the world than a smaller one. I would have been happy to include some more directly political components, but could think of none that seemed relevant and easily measurable for a wide range of countries. That the top fifteen countries ranked by the Index include all the permanent voting members of the UN Security Council, and also the G10 members, confirms that there is a broad correlation of the components used with real-world political power.

The five original components of my Index in 2012 were: GDP, foreign direct investment assets, military spending, the importance of a country’s currency in central bank FX reserves and a country’s ownership of the major international banks. The first three – GDP, FDI and military spending – have stayed in all the later versions. But I found much better and more representative measures for the final two components during my later investigations, including data for more countries. For these latter two, I now use the global volume of trading in particular currencies and the value of international bank loans and deposits centred in different countries.

These revised Index components were fully discussed in my 2016 book, The City, Chapter 5, ‘The World Hierarchy’, including the rationale for the particular data items used and the limitations they had. Yet, people being what they are, some writers have still managed to misinterpret what I said, so I will again review the key points below. I will also note the small amendments to how I have dealt with data for China in the latest Index values (which, however, is not the reason for China’s rise to #2), and discuss how to interpret China’s position in the world economy.

Index construction

The five components of my Index of Power are:

GDP: GDP measured in nominal US dollars, using IMF data for 2018.

FDI: The stock of foreign direct investment assets, using UNCTAD data for end-2018.

FX: The volume of global transactions in a currency, with April 2019 as the base period, using the latest BIS survey of September 2019 (euro transactions are allocated among the 19 euro members).

Banks: The outstanding international loan assets and deposit liabilities of banks in a particular country, using data from the BIS for end-2018.

Military: the military spending of countries, measured in nominal US dollars, using data from SIPRI for 2018.

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Three data components – GDP, FDI and Military – are available for most countries in the world, although the data may be a little old or not available in some cases. The two other components are available only for a smaller group of countries – 57 for FX (including all euro members) and 47 for Banks – although it is very likely that the countries left out will have minimal readings.

Each of the components is weighted equally in the Index. The country with the largest component reading gets a score of 100 for that item, and other countries get a scaled down number. So, for example, if Country A has the biggest GDP, then it is 100, and country B, with a quarter of that GDP is 25. To complete the Index, components are added up for each country then divided by 5.

If a country is the biggest in all components, its final Index number will be 100. That is almost true for the US, which has a value of 92.4, with the biggest GDP, FDI, FX and Military, but coming second to the UK as a location for Banks (rather, international banking).

Below I discuss the limitations of the available data used for the index components.

GDP

One can always doubt whether an economic statistic really does measure what it claims to measure. Nevertheless, Gross Domestic Product (GDP) has the big advantage of being an easily available item of data for almost all countries. For my current purpose, one problem with GDP is that it overstates the value of output that accrues to a particular country when it has net payments of income to foreign investors, and understates that value when the country has net income from foreign investment. For example, Ireland’s GDP is overstated in this respect, because it has to make big payments to foreign investors – more is produced in the country than ends up staying there. By contrast, Norway’s GDP underestimates how much revenue Norway receives because it gets big net payments from its foreign investments. An alternative measure, GNP, includes that difference, but is much less easily or widely available.

In any case, it is worth pointing out that GNP and GDP do not allow for the way economic data count value produced. As John Smith pointed out, these measures are better understood as measuring value appropriated by a country, rather than value created in that country.

GDP does not measure a country’s international influence directly. But a country’s ‘weight’ in the world economy is an important factor in its potential influence, and GDP is one measure of that weight. It is also better to look at nominal GDP, not on a Purchasing Power Parity basis, as a truer measure of this global weight. You cannot buy anything on the world market with PPP dollars, which do not exist.

GDP’s value as a component of a power index can be seen in another way: one can look at GDP as measuring population multiplied by GDP per head of population. This allows for the fact that in the world economy people count only insofar as they also have incomes, and how much income!

In the case of China’s GDP, the number I have used is the GDP of China itself, plus that for Hong Kong and Macau, which are counted separately in official data. Macau is a new addition compared to the last Index calculation, but this increases China’s total index number by less than 0.1.

FDI

Foreign direct investment is one measure of a country’s foreign ownership of assets, and its ability to exploit others in the world economy. However, especially given the registration of FDI in tax havens, a problem is that not all of the ultimate country owners of these assets are identified. In the case of the Republic of Ireland and the British Virgin Islands, and also for some other countries, they would score relatively highly on this index measure, but little of the FDI recorded as coming from these locations is owned by their residents.[1] Also, FDI is distinguished from portfolio investment in official data. To count as FDI, the investment has to account for more than 10% of a foreign company’s assets; otherwise it is counted as ‘portfolio’ investment.

Portfolio investment in equities and bonds is huge, but data covering it is much more patchy than for FDI, and is even less likely to identify the ultimate country-based owners. A very high proportion of portfolio investment is done through global investment funds that also make use of tax havens.

Another weakness of FDI data is that it does not include the economic privileges in economic relationships that major companies in the rich countries have with their suppliers in poor countries, or others in their ‘supply chains’, privileges backed by their states in international trade and investment deals. This omission is difficult to rectify, but the FDI numbers are one measure of a country’s international reach, and so will likely be correlated also with such privileges. I use FDI data as a rough guide to a country’s ability to exploit labour and resources in other countries. Though it has obvious flaws, I have not found any better data with a wide international scope for this purpose.

Data for China raise a problem under this heading. Some of China’s FDI is into Hong Kong, and some of Hong Kong’s is into China, so just adding up the two figures would exaggerate the international reach (outside China/HK) of the FDI for all of China. Previously, I included only China’s FDI number and left out that for Hong Kong, thinking this would give a decent estimate of the number for China as a whole. After recently finding a report on the source and destination of the FDI stock, it turns out that it did. Using figures in that report for the FDI stock at end-2018, I am confident that the latest FDI index component for China as a whole is reasonably accurate.

FX

Every three years, the Bank for International Settlements conducts a survey of the trading in foreign exchange. It is the most comprehensive account of how far a country’s currency is used in international markets, something that I think is one important reflection of that country’s international influence. As discussed in The City, Chapter 7, ‘The Imperial Web’, there are certain market privileges that accrue to a country’s companies and governments if their currency is used widely in the world.

This updated Index of Power uses the latest BIS survey published on 16 September 2019, with a base month of April 2019 for counting the volume of trading. As in previous Index calculations, the US dollar is by far the dominant currency used worldwide, being involved in 88% of all transactions in 2019. By comparison, the euro, consisting of 19 countries, is involved in just 32% of all transactions. (Note that two currencies are involved in an FX deal, so the total shares add to 200% when counting all of them) The Index weight for the euro’s FX component is allocated among all euro members according to their relative GDPs.

In the latest 2019 survey, the market share of the Chinese renminbi (CNY) has remained at 4%, the same as in 2016. It remains the 8th most traded currency, up from 17th in 2010. Given that part of China’s territory is Hong Kong, which has its own currency the Hong Kong dollar (HKD), I have had to judge how to use data on its trading. For simplicity, I have just added up the two numbers for the CNY and HKD. This boosts the China ranking, since the HKD’s share of currency trading rose from 2% in 2016 to 4% in 2019. But this does little to exaggerate the figure for China as a whole. Not all CNY or HKD currency trading is in the CNY versus the HKD, and the FX component has only a small impact on China’s overall index number when divided by five.

Banks

International bank lending and borrowing based in a particular country is another measure of a country’s importance in the financial sphere. It does not include other bank activities, or the operations of other financial institutions, but the scale of such borrowing and lending is a reasonable proxy for a country’s international financial status. That conclusion would have to be questioned when a country is the base for large-scale international banking activity that is operated almost exclusively by foreign banks, since, usually for tax reasons, the country is favoured as a financial dealing hub.[2]

As noted before, this is the only index component in which the US falls short of the top position, coming in second behind the UK. That may well change in future with the impact of Brexit, if/when it goes ahead, on reducing the operations of banks based in the UK, especially with regard to the rest of Europe, an important part of their business. But it was true at the end of 2018. While banking activity in the US is much bigger than elsewhere, a large portion of it is oriented towards the domestic US economy, so does not count in this index calculation.

The China-Hong Kong relationship emerges again in how to deal with the data for international banking. Hong Kong has a slightly bigger international banking sector than China, having initially been developed as a regional commercial and finance hub for British imperialism well before the growth of mainland China’s banking business. I do not have enough information to judge how much of their ‘international’ dealing is between each other and how much is with external countries, and have taken the simple approach of using an average of the index score for China and Hong Kong as an estimate of the external number for China as a whole.[3]

Military

Big spending on the military does not necessarily mean that a country has military clout and an ability to intimidate other countries, but it usually does. Despite the record of exorbitant cost overruns in military projects, ships crashing into each other and missiles or missile defence systems that don’t work, the scale of such spending is a measure of military power, the most explicit political component of my Index of Power.

As before, the US is by far the biggest spender. China comes second, but with less than 40% of the US number. The only other countries with even around 10% of the US number are France, Russia, Saudi Arabia and India. On the latest SIPRI numbers, the UK was at 7.7%.

One might well argue that China can buy more firepower with $1bn than the US, given cheaper costs and probably less scope for armaments producers to milk the taxpayer. Also, while China is likely to be behind the US in overall technological capability, this may not be true in all areas. Many of the US advances could prove to be unworkable, or be as effective as the Boeing software ‘upgrade’ to its 737 Max jets.

US military power is also boosted beyond its own huge spending by how it encourages other capitalist countries to join in and follow its strategic aims, in particular with NATO. This acquiescence adds to the influence it can project by the large number of military bases it has all over the world,

China: Duck theory versus historical materialism

With China at number 2 in my global power ranking, the question arises as to whether it should be considered an imperialist country. My view is that it should not. Nevertheless, this is a big topic that I will deal with only summarily here, noting what should be taken into account when deciding how to characterise China.

Firstly, it is not so much the actions of a country that should define it as the dynamic of the economy and society that produces such actions. In turn, this will also depend upon the international situation and a country’s position in it as much as on the internal political system. The term ‘imperialist’ should apply only to those capitalist countries with a dominant position in the world that are, directly or indirectly, part of the system of oppression, control and violence that acts to keep that system in place.

China is not a fully-fledged capitalist country with politicians and companies joining in the carve up of the world. Its newly minted billionaires do not have free rein to do more or less what they like within China, and even its privileged bureaucrats could find themselves jailed, or dead, if they step too far out of line with what the ruling party thinks is best for the country.

Critics of China would seem to be able to point to many things to justify calling it imperialist. For example, there is China’s political oppression of the 11 million population of the Uighur ethnic group in its Xinjiang region; China’s many deals for raw material supplies from Latin America and Africa; big loans to corrupt politicians for infrastructure projects that might later be paid off by being switched into Chinese ownership of ports, etc; its attempt to control territorial waters in the South China Sea, including creating a number of islands, and its growing volume of foreign investment.

But this is only a ‘duck theory’, pointing to similar things that the classic imperialist countries have done, or are still doing, to conclude that China is the same as them. In some respects, China may ‘look like a duck’, ‘swim like a duck’, etc, but that does not mean it has duck DNA. In other words, the dynamic of China’s economic and political system is not that of an imperialist power.

Above all, the imperialist dynamic is based upon a country trying to boost capitalist profitability and being in a position to do so, especially through the control of foreign markets and areas of investment. By contrast, China’s policy since the founding of the People’s Republic in 1949 has been largely defensive, trying to develop without being dismembered by the major powers, as it had been throughout the previous century. Its objective is to find a means of surviving in a hostile world economy run by the major capitalist countries.

Initially, this had disastrous results, as with the ‘Great Leap Forward’ in 1958-62 and millions of deaths by famine. By the 1970s, however, China began a cautious engagement with the world economy. It aimed to limit the impact of market forces in special economic zones, restricted the influence and property rights of foreign businesses, held back the formation of a domestic capitalist class and tried to build the foundations of an industrial economy through state spending and investment plans. Despite many negatives, including lots of pollution and wasted resources, this proved to be successful. It brought hundreds of millions of people out of grinding poverty and ended up with China as a major producer, one that has even begun to be successful in areas of modern technology, such as 5G mobile communications – much to the alarm of the US!

This striking record does not endorse China’s often repressive, and sometimes politically stupid, government policies. But it should serve at least as a counter-weight to the critiques of rich country, liberal democracy enthusiasts who are so eager to find fault with China, but who pay little or no attention to the depredations of their own governments, and all too often act to echo the anxiety of their own ruling elites that China has out-competed them.

Conclusion

The Index of Power is a summary way of representing each country’s importance in the world economy and can be used to track changes in status over time. For the top 20 countries there had previously been minor changes in ranking. This time around, the major changes concern the advance of China and the slipping back of the UK. Such a development counts for more than it might at first appear to do, because it reflects the diminished influence of the Anglo-American system.

Both changes in status were fairly predictable, with economic growth and investment boosting China’s, while Brexit turmoil has helped lower the UK’s rank. That has not made it any easier for the US. While the US index value remains way ahead of all the others, it has shrunk in absolute terms, and particularly in relative terms with respect to China.

This move, under way for a number of years, has been reflected in an increasingly aggressive policy of the US government towards China. The US does not only have multiple military bases surrounding China, in Okinawa, Japan, South Korea and elsewhere (China has none around the US), it has also stepped up its more specifically economic offensive. A key US target here is China’s flagship telecoms and electronics company, Huawei, and its 5G technology, the latter an area in which US companies are well behind the competition. The US uses its influence over allies and other subordinates to encourage them to boycott Huawei on laughable security grounds.

China is also a problem for the US in other respects. For example, it has recently offered Iran, a longstanding bête noire of American imperialism, huge investments worth several hundred billions of dollars, in contradiction to US edicts. By incorporating Iran into its mega development project, the Belt and Road Initiative, China is not only ignoring US sanctions, it will also be dealing with Iran in non-US dollar currencies. This puts a further squeeze on US global influence and is another threat to its formerly unrivalled hegemony.

Tony Norfield, 17 September 2019

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[1] For this reason, Ireland is excluded from the graph shown of the top index countries. It would have come in at number 17. Among others, a number of US corporations have done ‘tax inversions’ to incorporate in Ireland and so reduce their tax bills.

[2] The Cayman Islands stand out here, and this territory has also been excluded from the Index of Power graph shown above.

[3] What to do with Macao, a special administrative region of China, is another conundrum, although a small one. I have excluded its data from the bank index calculation for China, although these are part of the BIS country report on banks’ foreign assets and liabilities. Were Macao properly included this would boost China’s total index number a little.

Finance, Imperialism and Profits

Last Friday I took part in a panel to launch a new book, World in Crisis: A Global Analysis of Marx’s Law of Profitability, published by Haymarket Books, edited by Michael Roberts and Guglielmo Carchedi. The presentation was at this year’s Historical Materialism conference in London.

My presentation was on ‘Finance, Imperialism and Profits’, in which I stressed the need to develop Marx’s theory in order to explain the world today. I argued that an accurate measure of a rate of profit (in Marx’s sense) could not be gleaned from official statistics and that, among other things, this was because of the nature of the imperialist world economy. Also I noted that for some adherents of Marx’s ‘falling rate of profit’ theory, this theory was somehow consistent with their calls to nationalise banks and regulate finance. This expunges the revolutionary content of Marxist theory, shows a naïve faith in the capitalist state and makes concessions to nationalism.

This was a lot to cover in the twenty minutes available, so could only be done in summary form in the presentation (see below), but there was more time in the Q&A.


Tony Norfield, 12 November 2018

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Brexit & the City of London

Brexit is a big economic and political mess for British imperialism. It also undermines some of the previous plans to boost the City of London’s operations, especially in deals with China. The City will not collapse. But it will lose business as other European Union countries are already aiming to divide up the soon to-be-deceased member’s estate while the body is still stumbling around.

A large proportion of City financial dealing is with the rest of Europe, although London has been pre-eminent because of its worldwide links – including with offshore financial centres, many of which sing God Save the Queen as their national anthem. These European ties formerly helped underpin the City’s growth, but have since been a factor in decline, even before the Brexit vote in June 2016. So problems for British-based finance due to Brexit now add to those resulting from a drop in European economic strength.

Shift in economic power from Europe to Asia

IMF data show that the European Union’s share of world GDP fell from 25 per cent to 22 per cent from 2011 to 2016, a sharp fall in just five years. This was offset by a higher share for the US, and especially so for China, based on their faster growth. Weak economies, massive debts and bad loans also undermined Europe’s banks and led to a cut in their dealing operations – most of which are in London.

A good example of the impact is seen from the global foreign exchange market, which reflects the cross-border deals in the currencies used for investment in bonds, equities and real estate, and the buying and selling of goods and services. From 2013 to 2016, the size of the foreign exchange market had declined for the first time in more than a decade, based on low world growth and problems in banks. The UK’s share of the foreign exchange market fell from 41 per cent in 2013 to 37 per cent in 2016. Although the City still remained by far the world’s biggest FX dealing centre, and the US in second place had a much lower 19 per cent, the US share rose a bit, helped by the better position of its banks.

By contrast, Asian financial trading centres were the clear winners. Singapore’s share of trading rose from 5.7 per cent to 7.9 per cent from 2013 to 2016. Taken together, China’s and Hong Kong’s rose from 4.8 per cent to 7.8 per cent. Though still a small share, this is an astonishing result for China, one backed by the near-doubling in the use of the renminbi in global FX dealing to 4 per cent. This made the renminbi the eighth largest trading currency in 2016, just behind the far more established Canadian dollar and the Swiss franc. Meanwhile, the euro, now the currency of nineteen countries, saw its share slip to the lowest since its inception.

UK politicians: dumber than you might think

The City had a falling share of a falling market even before Brexit,[1] but now faces the prospect of Brexit. A key problem it faces is how far will UK-based financial companies be able to conduct business with the European Union once the UK leaves. Implausible as it may seem, despite UK governments having promoted the financial sector for more than three decades, there is no sign that the current UK government has given this much attention.

Under the Labour governments from 1997-2010, there was also a clear pro-finance policy. This was seen as one of the few competitive UK ‘industries’, one that also provided lots of tax revenues to fund public spending, from income taxes on the high paying jobs and the various duties imposed. Finance supported millions of jobs related to trading in foreign exchange and all kinds of financial securities and insurance services. It also provided international revenues that covered nearly half of the UK’s record-breaking trade deficit in goods that in 2016 amounted to 7% of GDP. Even non-financial UK business services, from accountancy to information technology, are very closely tied into the financial sector, and offset another chunk of the trade deficit. Basically, without the City’s financial business, UK living standards would be lower.

In more recent years, the UK political class has had trouble maintaining support from a disgruntled electorate. Voters worried about pressure on living standards focused on immigration from the EU, so this has led the two main parties, Conservative and Labour, to accept the referendum vote and reject EU membership. They obviously want free access for all UK business to the EU market, but this is not possible under EU treaties for a non-member, unless, at a minimum, that country also accepts the free movement of labour, ie no restrictions on migration from the EU. UK politicians can grandstand as much as they like, declaring what they want from a deal, but the end result will come from a negotiation

With the UK a member of the EU, City-based financial firms can freely do business across the rest of the EU single market, due to so-called ‘passporting’. This means that banks or other financial institutions in the UK can sell their services in all other EU countries, as these are considered part of the same market. Without the ‘passport’, or something very similar when the UK leaves the EU, that ability will either cease or become much more restricted.

More than 5,000 UK-based firms rely on these passport agreements, and some 8,000 European companies also need them to offer services in the UK. So there may be some compromise. But it is in the interests of the remaining EU-27 countries not to make this a favourable one for the UK, or else the longstanding European Union project would risk being unravelled as others considered the exit too.

How to get a piece of the financial action?

Whatever the wider economic and political issues for the UK and the rest of Europe, the UK’s financial business is an area coveted by some of the major EU players. Already, many UK and international banks and other financial institutions have said that they plan to relocate some business into the EU-27. So far it is only on a small scale, and as a precaution so as not to be left high and dry if there are barriers to their UK-based operations doing business in the EU. If it becomes clear that full access to EU financial markets will be difficult, more will follow.

The likely outcome is a piecemeal lopping off of some parts of City business into several other EU locations rather than into one new rival centre. Frankfurt, home of the European Central Bank, is one of the favoured alternatives, but there is also Dublin, Paris, Amsterdam, Luxembourg and others, depending upon where a financial company might already have some existing business.

Ironically, Frankfurt, the main financial centre for Europe’s largest economy, Germany, is a rather provincial town, not particularly attractive to financiers, and is based in country whose politicians have shown little orientation to finance. They have instead been able to benefit from the prowess of German engineering business and have had other ways of promoting German capitalists on their minds.

I do not think that the Brexit effect by itself is likely to add up to a dramatic reduction in the City’s operations. London has built up a series of reinforcing advantages that are difficult to replicate elsewhere, as shown by the several directions in which alternatives are sought. For now, at least, London has very many more international connections than rival financial centres, plus a broad range of financial services and personnel skills that other centres lack. English is the main business language and English commercial law is the foundation for many financial contracts, for example interest rate swaps, the largest traded financial derivatives contract.

The commercial law issue is more important than one might think. Lawyers based in other countries, or sent from the UK, might be trained in the relevant aspects of English commercial law, but legal judgements are based on court decisions. Being part of the relevant legal network is important. It would also take a long time before contracts are changed into another legal system, and that system may not have the specific aspects necessary that have been developed over decades within the UK legal set up.

Furthermore, most other possible centres have also had governments that have been advocates of a financial transactions tax. This will not help them make a convincing case for expanding their role as a financial business centre. Nevertheless, the incompetence of the present British government could make them question favouring London.

What next for the City?

Despite the impact of Brexit and the recent decline in the growth of financial dealing, it will not be easy to dislodge the City of London from its pre-eminent position. London will almost certainly lose business to other financial centres, but it is costly for banks to move even some operations from London to the rest of Europe, estimated at anything from $30-$50bn.[2]

As these decisions play themselves out, British financial elites are planning to secure for the London Stock Exchange the flotation of Saudi Aramco’s shares. This state-owned Saudi Arabian oil company is the world’s largest and the deal would produce big revenues for the exchange and banks handling it. Around five percent of the company might be on sale, but even this is expected to raise some $100bn.

Only a major stock exchange could handle such a large deal. But although New York is the biggest, and Trump’s pro-Saudi politics are supportive, US financial regulations could be a barrier since the Saudis do not like giving much information. London is more lax on that score and has also changed its rules to help its bid for the deal. Furthermore, there could be US legal claims against the Saudis regarding the 9/11 attacks that would impact Saudi Aramco, and this kind of trouble looks more likely to occur in a US court than any such thing in British courts.

One deal, no matter how big, would not point to sunlit uplands ahead for British finance. But the outcome for Saudi Aramco’s deal will be an interesting signal of how far a Brexit-hobbled City can have a future outside the European club. It would also indicate how far Britain’s status as a key player in world politics has been damaged, since the Saudi decision will certainly have that in mind.

Tony Norfield, 1 August 2017

Notes:

A fuller discussion of City finances in relation to British imperialism, plus Brexit and Trump is available in the paperback edition of my book, The City, available from these sources.

For a brief article on this blog covering the background to the City’s business relating to British imperialism, see here.

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[1] The Bank for International Settlements surveys from which this information is taken are conducted in April of the relevant years, so in 2016 it was before the June Brexit vote. Similarly, the UK’s share of the trade in financial derivatives fell back between 2013 and 2016, based largely upon a drop in the volume of dealing in euros.

[2] See this Bloomberg story: https://www.bloomberg.com/news/articles/2017-07-31/banks-may-be-hit-with-50-billion-capital-needs-after-brexit

Financial Claims on the World Economy

François Chesnais, Finance Capital Today: Corporations and Banks in the Lasting Global Slump, Brill, Leiden, 2016

This book is well worth reading. It is written in a clear and accessible style and discusses key points about the limitations of capitalism and the role of contemporary finance. Perhaps its most important point is how the financial system has accumulated vast claims on the current and future output of the world economy – in the form of interest payments on loans and bonds, dividend payments on equities, etc. These claims have outgrown the ability of the capitalist system to meet them, but government policy has so far managed to prevent a collapse of financial markets with zero interest rate policies, quantitative easing, huge deficits in government spending over taxation, and so forth. The result is an unresolved crisis, a ‘lasting global slump’, in which economic growth remains very weak and vast debts remain in place.

There are two related points in his approach to the world economy and finance that distinguish Chesnais from many other writers, and for which he deserves to be commended. Firstly, he states clearly that we are in a crisis of capitalism tout court (pp1-2), not a crisis of ‘financialised’ capitalism – the latter being one that could presumably be fixed if only the evil financiers were dealt with by a (capitalist) reforming government. Secondly, he takes ‘the world economy as the point of departure’ for his analysis, although that is ‘easier said than done’ (p11). While he shows the central role of the US, he avoids the wholly US-centred analysis common to radical critics of contemporary capitalism, and instead highlights how the other powers also play a key part in the imperial machine.

Finance Capital Today helps the reader’s understanding of the realities of contemporary global capitalism by providing a wealth of material evidence. It also helps one to clarify views about what is going on by discussing the theoretical context. In this review I will highlight the key points raised in the book and also discuss where I have a number of differences with Chesnais. These differences are sometimes merely of emphasis, or what may look like simply an alternative definition of a commonly used term. However, poor formulation of an argument can also lead to theoretical problems.

Chesnais begins by outlining the origins of the 2008 crisis, arguing that this had been postponed since 1998 by the growth of debt in the US and elsewhere, and by the surge of growth in China. In 2008, ‘the brutality of financial crisis was accounted for by the amount of fictitious capital accumulated and the degree of vulnerability of the credit system following securitisation’. The backdrop to the latest phase of crisis was also one that has made this crisis a global one to a degree unknown to previous crises (p25). It involved a far more integrated world economy, following the break up of the USSR and the incorporation of many more countries into the world trade and financial system. The crisis is one characterised by ‘over-accumulation of capital in the double form of productive capacity leading to overproduction and of a “plethora of capital” in the form of aspiring interest-bearing and fictitious capital’. But major governments tried to prevent the crisis from running its course in the way that occurred in the 1930s (p35).

Within the global set up, Chesnais has an interesting view of China, which he characterises as not suffering national domination by the major powers (p43). He notes its subordinate position in the world division of labour, having offered its cheap labour workforce up to the world market, but includes this as part of the development of the world market rather than being a sign of its oppression in the Leninist sense. This reflects the mixed dimensions of China’s economic and political status, and one that I would also characterise as being in transition to the premier league of major powers (China is actually number three in my ranking of countries by global power).[1]

Chapter 3 is titled ‘The Notion of Interest-Bearing Capital in the Setting of the Present Centralisation and Concentration of Capital’. This is an important topic, but one in which Chesnais’s commendable approach is let down by his exposition. He starts by arguing that ‘the channelling of surplus value in contemporary capitalism, through both the holding of government loans and the possession of stock, by a single small group of highly concentrated financial and non-financial corporations and private high-income-bracket asset holders, requires that several features of interest-bearing capital that were treated partly separately by Marx now be approached in toto’ (p67). I would certainly agree with this, especially since the relevant section in Capital, Volume 3, is a complete mess, one that Engels found extremely difficult to edit and to try and salvage. However, Chesnais does little to develop the argument at this point, and he tends to keep it focused on banks. Only later in the book does he explain better how interest-bearing capital is a more universal phenomenon for modern capitalism. Even then, I would argue that the forms it takes, especially in proprietary trading, are not fully or well explained by taking interest to be the source of revenue, or, as he notes from Hilferding, by taking one speculator’s gain as a loss to another speculator.[2]

This chapter also contains a discussion of two issues of Marxist theory on finance. One is the difference of opinion between myself (and others) and Costas Lapavitsas on the question of banks ‘exploiting’ workers through the charging of interest on loans, etc (pp76-77). He correctly notes that this interest is, in any event, only a small portion of bank profits, not the big event claimed by the ‘exploiting’ school. However, citing Rosa Luxemburg, he comes down on the side of the view that these deductions are a reduction of the value of labour-power. I disagree, and not only because Luxemburg’s judgements in matters of economic theory, let alone political strategy, leave very much to be desired. My argument, which Chesnais cites, is that the charging of interest does not by itself suggest a lowering of the value of labour-power. If this interest deduction became a significant part of workers’ incomes, then wages would tend to rise to offset this, making it effectively a deduction from corporate profits. This is not to exclude that the value of labour-power can be forced down, but it is in the febrile imagination of the anti-finance populists that this process results from banks charging workers interest on loans.

A second issue of theory raised in Chapter 3 is on the question of bank lending. In contrast to many other Marxists, Chesnais recognises that banks can themselves create new deposit assets. However, he confusingly calls these ‘fictitious capital’ (p84). This is a relatively common perspective, as seen also in David Harvey’s The Limits to Capital, but it is not consistent with Marx’s definition. A bank loan can be created out of thin air by a bank, and is not dependent upon a ‘real’ deposit of cash, so in that sense it is indeed fictitious. But it should then simply be called a ‘fictitious’ deposit or asset of the bank. Fictitious capital, by contrast, can most easily be described as a financial security that is traded in the market and which has a price that is a function of interest rates and future expectations of returns to the buyer of that security.[3] That is not true of bank deposit or loan assets, which remain on the bank’s books. Only if the loan assets later became securitised – that is, when the loans are the basis for payments made to owners of a tradeable security – would they become fictitious capital This was the gist of Marx’s definition of fictitious capital, although one that was not clearly spelled out in Capital (and neither was his view of bank loans/deposits). To call bank loans or deposits ‘fictitious capital’ can only lead to confusion when analysing developments in contemporary financial markets.

Chapter 4 is my favourite of the whole book. Titled ‘The Organisational Embodiments of Finance Capital and the Intra-Corporate Division of Surplus Value’, it does not bend to media demands for a snappy one-liner, but it does provide the reader with valuable information and analysis. Chesnais discusses the different forms of the evolution of capitalism in today’s major powers, focusing on Germany, the US, the UK and France. He examines the relations between the state, private corporations, banks and imperial power. While noting the importance of pension funds from the 1990s as major equity owners of big corporations, he argues that ‘rather than bankers, it is industrialists with financial connections that form the core of the European corporate community’ (p108). Despite some views that there is an ‘international’ capitalist class, his view, with which I agree, is that the main groups of ‘finance capitalists’ are domiciled within single countries.

One important point he makes, and one that he could have developed more, is how in contemporary capitalism, by contrast to the views of Marx and Hilferding, merchant capital (essentially commercial capital and finance) is not subordinate to industry, although it is dependent upon industrial profit, (p113). However, he does discuss the role of large commodity traders and retailers. In my view, this reflects the way in which the major powers have used the financial/commercial system to consolidate their economic privileges, something that was true for the UK even from the mid-late nineteenth century. Today, as most people should be aware, it is the poorer, subordinated countries that do most of the producing, at least in the non-monopolised fields of production.

In Chapters 5 and 6, Chesnais covers global oligopolies and the operations of international companies. He reviews theories of monopolisation and how the development of the European single market was favourable both for European and for US corporations. There is some overlap in this material with that covered by John Smith’s book, Imperialism in the Twenty-First Century (Monthly Review, 2016), with a predatory appropriation of value by the ‘buyer-driven global commodity chains’ of the major corporations (p161). However, Chesnais disagrees with Smith’s earlier work on a number of points, and argues that China, India and Brazil are not in the classical position of being oppressed countries, having a different, and higher, status in the world market. On a separate, important point regarding data on the global economy, Chesnais notes UNCTAD’s estimate that about 80% of global trade is linked to the international production networks of international companies, and that it would be wrong to focus on foreign direct investment data as giving a complete picture of international investment. This is due both to the blurring of lines between FDI and portfolio investment and to the importance of offshore centres as the apparent location of the headquarters of many companies.

Chapter 7 discusses the globalisation of financial markets and new forms of fictitious capital. This is a useful review of the growth of financial markets, although it relies very much on secondary sources, so the data is already several years out of date, and his coverage of financial derivatives misleadingly characterises them as being ‘claims on claims’, when derivatives are better described as difference contracts based on the price of the underlying security to which they refer. The fundamental point he makes is nevertheless that the apparent diversion of investment to financial markets has been prompted by the decline in profitable investment opportunities (p174). The chapter concludes with a review of financial and (foreign) debt developments in Ecuador, Brazil, Argentina and South Africa, including the role of ‘vulture funds’ dealing in Argentina’s defaulted debt.

Chapters 8 and 9 discuss contemporary developments in financial markets, focusing on banking and credit. This is well-covered ground, but is useful for those who are less familiar with recent history, and especially so in explaining the development of mortgage-backed securities, ‘universal banks’ in Europe, the monopolisation of banking, shadow banking, etc. There is also a discussion of how ‘leverage’ – ie borrowing to fund the growth of assets – rose to extreme levels due to the decline in profitability among financial companies (pp221-). I would note, however, the publisher’s poor proofreading: ‘over-the-counter’ (OTC) securities dealing is described as ‘off the counter’ in Chapter 7 and here has the designation ‘ODT’.[4]

Chapter 10 highlights ‘global endemic financial instability’ and points out that there is a ‘plethora of capital in the form of money capital centralised in mutual funds and hedge funds, bent on valorisation through the holding and trading of fictitious capital in the form of assets more and more distant from the processes of surplus value production. Financial profits are harder and harder to earn’ (p245). I would go further and also note how asset managers, pension funds and insurance companies – far more important investors in financial markets than hedge funds or mutual funds – are now finding their mountain of assets unable to generate the returns they have, implicitly or explicitly, promised, although Chesnais does mention this later in the chapter.

The ‘plethora of capital in the form of money capital’ is related to the declining profitability of capitalist investment. Chesnais notes how official reports, from the Bank for International Settlements, for example, allude to this problem, but also how they also mix in a description of low productivity growth and low economic growth in general. He correctly makes the point that the fall in interest rates long preceded the ‘quantitative easing’ policies that occurred after 2008.[5]

It is difficult to spell out these relationships empirically, given the available data, and Chesnais does not try to do this. It is also important to distinguish the rate of interest from the rate of profit on capital investment, which are two different things. However, I would suggest a measurement of how much global financial assets have accumulated – meaning principally equities, bonds and bank loans – against some measure of absolute global profitability over time. This would measure how far the financial claims on social resources have grown, in the form of interest and dividend payments, compared to the surplus revenues available to pay off these claims. My initial work on this suggests a decline in the rate of return from 2007 to 2014, whatever the more distorted profitability figures available for the US alone might say, data that are often used by people wanting a ready calculation of the ‘rate of profit’. The rate of return I suggest is not a ‘Marxist rate of profit’, as traditionally understood, but it would better reflect the malaise of the global capitalist system, especially from the perspective of the major claimants upon its resources, the ones based in the rich powers!

Chesnais finishes his book with two themes. One is a lament on the lack of Marxist study in universities and the lack of journals in which Marxist studies of capitalism can be published. This is true enough, and I am glad not to have been an undergraduate university student in the past few decades! Even apparently radical journals such as the UK’s Cambridge Journal of Economics are basically rather conservative in outlook, and are dominated by a facile Keynesian approach that dismisses a Marxist perspective out of hand if it upsets their advocacy of ‘progressive’ policies for the capitalist state to consider. Repeating radical consensus nonsense will get a pass; revealing the imperial mechanism of power has to jump a hundred hurdles to be an acceptable journal article. Such is the almost universal climate in academia today, despite the evidently destructive outcomes from the system they claim to be analysing.[6] Ironically, this is why the most trenchant and incisive critiques of capitalism today – at least from a descriptive point of view – often come from analysts working in the financial markets. They have to tell their clients what is really going on!

Friends have suggested to me that the situation for critical academics is even worse in the US, something I find easy to believe. I have some knowledge of, and better hope for, the development of a more critical intellectual climate coming from outside the Anglosphere. This should not be too difficult to achieve.

The second concluding remark by Chesnais is the question of how a new phase of capital accumulation might emerge. There is the plethora of (fictitious) capital with its claims on social revenue that cannot be met, but which, on the other hand, has not been devalued in a crisis collapse, because the major governments have done their best to prevent it, fearing the consequences. Chesnais discusses technical innovation to some extent, but sees this as being overshadowed by capital’s degradation of the environment. One is left with the ‘notion of barbarism, associated with the two World Wars and the Holocaust’ (p267). That is a downbeat but telling point about the progress of opposition to imperialism today. In the main imperial countries, the answer to the question of ‘Socialism or Barbarism’ is biased in favour of the latter.

Finishing on a more general comment, my own preference is to avoid the term ‘finance capital’ completely, whereas the book is titled Finance Capital Today. The term is associated with Hilferding and used by Lenin, but the definition is too bound up with Hilferding’s notion that banks control industry. This was not a good description of the situation in the early 20th century, and is far less true today. Chesnais would accept this and instead defines ‘finance capital’ as the ‘simultaneous and intertwined concentration and centralisation of money capital, industrial capital and merchant or commercial capital as an outcome of domestic and transnational concentration through mergers and acquisitions’ (p5). He explains how the different forms of finance capital evolved in different countries, making an important distinction between the privileges of the major powers and the subordinate position of others. I would go along with this definition, but I would argue for putting fictitious capital at the centre of attention, not ‘finance capital’. This would show more clearly that what Marx called the ‘law of value’ is today mainly expressed, or at least expressed more directly, via the markets for financial securities, rather than in the markets for commodities, although the latter are of course important. A company’s ability to access funds and at what cost, via the equity market or bond market, or a government’s ability to borrow and spend, is each signalled by the markets for their securities. These markets show what is good, bad and acceptable in the imperialist world economy today.

Tony Norfield, 24 November 2016

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[1] See my book, The City: London and the Global Power of Finance, Verso, 2016, p111.

[2] The City, pp144-147.

[3] For an explanation, see The City, pp83-92.

[4] The book is expensively priced, so order it for your library! The book will be cheaper when later published in paperback, however.

[5] See the note on this blog from a Bank of England report here.

[6] It works like this. Academic journals are graded according to their supposed value, and getting an article published in a highly ranked journal is the objective of all academics. Think what you like about the journal’s real worth, these grades are important for the scores achieved by contributors in the assessment they get from their universities, and, most importantly, in the assessment of their universities for government funding purposes. Over recent decades, this has led to a small group of mainstream, conservative, uncritical journals becoming the favoured destination for research articles, which in turn means that academics orient their work to what these journals will accept. It is a machine for generating very little worth reading, and also a system for maintaining a conservative status quo. That system is further maintained by a journal editorial board and a group of ‘peer reviewers’ with the same general outlook. A similar mechanism also leads academics to have absurdly long bibliographies and excessive citations in their articles, since citing their friends will encourage the return favour, and citations are another means by which academic value is assessed.

Rate of Profit, Rate of Interest

The rate of profit and the rate of interest are at the core of capitalism’s dynamic, but there is a huge amount of confusion in what is written on these matters. This article aims to clarify some key points. I outline the relevant aspects of some theories of profit and interest, but focus on how to understand profit and interest rates from the perspective of a Marxist understanding of capitalism. Underlying these abstract concepts are the realities of class and power in the world economy.

Rate of profit calculations

Profitability is obviously important for capitalism. Paying attention to the rate of profit, not just the amount, also makes sense, since this gives the amount of profit per unit of capital advanced, and the more the better. But this simple point hides two important complications.

Firstly, the calculation must be timed. Commonly, calculations are for the rate of profit per year, so that the amount of profit in a year is measured against how much capital is advanced at any one time to achieve it. Other things equal, this also means that the shorter the time period between advancing the money capital, buying the necessary means of production, producing and then selling the commodities at a profit, the greater will be the rate of profit per year. This can make shortening the buying/selling process also appear to be a source of value and profit, not just the production process itself. A quicker method of buying/selling will speed up the circulation process for the producer, raise the amount and rate of profit per year and allow a greater profit to be shared between the producers and the commercial capitalists who are more involved in this process.

Secondly, the rate of profit will be affected by how much of the capital advanced is from the company’s owners and how much is borrowed from banks or other money capitalists providing it with extra investment funds. If we assume a given, annual rate of profit of 10% for the company, then the return on its total investment will also be 10%. But if it has borrowed half its investment funds from banks at a rate of just 5%, or issued bonds with a yield of 5%, then the rate of profit on the funds that the company’s owners have advanced will be higher. For example, for 200 invested at 10%, the annual return is 20. But if the company’s owners have invested only 100 of their own money plus an extra 100 they have borrowed, the company then gets as its profit the 20 total minus the 5 it needs to pay on its borrowings, etc. The result is that its rate of return will be higher: 15 (20 – 5) over the 100 invested, or 15%.

This extra profitability depends on the rate of interest paid on the borrowings being lower than the underlying rate of profit on the total investment. That is not always the case, but it shows how profitability calculations for capitalist owners will tend to change when borrowing funds is taken into account.

What rate?

A company’s borrowed funds raise an ambiguity, one that has not been dealt with well by Marxist theory. If the money is borrowed via bond issues or bank loans, then the payment for the borrowing falls under the heading of interest, so the previous calculation will hold. But if the extra funds come from new money advanced by money capitalists buying any new equity the company issues on the stock market, then how should these extra funds be treated and what is the form taken by the deduction from profits?

If the money capitalists have put their funds into the company’s new equity issue, or even just bought previously issued equity from others, then they own part of the company, just as much as the original owners. To that extent, they will receive a share of the profits in the form of dividends on the equity they own, just like the others. However, there are some distinctions to take into account.

As newer entrants, unless the new equity buyers become big shareholders, they will have fewer claims on the company’s resources through the large salaries they might otherwise get by becoming executives and directors, with special bonuses or other payments. Small-scale equity owners also have little voting power in company decisions, and some of the equity sold and bought may even be devoid of voting rights on these decisions. Insofar as they are in this latter camp, the equity dividends for them are not so different from the interest payments on the company’s bond or bank loan borrowings. But they are still in a different economic situation from bond holders or bank lenders. They benefit from any rise in the price of the equity, and may suffer a loss from a collapse of equity prices. They have none of the usual debt holder or bank lender protection of being first in line for payments, if the company gets in trouble, and their dividends might be zero or very high, while interest and coupon payments are determined at a market level or fixed in advance.

Aside from any possible director benefits, the return on equity for the companies’ owners can be taken to be not only the dividends paid on the value of the equities purchased, but also on the change in the price of the equity itself. So, holding a company’s equity that pays zero dividends may be better than holding one with high dividends, if its equity price has risen far enough above the investor’s purchase price. For example, buying shares in a company at 100 and receiving no dividend for two years will be disappointing for money capitalists. But the outcome will nevertheless look attractive if the company’s share price rises to 150 over those two years, because a large capital gain has been made.

This is accentuated further by the way in which all equity prices (and, indeed, bond prices) tend to rise as interest rates fall, and vice versa, due to the lower, or higher, rates of discount on future earnings by money capitalists. Such calculations show how far capitalist views on what it a profitable investment can become divorced from a measure of the company’s actual return on capital or its underlying profitability.

Company reports usually standardise data with annual rates of profit, and also distinguish the profit due to shareholders after interest on borrowings and other special factors. These commonly lead to different rankings of companies, not necessarily only by their reported profits, but also, especially in recent decades, by the volatility of the returns they get. Extra borrowing usually leads to extra volatility of returns. These are other factors that influence the choices made by money capitalists, and thus the allocation of capital, but they do nothing to change the actual profits produced.

Rate of interest

At first sight, the rate of interest is more easily observable than the rate of profit on industrial or commercial investment. After all, the central bank’s key interest rates are published daily or intra-day, as are the yields on 3-month Treasury bills, 5-year or 10-year government bonds or rated corporate bonds. Nothing similar really happens for measures of company rates of profit. While there are many rates of interest – interbank borrowing rates, government Treasury bill or bond yields, corporate bond yields, borrowing rates for consumer loans or mortgages, etc – they are publicly observable in ways that a rate of profit on corporate investments is not.

How is this problem of many rates of interest dealt with in economic theory? Mostly, not at all. Instead, a sacred ‘rate of interest’ is often used in mainstream economic theory, with few, or no questions asked as to what kind of interest rate is meant. Financial theory may, for practical calculations, distinguish a corporate bond yield or government-borrowing yield, in order to determine the relevant price of a financial security, but there will be no serious investigation as to why this is at a particular level and not at any other. Instead, tautological assessments of ‘risk’ are offered, which make the banal observation that a more risky investment will probably have to offer a higher interest yield. But this does little to get around the problem that much mainstream financial theory, especially for financial derivatives, is based on the idea of there being, at bottom, a ‘risk-free’ interest rate, one that exhibits a zero, or negligible credit risk of not getting repaid by the borrower.

What rate is ‘risk free’? Usually this is assumed to be a government security yield, ignoring the inconvenient fact that governments have also been known not to repay in full. In the case of the US government’s security yields, the nec plus ultra of ‘risk free’ in financial theory, it is conveniently ignored that on several occasions the US government has run close defaulting on its debt repayments, owing to political turmoil in Congress. How far government yields can be seen as objective arbiters of the rate on ‘risk free’ debt is also questioned by a significant bias lower for this rate, especially in financial markets dominated by the major powers. Structural demand for the key government securities, from the domestic banking system, from international investor demand for the global currency security, and sometimes from their taxation policies (for example, exempting capital gains from tax), produces lower yields than would otherwise be the case.

The upshot is that ‘the’ rate of interest is as nebulous as ‘the’ rate of profit. Both sets of rates are determined in a chaotic capitalist market. Are there any laws determining these?

Relationships between interest and profit rates

A common view in mainstream economic theory is that the rate of profit and the rate of interest are either the same, or tend to equality over time. The logic is straightforward, but this logic also highlights the deficiencies of the argument. It is an example of the errors that arise when a focus on appearances is allowed to obscure the underlying processes of the capitalist economy. This happens when the social content of the relationship is ignored, with little attention paid to what the terms in an equation actually mean.

To illustrate this point, and even to make a mild concession to the argument, cast aside the messy reality that there are many rates of profit and many rates of interest, determined by all kinds of market pressures. Instead, assume that there is, in fact, one capitalist market rate of profit (r), available to industrial and commercial capitalists, and one market rate of interest (i) available to those putting funds into banks, buying bonds, etc. The basic case made by modern economics is that there is a tendency for r to equal i.

The rationale for this view is usually given from the perspective of the money capitalist. Let us call him (it is rarely her) Moneybags, and imagine him just sitting there with $1m in cash to play with. So what does Moneybags do with the cash when viewing the opportunities available?

            if i > r, just lend money in the market rather than invest directly in production

            if i < r, then invest in production rather than lend on the money markets

The actions of Moneybags supposedly tend to equalise the two rates, by investing or lending. How? The logic is rarely spelled out, but the mechanism assumed is as follows. If the rate of interest is above the rate of profit, the effect of offering more funds into the money market will tend to depress the rate of interest on loans towards the (lower) rate of profit. Alternatively, if Moneybags invested more in the higher rate of profit available on capitalist production, then that would tend to decrease the rate of profit on that activity towards the (lower) rate of interest on loans. Abracadabra, in a free market the rate of interest will therefore tend to equality with the rate of profit!

There is so much wrong with this argument, despite it often being taken as self-evident, or at least plausible. The problems can be seen in several steps.

Investment and ‘interest’

A money capitalist investor with funds of M can put them into a bank deposit, equity or bond investment, try to start up a business, or invest in someone else’s business. Assuming the investor is attracted by the relative yields, then this looks like a mechanism for equalising r and i, and the previous argument would hold.

However, that assumes there are diminishing returns on the M invested in industry and commerce, or in ‘financial’ ways, so that the flow of M into the different applications of funds will equalise the returns on the funds in each case. Rates of return may not initially move lower when M is applied a number of times to a particular type of investment, but eventually the extra supply of commodities produced, or of funds into an investment area, should presumably lower prices and reduce the rate of profit and also, in the alternate case, the interest return. Yet this seemingly valid logic ignores the nature of the investment that produces the return.

In one case, it is an advance of M to invest in means of production and labour-power to get a surplus value that results in a corresponding rate of profit. In the other case, it is an advance of M on the money markets, into bonds, etc, to get back a value of M plus interest. In the first case, the M may be advanced to expand the circuit of production. This could even raise the rate of profit if it boosted the productivity of a company versus its competitors, although, taken for the economy as a whole and over a period of time, probably not. The real problem for this proposed mechanism occurs for the advance of M for the ‘financial’ investment.

Moneybags wants to get back the invested funds, M, plus interest. But is Moneybags literally a bag of money hovering in the air, having no costs of investment that need to be deducted from the interest received? Also, what if Moneybags also borrows money from others to help fund the investment? Then the net investment return will depend on the difference between the borrowing and lending interest rates, as well as the deduction of his relevant costs. This means that the ‘rate of interest’, seen as a return on money capital advanced, is not as straightforward for Moneybags as the economists’ assertion of the letter i for interest would suggest.

Neither is the ‘r’ for the profit rate unambiguous. Industrial and commercial companies will borrow funds for investment as well as using their own funds. This means that their net profit is reduced by their interest payments; to give what Marx called the ‘profit of enterprise’. This latter profit is best measured over the money advanced by the industrial and commercial capitalists to get their ‘rate of profit’, but that will generally be a different number from the rate of return on the investment as a whole, as explained earlier.

The industrial and commercial capitalists will tend to borrow more, the lower is the rate of interest on borrowing versus the going rate of profit. They might also stop any extra borrowing when the rate of interest rises to equal the rate of profit that extra investment funds could generate. Yet, while that looks like a possible market mechanism for tending to equalise the rate of interest and the rate of profit, it is at best only a partial one. For example, companies would not borrow indefinitely with a lower rate of interest than the rate of profit. To do so would greatly increase their ‘leverage’ and expose them to the risk of having to service debt and pay interest even if the conditions of profitable production deteriorate. For such reasons, stockmarket investors usually frown upon highly leveraged companies.

In addition, there is the point, explained in my book, The City,[1] that the ‘profit rate’ of financial firms, such as banks who can create their own financial assets, or who depend upon attracting funds from other money capitalists and savers, such as asset managers, cannot sensibly be compared with the profit rate of industrial and commercial corporations advancing capital for their business. It is not comparing like with like.

Conclusions

In Marxist theory, there is no law determining the rate of interest, while profits are determined by the surplus value extracted from productive workers. That profit is measured over the capital invested, to determine a rate of profit for the system as a whole, and the profit remaining to the productive capitalists is determined after paying the amount of interest. [2] The only barrier to the rate of interest is that it cannot be sustained at a level that eats up all the profit of productive capital. In recent years, ‘real’ rates of interest have been negative (when compared to inflation levels), and have even been negative for some rates in nominal terms, but no statistician has so far claimed that corporate profitability has become close to zero or negative for the economy as a whole. This gives empirical support to the argument in this article that there is no equalisation of the rate of interest and rate of profit.

Developments in capitalist society mean that the 19th century picture of the industrial capitalist versus the money capitalist and, correspondingly, the rate of profit versus the rate of interest have taken on a new form today. While it is possible to identify capitalist entrepreneurs who have founded companies, from James Dyson (vacuum cleaners) to Mark Zuckerberg (Facebook), most of these have also evolved into being financial entrepreneurs, using borrowings from capital markets and financial operations to boost their market status and power. It is commonly the case that ‘entrepreneurs’ these days cannot readily be separated from ‘financiers’, given their often multiple shareholdings and other financial interests; still less can the initial investors in their projects from the financial elite be considered under the same heading as Marx’s industrial capitalists.

So there is not any longer, even if there once was in Marx’s time, a distinct class of ‘money capitalists’ versus the rest of the capitalist class. Individual capitalists will often have a portfolio of more important and less important holdings in companies, ones they pay more attention to and others, ones that are industrial, commercial or financial, together with the additional assets they hold in the form of government and corporate bonds, money market securities, bank deposits and so forth.

The activities of asset managers, insurance companies and pension funds complicate the situation further. In the rich countries, where financial operations are more prevalent, a significant proportion of the population indirectly owns a large share of corporate equity. No individual among these feels in control. Rightly so, since their monthly payments or accumulated savings are used to boost the corporate elite. But they nevertheless also benefit from and have a stake in the fortunes of the capitalist corporations in which they have invested. This has an impact on the politics of the populations concerned. But I do not cite this as the only political problem faced, since in the richer, imperialist societies the poorest will also commonly be among the most aggressive supporters of their state’s power.

Tony Norfield, 26 August 2016

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[1] See here.

[2] Even this simple summary ignores the question of rent on land ownership, dealt with in the latter parts of Volume 3 of Capital. In this article, I do not cover the separate question of the tendency of the rate of profit to fall. My book, The City, discusses how measures of the rate of profit are impacted by financial developments, state intervention and, especially, by the position of a country in the world economic system.