The topic of greening the economic and financial system is broad and daunting. However breaking it down into a few key questions can highlight the steps that we as Greens must urgently take to reign in the financial industry.

What is “the economy” for?

– Allocating natural, human and financial resources to the production of goods and services that improve human well-being in a sustainable way.

What is “the financial system” for?

– Transporting financial resources through space and time in a way that efficiently and sustainably supports the objectives of the economy.

Hopefully people of all political persuasions will agree (at least in public) that the ultimate aim of the economy is to benefit society.

The main source of disagreement is whether the objective of profit maximisation should be the principle determining the design of the economy (with ex-post redistributive taxation taking care of the social and environmental objectives) or whether social and environmental objectives should actually be built into the design of the economy.

This is where a Green world view can claim the intellectual (as well as moral) high ground: it holds that a poorly designed economy can actually be an obstacle to achieving essential social and environmental objectives as well as create extra economic costs.

What we have now is an economy that is blind to the social utility of what it produces and that, due to the resultant misallocation of environmental, human and financial resources, provokes unrest, creates social hardship and generates huge “externalities” that deplete the very social and environmental capital upon which it depends.

This article sets out some of the most important flaws in the current design and measures that can be taken to correct them.

Austerity continues to cause real hardship and is damaging social cohesion as well as future productivity; many EU democracies are still subordinated to the wishes of “the market”

Why should Greens be as militant about changing the economy and the financial system as they are about the environment and social justice?

– Because that system is the main obstacle to implementing Green environmental and social policy.

  • Oh yes! The Crisis continues – Austerity continues to cause real hardship and is damaging social cohesion as well as future productivity; many EU democracies are still subordinated to the wishes of “the market”, EU banks have not been cleaned up (hundreds of billions in subsidies and public bail outs so far [ref ECB], and more on the horizon in the wake of the ECB’s review of banks next year), corporate and household debt is still huge in the EU (average = 200% of GDP), with productive investment and innovation smothered as SMEs in many countries struggle just to pay the interest.
  • This crisis is NOT new or different – There have been hundreds of monetary, sovereign debt and banking crises in the world over the last 4 decades [see  “This Time its Different” by Reinhart & Rogoff]. If you had a car that broke down days after you had it repaired, wouldn’t you question its design rather than your luck?
  • The “economic Taliban” are the mainstream politicians who lack the intelligence or courage to question economic ideas that are hundreds of years old (and originated as frameworks to help monarchs finance expansionist wars and colonialism – not to help democratic societies finance innovation and the production of goods and services that promote human well-being [see “The Cash Nexus” by Ferguson]).
  • Greens already have “ownership” of a key concept: sustainability (Lietaer et al, provide a useful definition: the “optimal balance between (long-term) resilience and efficiency” [see Money and Sustainability“, 2012] – this concept can and should be applied, not just to ecosystems, energy use, social structures etc., but also to the economy.
  • Greens must be vocal on the economy and finance – not only the current crisis but also the mainstream conception of the economy and finance is one of the major obstacles to implementing a Green policy framework because:
    a) Greens are being perceived as having concrete proposals about it, and,
    b) the current economy is incompatible with Green environmental and social policy objectives.

What’s wrong with the economic and financial system we have?

– It is inherently unstable and inefficient at allocating natural, human and financial resources towards production that enhances human quality of life.

  • The role of the public economy is underestimated: when “the economy” is discussed in the mainstream, the term is virtually synonymous with the “(free) market economy”, in which the profits accrue to private producers. The notion that some production should be controlled by Government or civil society or even the consumers of the products (e.g. cooperatives and mutuals) is considered naive, especially since it is often compared to the disastrous Soviet model. The market economy is good for certain kinds of optimisation, but the public economy plays a very important role, particularly with respect to innovation and strategic investment.
  • Market economies are not efficient, even in their own terms: it is naive to believe that markets are efficient, even if the only efficiency you consider important is measured in terms of profit. Markets are blamed for both “irrational exuberance” and “irrational discounting”. When markets will not provide capital to banks, they are deemed totally irrational and governments have to take action to avoid austerity for the banks. When the same markets, at the same time, demand austerity from governments, this, however, is deemed perfectly rational and Governments have to take action. This is all the more ironic when one considers that the two biggest global economic crises in the last 100 years were delivered by the “hidden hand” of the markets, not the public sector.
  • Efficiency is more than profit maximisation: the mainstream mantra is to “maximise economic efficiency (= profits) first, then to use the wealth generated to fund social (and maybe even environmental) objectives later”. A Green response is to “set the social and environmental objectives first, then ensure that the economy is as efficient as possible under those constraints”. Anything else is neither efficient nor resilient.
  • Market economies are blind to “social utility”: this leads to an allocation of scarce environmental, human, financial and physical capital resources that is blind to social utility. Indeed, it often leads to forms of resource distribution that generate huge social and environmental costs. Taxing profits to repair the damage caused by the way the profits were achieved is hardly efficient and, furthermore, such attempts to internalise the social and environmental costs are usually met with huge resistance from business, finance and, more importantly, politicians with a vision that does not extend further than the next election.
  • Market economies are poor at radical innovation: a further market failure is the lack of innovation. Markets are set up to be good at finding innovative ways of lowering the cost of production (including wages) and increasing the price that consumers are willing to pay (marketing) for things that already exist. However, as the usually pro-market Economist pointed out (12/1/2013) in a memorable cover story, the most useful innovation the market has produced in living memory may well have been… the flushing toilet. Radical innovation tends to best fostered most effectively in universities or through government funded programs (including, unfortunately, military ones).
  • Globalisation spreads losses as well as profits: a major source of the instability of market economies is that all transactions pass through a monolithic medium of exchange: conventional “money”. This means that all products can be substituted for each other from an investors point of view. Those with surplus money can, directly or through financial intermediaries, equally invest in all products and will do so on the basis of what generates the most profit. Via the “pockets” of these investors, not only profits but also losses in a market for one kind of product are transmitted to other kinds of product. This means that markets become more interdependent and hence less resilient to shock. The more global the reach of investors, the more global this vulnerability. The consequence is that late payments on mortgages in Los Angeles can lead to a potter losing her job in Lubjanka.
  • “Sovereign debt”: contrary to the popular view, it is private banks that create money (when they make loans). Since they do this for profit, they have an incentive to oversupply, which leads to bubbles. When these burst, markets fail and governments must borrow from the markets, including banks, to save the markets. The latter then tell governments to cut spending, raise taxes and sell off public assets to pay the interest and the principal, which leads to a further transfer of wealth to the markets (i.e. a further transfer of political power), further weakening public control over markets and so on. Debt is definitely sovereign.
  • “Money for nothing”: even worse, when there is nowhere to invest the bank-created money in the real economy, this does not necessarily result in the tap being turned off: banks and other financial intermediaries can create ex nihil not just the money itself but also things to spend it on. A bet is a classic example: it can be created by mere agreement. Nothing has to be produced at all, other than a contract. This parallel casino economy is not constrained by the physical limits to which the real economy is subject. There is, in principle, no limit to how much money can be passed around in complex circles of bets in the virtual economy which can therefore, in “money” terms, dwarf the real economy. But, of course, losses in the virtual economy, which can also be unlimited, can flow at the speed of light into the real economy to which it is linked through the use of the same medium of exchange, resulting in the kind of disastrous circumstances that we have experienced over the last five years.
  • Markets foster short-termism: where all products of the economy are treated as investment opportunities, money becomes impatient. This is made worse by the inherent instability of markets leading to boom and bust cycles. Investors are impatient to cash in on profits during booms and unwilling to ride out the busts. While everyone seems to admire Warren Buffet-style investors who analyse an investment target deeply and then invest for 10 years or more, such investors are extremely rare. The speculation mentioned above further encourages the view of markets as a form of lottery where an understanding of the fundamentals of what you are investing in is unimportant and the focus is on “beating the odds” with fancy, but flawed, mathematical models. Similarly, policymakers tend to focus on the next election and are therefore unlikely to provide a counterweight

So what kind of an economy do Greens propose, and what route can they suggest to get from here to there?

–  The key is to “plant” a diversity of economic tools for various tasks alongside the old oak of orthodoxy and to remove the stifling weeds in the overgrown financial sector. These tools should promote long-term resilience and efficiency over short-term profit maximisation, diminishing the role of the outdated economic model without requiring it to be felled overnight.

Boost public sector involvement in strategic innovation: renewable energy, energy efficiency, efficient transport and communications, preventative healthcare are all essential medium- to long-term goals for human well-being. “NASA-style” public programs should be established and funded, combining public, academic and (carefully circumscribed) private resources to achieve set objectives.

Promote a nested economy: provide incentives for economies that match supply and demand locally first, with any imbalances being met at the next level up until (where necessary) the global level. This leads to a more resilient economy, less subject to the political risks and supply chain issues inherent in a model in which all supply and demand is met at the global level under the sole constraint of profit maximisation.

Promote alternative currencies: over one hundred schemes based on a medium of exchange that can be used to match supply and demand in related goods and services exist. They serve not only to promote the kind of nested economy described above, but can also have features such as a negative interest rate which provide disincentives to the accumulation of such money for its own sake, thus encouraging its circulation and the production of the goods and services to which it relates.

Ensure financial services serve the real economy, not the other way round.

Significantly reduce the role of debt: public, private and financial entities already owe more debt than can possibly be repaid. Public policy should aim to reduce the overall level of debt. One strategy is to enforce the write down of debt in a “jubilee”, another strategy proposed by enlightened economists is to use newly created public money to pay off private debt (instead of using it to prop up the price of existing debt in order to assist financial markets, as is currently being implemented on a massive scale under the name of “quantitative easing”).

Restrict the role of financial intermediation: financial intermediaries should be just that; the “plumbing” of the economy provides a “transport” service in time and space for surplus money, bringing them to the productive long-term investments where they are needed. In particular, the speculative activities encouraged by rampant “financial engineering” by banks, hedge funds, investment firms, insurance companies etc. should be severely curtailed by law. There is a role for speculation: there are situations where risk cannot be spread between actors in the real economy and speculators are able to distribute this risk amongst themselves, but the volume of speculation should be a fraction of the total volume of real economic activity, not a huge multiple as is currently the case in many markets.

Public policy should aim to reduce the overall level of debt. One strategy is to enforce the write down of debt in a “jubilee”.

Shrink the banks: “too big to fail is too big to exist”. Banks have become obese through an oversupply of loans and the over-development of speculative activities. The “plumbing” they provide to the economy is so deeply embedded in all the blubber of excessive risk-taking that governments are forced to step in to support them with the negative consequences described above. It is critical that banks be split into activities critical to the smooth functioning of the real economy (such as providing for the safekeeping of cash, liquidity management and hedging tools for households and businesses) and those that are not (such as capital market activities and proprietary trading). It is also critical that they be made smaller, less complex and less interconnected so that, if they get into trouble through poor business decisions, they can be allowed to go bust without taking the economy hostage.

Severely curtail or completely proscribe money creation by banks: When a bank makes a loan, it simultaneously creates in its accounts: an asset – the promise by the borrower to pay the loan back with interest – and a liability – the promise by the bank to pay the borrower the amount lent. The liability is a deposit and most of the money in circulation is in this form. This is what is meant by saying that banks create money out of nothing. Back in the 1930s, following the Wall Street Crash and the Great Depression it caused, it was proposed to stop this privatised money creation entirely. Banks lobbied hard against the removal of this privilege and eventually won. Instead of halting such private money creation, the Glass-Steagal act was adopted which merely separated deposit and loan activities from speculative activities.  The same debate was sparked by the current crisis, but this time policymakers should have the courage to remove money creation from the hands of private banks in the interest of economic stability. This radical but perfectly feasible change would greatly dampen boom and bust cycles, eliminate the risk of bank runs and the consequent interruption of useful banking services, eliminate the threats to democracy inherent in Governments being indebted to banks and greatly reduce the risk of over-indebtedness of the economy [see Chicago plan revisited, IMF).

Provide incentives for “patient money”: long-term equity investment is important not only to ween households and companies off debt but also to promote more stable markets. Currently, interest on loans is tax deductible in many EU Member States whereas dividends on shares are taxed. This gives precisely the opposite incentive. Reversing this incentivisation and lowering taxes on profits as a function of the duration of investment would be a very helpful step. In addition, however, in order to foster long term investment in strategic projects the public sector can attract households and companies to invest in infrastructure for renewable energy, energy efficiency, transport, communications etc. by promoting a wide range of funds with long investment horizons which are structured such that the private investors (directly or indirectly through state and occupational pension funds) take less risk for lower returns and the public sector takes more risk for higher returns.

Taming the Giant – Towards a Sustainable Financial System
Taming the Giant – Towards a Sustainable Financial System

How to create a financial system that helps, not destroys, the real economy? Seven years on from the financial crisis that heralded the great recession, this question remains unresolved.

Cookies on our website allow us to deliver better content by enhancing our understanding of what pages are visited. Data from cookies is stored anonymously and only shared with analytics partners in an anonymised form.

Find out more about our use of cookies in our privacy policy.