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Relations between Finance and the Real Economy: The South African Case

Written by Siyaduma Biniza *

A response to the question whether increased finance leads to increased real economic activity warrants a thorough understanding of the relations between finance and the real economy. Whatever argument is given as ones understanding, or qualification of, the relations of finance and the real economy determines the kind of economic reality one sees and their preferred policy stance. For instance, one could understand the relations between finance and the real economy as being best determined by market mechanisms between buyers and sellers in the financial and real economy sectors of the economy; making state interventions such as financial regulation inefficient and even undesirable. Or alternatively one might understand that the relations between finance and the real economy require intervention in order to avoid socially undesirable outcomes of markets no matter how efficient markets might be. Regardless, the spate of financial crises since the 1990s make the latter view more defensible irrespective of the ideological persuasion underpinning ones understanding of the relation between finance and the real economy. This has become a significant view due to the failure of unregulated financial markets which have led to an increase in finance without any concomitant increases in real economy activity, and in fact have even reduced real economic activity and resulted in crises in many instances. I argue that, since the relation between finance and the real economy is determined by the dominant rules of international finance and corporate governance models, more finance does not lead to more real economic activity in the South African case and instead more finance has resulted in less real economic activity; because the relation between finance and the real economy is characteristic of financialisation due to neoliberal rules governing international finance and shareholder-value-type corporate governance. But, this is not necessarily the case unless domestic rules of international finance embrace neoliberalism as evidenced by some countries that do not share the same relation between finance and the real economy. Therefore this paper begins with a brief discussion about what determines the relations between finance and the real economy. Then the paper gives an in-depth analysis of financialisation of the relation between finance and the real economy in South African before concluding remarks.

By the real economy I refer to those economic sectors that are directly involved in the production of goods and services; and finance refers to the monetary reserves of accumulated capital which comes in the form of loans or financial flows. Historically firms involved in production would sometimes finance their operations through loans from banks and they would accumulate surplus profits (finance) which was reinvested in the firm in order to increase operations or improve efficiency (Hudson, 1998). This excludes firm which offer financial services because classifying operations such as intermediation and financial exchange facilitation as productive is controversial. However, this is simply a matter of convention (Christophers, 2011). From this, real economic activity is regarded as being constituted by the production of goods and services; and is characterised by the employment of individuals who are integral in producing those goods or offering those services. On the other hand finance, which is juxtaposed with production, constitutes monetary accumulation of capital and it is characterised by its importance towards real investment in the production of goods and services or its importance towards rentiertype investment. Real investment involves investing in physical capital, new hires, further research and development which all contribute towards expansion or improving the efficiency of production. Rentier-type investment involves investing in assets that do not contribute directly in production but instead influence the firms financial position. These are two common uses of finance which are often analysed with a normative preference towards real investment as opposed to rentier-type investment. The utilisation of finance towards the production of goods and services is seen as being more preferable or sustainable because of its employment of labour and the ability to create long-term profits; whereas finance that is used for rentier-type inverstments is unsustainable due to its speculative and volatile nature. However, the relation between finance and the real economy is the focus here because it sets out the uses of finance and consequently the normative perspective based on the implications for the real economy. Given the above, the traditional relation between finance and the real economy is characterised by accumulation and reinvestment. This means that firms traditionally accumulated surplus profits which were reinvested towards increasing production or improving efficiency of the firms operations (Hudson, 1998). However, this traditional relation is challenged by financialisation under contemporary capitalism.

Financialisation is a very broad concept and some of its characteristics are: The expansion of finance as a share of gross domestic production, the proliferation of financial instruments and assets, increased speculation at the expense of the real economy, the penetration of finance into new areas of the economy such as food and energy markets, the creation of a rentier class from the asymmetric gains from finance, clashes between finance and industry and associated debt-driven consumer expenditure (Mohamed, 2008; Kotz, 2010; Ashman, Fine & Newman, 2011b; McKenzie & Pons-Vignon, 2012). But I will not get into all of these characteristics of financialisation. For the purposes of this discussion, the most important characteristic of financialisation is the phenomenon where increases in financial accumulation do not result in more real investment because the additional finance is directed towards financial speculation as opposed to being invested in production. Moreover, the short-term profits of financial speculation entice productive capital to speculate with its surplus earnings instead of reinvesting it (Ashman et al., 2011b). This change did not simply occur as a result in the profitmaximisation matrix of firms decision-making. Instead this is the result of changes in the environmental constraints as embodied by economic policies governing the rules of domestic and international finance; as well as the behavioural constraints as embodied by the corporate governance of firms. Economic policies governing the rules of domestic and international finance are important in defining the relation between finance and the real economy. This is because the policies define what and how finance can be utilised which determines the relation between finance and the real economy, thus determining the structure of accumulation. For example, the policies of international financial institutions such as the International Monetary Fund (IMF), which promoted the deregulation of trade and finance, were forcibly imposed on debtor nations which determined the economic reality in those countries to a large extent (Hudson, 1998). Domestic examples of this are macroeconomic policies such as the Growth, Employment and Redistribution (GEAR) which also promoted the same kind of policies within South Africa resulting in

jobless economic growth (Mohamed, 2011; Satgar, 2012). Therefore, policies are important in determining what finance is spent on and where finance can be spent, thus determining the structure of accumulation in the economy. During Apartheid, the South African economy was closed off from the rest of the world through economic sanctions and boycotting of products produced by foreign affiliates operating in South Africa. This resulted in the exclusion of South Africa from foreign finance and investment which led to the domestic-orientation of large mining firms that diversified domestically instead of specialising globally (Habbard, 2010). Therefore surplus profits of the mining firms were forced to accumulate domestically which led to conglomeration in the economy. Furthermore these conglomerates have been able to direct domestic policy-making in their favour due to their centrality in the economy (Habbard, 2010). The conglomerates successfully accomplished the neoliberalisation of South Africa which was in their favour because the conglomerates seized the opportunity to focus on shareholder value through unbundling, selling of assets, focusing on core business and exporting their capital after the removal of capital controls in South Africa (Habbard, 2010; Ashman, Fine & Newman, 2011a). The era of South African neoliberalisation began with the post-Apartheid governments adoption of the Apartheid governments debt and it was followed by the GEAR macroeconomic package which was an indigenised policy package similar to the transnational neoliberal package of the IMF (Satgar, 2012). The piecemeal removal of all capital controls was a consequence of this neoliberalisation. This allowed for unchecked extraction of capital and repatriation of profits as the evidenced by rampantly high levels of capital flight which peaked at approximately 20 per cent of gross domestic product in 2007 (Ashman et al., 2011a). Therefore the policies ushered in neoliberal rules of international finance which allowed for the extraction of capital from South Africa meaning that finance did not accumulate domestically. This has impacted the real economy because finance was no longer used towards reinvestment within South African. Furthermore, these policies have created an environment that encouraged rentier-type investment as opposed to real investment. South Africa has had to balance its rampant capital flight with increased foreign portfolio flows which are unsustainable due to their volatile and short-term nature (Ashman et al., 2011b). Also, South Africa has only been able to maintain a persistent

current account deficit through these foreign savings. This is illustrated in the graph below which illustrates an almost mirrored-trend between the financial account and the current account balance. Therefore there has been an explosive growth of finance in post-Apartheid South Africa which has been conducive towards the financialisation of the relations between finance and the real economy. Moreover, the continued growth of finance could have the impact of further financialisation which would put the economy at great economic and financial risks (McKenzie & Pons-Vignon, 2012; Mohamed, 2003). Thus the policies have created an environment that is conducive to conglomerates which have used their economic power to influence policies and thus changed the relations between finance and the real economy through the neoliberalisation. The result is that South African policies have been more conducive to financial capital, capital flight and volatile rentier-type foreign investments.
Figure 1: Current Account, Financial Account (ZAR, million)

200000 150000 100000 50000 0 2003 -50000 -100000 -150000 -200000

Source: South African Revenue Service Current Account Balance Financial Account









Moreover, the commitment to neoliberalism and global competitiveness pressures meant that many domestic firms had to restructure through right-sizing and downsizing which led to large-scale job losses (Satgar, 2012, p.47). More importantly labour-intensive import-substitution industries suffered the most whilst export-led industries failed to create jobs due to a shift towards capital-intensity in order to retain competitiveness (Satgar, 2012). The shift toward capital-intensity as a way to retain competitiveness is a suboptimal use of labour and an alternative to methods that utilise domestic exchange rates to retain competitiveness. As a counterexample, China has consistently undervalued its currency in order to compete in the global economy

and continue its labour-absorptive export-led growth path (Herr, 2009). The neoliberal policies have strengthened the economic and political clout of finance in the South Africa economy. Furthermore, although finance has contributed towards economic growth in South Africa, this growth has not created sufficient employment opportunities because of the rising dominance of financial capitalism and financialisation (Mohamed, 2011). Hence there has been a growing preoccupation with labour-absorbing growth in attempt to redirect the macroeconomic trajectory, which came as a criticism of GEARs neoliberal policies that promoted finance-led economic growth (Habbard, 2010). In addition, these domestic policy reforms have affected corporate governance through the deregulation of finance which has enabled shareholder-value-type models of corporate governance that have also contributed towards the dominance of finance capital. Corporate governance is important because the aggregate financial actions of firms also define the reality of accumulation in the economy. Firms either invest in physical capital, in favour of industrial capital, or they invest in financial speculation which favours finance capitalism. Given the importance of corporate governance, South African firms have shifted towards shareholder-value-type corporate governance which has resulted in rentier-type investment and less real economic activity. Shareholder-value-type corporate governance models are underpinned by the idea that, in order to maximise the efficiency of resource allocation in firms, the interests of managers and shareholders need to be aligned through remuneration in the form of stocks and share options (Newman, 2012). Therefore driven by the pursuit of shareholder value, many firms have focused on specialising in core business, selling off assets and shutting down operations that neither contributes to shareholder value nor form part of the core business. The pursuit of shareholder value has thus led to firms increasing their financial capital by buying back company shares in order increase stock prices, reducing real investment and industrial capital in order to distribute financial gains as dividends and acquiring of other firms that contribute towards narroweddown operations of the core business (Newman, 2012). And South African firms have increasingly pursued shareholder value which is another characteristic of South Africas financialisation.

Financialisation is not an arbitrary consequence in the South African economy because the policy environment has favoured neoliberal policies and market-orientated economics in addition to shareholder-value-type corporate governance. Government has embarked on a piecemeal removal of all regulatory restraints on international capital flows and trade; which was intended to attract foreign direct investment (Vickers, 2002). But the consequence of this has been a growth in foreign portfolio flows which are volatile and do not contribute towards employment and real gross domestic production. Moreover, this situation has allowed the uncheck repatriation of foreign capital by domestic conglomerate firms that were dismantled during the final phase of Apartheid and listed abroad as foreign firms which has enabled a change in corporate governance in favour of shareholder value (Habbard, 2010). The result of this has been an increase in finance without any concomitant increases in the real economy. Instead there has been a decrease in manufacturing and other sectors of the real economy. There has been a decline in manufacturing jobs and increases in jobs with low productivity and slow wage-growth in services such as retail, personal services, security, domestic services and office-cleaning (National Planning Commission, 2011). The steady decline in manufacturing jobs and significant dominance of jobs in the tertiary sector signifies this trend, as illustrated in the graph below.
Figure 2: Finance and Production Indicators in Post-Apartheid South Africa

350 300 250 Percentage 200 150 100

Share of Services Jobs

JSE Market Capitalisation (%GDP)

50 0

Share of Industrial Jobs Gross Capital Formation Share of Agriculture Jobs

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: World Bank Databank

We can interpret the dynamics of shareholder-value-type corporate governance and financialisation from the graph above as illustrated by the volatile market capitalisation of listed firms which has persistently been much higher than GDP. Moreover, the market capitalisation has been significantly higher than gross capital formation which has been consistently low. This illustrates the dominance of finance capitalism over industrial capitalism. These trends are characteristic of firms pursuit of shareholder value by strengthening their financial positions through rentier-type investments as opposed to real investment. Also, it is important to note the consistent decline in industrial and primary sector jobs. Therefore, the dominant rules of international finance and corporate governance have resulted in a relation between finance and the real economy that is characteristic of financialisation due to neoliberal rules of international finance and shareholder-valuedriven corporate governance. Firstly, the neoliberal economic policies governing domestic and international finance have resulted in increased volumes finance into and out of South Africa. This explosive growth in finance was not only characterised by a general growth in finance but a specific kind of financial accumulation. Finance is usually separated into industrial capital and financial capital which draws on the different uses of finance discussed above. Industrial capital is characterised by its importance as an additional input to production of goods and services; meanwhile financial capital is characterised by its importance in the creation of rents (Hudson, 1998). Secondly, neoliberal policies have attracted financial capital allowing for shareholder-type corporate governance of firms and more rentier-type investments as well as the unbundling and downsizing of firms in order to maximise shareholder value. The growth of finance is therefore associated with a massive growth in financial capital hence the emergence of the concept of financialisation. But one of the key implications of this is that even though there was an exponential growth in finance this did not necessarily lead to a growth in real economic activity. Moreover, this has resulted in a reduction in real economic activity as more industrial capital became drawn towards rentier-type investment tendencies due to shareholder-type corporate governance. On the other hand, the explosive growth in finance was characterised by a general growth in the accumulation of financial capital and portfolio flows which have increased liquidity in the domestic economy leading to a significant rise in household

debts and debt-driven expenditure (Mohamed, 2011). Moreover, as McKenzie and Pons-Vignon argue, there have been financial bubbles, housing price bubbles and a persistent trade deficit as a result of increased private debt due to an increase in financial capital in the South African economy (2012). Thus, due to the policies and corporate governance structures in South Africa, the increases in finance have not led to an increase in real economic activity. Instead more finance has reduced real economic activity in many cases. This is because the policy environment and corporate governance have resulted in relations that encourage unproductive financial capital accumulation in South Africa. However, this is not necessarily true when the dominant policies are not strictly neoliberal and thus do not encourage shareholder-value-type corporate governance. As evidenced by countries such as Germany and China, which have been able to maintain sufficiently high levels of industrial capital amidst global increases in portfolio flows and the predominantly neoliberal rules of international finance, the consequence of financialisation can be avoided through domestic policies. China, in particular, has not followed the neoliberal policy prescriptions of the IMB and World Bank. Instead China has focused in stimulating industrial capital by restraining capital in order to support its export-led model of growth (Herr, 2009). Thus financialisation is not an inevitable consequence of domestic and global changes; instead it is an outcome that is encouraged by neoliberalism. But financialisation is not just an outcome of neoliberalism (Kotz, 2010). Financialisation is closely associated with central processes within capitalism which have led to corporate capitalism, where the control of capital and productive inputs is controlled by corporations as opposed to being directly controlled by rentiers and individual (Kotz, 2010). In this process, individuals have indirect control over corporations through shares and stocks as opposed to direct ownership of physical and other forms of capital. This is why shareholder-value-type corporate governance has become a dominant dynamic of financialisation because the owners of corporations do not only gain benefits from ownership of physical capital but through the ownership of corporations through stocks and shares predominantly. Therefore the emphasis on redistributing gains through dividends is the culmination of this reality of contemporary capitalism because the ownership of capital does not lead to gains through the utilisation of physical capital but through financial capital as well.

Moreover, there are major short-terms gains which entice owners of capital to overemphasise the productivity of financial capital. Thus, financialisation has led to a separation between finance and the real economy (Kotz, 2010). The separation overemphasises finance and this creates a contradictory logic and zero-sum-type relation between finance and production. But this does not have to be the case unless the policies governing international finance are of a certain type and corporate governance of firms result in a specific type of relation between finance and real economy. The policies define the environment where financial decisions are made whilst corporate governance defines the behaviour of firms; and together these two important elements determine the relation between finance and the real economy. Therefore, given that neoliberal policies governing international finance and shareholder-value-type corporate governance result are closely associated with key elements of financialisation, the growth of finance does not lead to an increase in real economy activity. Thus the relation between finance and the real economy has resulted in a separation that contradicts mutual growth of finance and the real economy.


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Personal Insights and Conjectures about the Future of Financialisation Perhaps the last global financial and economic crisis is the first step towards the collapse of the US dollar as an international quasi-currency. I anticipate that this will lead to the establishment of an international currency that will be run parallel to all national currencies with the intention of harmonising or dissolving domestic currencies completely and the Euro would be able to best play this role as it offers many lessons necessary for the creation of a global currency. However, the Euro is not without problems of its own but its important to understand how the Euro is an experiment in the learning process towards the creation of a global currency. This will all be asserted as a direct consequence of financialisation and a solution in the aversion of financial crises associated which will begin as the replacement of the US dollar as the traded currency with a regional currency in order to realise the final goal of an electronically controlled and centralised currency for the whole world. Of course this does not preclude political and economic machinations and coerced integration of those nation states that do not respond to the impetus that substantiates a global currency; as evidenced by the memory of structural adjustment programmes. Yours truly,

Mr Siyaduma Biniza

*Siyaduma Biniza is currently a B.Com. (Hon) in Development Theory and Policy student at the University of the Witwatersrand, holding a B.Soc.Sci in Politics, Philosophy and Economics from the University of Cape Town.