Despite energetic conversations around stagnant wages and job creation, few consider that the financialization of America’s public corporations has contributed just as much to economic inequality as more commonly-cited factors. The debate seems well-settled: scholars point to globalization, skill-biased technical change, and the decline of union density. Others point to the “rise of the robots”, claiming that automation and technology are driving us towards a jobless future.
I define corporate financialization as the shift within public companies from making money off of selling goods and services to making a higher proportion of their profits off of financial activity—and sending those profits back to shareholders rather than investing them in the firm or its workers. Corporate America has shifted its behavior dramatically across industries—the ratio of financial profits out of overall corporate profits has increased dramatically in the last few decades, and corporations have spent trillions purchasing back their own stock simply to increase their share price since such maneuvers became legal in 1982.
Some think that America’s largest businesses function as they did in the post-World War II era: they earn profits and use those profits in part to enrich their top CEOs, but also to invest in their workforce, innovation, and in better prices for all of us. But somewhere along the way, starting in the Reagan administration, this productive cycle was broken due to government regulations and reforms in corporate governance, and corporate America started making more money off of moving money around than they did by selling us actual goods and services. The shift was led by our industrial mainstays—the paradigmatic American firm, General Electric, earned 43% of its profits in its banking arm, GE Capital, as recently as 2014.
Once corporate profit-making became dependent on super-fast computers and top executives with M.B.A.s, investing in a stable and productive workforce was no longer essential, and as a result wages and jobs declined. The last few decades have seen the rise of the fissured workplace, as firms increasingly outsource once-core functions, making jobs increasingly precarious. Firms made these choices in direct response to rising pressure from capital markets to move money out of the firm to shareholders and keep share prices steadily rising—choices that were sweetened by the fact that CEOs were increasingly paid in company stock. Before the 1970s, American corporations paid out 50% of profits to shareholders, while retaining the rest for investment. Now, shareholder payouts are over 100% of reported profits, because firms borrow in order to lift payouts even higher.
Thus, the changing nature of work—the rise of the fissured workplace and the gig economy—is driven not just by a generic drive for profit or the attributes of the “knowledge economy,” but also a structural shift within corporations from productive to financialized profit-making. The relentless search for short-term profits expresses itself through squeezing employees’ pay, transforming employees into independent contractors to avoid paying benefits or having responsibility for pensions, and outsourcing work to contracting firms that compete to pay lower and lower wages. If firms don’t count on their employees to come up with the next big productivity improvement or exciting product idea, because they make their money off of secondary market trading and collecting interest payments, there’s no reason to invest in employee longevity with the firm.
One example of rising financialization has been the dramatic increase in stock buybacks and the subsequent decrease in productive investment—buybacks being a practice that serve no productive purpose but are conducted simply to boost share price. Pressures on firms rose with the rise of “activist investors,” formerly known as corporate raiders. As institutional investors became large shareholders of major corporations, they pressured firms to maximize short-term profits to push up share prices. Since such institutional investors could move their investments around easily, firms grew more and more responsive to capital markets rather than to their customers. The rise of private equity and the increase in leveraged buyouts has led to extractive financial strategies in which firms cut jobs and reduce wages in order to extract maximum wealth for the holders of equity. Key regulatory and legislative changes allowed for this shift: In 1982, Congress passed the safe-harbor provision for buybacks, which formerly would have been considered market manipulation, and the shift to allow CEO “performance pay” to be deducted from corporate tax incentivized corporations to pay CEOs in stock.
Though the literature is still nascent, several scholars have examined the direct negative impact of corporate financialization on income inequality. One study found that financialization, net of other factors, could account for more than half of the decline in labor’s share of income in the non-financial sector of the economy and is comparable to the effect of de-unionization, globalization, and technological shifts. Others look directly at the impact of financialization on declining corporate investment, finding that the financial profit rate is correlated with a significant decline in investment, especially for large firms. Less investment can mean less to spend on improving the skills and productivity of one’s workforce.
To be sure, financialization is not the only driver of labor market challenges, but it has become increasingly impossible to think about how to solve problems in the labor market without taking on corporate financialization. It is not simply that firms want to spend less money on workers—it’s that they actually need them less, and so the incentive to invest in a high-quality workforce is much reduced. In order to have stable and productive workforces, the incentives that drive corporations to financialize must be reformed.
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