Fallacies of Capitalism 11: The Financialization Fallacy

The Financialization  Fallacy

Financialization refers to the increasing influence and dominance of financial markets, institutions, and activities in the economy. It involves the growing importance of financial transactions, speculation, and the pursuit of short-term profits in shaping economic decisions. While financialization has become a prominent feature of modern economies, it is considered a fallacy because it prioritizes financial activities over real productive activities, leading to detrimental effects on the economy and society. Let's explore this concept further with simple examples, quotes, and explanations:

1. Focus on short-term gains: Financialization often emphasizes short-term profits and quick returns on investments, rather than long-term productive investments. Economist John Maynard Keynes warned, "Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation." This suggests that when financial activities overshadow productive investments, it can lead to economic instability and hinder sustainable growth.

2. Financial sector dominance: Financialization can lead to an over-reliance on the financial sector for economic growth, potentially at the expense of other sectors. Economist Hyman Minsky cautioned, "In capitalist economies, the financial system is supposed to serve the needs of the real economy, not the other way around." However, when financial activities take precedence, it can create an imbalance, diverting resources away from productive sectors like manufacturing, innovation, and infrastructure development.

3. Risk and instability: Financialization often involves increased complexity and risk-taking in financial markets. Financial instruments and practices become convoluted, making it difficult to assess true risks. Nobel laureate economist Robert Shiller observed, "Financial innovation is a little like technology innovation: not all of it has value." The pursuit of financial innovation without proper regulation and oversight can lead to financial crises, as seen in the 2008 global financial crisis, when risky financial practices caused severe economic downturns.

4. Growing inequality: Financialization tends to exacerbate wealth and income inequality. Financial activities can disproportionately benefit a small segment of society, such as high-income individuals, large corporations, and financial institutions. Economist Thomas Piketty noted, "When the rate of return on capital exceeds the rate of growth of output and income, as it did in the 19th century and seems quite likely to do again in the 21st, capitalism generates arbitrary and unsustainable inequalities." The concentration of wealth in the financial sector can widen the wealth gap and hinder social mobility.

5. Neglect of real economy: Financialization can divert resources and attention away from the real economy, where goods and services are produced. Financial markets can become detached from the underlying value and productivity of the real economy. Economist Ha-Joon Chang remarked, "Financial markets, far from being simply 'efficient' mechanisms for allocating capital, are inherently unstable and crisis-prone." Neglecting the real economy in favor of speculative financial activities can lead to economic imbalances and distortions.

In conclusion, financialization as a fallacy arises when financial activities and priorities overshadow real productive activities and the long-term health of the economy. The focus on short-term gains, dominance of the financial sector, increased risk and instability, growing inequality, and neglect of the real economy are all detrimental consequences of financialization. Recognizing and addressing these issues is crucial to ensuring a more balanced and sustainable economic system that benefits society as a whole.

China's economic woes extend far beyond its stock market

Michael Boskin in The Guardian

The Chinese government’s heavy handed efforts to contain recent stock market volatility – the latest move prohibits short-selling and sales by major shareholders– have seriously damaged its credibility. But China’s policy failures should come as no surprise. Policymakers there are far from the first to mismanage financial markets, currencies, and trade. Many European governments, for example, suffered humiliating losses defending currencies that were misaligned in the early 1990s.

Still, China’s economy remains a source of significant uncertainty. Indeed, although the performance of China’s stock market and that of its real economy has not been closely correlated, a major slowdown is under way. That is a serious concern, occupying finance ministries, central banks, trading desks, and importers and exporters worldwide.

China’s government believed it could engineer a soft landing in the transition from torrid double-digit economic growth, fuelled by exports and investments, to steady and balanced growth underpinned by domestic consumption, especially of services. And, in fact, it enacted some sensible policies and reforms.

But rapid growth obscured many problems. For example, officials, seeking to secure promotions by achieving short-term economic targets, misallocated resources; basic industries such as steel and cement built up vast excess capacity; and bad loans accumulated on the balance sheets of banks and local governments.

Nowhere are the problems with this approach more apparent than in the attempt to plan urbanisation, which entailed the construction of large new cities – complete with modern infrastructure and plentiful housing – that have yet to be occupied.

In a sense, these ghost cities resemble the Russian empire’s Potemkin villages, built to create an impressive illusion for the passing Czarina; but China’s ghost cities are real and were presumably meant to do more than flatter the country’s leaders.

Now that economic growth is flagging – official statistics put the annual rate at 7%, but most observers believe the real number is closer to 5% (or even lower) – China’s governance problems are becoming impossible to ignore. Although China’s growth rate still exceeds that of all but a few economies today, the scale of the slowdown has been wrenching, with short-run dynamics similar to a swing in the U S or Germany from 2% GDP growth to a 3% contraction.

A China beset by serious economic problems is likely to experience considerable social and political instability. As the slowdown threatens to impede job creation, undermining the prospects of the millions of people moving to China’s cities each year in search of a more prosperous life, the Communist party will struggle to maintain the legitimacy of its political monopoly. (More broadly, the weight of China’s problems, together with Russia’s collapse and Venezuela’s 60% inflation, has strained the belief of some that state capitalism trumps market economies.) 

FacebookTwitterPinterest Pedestrians in Hong Kong walk past an electronic board displaying the benchmark Hang Seng index. Photograph: Philippe Lopez/AFP/Getty Images

Given China’s systemic importance to the global economy, instability there could pose major risks far beyond its borders. China is the largest foreign holder of US treasury securities, a major trade partner for the US, Europe, Latin America, and Australia, and a key facilitator of intra-Asian trade, owing partly to the scale of its processing trade.

The world has a lot at stake in China, and China’s authorities have a lot on their plate. The government must cope with the short-term effects of the slowdown while continuing to implement reforms aimed at smoothing the economy’s shift to a new growth model and expanding the role of markets. Foreign firms are seeking access to China’s rapidly growing middle class, which the McKinsey Global Institute estimates exceeds 200 million. But that implies a stable business environment, including more transparency in government approvals, and looser capital controls.

With these goals in mind, China’s government recently engineered a modest currency devaluation – about 3% so far. That is probably too small to alter the country’s trade balance with Europe or the US significantly. But it signals a shift toward a more market-oriented exchange rate. The risk on the minds of investors, managers, and government officials is that currency markets – or government-managed currencies buffeted by market forces – often develop too much momentum and overshoot fundamental values.

As China’s government uses monetary policy to try to calm markets, micro-level reforms must continue. China must deploy new technologies across industries, while improving workers’ education, training and health. Moreover, China needs to accelerate its efforts to increase domestic consumption, which, as a share of GDP, is far below that of other countries.

FacebookTwitterPinterest A bank clerk counts Chinese banknotes in Huaibei, Anhui province. The government recently engineered a modest currency devaluation. Photograph: AP

That means reducing the unprecedentedly high savings rate, a large share of which accrues to state-owned enterprises. If private firms and households are to replace government-led investment as the economy’s main drivers of growth, the state must reduce its stake in major enterprises and allow more profits to be paid directly to shareholders, while providing more of the profits from its remaining shares to citizens.

The shift away from excessive state control should also include replacing price subsidies and grants to favoured industries with targeted support for low-income workers and greater investment in human capital. In addition, China must reduce administrative discretion, introducing sensible, predictable regulation to address natural monopolies and externalities.

Back at the macro level, China needs to reallocate responsibilities and resources among the various levels of government, in order to capitalize on their comparative advantage in providing services and raising revenue. And the country must gradually reduce its total debt load, which currently exceeds 250% of GDP.

Fortunately, in facing the difficult adjustment challenges that lie ahead, China’s $3.6tn (£2.3tn) in foreign-currency reserves can serve as a buffer against unavoidable losses. But China must also avoid reverting to greater state control of the economy, a possibility glimpsed in the authorities’ ham-fisted response to the correction in equity prices. That approach needs to be abandoned before it does any more damage to China’s quest for long-term stability and prosperity.

‘Quarterly capitalism’ is short-term, myopic, greedy and dysfunctional

Will Hutton in The Guardian


It has been obvious for years that British capitalism is profoundly dysfunctional. In 1970, £10 of every £100 of profit was distributed to shareholders: today, under intense pressure from short-term owners, companies pay out £70. Investment, innovation and productivity have slumped. Few new companies grow to any significant size before they are taken over.

Exports have stagnated. The current account deficit is at record proportions. The purpose of companies now is not to do great things, solve great problems or scale up great solutions –why capitalism is potentially the best economic system – it is to become payolas for their disengaged owners and pawns in the next big deal or takeover. Not only the British economy suffers – this process has become the major driver of rising inequality, low pay and insecurity in the workplace as management teams are forced to treat workers as costly commodities rather than allies in business building.
Regular readers of this column will be familiar with the refrain, and the stubborn resistance from the British mainstream. There is absolutely nothing wrong at all with the British private sector, runs the Conservative argument: to the extent the British economy does have problems they are rooted entirely in taxation, regulation, unions and government. But in a week when the Financial Times – a great British asset and embodiment of the best of our journalism – has been sold to Nikkei for no better reason than to support Pearson’s short-term share price, powerful and public criticism of the way British capitalism operates has come from an unexpected quarter.

Last year, the governor of the Bank of England, Mark Carney, called on firms to have a greater “sense of their responsibilities for the system”, in particular the social contract on which market capitalism’s long-term dynamism depends. On Friday’s Newsnight, the chief economist of the Bank of England, Andy Haldane, built on the governor’s concerns. He began with the seven-fold increase in the proportion of profit distributed to shareholders in dividends and bought-back shares over the last 45 years, which he said necessarily “leaves less for investment”. The explanation was simple: British (and indeed American) company law “puts the shareholder at front and centre. It puts the short-term interest of shareholders in a position of primacy when it comes to running the firm.” He thought company law that placed shareholders on a more equal footing with other stakeholders – workers, customers, clients – would work better. Dare I say it – stakeholder capitalism?

He damned the way the public limited company has developed. “The public limited company model has served the world well from a growth perspective. But you can always have too much of a good thing. The nature of shareholding today is fundamentally different than what it was a generation ago. The average share was held by the average shareholder, just after the war, for around six years. Today, that average share is held by the average shareholder for less than six months. Of course, many shareholders these days are holding shares for less than a second.”

In New York, at almost exactly the same time Newsnight was transmitting its interview with Andrew Haldane, Hillary Clinton was speaking from the same script, attacking what she called “quarterly capitalism”. “American business needs to break free from the tyranny of today’s earning report so they can do what they do best: innovate, invest and build tomorrow’s prosperity,” the Democratic presidential front runner declared. “It’s time to start measuring value in terms of years – or the next decade – not just next quarter.” She does not want to reinvent the public limited company, but she proposed the most far-reaching tax reforms of any Democrat presidential nominee to change the incentives for shareholders and executives alike. In American terms this is a revolution.

It is long overdue and the argument is beginning to get traction in the US. Free-market apologists insist that the more cash is handed back to shareholders, then the more they have to invest in innovation. The stock market is doing its job: promoting efficiency. The trouble is that everyone can see it’s 100% wrong. The market is hopelessly inefficient, greedy and myopic. When Larry Page and Sergey Brin floated Google, they took care to insulate the company from “quarterly capitalism”: they accorded their shares as Google’s founders 10 times the voting rights in order to protect their capacity to innovate from the stock market – what they considered Google’s real business purpose.

From robots to self-driving cars, from virtual reality glasses to investigating artificial intelligence, Google is now one of the most innovative firms on Earth. Meanwhile the typical US Plc, like its counterpart in Britain, is hunkering down, investing and innovating ever less and distributing more cash to shareholders for the reasons Haldane explains. Far from market efficiency, the whole system is undermining the legitimacy of capitalism.

But bit by bit influential voices such as Haldane’s are having the nerve to declare the Anglo-American system does not work. A rich collection of reflections and commentary edited by Diane Carney (Mark Carney’s wife) was published after London’s Inclusive Capitalism conference last month. Yet, except for former business secretary Vince Cable, no leading British politician has entered the lists. It will be intriguing how George Osborne reacts: one instinct will be to sack Carney and Haldane, as he has done Martin Wheatley, the head of the Financial Conduct Authority, for being too tough on the City. Another will be to co-opt the argument for the one nation Tory cause before the Labour party does.

He needn’t worry too much. One of the reasons that Tony Blair dropped his advocacy for stakeholder capitalism back in 1996 after the publication of The State We’re In was because too many leftwing Labour MPs took the Jeremy Corbyn line that the party’s mission was to socialise capitalism rather than reform it, while too many rightwing Labour MPs such as Peter Mandelson and Alistair Darling were terrified of upsetting business, as today, it seems, is Liz Kendall. He had zero internal political support, business was distrustful and the Tories were accusing him of returning to 1970s corporatism. Today the Bank of England and the likely next US president are supporters. Will one of the contenders for the Labour leadership have the courage to make the case? So far, they have all been mute. If Andy Haldane has done nothing else, he will have dramatised the poverty of today’s thinking about capitalism – in both main political parties.

Saving the planet from short-termism will take man-on-the-moon commitment

JFK's lunar vision is needed if business is to see the long-term benefits of greening the economy as well as the short-term costs

President John F Kennedy's moon speech was made in an age when both sides on Capitol Hill were prepared to invest in the future. Photograph: John Rous/AP

We choose to go to the moon. So said John F Kennedy in September 1962 as he pledged a manned lunar landing by the end of the decade.

The US president knew that his country's space programme would be expensive. He knew it would have its critics, but he took the long-term view. Warming to his theme in Houston that day, JFK went on: "We choose to go to the moon in this decade and do the other things, not because they are easy but because they are hard, because that goal will serve to organise and measure the best of our energies and skills, because that challenge is one that we are willing to accept, one we are unwilling to postpone, and one which we intend to win, and the others too."

That was the world's richest country at the apogee of its power in an age where both Democrats and Republicans were prepared to invest in the future. Kennedy's predecessor, Dwight Eisenhower, took a plan for a system of interstate highways and made sure it happened.

Contrast that with today's America, which looks less like the leader of the free world than a banana republic with a reserve currency. Planning for the long term now involves last-ditch deals on Capitol Hill to ensure the federal government can remain open until January and debts can be paid at least until February.

The US is not the only country with advanced short-termism. It merely provides the most egregious example of the disease. This is a world of fast food and short attention spans, of politicians so dominated by a 24/7 news agenda that they have lost the habit of planning for the long term.

Britain provides another example of the trend. Governments of both left and right have for years put energy policy in the "too hard to think about box". They have not been able to make up their minds whether to commit to renewables as Germany has done, or to nuclear as France has done. So, the nation of Rutherford is now prepared to have a totalitarian country take a majority stake in a new generation of nuclear power stations.

Politics, technology and human nature all militate in favour of kicking the can down the road. The most severe financial and economic crisis in more than half a century has further discouraged policymakers from raising their eyes from the present to the distant horizon.

Clearly, though, the world faces long-term challenges that will only become more acute through prevarication. These include coping with a bigger and ageing global population, ensuring growth is sustainable and equitable, providing resources to pay for modern transport and energy infrastructure, and reshaping international institutions so they represent the world as it is in the early 21st century rather than as it was in 1945.

Pascal Lamy had a stab at tackling some of these difficult issues last week when he presented the findings of the Oxford Martin Commission for Future Generations, which the former World Trade Organisation chief has been chairing for the past year.

The commission's report, Now for the Long Term, looks at some "mega trends" that will shape the world in the decades to come, and lists the challenges under five headings: society, resources, health, geopolitics, governance.

Change will be difficult, the study suggests, because problems are complex, institutions are inadequate, faith in politicians is low and short-termism is well-entrenched.

It cites examples of collective success, such as the Montreal convention to prevent ozone depletion, the establishment of the Millennium Development Goals, and the G20 action to prevent the great recession of 2008-09 turning into a full-blown global slump. It also cites examples of collective failure – fish stocks depletion, the deadlocked Copenhagenclimate change summit of 2009.

The report suggests a range of long-term ideas worthy of serious consideration. It urges a coalition between the G20, 30 companies and 40 cities to lead the fight against climate change. It would like "sunset clauses" for all publicly funded international institutions to ensure they are fit for purpose; removal of perverse subsidies on hydrocarbons and agriculture with the money redirected to the poor; introduction of CyberEx, an early warning platform aimed at preventing cyber attacks; a Worldstat statistical agency to collect and ensure quality of data; and investment in the younger generation through conditional cash transfers and job guarantees.

Lamy expressed concern that the ability to address challenges was being undermined by the absence of a collective vision for society. The purpose of the report, he said, was to build "a chain from knowledge to awareness to mobilising political energy to action".

Full marks for trying, but this is easier said than done. Take trade, where Lamy has spent the past decade, first as Europe's trade commissioner then as head of the WTO, trying to piece together a new multilateral deal. This is an area in which all 150-plus WTO members agree in principle about the need for greater liberalisation but in which it has proved impossible to reach agreement in talks that started in 2001.

Nor will a shakeup of the international institutions be plain sailing. It is a given that developing countries, especially the bigger ones such as China, India and Brazil, should have a bigger say in the way the International Monetary Fund and the World Bank are run. Yet it's proved hard to persuade developed world countries to cede some of their voting rights, and the deal is still being held up by US foot dragging. These, remember, are the low-hanging fruit.

Another conclave of the global great and good is looking at what should be done in the much trickier area of climate change. The premise of the Global Commission on the Economy and Climate is that nothing will be done unless finance ministers are convinced of the need for action, especially given the damage caused by a deep recession and sluggish recovery.

Instead of preaching to the choir the plan is to show how to achieve key economic objectives – growth, investment, secure public finances, fairer distribution of income – while at the same time protecting the planet. The pitch to finance ministers will be that tackling climate change will require plenty of upfront investment that will boost growth rather than harm it.

Will this approach work? Well, maybe. But it will require business to see the long-term benefits of greening the economy as well as the short-term costs, because that would lead to the burst of technological innovation needed to accelerate progress. And it will require the same sort of commitment it took to win a world war or put a man on the moon.

An Article against MBAs

Bloodless bean-counters rule over us – where are the leaders?

The inexorable march of the managerialists is creating resentment and social division. 

Charles Moore in The Telegraph

Recently, a man got in touch with me who works for the defence services contractor QinetiQ. He wanted to complain about the way it was run. The company, in his view, suffers from “managerialism”.

Managerialists, he says, are “a group who consider themselves separate from the organisations they join”. They are not interested in the content of the work their organisation performs. They are a caste of people who think they know how to manage. They have studied “The 24-hour MBA”. There is a clear benefit from their management, for them: they arrange their own very high salaries and bonuses. Then they can leave quickly with something that looks good on the CV. The benefit to the company is less clear.

I also spoke to a former senior employee of QinetiQ. He corroborated my informant’s points with gusto. He said managerialists were particularly unsuited to industries such as QinetiQ’s, where scientific knowledge is all. He put it simply: “People who are making bits of technology, or servicing them, should know about technology.”

Skills are not infinitely transferable. “You used to be the editor of a broadsheet newspaper,” he said to me. “How do you think a former chief executive of Ford would perform if he suddenly came and edited a national title?” (or, he politely didn’t say, if the reverse were to happen).

The lack of knowledge at the top of a firm obviously creates a practical problem – “You don’t have people to get under the bonnet. They can only kick the tyres and change the oil.” They don’t understand the needs of the core customer. It also, in his view, creates a moral problem. The workers cannot respect their bosses. Management becomes “not symbiotic, but parasitic”.

I do not know whether these men are right about QinetiQ. I have no experience of the company and no technical expertise. One must also allow for the fact that, in any organisation, there are people with axes to grind. But I did find the way they talked striking. It seemed to accord with so many things I hear about life in so many organisations.

It is a big complaint, for example, about the modern National Health Service. Nowadays, on the dubious principle that all businesses and services are essentially the same, managers are a non-medical breed. The effect can be laughable. I heard of a case in which the managers told the doctors in a big hospital to save money by sending all their instruments away to a centralised off-site sterilising unit. Fine, said one mischievous consultant, but in that case may I have a second set of instruments so that I can work on my patients in emergencies? The managers, having no idea about his instruments, thought he probably could. “That’ll be £2 million then,” he said.

Comparable problems afflict the Armed Forces. They have fought several wars in the past 15 years, dealing with a Ministry of Defence staffed by people who know nothing about war. More generally in the Civil Service, it has become common to reduce specialist skills – language training in the Foreign Office, for example – and to move able people around from department to department. The present permanent secretary of the Home Office had never worked there before she took her present post at the beginning of last year. Since it is a department of fantastic complexity, it is perhaps not surprising that it has recently taken a series of tumbles on such issues as deportations and borders.

You find this hollowing-out everywhere. In schools, the head who does not teach is now a familiar, indeed dominant figure. University vice-chancellors, instead of being dons who move from their subject into administration for a period of their lives, are now virtually lifelong managers, with hugely increased salaries to match. It is even commonplace for charities to be run by people with no commitment to the charity’s specific purpose, but proud possession of what they call the necessary “skill-sets”, such as corporate governance.

With the rise of the managerialist comes a special language – a weird combination of semi-spiritual banality (“unlocking energies”), euphemism, and legalese. If you want to see the difference between people steeped in their trade and people steeped in managerialism, compare the testimony, at the Leveson Inquiry, of the Murdochs, father and son. The wicked old man spoke in the language, simultaneously sharp and blunt, of people who know and run their business. The evasive son adopted the locutions taught in business-school courses, honed by big law firms, footnoted by anxious compliance officers.

My friend at QinetiQ draws my attention to some of the usages which predominate where managerialism rules. The system of internal communications becomes a platform not for sharing knowledge but for propaganda. Human Resources invent things like the Personal Improvement Programme, which is really a means of punishing staff. “Consultation”, he says, is a word meaning that managerialists “tell you what they are going to do, 30 days before they do it”.

These habits are now pervasive across industry and the public services. “Diversity” is always “celebrated”, but it never means diversity of thought. The people who tell you they are “passionate about” X or Y are usually the most bloodless ones in the outfit.

In such cultures, just as the experts, the professionals and the technicians bitterly resent the managerialists for neither understanding nor caring, so the managerialists secretly detest the professionals who, they believe, get in the way of their rationalisations. They are desperate to “let go” of such people. Very unhappy organisations result.

A few weeks ago, after Dr Rowan Williams had given notice of his retirement as Archbishop of Canterbury, there was a story about his potential successor, Dr John Sentamu, the Archbishop of York. Dr Sentamu’s critics, apparently, had been saying that he was too much like an African tribal chief. Friends of Dr Sentamu were angry at what they saw as a racial slur.

But it struck me that the qualities of a tribal chief are now shockingly rare in big modern organisations. They might be just the job, and not only for the poor old C of E. The point about a tribe is that it unites its members by ties that are very hard to break. Tribalism, for sure, can be a bad thing, but a tribe understands matters of life and death. It recognises the importance of yesterday and tomorrow as much as today. It maintains the interest of the whole over that of a particular part. The chief of the tribe is not a manager: he is a leader.

No one sensible thinks that a large organisation can exist without being managed. Old stagers in companies, regiments, professions and, in my own experience, newspapers, easily over-romanticise their achievements and are unfair about the poor “bean-counters” who make the sums add up. But management should not dominate. As Lord Slim, who brilliantly led the British Army through the Burma campaign, put it: “Managers are necessary; leaders are essential.” We now have unprecedented numbers of the former, not so many of the latter.

Because, since the credit crunch, Everything Is Different Now, this problem is causing real social division. It explains much of the rage about executive pay. It is not so much the numerical difference between the top and the bottom which causes the anger, as the sense about why that difference exists. It has been arranged by the managerialists. It may even be the chief purpose of the managerialists’ working lives, as they edge towards the exit with the largest portable share of the takings available.

It's time to start talking to the City

A radical reform of the financial sector can only be achieved if we know what kind of capitalism we want

• Ha-Joon Chang
• guardian.co.uk, Monday 20 February 2012

Last week I delivered a lecture on my latest book to about 150 people from the financial industry at the London Stock Exchange. The event was not organised or endorsed by the LSE itself, but the venue was quite poignant for me, given that a few months ago I did the same thing on the other side of the barricade, so to speak, at the Occupy London Stock Exchange movement.

At the exchange I made two proposals I knew may not be popular with the audience. My first was that we need to completely change the way we run our corporations, especially in the UK and the US. I started from the observation that financial deregulation since the 1980s has greatly increased the power of shareholders by expanding the options open to them, both geographically and in terms of product choice. Such deregulation was particularly advanced in Britain and America, making them the homes of "shareholder capitalism".

With greater abilities to move around, shareholders have begun to adopt increasingly short time horizons. As Prem Sikka wrote in the Guardian in December 2011, the average shareholding period in UK firms fell from about five years in the mid-1960s to 7.5 months in 2007. The figure for UK banks had fallen to three months by 2008 (although it is up to about two years now).
In order to satisfy impatient shareholders, managers have maximised short-term profits by squeezing other "stakeholders", such as workers and suppliers, and by minimising investments, whose costs are immediate but whose returns are remote. Such strategy does long-term damages by demoralising workers, lowering supplier qualities, and making equipment outmoded. But the managers do not care because their pay is linked to short-term equity prices, whose maximisation is what short term-oriented shareholders want.

That is not all. An increasing proportion of profits are distributed to shareholders through dividends and share buybacks (firms buying their own shares to prop up their prices). According to William Lazonick – a leading authority on this issue – between 2001 and 2010, top UK firms (86 companies that are included in the S&P Europe 350 index) distributed 88% of their profits to shareholders in dividends (62%) and share buybacks (26%).

During the same period, top US companies (459 of those in the S&P 500) paid out an even greater proportion to shareholders: 94% (40% in dividends and 54% in buybacks). The figure used to be just over 50% in the early 80s (about 50% in dividends and less than 5% in buybacks).

The resulting depletion in retained profit, traditionally the biggest source of corporate investments, has dramatically undermined these corporations' abilities to invest, further weakening their long-term competitiveness. Therefore, I concluded, unless we significantly restrict the freedom of movement for shareholders, through financial reregulation, and reward managers according to more long term-oriented performance measures than share prices, companies will continue to be managed in a way that undermines their own viability and weakens the national economy in the long run.

My second proposal was that, in order to improve the stability of our financial system, we need to radically simplify it. I argued that financial deregulation in the last 30 years led to the proliferation of complex financial derivatives. This has created a financial system whose complexity has far outstripped our ability to control it, as dramatically demonstrated by the 2008 financial crisis.
Drawing on the works of Herbert Simon, the 1978 Nobel economics laureate and a founding father of the study of artificial intelligence, I pointed out that often the crucial constraint on good decision-making is not the lack of information but our limited mental capability, or what Simon called "bounded rationality". Given our bounded rationality, I asserted, the only way to increase the stability of our financial system is to make it simpler. And the most important action to take is to restrict, or even ban, complex and risky financial instruments through the financial world equivalent of the drugs approval procedure.

The reactions of my audience were rather surprising. Not only did nobody challenge my proposals, but many agreed with me. Yes, they said, "quarterly capitalism" has been destructive. True, they related, we've seen too many derivative products that few people understood. And, yes, many of those products have been socially harmful.

It seems that, as it is wrong to label the Occupy movement as anti-capitalist, it is misleading to characterise the financial industry as being in denial about the need for reform. I am not naive enough to think that the people who came to my lecture are typical of the financial industry. However, a surprisingly large number of them acknowledged the problems of short-termism and excessive complexity that their industry has generated to the detriment of the rest of the economy – and ultimately to its own detriment, as the financial industry cannot thrive alone.

The rest of us need to have a closer dialogue with reform-minded people in the financial industry. They are the ones who can generate greater political acceptance of reforms among their colleagues and who can also help us devise technically competent reform proposals. After all, without a degree of "changes from within", no reform can be truly durable.