Finance, the Rate of Profit and Imperialism

Paper for MPE2 session, WAPE/AHE/IIPPE conference, Paris, 5-7 July 2012

By Tony Norfield

AbstractThis paper examines how Marx’s theory of value can be developed to understand the role of finance for imperialism today. The basic outlines of Marx’s theory of credit and finance are given in Capital, but this is an incomplete work. Hilferding’s classic book, Finance Capital, was an important advance, with its analysis of the connections between monopoly and finance. However, there has been little progress in the Marxist analysis of finance since its publication. Recent work has tended to focus on financial crises, or on the role of the financial sector in the national economy and the growth of financial trading. There has been little or no attention to the question of finance and imperialism. This paper will offer a framework for understanding the imperialist financial system using value theory. It will examine the relationship between the Marxist concepts of the rate of profit, accumulation and fictitious capital and the ‘modern’ concepts of return on equity and leverage. This forms the basis for understanding how the financial system is a key part of the mechanism by which the major imperialist powers maintain their economic privileges in the global economy.

Keywords: Finance, credit, fictitious capital, accumulation, rate of profit, return on equity, leverage, value theory, imperialism, parasitism, productive and unproductive labour.

1. IntroductionFinancial markets and companies have been the focus of attention in recent years, especially following the crash of 2008. Yet while there has been plenty of coverage of the crisis in both the popular media and in academic journals, there have been few analyses that have gone beyond documenting in a descriptive fashion the expansion of financial trading and the various forms this has taken. Marxist scholars generally base their critique of finance on the theory of value and accumulation, noting that finance is unproductive, parasitic and prone to speculative excess. However, while these views may follow the analysis in the classical literature, from Marx to Hilferding and Lenin, they do little to go further in understanding how the financial system works in the context of Marx’s value theory. Neither do they do much to examine the role the financial system plays for imperialism today.

This paper aims to ‘go back to basics’ and to build up a framework using value theory to explain the role of finance for the imperialist world economy. First I will summarise the core concepts of value theory as set out in Marx’s Capital, then I will discuss how these are used to conceptualise the rate of profit for the capitalist system as a whole. One important issue is to distinguish productive capital from other forms of capital, but the trickiest question is how to incorporate the financial system into the analysis. Volume 3 of Capital has incomplete and fragmentary remarks on banking and credit, which enabled Hilferding’s Finance Capital, published in 1910, to stand out as the ‘fourth volume’ of Capital in contemporary eyes, given that it offered a comprehensive analysis of the relationship between banks and industry.1 I discuss not only how the financial system has an important impact on the rate of profit calculations for the system as a whole, but also how its special position in the

1 We shall see below that while Hilferding introduced some important concepts he also made some questionable calculations on profitability. This is quite apart from his distortions of Marx’s crisis theory, where he focuses on disproportionality and argues for more regulation, on which see Grossmann (1992, Chapter 1).

1

sphere of circulation leads to a different profit dynamic from those for industrial and commercial companies. Finally, I discuss the principal ways in which the financial system acts as part of the mechanism by which the major imperialist powers – particularly the US and the UK – maintain their economic privileges in the global economy. It is shown that this mechanism does not depend upon financial crises and predatory relations between creditor and debtor, although these certainly exist; it operates on a day-to-day basis as part of the fundamental structure of the imperial system.

2. Value theory and calculations of the rate of profitThe sole aim of capitalist production is to make a profit. Marx’s theory of value explains the origin of this profit and how the dynamic of capitalist accumulation takes particular forms, resulting in a tendency of the rate of profit to fall. This tendency is what Marx termed ‘just an expression peculiar to the capitalist mode of production of the progressive development of the social productivity of labour’.2 Here I will focus not on this law, although I would endorse Marx’s observation that it is ‘in every respect the most important law of modern political economy, and the most essential for understanding the most difficult relations’.3 Instead of analysing trends in the rate of profit over time, I will show how to conceptualise the rate of profit, explaining the different factors that determine its magnitude.

First, it is necessary to outline some elements of Marx’s theory of value. This theory applies solely to capitalism, that historically specific form of social organisation in which the products of human labour are commodities and in which labourers work for the profit of the capitalists, the owners of the means of production. The value of commodities is a function of the socially necessary labour-time that went into their production, both directly in terms of the new expenditure of ‘living’ labour by the workers and indirectly as a result of the value transferred to the product by the means of production. The profit of the capitalist employers depends on the amount of surplus value produced by the workers, which in turn results from the time that they work after producing a value equal to the wage they are paid.

This leads to the definition of productive labour in Marxist theory. The definition has nothing to do with a moral judgement about whether the work done is socially useful, useless or otherwise. It rests on what directly produces value and surplus value for capitalism. Marx’s analysis in Capital is focused on the dynamic of this process, and Volumes 1 and 2 deal almost exclusively with industrial capital because this ‘is the only mode of existence of capital in which not only the appropriation of surplus value, or surplus product, but simultaneously its creation is a function of capital’. Industrial capital is, then, the most general and most important form of capital, and the one that is considered to employ productive workers.4

However, this is too narrow a definition of productive labour, and both the logic and text of Marx’s analysis also point to other groups of workers who are productive of value and surplus value for capital. One group is involved in the transport and packaging of commodities, since this function also adds to their use-value.5 Another group includes producers of use-values that are not material commodities who nevertheless work for a capitalist company, for example in private hospitals and education.6 In the following sections, however, I will use the shorthand of ‘industrial’ capital to refer to employment in and the operations of productive capitalists.

2 Marx (1974c, Chapter 13, p213). Marx outlined a number of ‘counteracting influences’ that make the fall only a tendency.3 Marx (1973, p748).4 Marx (1974b, Chapter 1, Section 4, p57).5 This is also true for those storage costs that do not arise out of the difficulty of realisation. See Marx (1974b, Chapter 6, Sections 2.2 and 2.3, pp151-153).6 See Marx (1969, Addenda 12, Section H, pp410-411).

2

Many workers employed by capitalist companies do not produce value and surplus value. These are the ones operating in what Marx calls the ‘sphere of circulation’. One area of this is the capitalist market activity of transforming use-values into values or the reverse operation, ie the selling or buying of commodities, including the accounting processes, as in the case of those working for merchant or money dealing capital (which we shall call commercial capital below). Another important area covers the workers in the more specifically financial sphere, providing services in the exchange between different agents of titles to the ownership (and use) of money and capital. This includes banks and other financial companies, real estate agents, and so forth. Whatever profits the labourers in these occupations bring to their particular employer, via mark ups, fees or interest payments, workers in the sphere of circulation do not produce new value (nor any surplus value) for the system as a whole.

Another group of workers is not employed by private capital but is important to consider briefly: public sector workers in local and central government, and others providing state-funded services. They have become increasingly important in the post-1945 period, along with the expansion of state expenditures and taxation. The growing gap between spending and taxation, and the related growth of government debt, are clear signs of problems in capital accumulation.7 Private capital depends ever more upon state-driven demand and financial support, as well as on the police and the armed forces. This is a big topic to analyse in its own right and it mostly falls outside of the focus of our inquiry into the role of finance for imperialism. However, it is worth making some brief points on this topic.

Public expenditure is largely financed through taxation, so it is a drain on the private capitalist sector and on the total surplus value produced, even though some of the expenditures may also benefit sections of private capital. Some expenditures are transfer payments of various kinds – giving to one section of the population what is taken away in taxation from others. These may be seen as redistributions of value and, while they may influence the pace of accumulation, they are not necessarily a drain on total surplus value in private capitalist hands. Nevertheless, much of public expenditure will be a consumption of resources – even in the administration of transfer payments - that is such a drain. Indirectly, there may be some savings for private capital, for example in the provision of health and education services for workers compared to the costs of what private capital would otherwise provide. But it is no surprise that state spending is normally seen as unproductive for private capital, and there is a real basis in the logic of capital accumulation for the attacks on ‘bureaucracy’ and public services. Hence, another qualifying factor in considering the profitability of the capitalist system as a whole is to allow for unproductive state spending that is a drain on the total surplus value produced. However, this factor is not included in the analysis that follows.

2.1 How to approach the rate of profit on capital investment

In Marx’s analysis, the rate of profit, r, is expressed as the total surplus value produced, divided by the advance of both constant and variable capital, or:

(i)

This simple formula is the one commonly used to represent the rate of profit on total social capital. However, this formula leaves out of account two important sets of qualifying factors, aside from the issue of state expenditure and taxation noted above. These need to be considered before a correct concept of the rate of profit in the capitalist system can be derived.

The first set of qualifying factors concerns the period of turnover:

7 See Haldane (2011, Chart 16) for the trend increase in public debt ratios for G7 countries from the 1970s.

3

- r should be considered as the annual rate of profit, the total surplus value produced in a year, S, divided by the capital advanced in that year;

- C is the total advance of constant capital, ie the advance of the fixed capital (machinery, buildings, etc) plus the advance of constant circulating capital (raw materials, energy used, etc). Fixed capital transfers its value to the product over several labour processes, meanwhile retaining its ‘definite use-form’,8 and we can assume that it is advanced for a year or longer. Circulating capital, on the other hand, is entirely consumed in the labour process and it may be may be turned over several times per year. In the latter case, while a total of, say $10m of raw materials may be used up in a year, only $2m may need to be advanced at any one time for the purchase of raw materials for the next period of circulation;

- V is the total advance of variable capital (wages), and it will also be less than the total annual wage bill if the period of circulation for variable capital is less than one year.9

These turnover elements of the formula are important, though they are usually set aside because of the difficulty of getting comprehensive information on turnover time. A shorter turnover time will mean that there is more surplus value produced compared to the advance of capital in a year, so that the rate of surplus value and the rate of profit per annum will also rise.10 In practice, most Marxist analyses of the rate of profit using national government statistics consider some proxy for the total surplus value in a particular year divided only by the stock of fixed assets that capitalists advance. This is a reasonable simplification to deal with the problem of turnover times. However, it will overstate the rate of profit because it excludes circulating capital altogether, rather than dividing the annual amount of circulating capital by its average turnover time as an additional element to add to the fixed capital.11 In what follows, the formulae I develop are for an annual rate of profit. Turnover time is not explicitly considered, but it should be noted that the rate of profit would increase if turnover time were reduced.

The second set of qualifications is more critical, in my view, when conceptualising the rate of profit: these relating to the advance by capitalists of funds that do not produce value and surplus value. This is unproductive employment of economic resources within the private capitalist sector. As will be shown, such funds need to be allowed for not only in the denominator of the rate profit formula. They will also deduct from the numerator.

Capitalist expenditures that do not produce value and surplus value fall into two categories: commercial (or merchant) capital and financial capital, as noted above. The standard rate of profit formula noted above can be amended to allow for these. Yet this is rarely done in the literature, even though the majority of Marxist commentators would agree that commercial and financial activities, being in the ‘sphere of circulation’, are unproductive of value and a drain on the productive sector of the capitalist economy. Below I explore this question.

2.2 Productive and commercial capital and the rate of profit

To the best of my knowledge, the first scholar to produce an amendment to the rate of profit formula to include commercial capital was Ben Fine.12 His derivation uses Marx’s analysis

8 Marx (1974b, Chapter 8, ‘Fixed capital and circulating capital’, p160).9 In Capital, Volume 3, Chapter 4 ‘The effect of turnover on the rate of profit’, Marx assumes that circulating constant capital is turned over in the same time as the variable capital (Marx 1974c, p72). Variable capital is also circulating capital in Marx’s definition.10 See Marx (1974b, Chapter 16) for examples of the higher annual rate of surplus value compared to the rate of surplus value for one labour process period.11 For a discussion of this point, see Kliman (2012, pp80-82).12 Fine (1985-86). Fine’s article corrects an interesting (Sraffian) analysis of commercial and financial capital produced by Panico (1980). Although Fine’s article covers the theory of interest, his formulae

4

that the commercial capitalists can be considered as buying commodities from the productive capitalists below value and selling them at value, while achieving the same average rate of profit as the productive capitalists. In this activity, the commercial capitalists have to advance cash or other means of payment, and they also need to advance capital to pay for buildings, equipment, commercial workers, etc. Marx assumes an equal rate of profit between the two types of capital because, in practice, they overlap. It is considered relatively easy for a producer to move (at least partially) into commerce, or vice versa, if the rates of profit are significantly different and attractive enough to induce such a change.13

The productive capitalist sells his commodities at the following price:

(ii) (C + V)(1 + r)

The commercial capitalist buys from the productive capitalist at this (lower than value) price and sells his commodities at value, equalling the total value produced. If B is the sum of commercial money capital advanced to buy the commodities and K is the advance of commercial capital for expenditures on buildings, commercial workers, and so on, then:

(iii) (C +V)(1 + r) + Br +K(1 + r) = C + V + S

Note here that the commercial money capital advanced, B, is used in exchange but returned on the sale of commodities, so there is no ‘loss’ of this sum of value. It does not have to be added to the selling price of the commodities. The only concern of the commercial capitalist is that he earns a return, r, on the money advanced, hence the term Br. His advanced capital K, by contrast, is money actually expended and does not come back to him except by being added to the price at which he bought the commodities, along with a profit, r, on that advance of K. Hence the term K(1 + r).

Rearranging equation (iii) and solving for r gives the following, amended formula, for the rate of profit on the total social capital:

(iv)

This should be considered as the rate of profit on the sum of productive and commercial capital advanced. As is clear from this formulation, the new rate of profit allowing for the separate existence of commercial capital appears to be lower than in formula (i), which only considers productive capital. This is both due to a reduction of the total surplus value by the costs of circulation K, and because of the larger denominator that reflects the higher value of advanced capital, including commercial capital (the B and the K). However, Marx’s simple formula for industrial (or productive) capital was still valid, and would have given the same result, as it implicitly included the operations of commerce within its terms. Marx evidently considered all the phases of circulation and production of commodity values, but in the simple rate of profit formula the costs of circulation were being borne directly by the industrial capitalists.

The previous analysis of how to account for commerce in the formula for the rate of profit is taken from Fine’s article, already cited. It is worth noting that if commercial capital has a faster turnaround of buying/selling that shortens the M – C or the C’– M’ phases in the standard Marxist notation of M – C … P … C’– M’, then there is a reduction of the

do not cover financial or banking capital, nor the rate of profit including these elements. Fine also suggests that banking capital will not achieve the same rate of profit as other forms of capital investment, but a higher one due to barriers to entry in banking based on a denial of loans by existing banks. The same commercial capital formula and similar comments on banking profitability appear in Fine & Saad-Filho (2004, p138). Section 2.5 below reaches different conclusions on bank profitability.13 Vertical integration of industry helps companies manage commercial costs internally. Retailers, by contrast, do not often get involved directly in production. In recent decades the hold of large, imperialist retailers over producers (eg Wal-Mart and China) has increased with ‘globalisation’. But this is a feature of the imperialist world economy rather than one that indicates an equalisation of profit between retailers and producers.

5

advanced B or K compared to the total surplus value produced. In this way, commercial capital is less of a drain on the surplus value produced by productive capital and the system rate of profit (per annum) will rise. A smaller negative thus appears as a productive increase of value.

2.3 Banks, financial capital and the rate of profit

The previous formula for both productive and commercial capital was not quite as direct in its implications as the simple rate of profit formula, but it was nevertheless clear. Fine’s methodology can also be extended to incorporate banking or financial capital into the averaging process, although this was not done in his article. Such a calculation depends on two assumptions: firstly, that banking or financial capital, operating in the sphere of circulation is unproductive of value; secondly, that this part of capital earns the same rate of profit as the other capitalist functional forms. There are likely to be fewer disagreements with the first assumption, which is the same as for commercial capital, and indeed none can be conceded if one holds to a Marxist theory of value. However, for the second assumption, the fact that banks have appeared to earn a dramatically higher rate of profit than industrial or commercial companies in recent decades might lead to more questioning of its validity. Here I will show how banking profitability can be understood in an ‘equal rate of profit’ framework. Later, I explain how the calculation of profitability can be developed to explain the source of the higher banking sector profit rate.

Firstly, it is necessary to discuss what is meant here by the banking and financial sector. In recent decades, the financial system has expanded dramatically, taking on many forms beyond the concept of banking covered in Marx’s analysis in Volume 3 of Capital. Marx’s analysis is built around the notion of banks as intermediaries, drawing on the pools of spare liquidity in the economy, whether household or corporate funds, and being able to use these for loans to industrial and commercial capital. This is the key to Marx’s explanation of the modern credit system as a spur to capital accumulation, but it also underpins his comments on how the credit system develops into a ‘colossal form of gambling and swindling’, as the gap between ownership and control of capital grows.14 The credit system is also a mechanism for the centralisation of capital, whereby companies merge, or are taken over, via the transactions of shares on the stock exchange.

By the banking and financial sector I mean those companies whose activities are largely confined to borrowing (or taking in deposits) and lending (or investing in financial assets, including corporate bonds or equities). These are companies that can utilise social money resources to lend to industrial and commercial capitalists, whether directly through loans or through subscribing to company bond or equity issues. I do not separately consider their financial dealings with households, though household deposits will form part of the total funds they can lend to companies. Neither do I specifically consider insurance companies, pension funds and other financial asset managers. However, these latter are included to the

14 Marx (1974c, Chapter 27, ‘The role of credit in capitalist production’, p441): “The credit system appears as the main lever of over-production and over-speculation in commerce solely because the reproduction process, which is elastic by nature, is here forced to its extreme limits, and is so forced because a large part of the social capital is employed by people who do not own it and who consequently tackle things quite differently than the owner, who anxiously weighs the limitations of his private capital in so far as he handles it himself. This simply demonstrates the fact that the self-expansion of capital based on the contradictory nature of capitalist production permits an actual free development only up to a certain point, so that in fact it constitutes an immanent fetter and barrier to production, which are continually broken through by the credit system. Hence, the credit system accelerates the material development of the productive forces and the establishment of the world-market. It is the historical mission of the capitalist system of production to raise these material foundations of the new mode of production to a certain degree of perfection. At the same time credit accelerates the violent eruptions of this contradiction - crises - and thereby the elements of disintegration of the old mode of production.’

6

extent that they also draw upon social money resources to lend to companies by purchasing their bond and equity issues.15 Furthermore, I do not consider relationships between the companies in the banking and financial sector, but treat them as one unit having a relationship with industrial and commercial companies. While this will omit a number of dimensions of financial activity today, it will include those financial dealings that have the most direct bearing on the process of capital accumulation.16

In order to show how banking and financial capital can be included in our calculations of system profitability, it is necessary to define additional variables for this sector. Let E be the value of bank equity capital, or ‘shareholders’ equity’. This is equal to the original subscription of equity when the bank started operations, plus any further share issues, plus retained earnings, minus Treasury shares.17 This equity capital value does not vary with the bank’s share price in the market.

Let D be the value of deposits and other net borrowings from the non-bank sector (hence excluding interbank loans). It is worth noting that these deposits include not only the surplus cash resources of the non-bank sector, but they will also be boosted by the banking sector’s own creation of money through its recycling of deposits.18 These can nevertheless still be counted as included in D, since they are deposits in the banking system, deposits that are the banks’ liabilities.

The value of D plus E amounts to the bank’s total liabilities and these are used to fund its total assets, which we will define as A. For simplicity, we will assume that total assets equal total liabilities. So the next formula is:

(v) A = D + E

Assume for simplicity in what follows that, of the bank’s total assets, a value equivalent to E covers the bank’s fixed and circulating capital costs (buildings, technology, managerial and labour costs) and its core reserve capital. This leaves a value equivalent to D to be lent out to industrial and commercial companies (we exclude lending to households from the analysis). In practice, a portion of E may also act as loanable funds, but it is unlikely that any of D would cover the bank’s costs, except in the case of fraud! In this analysis, the use of any part of D for financial or other investments aside from lending to industrial and commercial companies is also excluded.

Then, if the average interest rate paid on deposits is id, and the average return on bank investment assets is ia, the bank’s net interest income (before deducting other, non-interest costs) can be written as:

(vi) Aia – Did , or, alternatively, D(ia – id) if ia is considered as the return on assets lent.19

Referring back to equation (iii), we can consider the invested deposit sum D as representing the borrowed funds of industrial and commercial companies. These latter funds are for their investments in constant capital, variable capital, a proportion of commercial money capital advanced and for the fixed and circulating costs of commercial capital. For the total constant 15 Asset managers will only be investing new funds in companies when they purchase equity and bond issues, not when they purchase previously issued securities from other holders in the market.16 UK data show that at the end of 2010, UK individuals held only 11.5% of UK shareholdings, down from 47.4% in 1963, with the rest being held by foreign investors and institutions of various kinds. See ONS (2012).17 Treasury shares are shares held by the company that issued them. A company acquires treasury shares by buying them in the market. In the UK, Treasury shares can be cancelled, sold, or used in employee share (or share option) schemes.18 See Hall (1992) for an interesting analysis of this deposit creating process, and a critique of the Marxist literature at the time for ignoring it! Dos Santos (2011a) does include this element in his useful discussion of the credit system and accumulation.19 This assumes that banks only make a return on lending, and excludes the fees and charges they impose on their customers, and any net earnings they derive from financial trading. The latter items could be included, but would unnecessarily complicate the argument here.

7

capital, C, this can be broken down into C1, advanced by the industrial capitalist directly, and C2, that portion borrowed from the bank. Hence

(vii) C = C1 + C2

similarly,

V = V1 + V2

B = B1 + B2

K = K1 + K2

Since, by assumption, all the borrowed funds equal the total deposits of banks, then:

(viii) D = C2 + V2 + B2 + K2

These formulations may be rather fiddly, however the logic is simple enough and it can be developed to derive some interesting and intuitively reasonable results.

Firstly, total surplus value remains S, but the surplus value is not only shared between industrial and commercial capitalists and the financial sector in proportion to their advance of capital. For the latter two sectors, their costs of capital outlay for buildings, technology, personnel, etc, are not transferred to the values of commodities, so these costs must be recovered from the total surplus value produced in society. Hence, the total profit appropriated by the three sectors is lower. It can be represented as:

(ix) S – K – E

The total capital advanced by all three sectors can be given as the sum of that belonging to the industrial and commercial capitalists, the funds they have borrowed from the financial sector plus the financial sector’s own equity. Hence we can now write the rate of profit on total social capital as:

(x)

While based on simplifying assumptions, this overall result, highlights the impact of the commercial and financial sectors on the total rate of profit. I believe this to be an original formulation, though elements of it have been discussed in the literature.20 I will discuss the implications after first noting how Marx tackled the issue of finance and the rate of profit in Capital and how this was developed in Hilferding’s Finance Capital.

2.4 Bank capital, the rate of profit, Marx’s Capital and Hilferding’s Finance Capital

There is little direct guidance from Marx on how to conceptualise the impact of financial capital on the rate of profit.21 In Volume 3 of Capital, Marx conducts an ample discussion of how the rate of interest is determined; that interest is a deduction from surplus value, and that gross profit is split into interest and profit of enterprise.22 However, this only relates to the distribution of a given total of surplus value. There is no discussion of how the total surplus value is reduced in order to meet the unproductive costs of finance. Neither is it clear what

20 See Lapavitsas & Itoh (1998, p95). They note that bank capital covers the costs of office buildings, equipment, personnel, etc, and that these costs are ‘pure costs of circulation … As such, these costs are replenished out of the total surplus value produced in a given period’. However, they give no formula that expresses the broader relationship to the rate of profit on total social capital. Panico (1980) makes an interesting attempt to derive a system of equations to represent the relationships between the industrial and financial sectors. However his analysis and system assumptions are closer to Sraffa than to Marx, being driven by physical inputs and technical coefficients, and he combines the industrial and the commercial sectors as one unit in his general equation system.21 However, the logic of value theory suggests what should be done, and the analysis of the previous section gives my approach to this question.22 Marx (1974c, Chapter 23, especially pp372-374).

8

kind of deduction should be made. These omissions no doubt arise from the fact that only Volume 1 of Capital was fully completed by Marx. For both Volumes 2 and 3, Engels had a long struggle trying to piece together the notes that Marx had left into a coherent presentation!

Marx’s comments on bank capital are contained in Chapters 29 to 32 of Volume 3. He says that bank capital consists of a bank’s cash plus its holdings of securities of various kinds. This sum of capital can also be divided in a different way, between the banker’s invested capital and his deposits.23 This latter division corresponds to the variables introduced in the previous section: E, equity capital, and D, deposits. However, Marx does not analyse these again, except in the context of his discussion of ‘fictitious capital’, that we examine in the next section.

In Capital, Marx does not consider how, or whether, these sums of capital enter into the formation of the average rate of profit for the whole system. His analysis also sets aside the fact that banks have physical assets, buildings, equipment, etc, which need to be funded. The sum of a bank’s capital cannot be made up solely of cash and securities. For Marx in Volume 3, banks are essentially considered only as bearers of cash to lend (or to invest in securities) and to get interest from this. The issue of the average rate of profit including banks is not dealt with in the analysis.

Hilferding develops Marx’s analysis more explicitly to take account of the operations of the banking system. He notes that for capital ‘banking is a sphere of investment like any other, and it will only flow into this sphere if it can find the same opportunities for realising profit as in industry or commerce; otherwise it will be withdrawn’.24 This is part of Hilferding’s discussion of how the rate of profit for banks tends to be the same as the rate of profit elsewhere. However, his argument on how the average is derived is flawed, partly because Hilferding confuses the operation of the rate of profit and the rate of interest in this process and partly because he reverses the logical sequence.

He notes, correctly, that ‘the rate of interest is governed in the first place by supply and demand of loan capital as a whole, and this determines the gross profit of the banks, which they make by lending the money’. But then he says that the ‘basic datum is the level of profit, and the amount of their own capital must be adjusted in accordance with it’. The meaning of this latter statement is not clear until later in the same paragraph when he says that the ‘bank's own capital must be reckoned in such a way that the profit on it is equal to the average profit’. In an example, he argues that, if the average profit rate is 20%, then for a given net profit of 2 million marks, the bank’s capital can be reckoned as 10 million marks. Furthermore, if the bank has at its disposal a loan capital of 100 million marks, the remaining 90 million marks ‘are available as deposits of its customers’.

This argument ignores the fact that the deposits of the bank’s customers are a given, whatever may be the level of profit. It also confuses what, in modern terminology, is the bank’s equity capital plus deposits with the bank’s equity market capitalisation. The ‘E + D’ terms are givens, and not dependent on the bank’s market capitalisation which will vary with changes in its share price.

Hilferding makes a clear distinction between the rate of interest and the (average) rate of profit, using this in his analysis of ‘promoter’s profit’.25 However, even here he does not make a clear distinction between the value of a bank’s share capital when issued and the market price of such shares at a later point. While a bank’s market capitalisation will influence its financial power in the market, and it can also act as a ‘means of payment’ in share swaps to purchase other companies, market capitalisation does not have a direct relationship to the size of a bank’s share capital nor to its ability to make loans.

23 Marx (1974c, Chapter 24, p463).24 Hilferding (1981, p172).25 Hilferding (1981, pp107-116).

9

Alongside these issues, Hilferding takes the average rate of profit as a given, one that the banks also earn on advanced capital. However, as the previous section has shown, banking capital has to be allowed for as a factor that reduces the average rate of profit. Hilferding’s presentation does not show how this can be calculated, although he agrees that there should be a reduction, since it is a clear consequence of Marx’s theory of value.26

2.5 Fictitious capital, finance and the nature of modern capitalism

One of the ironies in Volume 3 of Marx’s Capital is that the first discussion of ‘fictitious capital’ does not occur in Chapter 25 entitled ‘Credit and fictitious capital’ – the chapter does not even mention the term! Instead, it is covered in later chapters, and especially Chapter 29, entitled ‘Component parts of bank capital’. Essentially, fictitious capital is a sum of value represented by a financial security whose value is determined by the capitalisation of future (expected) income.27 As such, even though the security may also represent a claim to ownership of the assets of a company, as with an equity, its value does not represent real capital. In the case of government securities, there is no representation of capital at all. The value of a government bond only represents the net present value of future coupon payments, plus a principal repayment, based on the financing of these payments from future tax receipts.

In general, the value of such securities goes up as the interest rate (the discounting rate) goes down, and vice versa. This makes the value of securities appear quite divorced from the rate of profit in the capitalist system, and from any relationship to the production of value, a feature that is underlined by the far less visible nature of the average rate of profit compared to the market rate of interest.

Furthermore, as the form of fictitious capital developed in the 19th century, with the growth of joint-stock companies, so did a trading market in the assets of companies. Capitalist investors view company assets as financial assets with prospective nominal returns – an expansion of value – rather than as real assets of companies that are producing use-values of particular kinds. This accentuates the inherent tendency of capitalist production to have value expansion as its sole aim.28 The phenomenon of ‘financialisation’ thus has a far longer history than the contemporary users of this term tend to appreciate.

One important feature that follows from this is the lack of distinction between different forms of capitalist enterprise when viewed from the standpoint of value expansion. The companies may do different things – from high-tech or dirty industrial, to smart or dumb commercial, to complex or high street financial – but they are all measured according to how much profit they make. This is not to deny that the source of the capitalist system’s profit lies in exploiting labour that is productive of value, just to note that they do not need to care about such details. The details that are at the centre of attention are those that will accrue the highest

26 He notes that since “circulation does not produce a profit, and simply represents costs, there is a tendency to reduce the capital applied in this sphere to a minimum. Bank capital … including both the bank's own capital and deposited capital, is nothing but loan capital and as such it is, in reality, only the money form of productive capital” (Hilferding 1981, p173). This latter point is incorrect. What is deposited in banks is not necessarily the money form of productive capital, and it may not become productive capital when lent out. Neither can the bank’s own (equity) capital be considered as productive capital, since it will largely be used to fund the bank’s operations. In this analysis, however, I assume that deposits at banks are lent out to industrial and commercial capitalists for their operations.27 This definition is the same as Marx’s (1974c, p467), but differs from Harvey’s, who confuses ‘fictitious value’ – his term for credit money backed by an unsold commodity as collateral - and ‘fictitious capital’: ‘If this credit money is loaned out as capital, then it becomes fictitious capital’ (2006, p267). A bank loan to a company only becomes fictitious capital if that loan is securitised.28 One incident from my professional career highlights this. A company finance director I was interviewing took me around his copper semi-manufacturing plant to see the striking, shimmering, golden metal, fresh from the extrusion process. He held back his sense of awe and said: ‘It’s beautiful, but we have to make money on it’.

10

profits, whether these result from influencing commercial legislation, from imposing monopoly barriers in their buying and selling, or from driving down their costs.

The concept of fictitious capital and Marx’s related analysis of the credit system point to a broader view than is usually taken of the role of finance in capitalism, one that is not focused solely on the banking sector, nor one that poses a schism between ‘finance’ and ‘industry’. In this context, I would agree with Hoca on how to define ‘finance capital’ today, when he argues against confusing – and counter-posing – functional divisions between different areas of capitalist activity with the essence of modern capitalism that combines monopoly and finance.29

2.6 Implications of the general formula: borrowing, equity and leverage

Section 2.3 introduced a set of formulae to represent how banks and financial companies lend to industrial and commercial companies, who then use these funds to finance their expenditures on constant and variable capital, and on the costs of circulation. Here I will examine some important relationships using these formulae.

2.6.1 ‘Profit of enterprise’, interest and surplus value

Marx divided the total surplus value into ‘profit of enterprise’ and interest. This division occurs before he has introduced landed property and rent into the analysis, and likewise I will exclude landed property and rent. However, in Marx’s analysis of profit of enterprise, while he considers both industrial and commercial capitalists, he gives the impression that the only deduction to be made from the total surplus value accruing to these capitalists is the interest paid to ‘the owner and lender of money capital’.30 As already shown, however, the total surplus value available for distribution is much lower than this, since it must cover the costs of both commercial capital (K) and banking capital (E). Total surplus value available for distribution among all capitalists is equal to S – K – E, as noted in (ix) above.

This implies that the correct formula for the profit of enterprise is:

(xi) S – K – E – Dia

where the final term is the interest paid on the funds that industrial and commercial companies borrow from the banks.31 If the former also lent funds to the banks, then they would also receive a portion of Did in interest, but that would not be profit of enterprise, strictly speaking. If that portion were represented by α, then the total returns of industrial and commercial companies would be:

(xii) S – K – E – Dia + αDid

If it were assumed that the source of all the deposits lent by banks came from industrial and commercial companies, then α then would be equal to 1. In this case, the net deduction of interest would have the same magnitude as (though the opposite sign to) the net interest income of banks shown in equation (vi).

29 Hoca (2012).30 Marx (1974c, Chapter 23, p371).31 Dos Santos (2011b, p26) ignores the deductions from total surplus value due to commercial and financial capital when giving his formula for the profit of enterprise.

11

2.6.2 Return on equity: industrial, commercial and financial capitalists

The owners of capitalist companies, whether industrial, commercial, financial or otherwise, must usually advance some of their own capital to begin operations, or to continue to operate. However, they will normally also borrow investment funds from the financial system. When this occurs, while they are concerned about the returns they get on the total advance of capital, they are more particularly focused on the return on their ownership stake, or the ‘return on equity’. The return on equity - or another form of it, earnings per share – is a common metric reported for companies quoted on the stock exchange. This is different from the simple measure of the rate of profit S/(C + V) cited in Marxist literature, and also from the more complex derivation in equation (x). Equation (x) gives the calculation of the system rate of profit including borrowed capital, but it does not show the return on equity that different groups of capitalists may earn.

Capitalist corporations do not pay any attention to the Marxist calculation of the rate of profit and have no interest in reporting such a thing as it applies to them, even if they could calculate it.32 However, as will be shown below, that the return on equity is still determined, or at least constrained, by the rate of profit on the capitalist system as a whole.

The return on equity for the industrial and commercial capitalists is their profit of enterprise, plus any deposit interest received from banks, divided by their own advance of capital, or:

(xiii)

This return on equity measure also makes clear how profitability can be boosted from the point of view of equity investors, without them necessarily providing any more funds for investment, but instead relying on borrowed funds. Within limits, this can mean that it is possible for the RoE to rise even if the rate of profit on total investment falls. It is nevertheless the rate of profit that determines the volume of profit that the total investment will bring, to be divided up between shareholders and bondholders. Whatever may be the borrowing ratios of a company, the underlying rate of profit on the total investment of funds, both those advanced by the owners and those borrowed from the financial market, will determine the final verdict. This can be seen by examining the relationship between the system rate of profit, equation (x), and the previous formula for the return on equity for industrial and commercial companies.

Rearranging equation (x) to make the total capital advanced the subject, the result is:

Hence,

Now, substituting the right hand side of the previous equation for the denominator in (xiii) and multiplying the right hand side fraction (top and bottom) by r, the result is:

This shows that the return on equity for industrial and commercial companies will decline as r falls, since both the numerator falls and the denominator rises.

32 The Marxist concept of the rate of profit is one that applies to the whole system. Individual capitals are considered as portions of the total social capital advanced and will tend to get a share of the total surplus value in proportion to their capital as the rate of profit is equalised between different sectors.

12

However, the return on equity for the banks has a less clear relationship to the system rate of profit. This RoE is the net interest income, after deducting other costs (assumed here to be equal to E), divided by the advance of their own capital, E, or:

(xiv)

In this case, the trend in the system rate of profit, r, has a less direct impact on the RoE. If there is a trend of falling profitability, then the RoEICC will fall, as previously indicated. This will reduce these companies’ ability to meet interest payments on borrowed funds, so there is likely to be downward pressure on ia (considered as a percentage return on assets, not simply as an interest rate) through a lower demand for funds and also due to potential loan losses. That will probably feed into a lower figure for ROEBanks eventually. Nevertheless, there are some degrees of freedom on this measure that could make the banks still look profitable, despite lower returns elsewhere. In particular, it is the gap between borrowing and investing (lending) rates that is critical for the banks.

Two other important points can be made about the RoE equations (xiii) and (xiv). Firstly, being composed of very different elements, there is clearly no direct relationship between the two equations and the respective rates of return on equity are liable to be different at any moment. However, a reasonable assumption is that capitalist competition will tend to equalise these RoE measures over time.

Take the example where the RoE for industrial and commercial companies is systematically higher than that for banks. In this case, the banks might be able to charge more for loans because the other companies may be more willing to pay the higher interest charges to borrow funds. This would help equalise RoE figures. In addition, there could be an allocation of extra capital into the industrial and commercial sector. This could come from the investment of new capital, or a switch of funds out of the banking sector and into the other sectors. In the opposite case, when the RoE for banking capital is systematically higher, then there could also be a shift of new or existing capital into banking/finance, or the banks may compete with one another to reduce interest rates to industrial and commercial companies, or to raise interest rates in order to attract more deposits. In practice, there are only few examples of non-financial capitalists moving into finance, or of financial companies moving into industrial and commercial operations.33 Hence, it is more likely that an equalisation of RoE measures would come about through changes in the structure of market interest rates rather than through a significant shift of capital between sectors.34

Secondly, it is interesting to note the impact of a rise in the volume of borrowed funds on the different RoE measures. In the case of industrial and commercial companies, more borrowed funds will tend to reduce the RoE in a particular year, unless the sum of surplus value rises sufficiently. The extra profits they gain from their extended operations must be greater than the extra interest costs they pay for the funds in order to boost their RoE. Even then, any borrowings that increase C2 and V2 will increase the denominator of the system rate of profit measure, r, and might reduce the rate of profit. If so, this will have an impact on the RoEICC as already shown. Any borrowings that increase K will tend to have an even more detrimental effect on the RoE. Commercial capital produces no extra surplus value, and a higher value of K will be a bigger deduction from surplus value, even if there is no rise in the denominator term K1.35 Hence there are evident constraints on the volume of funds that it makes sense for these companies to borrow, as suggested by formula (xiii).

33 The ‘private equity’ phenomenon of recent years might be seen as an example of financial capitalists moving into other spheres. However, it is based on leveraged buy-outs, financed with relatively cheap bank funds and dependent on advantageous tax laws. It represents an example of predatory and parasitic capitalism rather than financial capitalists wishing to become ‘productive’.34 Using a different measure of profitability, Duménil and Lévy (2004, p98) show there were flows of capital between the non-financial and financial sectors of the US economy, attracted by the profitability gap, although these did not close the gap.

13

This constraint is very different for the banks. By virtue of their position in the capitalist economy, they have relatively easy access to deposits and, as their RoE formula (xiv) indicates, every reason to expand deposit taking (through their ability to create credit) as long as the return on lending/investing is higher than the interest rate they pay for those deposits. While getting extra deposits – and making extra loans and investments - may imply some extra costs for their operations and their advances of capital (eg through opening more branches), on the whole one would expect these to be less than proportionate to the extra deposits taken in. This leads on to a discussion of leverage.

2.6.3 Rates of return and leverage

Industrial and commercial companies borrow far less as a proportion of the equity held by the company’s owners than do banks and other financial companies. The ratio of borrowing to shareholders’ equity, a common definition of leverage, is much higher for banks. This is a function of the role of banks, drawing in funds from society and to lending these to those who want or need them. If the deposit or money creating ability of banks is included, then this operation can expand dramatically. The ratio of borrowed funds to equity will change according to economic conditions, with borrowing growing rapidly when times look good and growing less, or even falling, when times are bad. Nevertheless, at all times banks borrow far more than do other capitalist companies when compared to the size of their capital or equity base.

As an indication of the divergence, it is considered normal for banks to have a leverage ratio of around 20 – in other words, when borrowing is 20 times the size of equity.36 Industrial and commercial companies, by contrast, are looked upon questioningly by the stock market if their ratios are more than 1.37 One other divergence with the banks is that even if the companies borrowed funds they would be very likely to use the funds for investment in their own productive and commercial operations. The banks borrow funds to lend to others, or to invest elsewhere, since that is the economic function they perform.

Higher leverage means higher risk, since the interest on the borrowing must still be paid even if the investment turns out badly. But if investment returns are good, a low cost of borrowed funds relative to the investment returns will magnify the return on equity. This increases the volatility of returns, and standard portfolio investment theory makes an adjustment for this, deflating the higher returns by the higher volatility, when calculating an ‘information ratio’ on investment performance.38 This approach corresponds to a common sense view that high risks are only worth taking if the potential rewards are commensurately higher.

Data on the leverage of banks versus industrial and commercial companies, and on the relationship of leverage to reported profitability, is very patchy. However, my assessment of the information available for the UK and the US reaches the following conclusions.

In the period prior to the 1980s, the higher, but relatively stable, level of leverage for banks was ‘normal’. Bank profitability was on a par with industrial and commercial companies, and the banks’ higher leverage ratio was part of the process by which they compensated for a lower rate of return. In other words, they would have made lower than average profits if they did not borrow (relatively cheap) funds via deposits to re-lend to other 35 It is possible, however, that investments in the sphere of circulation by commercial capital will help reduce capital’s overall turnover time, thus increasing the annual production of surplus value for a given amount of productive capital. This issue is dealt with in Volume 2 of Capital. See Marx (1974b, especially Chapter 16).36 See Haldane (2011).37 For the aggregate of US manufacturing companies, debt holdings were less than the value of equity in each year from 2001 to 2010. Hence leverage was less than 1. This was also true for the aggregate measures of mining and wholesale trading companies. See US Census Bureau (2012, Table 794).38 See the following for details of the information ratio: http://en.wikipedia.org/wiki/Information_ratio

14

companies. After the early 1980s, however, the banking sector began to expand dramatically and so did their leverage ratios as market interest rates fell, and general returns fell, following a slowdown in economic growth. Because the financial sector is most able to access high volumes of (cheap) funds, banks were at the forefront of increasing leverage. While there were many market upsets from the mid-1980s, these lower interest rates and, from the early 2000s, a more benign, stable rate of economic growth in major countries, gave the basis on which higher leverage did not seem so risky.39 Higher leverage was a means by which banking capital could counteract a fall in profitability, and, for a while, even boost it. Leverage ratios for some institutions hit levels in excess of 100 in the US, and as high as 60 or 80 in Europe. Once the credit-fuelled bubble burst, however, this gave a particular ‘financial’ form to the crisis that broke in 2007-2008.

3 Finance and imperialismThe previous calculations were for the capitalist system as a whole, using the abstraction of one set of industrialists, one of commercial capitalists and one of banks. The commercial capitalists and banks share in the profits produced by the industrial capitalists, and the capital they advance for their operations also weighs on the profit rate. However, this abstraction sets aside the facts of international trade, investment and financial relationships, and does not take account of the unequal status of different countries in the world capitalist system. Including these points, in other words, accounting for the fact of imperialism, brings two further developments of the general system relationships discussed above.

Firstly, industry, commerce and finance in a particular country can grow beyond what might be expected to put a limit on this growth when their field of operations is expanded beyond the limits of one country. This is a standard conclusion from international trade theory, based on specialisation and the international division of labour. However, as critics of the standard theory point out, this division of labour is not simply based on which country has the best products or the most efficient business operations. It is also determined by state, industrial, commercial and financial power.40

Secondly, the previous analysis was based on Marx’s theory of value for the capitalist system as a whole. This analysis needs to be modified in order to understand more clearly the position of individual countries within the system, in particular the privileged position of the imperialist countries when the operation of the law of value is examined on an international scale. My focus is on the financial aspects of imperialism - how financial power boosts the economic gains that imperialist powers enjoy - rather than on all international economic relationships under imperialism. Not only do ‘the banks’ of a particular country benefit; the banks also form part of the overall mechanism that supports an imperialist country’s gains from the world economy.

One result easily follows from extending value analysis for the whole system to a closer examination of relationships between different countries. The limits to the growth of commerce and finance in one country given by the costs these sectors impose on the value-productive sector of that country are lifted when revenues from other countries can meet the higher costs of commerce and finance! In particular, a country’s financial sector may expand dramatically if that system can appropriate surplus value produced elsewhere in the global capitalist system.41 Surprisingly, this simple point receives no coverage in the Marxist literature. But this omission is consistent with that literature analysing neither why the

39 This was true for banks in most capitalist countries, but especially in the US, UK and the main imperialist powers. See Norfield (2011c) for further details.40 See, for example, the interesting analysis of European economic integration in Carchedi (2001). He gives a careful and detailed analysis of value theory in the context of European integration, but he only discusses foreign exchange markets, monetary crises and ‘seigniorage’ as mechanisms of financial value extraction, in addition to the core notion in his analysis that competitive advantage lies with the more productive (higher organic composition) capitalist producers

15

financial sector in the UK, for example, is so big, nor how the financial sector operates as a functional part of imperialist economic power.42

Before addressing these questions in more detail it is worth making some further preliminary remarks. Each of the world’s major economic powers has sizeable financial sectors compared to the rest of the national economy, but the UK stands out. One measure of size is the ratio of bank liabilities to national GDP. In 2008, the UK’s ratio was 5.5, the second highest in the world. While Switzerland’s ratio was higher at 6.3, the Swiss economy is less than a quarter of the size of the UK economy, showing how much bigger is the UK banking system in absolute terms. The ratio for the US was relatively low at 0.9 times GDP, but given that the US has a higher GDP (6.5 times that of the UK), the scale of the US banking system on this measure was just above that for the UK, making it the biggest in the world.43 Any single measure of the size of the financial sector will have drawbacks, but these figures are consistent with other information on the scale of the financial markets (equities, bonds, foreign exchange, commodities, derivatives, etc) based in each country. The evidence clearly points to the UK and the US as being the pre-eminent financial imperialist powers, but the UK has boosted its financial sector by much more than the US compared to the size of the domestic economy.

It is not open to every country to establish a major international banking and financial network: the growth of the UK financial sector is based on its status and privileges in the world economy. In the remainder of this section, I highlight the features that allow the financial system to act as a prop for an imperialist power’s wealth and income.

3.1 Finance and value extraction under imperialism

There are three important ways in which the financial sector can play a key role for the economic livelihood of an imperialist power: (a) by drawing on (relatively low cost) funds from abroad to lend to domestically based capital and to the state; (b) by financing the foreign operations of domestic corporations, whether from domestic or from foreign funds, so that they can exploit foreign labour, and (c) by taking a share of globally produced surplus value through providing loans and other ‘financial services’ to foreign businesses and governments. Each of these financially derived benefits for the imperialist power concerned depends on a privileged relationship with other countries. I exclude from consideration the wholly domestic operations of banks and other financial companies. However, I do include access to foreign funds that is open to governments directly, for example through their auctions of public sector debt, since this auction process is usually managed by the private financial sector alongside the government.

Note also that while much of the discussion has been of ‘banks’, this term should be considered shorthand for the operations of the private capitalist financial system in toto. This comprises the bond, equity, money (including foreign exchange), commodity and derivatives markets. Of course, the ‘banks’ concerned need not be of the same nationality as the country

41 Smith (2010) analyses the process of value appropriation by imperialist powers in the context of globalised production, and details the mechanism for what we have termed here ‘industrial and commercial companies’. This thesis focuses on the financial dimension of the process that he does not cover.42 For example, Callinicos (2009, p193) merely notes the City’s growth as a UK ‘response to relative economic decline’, and that is all in a 300-page work on ‘global political economy’. He pays no attention to the role of finance for British imperialism today.43 For the ratios to GDP, see Demirgüç-Kunt and Huizinga (2010, Table 2, p29). Relative GDP sizes are taken from IMF data for 2010. Switzerland’s banking system has expanded largely on the basis of banking secrecy laws, low tax rates and tax evasion by plutocrats and criminals from a wide range of countries. The UK has also adopted these methods to some degree, but the ratio of bank liabilities to GDP per extra billion dollars of funds grows faster for a smaller economy. See Shaxson (2011) for a discussion of tax havens.

16

in which they operate, and almost all will have ownership that is geographically diverse. However, the focus here is on how the financial system based in an imperialist country is part of that country’s economic power structure.

3.1.1 Imperial privilege and access to foreign funds

Governments, households, companies and banks borrow from the financial system for a variety of reasons, and easy access to (relatively low cost funds) is an important economic advantage to have. Access to funds will be a function of how developed the financial system is, and potential access to funds by governments and companies will be increased if the financial system in a country is integrated with the rest of the world economy. Of course, this can also prove to be a serious disadvantage if foreign funding suddenly dries up, or if the credit system, locally or globally, fuels a speculative bubble that bursts and damages the economy. There are many such examples! However, the financial system provides support both for investment and consumption spending, whether through direct funding or via financing government expenditures and welfare payments in all capitalist countries. For imperialist countries, particularly those that have specialised in finance, their economic privileges put them in a stronger position than others, even when there is a crisis that engulfs them too – something that the US and the UK are benefiting from in the present turmoil.

One important way in which these advantages accrue is from the high credit ratings that the major ratings agencies grant to the strongest powers. Many government credit ratings have been downgraded since the onset of the crisis in 2008, and some countries remain at risk of new or further downgrades, but most of the so-called G10 countries, the most wealthy and influential of the established capitalist powers, still have a triple-A (or close to it) credit rating.44 This means that they can get credit from international lenders and investors on the most favourable terms.45 The nationally owned private sector companies of these countries can potentially enjoy these benefits too, not simply the government, since the sovereign credit rating normally sets the upper limit on the rating of companies. By comparison, the weaker and non-imperialist powers usually pay more to borrow from international markets.

One study notes that ‘developing countries have low credit ratings and high risk premia while exhibiting credit ratios that are often much stronger than highly rated developed countries’. 46 This is because they are unable ‘to borrow at long maturities and fixed rates in domestic currency’. Instead they must either borrow major foreign currencies (usually US dollars) or only borrow short-term domestic currency. This makes their ‘debt service vulnerable to shocks to the short-term real interest rate and the real exchange rate’, a risk that the imperialist powers generally manage to avoid. An interesting question is how far the US, with its burgeoning private and public sector debt levels, has been favoured by the agencies more because of its economic and political might rather than because it meets a set of strict criteria that indicate it is able and willing to meet its obligations. 47

44 The ‘G10’ actually comprises 11 countries: US, Japan, UK, Germany, France, Switzerland, Italy, Canada, Belgium, Netherlands and Sweden. The US had its rating reduced from triple-A in August 2011 by one of the three main agencies, S&P, while Japan, Italy and Belgium have lower ratings given their very high (government) debt levels. However, the remaining G10 countries (and some others) have triple-A ratings from all three major agencies. This information is correct as of end-March 2012.45 The lowest credit risk does not necessarily mean the lowest interest rate on borrowing, since many other factors will affect interest rate levels, not least expectations of inflation and central bank policy. For example, Japan has had the lowest government borrowing rates for many years, given its chronic deflation, despite having had its rating downgraded to AA by the agencies.46 See Hausmann (2002).47 It has been notable that a series of US government shutdowns – five since 1981 - and debates on whether to raise the debt ceiling (and thus obtain the funds to pay creditors) did not lead the agencies to downgrade the US until 2011. The same concessions would not have been allowed for other countries.

17

The second dimension of advantage for the major financial powers, the US and the UK, comes from them having fashioned an international financial system that works in their interests. Despite these powers being persistent borrowers in global financial markets through their chronic current account deficits, and despite them being large net debtors in terms of their national balance sheets, they are unique in managing to earn a net positive return on their negative overseas investment positions! In the US case, the mechanism works mainly through the international role of the US dollar, the main vehicle currency for trade and investment. In addition to seigniorage benefits, the most important result for the US has been low cost funding for its chronic external deficit through massive foreign purchases of US government securities.48 For the UK, the most significant source of cheap funding has been international bank borrowings, generated via the City of London, the world’s biggest international money market.49

If finance is a relation of power between creditor/lender and debtor/borrower, the facts of an imperialist world economy show that is not a simple case of the creditor being in charge! The structure of the imperial financial system means that the debtor imperialist power can be in a surprisingly strong position. This is not directly dependent on military force. It is a market ‘fact’, something that other countries have to put up with. This is the ‘normal’ situation of the imperialist world economy, a normality that each power will fight to defend.

3.1.2 Financing foreign operations of domestic capital

The imperialist powers can use the international financial system as a source of funds for domestic corporate, household and government needs, but the system can also be used to promote the foreign operations of domestic capital. The focus in this section is on how the financial system enables them to expand their sources of surplus value from across the globe.

Marx noted how the credit system could accelerate the growth of capital. In his terminology, a ‘concentration’ of capital occurs when an individual company expands, and a ‘centralisation’ of capital when existing companies are combined. The credit system draws into the hands of capitalists ‘the money resources which lie scattered, over the surface of society, in larger or smaller amounts’ and ‘it soon becomes a new and terrible weapon in the battle of competition and is finally transformed into an enormous social mechanism for the centralisation of capitals’.50 This weapon is used aggressively by the stronger imperialist powers to take over rivals, to expand their operations and to restrict competition.

A good example is UK company Vodafone’s takeover of German mobile company Mannesmann in February 2000. The deal worth £112bn was then the world’s biggest ‘hostile’ (not mutually agreed) takeover. Mannesmann had been an ‘alliance partner’ of Vodafone, and Vodafone owned 35% of its shares via an earlier acquisition. But when Mannesmann bought another UK company, Orange, in October 1999 this ‘contravened a gentleman's agreement not to compete on each other's territory’. Enraged that its own monopolistic plans were under threat as the industry was in a merger boom, Vodafone launched its hostile bid for Mannesmann in November 1999.51 The deal was concluded via a ‘share swap’, in which a certain number of Vodafone shares were exchanged for Mannesmann shares; Vodafone paid no cash for the takeover. Mannesmann ended up owning 49% of the combined group - less than a controlling interest - and its stock was delisted on the Frankfurt exchange.

48 See Norfield (2011a) for a discussion of ‘dollar imperialism’. Asian central banks were the main purchasers in the 2000s, as they attempted to insulate themselves from further financial turmoil after the financial crisis of 1997-98 by building up foreign exchange reserves. One study suggested that foreign buying of US Treasuries had reduced yields by as much as 150 basis points. See Warnock and Warnock (2005).49 See Norfield (2011b) for details.50 Marx (1974a, Chapter 25, Section 2, p587).51 See BBC News (2000).

18

On the takeover, the new company became by far the largest company on the London stock market and the fourth largest in the world, consolidating its lead position in the global telecom market. Vodafone now owns networks in over 30 countries and has partner networks in over 40 additional countries.52 The ability to conclude the deal – and many before it – was not simply a question of price. It depended on Vodafone being listed on a major stock exchange. Without this, it would not have been able to grow by attracting vast resources from global investors, and neither would its shares have been an acceptable means of payment for Mannesmann’s shareholders.

In this way, the ‘financial’ power of an imperialist country can be translated into a more broadly defined economic power and influence. Companies based in imperialist powers have more scope to scour the world for sources of surplus value. They can finance their expansion by drawing on the capital resources of the world from their home financial markets. They can also use the capitalised market value of their corporate assets (via share swaps), rather than cash, as a means to pay for their takeover targets, although they can also get easy access to cash from major banks if necessary. With these resources, they can act as predator rather than prey, with a wide range of financial weapons. The range of such weapons was steadily extended across the globe, especially from the 1980s, as US and UK imperialism pressured all countries to relax controls on financial transactions and capital flows.53

Financing and facilitating takeover activity is a key function of major financial markets. It is a driver of what Marx called the ‘centralisation’ of capital and helps create the conglomerates and monopolies that dominate the world’s industries and economies today. This is a mode of the accumulation of capital that has less to do with developing the productive forces and raising productivity than in Marx’s day. Instead, it is a feature of parasitic imperialism, one that seeks control of markets and appropriation of value, rather than its creation.

3.1.3 Appropriating global surplus value

Major capitalist powers that are the base location for global financial markets benefit not just from easier, and cheaper, access to international funds, nor just from the financial power that these markets can give to their corporations. They can also make money from the operations of the financial markets themselves. At the beginning of this section, I noted that the limits one might expect on the growth of the unproductive financial sector in a country are lifted when it can gain revenues from abroad. The rapid expansion of international financial dealing since the 1980s has been a potential source of profit for, and an incentive behind the growth of, the financial sector of the economy in many countries. However, at the forefront of this trend has been the boom in the activities of the City of London, the centre of dealing for the imperialist power most closely associated with finance.54

Profits from financial dealing may come from differences in interest rates on borrowing and lending and other bid-offer spreads in transactions, from fees for financial services (advice on mergers, organising the issue of equity or bond securities, etc), or from speculative bets on market prices. However, all these profits arising in the sphere of circulation are a deduction from the surplus value produced elsewhere. More than this, the whole costs of the financial sector are also a deduction from surplus value, as shown in Section 2. A financial company may specialise in international dealings, but will not care about the source of the profits, which could also come from domestic capital. However, a financial company operating in a major international financial centre can draw upon the surplus value produced anywhere in the world, for the ultimate benefit of the imperialist power in which it is based.52 Vodafone (2012).53 See Helleiner (1996) for a review of this process up the mid-1990s.54 Since 2007, the City of London has produced a regular report on major global financial centres, The Global Financial Centres Index. London has remained in top position up to March 2012, and usually ranks close to New York as a favoured centre for financial business. See City (2012).

19

Striking examples of this can be seen in the case of the UK financial sector. The following table gives a snapshot of the figures showing the gross and net revenues ‘earned’ from international financial services dealings.

Table 1: UK international financial services revenues and payments(£ billion) 2010 2011Financial services revenues 42.3 47.7

Financial services payments 10.7 12.8Total net financial services revenues 31.7 34.9Source: UK Office for National Statistics, 28 March 2012

For the UK, the net financial services balance is the biggest positive item in its balance of payments on goods and services. At close to £35bn in 2011, it amounted to a little over 2% of UK GDP and covered a third of the UK’s big deficit in visible goods trade. The £35bn figure is not a measure of the net profits of financial services from international dealing, being only the net revenue accrued before allowing for costs. However, it is a guide to the extent to which the UK financial services sector draws in surplus value produced abroad. The source of the surplus value is hidden by a multitude of transactions between financial, commercial and industrial companies and governments, and part of it may even come from the exploitation of workers in Britain.55 The UK data breakdown indicates that around three-quarters of the net surplus comes from ‘monetary financial institutions’, ie banks, while a fifth comes from securities dealers and a small share is from the activities of fund managers.56

In practice, while the financial companies do not need to care about the source of their profits, the UK financial sector has grown so large because of its ability to draw in big revenues from its international operations. Critics of the banks, especially in the UK, will often attack them for not giving enough support, or loans, to domestic businesses.57 But this call for banks to play a more useful role in economic activity typically ignores the parasitic role of the financial sector, and, in particular, the role that the financial system plays in the world economy for the imperialist powers.

In addition to their ability to gain financial dealing, or broking, revenues from abroad when based in the Britain, UK banks, like their peers, will also derive revenues from their own foreign-based operations. Data for such revenues do not exist, but my observation from nearly two decades working in different international banks is that they are high. Banks based in the major capitalist countries make high returns from their branches in poor countries, where labour and other costs are lower, and where transaction margins are usually also much higher. Their foreign branches in all countries pay a contribution back to the headquarters, as a licensing fee, for the use of technology and for the use of the home bank’s credit, etc. This is quite apart from the information that the foreign branches can pass back to the main dealmakers in the bank’s home base,58 and the ability that local bank branches may have to help the home bank circumvent a country’s controls on capital flows.55 One interpretation of how the law of value operates in the global economy is that there is a world average rate of profit towards which the rates of profit registered in different part of the world economy will gravitate. As a result, surplus value produced anywhere will form part of this averaging process, so that it is not correct to say that the profits reported come from a particular place. Instead, the total system profits are distributed according to the share of the total capital advanced by different capitals. In our view, it is questionable how far this averaging process works out in reality, given monopoly barriers to competition and a stratified world economy.56 UK Pink Book (2010, Table 3.6, p53).57 See, for example, NEF (2011).58 This can lead to a major bank taking a significant position in the financial market of a small country, backed by its superior resources, enabling it to manipulate prices to profit from dealing.

20

4 ConclusionThis paper has set out a framework for analysing the role of finance using Marx’s theory of value and argued how this can contribute to a fuller understanding of imperialism today. After summarising the main elements of Marx’s theory of productive and unproductive labour, the paper showed how to account for ‘commercial’ and ‘financial’ capital, important forms of capital that are often ignored in expositions of Marx’s conception of the rate of profit. This paper also showed how that key target of capitalist corporations - the ‘return on equity’ - is governed by the rate of profit of the system as a whole. By highlighting this relationship, the paper illustrated how such phenomenal forms as return on equity and leverage are related to the fundamentals of value and surplus value production.

Other scholars have assessed the imperialist world economy, examining ‘unequal exchange’ in trade, manipulation of markets by powerful countries and predatory finance in creditor-debtor relationships. This paper focused instead on how the ‘normal’ operation of finance is an important part of the mechanism by which major imperialist powers – especially the US and the UK - sustain their privileges in and appropriate value from the global economy. This mechanism does not necessarily depend on debt crises, notwithstanding how frequent and destructive these are. Nor does it depend directly upon military force, though this is an important part of an imperialist power’s overall position in the global hierarchy.59 The global financial system is a critical dimension of imperialist power today, and it should be no surprise that the latest crisis has taken a peculiarly financial form.

Tony Norfield, 5 May 2012

PhD Student, Economics Department, School of Oriental and African Studies, London

Email: tonynorfield@gmail.com

59 See Norfield (2012) for a discussion of an ‘index of imperialism’, including GDP, military spending, banking status and the role of a currency in central bank FX reserves.

21

BIBLIOGRAPHY

BBC News 2000, ‘Vodafone seals Mannesmann deal’, 11 February 2000 http://news.bbc.co.uk/1/hi/business/630293.stm

Carchedi, Guglielmo 2001, For Another Europe: A Class Analysis of European Economic Integration, London: Verso Books.

Callinicos, Alex (2009), Imperialism and Global Political Economy, Polity Press, 2009.

City 2012, The Global Financial Centres Index 11, City of London Corporation, March 2012

Demirgüç-Kunt, Asli and Harry Huizinga 2010, ‘Are Banks Too Big to Fail or Too Big to Save? International Evidence from Equity Prices and CDS Spreads’, World Bank, Policy Research Working Paper 5360, July 2010

Dos Santos, Paulo L 2011a, ‘Notes Towards a New Political-Economy Approach to Contemporary Credit Relations’, Research on Money and Finance Discussion Paper 35, Autumn 2011

Dos Santos, Paulo L 2011b, ‘Credit, Profitability and Instability: A Strictly Structural Approach’, Research on Money and Finance Discussion Paper 36, Autumn 2011

Duménil, Gérard, and Dominique Lévy 2004, ‘The Real and Financial Components of Profitability (United States, 1952-2000)’, Review of Radical Political Economics 36 (2004): 82-110.

Fine, Ben 1985-86, ‘Banking Capital and the Theory Of Interest’, Science & Society, Vol. 49, No. 4, Winter 1985-86, pp. 387-413

Fine, Ben, and Alfredo Saad-Filho 2004, Marx’s Capital, 4th edition, London: Pluto Press.

Grossmann, Henryk 1992, The Law of Accumulation and Breakdown of the Capitalist System, London: Pluto Press.

Haldane, Andrew G 2011, ‘Risk Off’, Speech given on 18 August 2011, Bank of England http://www.bankofengland.co.uk/publications/Documents/speeches/2011/speech513.pdf

Hall, Mike 1992, ‘On the Creation of Money and the Accumulation of Bank-Capital’, Capital & Class, 48, Autumn 1992.

Harvey, David. The Limits to Capital, London: Verso Books.

Hausmann, Ricardo 2002, ‘Good credit ratios, bad credit ratings: the role of debt structure’, Third Draft, November 2002 (Paper prepared for the Conference on ‘Rules-Based Fiscal Policy in Emerging Market economies’, Oaxaca, Mexico, February 2002).

Helleiner, Eric 1996, States and the Reemergence of Global Finance: From Bretton Woods to the 1990s, Cornell University Press.

Hilferding, Rudolph 1981 [1910], Finance Capital: A Study in the Latest Phase of Capitalist Development, London: Routledge.

Hoca, Bűlent 2012, ‘A suggestion for a new definition of the concept of finance capital using Marx’s notion of “capital as commodity”’, Cambridge Journal of Economics, 36 2012

Itoh, Makoto, and Costas Lapavitsas 1998, Political Economy of Money and Finance, London: Palgrave Macmillan.

Kliman, Andrew 2012, The Failure of Capitalist Production: Underlying Causes of the Great Recession. London: Pluto Press.

22

Marx, Karl 1969, Theories of Surplus Value: Part One. London: Lawrence & Wishart.

Marx, Karl 1973, Grundrisse: Foundations of the Critique of Political Economy (Rough Draft), Translated by Martin Nicolaus, England: Penguin.

Marx, Karl 1974a, Capital, Volume 1, London: Lawrence & Wishart.

Marx, Karl 1974b, Capital, Volume 2, London: Lawrence & Wishart.

Marx, Karl 1974c, Capital, Volume 3, London: Lawrence & Wishart.

NEF 2011, Where Does Money Come From? A guide to the UK monetary and banking system, New Economics Foundation, September 2011.

Norfield, Tony 2011a, ‘Dimensions of Dollar Imperialism’, 5 October 2011, available on http://economicsofimperialism.blogspot.co.uk/2011/10/dimensions-of-dollar-imperialism.html

Norfield, Tony 2011b, ‘The Economics of British Imperialism’, 22 May 2011, available on http://economicsofimperialism.blogspot.co.uk/2011/05/economics-of-british-imperialism.html

Norfield, Tony 2011c, ‘Bank Profits and Leverage’, 25 August 2011, available on http://economicsofimperialism.blogspot.co.uk/2011/08/bank-profits-leverage.html

Norfield, Tony 2012, ‘Imperialism by Numbers’, 1 May 2012, available on http://economicsofimperialism.blogspot.co.uk/2012/05/imperialism-by-numbers.html

ONS 2012, http://www.ons.gov.uk/ons/rel/pnfc1/share-ownership---share-register-survey-report/2010/stb-share-ownership-2010.html

Panico, Carlo 1980, ‘Marx's analysis of the relationship between the rate of interest and the rate of profits’, Cambridge Journal of Economics, Vol 4, No. 4, 1980

Shaxson, Nicholas 2011, Treasure Islands: Tax Havens and the Men Who Stole the World, Great Britain: Bodley Head.

Smith, John 2010, Imperialism & the Globalisation of Production, PhD Thesis, University of Sheffield, July 2010, http://www.mediafire.com/?5r339mnn4zmubq7

UK Pink Book 2010, United Kingdom Balance of Payments, 2010 Edition, Office for National Statistics.

US Census Bureau, 2012, The 2012 Statistical Abstract, http://www.census.gov/compendia/statab/cats/business_enterprise/profits.html

Vodafone 2012, http://www.vodafone.com/content/index/about/about_us.html

Warnock, Francis E and Veronica C Warnock 2005, ‘International Capital Flows and US Interest Rates’, Board of Governors of the Federal Reserve System, International Finance Discussion Papers, Number 840, September 2005

23