Year of selection 2012
Institution Sciences Po Paris - IEP - FNSP
In September 2011 the Occupy Wall Street movement broke out in the heart of the financial world. For the protesters, this was the center of a system responsible for increasingly severe inequality and growing instability in society. Their actions sparked a global movement, but were they right? Not so much to "occupy", but to establish such a causal claim? Greater inequality had been widely observed; more and more financial activity, too. However, the possible link between the two trends was not well documented or understood, explains Prof. Olivier Godechot. He set out to identify whether increasing financialization leads to more inequality, which dimensions might be responsible, and how exactly this might occur.
Digging into data on 18 member-countries of the OECD for the period of 1970 to 2011, Prof. Godechot’s team showed that the share of countries’ GDP contributed by the finance sector is a major driver of inequality around the world. Indeed, between 1980 and 2007, a period that witnessed several financial crises, this factor explained 20-40% of the increase in inequality. The effect is strongest at the top of the income distribution, with the highest earners benefiting disproportionately from financial activity. Finance is multi-faceted, though, and not every aspect worsens inequality, Prof. Godechot found. Traditional banking and household debt do not seem to contribute; rather, it is due to the “growing amount of social energy devoted to the trade of financial instruments on financial markets,” he explains.
Going further, the researchers identified the mechanism by which financialization could exacerbate problems of social equality. The top players in financial markets can achieve such high pay by leveraging their social and technical capital. This allows them to move—or threaten to move—assets and knowledge from one firm to another, in a maneuver described as a “hold-up”. At its extreme, Prof. Godechot gives the example of two trading room managers who each secured a multimillion-dollar bonus by threatening to resign and take the entire team with them, unless their employer could match a rival firm’s offer within 48 hours. The financial sector is unique in its vulnerability to this strategy. While, in industry, a factory is protected by property rights, in finance, patents and non-compete agreements do at best a poor job to protect the firm's assets.
It is crucial to understand and mitigate the risks described, because their impact is not just financial, but social, too. And the huge bonuses seen in finance provide an incentive to misjudge the risk involved, creating ever more social risk. Olivier Godechot suggests that measures limiting the size of finance could alleviate both the issue of hold-ups and of worsening inequality. These might include a special tax on finance income, or policies requiring banks to hold more capital before engaging on the financial markets. Controlling the financial hazard could, thus, lead to greater equality and a healthier sense of cohesion across society.
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